Will interbank resumption stabilise exchange rate?

ON Wednesday, the government announced a raft of policy measures designed to reconfigure and help stabilise the economy.The interbank foreign currency market, which was suspended in March, will be restored effective June 23, 2020. Civil service wages will now be partially settled in US dollars although the actual statement said this is a Covid-19 allowance running for only three months.

Respect Gwenzi

Retailers will now be compelled to display prices in both US dollars and the Zimbabwean dollar as part of the measures. To cushion its 300 000-plus employees, government has adjusted wages by 50%. These collective measures point towards increased re-dollarisation of the economy at least in part which, in turn, is as a result of sustained depreciation of the Zimdollar.

For its part, the government holds that the Zimdollar’s depreciation is a culmination of speculative trading and that the core fundamentals of the economy are firm. However, since the suspension of the interbank market in March, the Zimdollar has lost 73% on the parallel market, which is a far much quicker depreciation rate than in prior periods when the interbank market was operational. On the interbank market, periods of tighter controls were associated with lower depreciation rates, but also lower volumes of trades on the respective market. Likewise, the parallel market responded to these developments on the interbank market in such a way that in periods of tighter controls, the parallel rate depreciated faster. For example, the Zimdollar lost 75% on the parallel market between April and June 2020, which is higher compared to a loss of 31% between July and August 2019, a period when the interbank market rate was most liberal. While flows on the parallel market are difficult to ascertain, it is logical to deduce that flows on the parallel market improved when the interbank controls were tightened and this is justified through a high US dollar, a representation of increased demand.

Resumption of the Interbank market may help in forex price discovery, which closely mirrors economic fundamentals and less of speculation, in turn smoothening the forex price movement, if all other factors are stable. Between October 2019 and March 2020, flows on the interbank market dwindled sharply in response to capped movements in the X-rate by the RBZ. Real sector players said the interbank market was as good as non-operational. Instead, off-market trading became a preferred route.

It is worth interrogating why the interbank market failed to work in the first place. It was largely because of two factors: the main one being the Reserve Bank of Zimbabwe’s cap on daily rates. The central bank imposed circuit breakers to curtail daily depreciation rates. This gradually created wide gaps to the parallel market rate and other off-market arrangement such as twinning arrangements. The dual forex pricing system has an inherent challenge of under-pricing export receipts. To the extent that exporters cede a fraction of their proceeds, the net result is a loss on potential income. Assuming there are only two rates in a market, one being the RBZ peg and the other the float rate, the more the float moves away from the peg, the wider the losses to the exporter ceding part of their proceeds to the RBZ. Gradually, this dis-incentivises production and capital inflows. In the short term, it creates or retains market distortions and incessant arbitrage which have proliferated in Zimbabwe in recent periods.

The RBZ argues that the movement in the parallel rate over the last few weeks has largely been speculative and cannot be sustained. This however can easily be tested through the resumed interbank market which brings together more participants in a more transparent manner than the parallel market, assuming the apex bank does not manipulate the process as alleged in the past.

We still maintain the view that the economy faces significant tailwinds emanating from drought, Covid-19, low production and fundamental budgetary and external trade imbalances. The latter recorded marginal improvements in 2019 due to austerity measures, but the payoffs and opportunity cost in terms of lost production (-10% gross domestic product growth) far outweighs the benefits. Against these fundamental challenges and emerging dynamics such as increases in civil service wages plus a US dollar allowance, we do not see the Zimdollar stabilising anytime soon.

Gwenzi is a financial analyst and MD of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — respect@equityaxis.net