Tight money supply and rationing answer to Zim currency stability?

ZIMBABWE has been facing rampant inflation since 2019 and currently has the second highest inflation rate in the world after Venezuela.

Respect Gwenzi:analyst

There have been different views on the main causes, with the government blaming human behaviour (speculative activities) as well as mobile money providers mainly Ecocash. On the other hand, independent institutions like Equity Axis have attributed it to the government itself as the chief reason for skyrocketing prices. A Nobel laureate Milton Friedman, who is believed to be the father of monetary economics once said, “Inflation is always and everywhere a monetary phenomenon.” What he meant was that inflation is and can be produced only by a more rapid increase in the quantity of money than output.

A review of history shows that the 2007/8 hyperinflation was caused by massive money supply in the economy. Government, through the Reserve Bank of Zimbabwe engaged in massive quasi-fiscal activities where expenditure activities, which should have been done through the national budget (fiscal side) ended up being financed through money printing.

In the end, we ended up with too much local money circulating in the economy chasing few goods causing a run on the exchange rate thereby affecting prices. Typically, money in circulation should always correspond to activity in the real sector. After the local unit became valueless and inflation reached a million percent, the economy was officially dollarised in February 2009. During the period of this reform, we witnessed steady prices and at some point authorities were struggling with deflation.

Price stability emanated from the fact that the government was not able to print the US$ as was the case with Zimdollar. It was forced to spend within its means through running sustainable deficits.

The situation started to summersault again when government started to spend unsustainably between 2015 and 2018. To finance these huge deficits, government issued treasury bills (TBs) as if there were cookies taking the US dollar from the private sector. The irony of the borrowing was that it was mainly for recurrent expenditures instead of capital investments which generate future income. This is the time when the country unofficially introduced a local currency in the bond form of rising RTGS balances as well as bond coins and notes.

Towards the end of 2018, austerity measures were introduced and everything else got loose. In economics, austerity is a set of economic policies that aim to reduce government budget deficits through spending cuts, tax increases, or a combination of both.

Faced with a limited fiscal space, we witnessed the introduction of electronic tax now famously known as the 2% tax among other factors. The country was battered by drought, a cyclone, electricity and forex shortages among other factors. These variables shrunk revenue receipts and money creation became an option.

Between December 2018 and December 2019, broad money went up by 250,2% and base money was up 169,94%. Base money which is also known as high powered money is the most price sensitive component of money supply because it is injected in an economy directly at the discretion of the central bank. This component also functions more as a medium of exchange as opposed to broad component which is more of store of value. By July 2020, year-on-year growth of base money was up at 329,71% and annual inflation stood at 837,5% in the same month, the highest recorded since 2008.

It is also interesting to note that during this period of excessive money supply growth, the local currency which was officially introduced in February 2019 suffered its worst performance. Between February 2019 and February 2020, the ZWL$ erased 86% of its value on the interbank while losing 91,3% on the parallel market. This shows that it is money supply growth which is the main cause of exchange rate run. I agree that mobile money transactions were helping parallel market liquidity but it was just a product of an economy with too much ZWL$ circulating. Zimbabwe has suffered two consecutive recessions of a magnitude of -10% though government puts it at -6% and -4,1% for 2019 and 2020 respectively.

Whatever the case maybe, the fact is that the country is in a stagflation — a period of high inflation combined with a fall in GDP. Cognisant of this, government changed its policy thrust to address exchange rate instability.

In the second half of the year, the RBZ started releasing weekly base money statistics. The statistics are showing sustainable growth in the component and this helps in anchoring inflation expectations. Limits on mobile money transaction were instituted to curb excessive parallel market liquidity. Also, an exchange rate management system biased towards market forces in the form of Dutch auction was introduced.

The auction was launched on June 23, and saw ZWL$ falling by 56% to settle at 57,36 to the dollar from the fixed peg of 25 to the US$. In the subsequent 10 weeks, the unit fell by 31% followed by gains of 2,3% for seven weeks before falling again 0,6% for another seven weeks. On the auction trade of Dec 8, ZWL$ marginally gained 0,02% of its value. In the same period, statistics show that reserve money grew by 5,9% in Q3 (after reserve targeting) from a growth rate of 28,7% seen in the previous quarter (before reserve targeting). Monetary Policy Committee (MPC) targets a quarterly base money growth not exceeding 15%.

Reserve money targeting and market based exchange rate is helping ZWL$ to find its true market value emanating in price stability. Since August, annual inflation is trending downwards while monthly rates are hovering below 10%. Latest statistics show that annual inflation for the month of November was 401,66% down from 471,25%.

Nonetheless, it is my view that the exchange rate stability is still in fragile state. It is productivity in the real sector that determines long-term value of a currency.

This economy is plagued by strong structural rigidities like rampant corruption, pricing distortions and weak institutions among other variables. Also, the political environment is unstable as it is marred by disputes between ruling party and main opposition.

All this stifles investment, particularly foreign investment.

The stability in prices however, is yet to be felt in the pockets as the gap between salaries and cost of living was already too wide. The least paid civil servant is earning ZW$14 500 (US$177) while the cost of living for an average family of five in November was up 3,2% from October level of ZW$18 750 (US$229). This shows that we are a long way to go until millions are lifted out of poverty.

All being said, it is my view that since the turn of the second half of 2020, the economy is gradually moving in the right direction.

The reigning in on money supply while targeting real sector through raw material and machinery prioritisation on the auction market is commendable.

Many companies have witnessed a better Q3 thanks to price and exchange rate stability. If this is sustained, 2021 will likely be the best year for manufacturing sector since the return of the Zimdollar.

The economy is poised for a mild recovery in 2021 on the assumption of normal rainfall to support agriculture, the mainstay of the economy. Also, news of successful Covid-19 vaccines will help propel commodity price recovery, the major forex revenue generator for this economy.

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

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