BY VICTOR BHOROMA
The widening spread between Zimbabwe’s formal exchange rate (US$1:ZW$83,98) and the parallel market rate (US$1:ZW$130) is creating a fertile for market instability in the short to medium term.
The spread creates unhealthy arbitrage opportunities on the marketing of all major commodities and skews prices towards the parallel market rate. The central bank introduced the foreign currency auction system on June 23, 2020 and the mechanism has played a significant role in channeling earned foreign currency to the productive sector, where 70% of the total foreign currency has been allocated to the importation of raw materials, machinery, spares and equipment. On the other end, the parallel market has grown from strength to strength since the introduction of bond notes in November 2016, filling in the gap left by financial institutions in buying and selling foreign currency at competitive bids favorable to foreign currency holders.
So far the auction market is falling short by allocating approximately US$135 million per month versus national demand of at least US$420 million required to import various commodities into the country. The widening spread between the two exchange rates will have the following impact:
The agricultural marketing season is set to start in March with the tobacco marketing headlining the season with its opening on April 7. Key concerns for the farmers in the upcoming season include accessibility to the market as most road infrastructure in the country has been damaged by heavy rains. Similarly, farmers also require efficient and timely settlement of payments for delivered crops, and fair pricing of agriculture commodities.
Last year Zimbabwe produced 908 000 tonnes of maize, with over one million tonnes being imported to avert starvation. This year the country expects a yield above 2,5 million tonnes, which will be more than enough for domestic and industrial demand.
Tobacco production in 2020 fell by 23% to 185 million kilogrammes due to drought and decline in planted hectrage. This year the country expects production to reach 200 million kilogrammes.
However, the spread between the formal and parallel rates provides a disincentive to tobacco farmers who are legally compelled to sell 40% of their foreign currency earnings to the central bank using the soft pegged formal exchange rate. Maize farmers will be paid ZW$32,000 (US$380) per tonne and an additional 20% incentive by the government. All these prices are dependent on rate stability which anchors current inflation levels in the economy. The government will inevitably print billions of the local currency to buy agriculture produce, which will further widen the rate spread and trigger price increases in the market. Already, most retailers are taking cover by indexing prices using rates above US$1:ZW$130 in anticipation of growth in money supply and Zimbabwean dollar depreciation.
Zimbabwe imported fuel worth about US$540 million in 2020, down from the 2017-2019 average of US$1,2 billion. Part of the decline was due to the lockdown which restricted business activities and traffic volumes. The removal of consumption subsidies and fair pricing of the commodity also curtailed artificial demand that was rampant in 2018 and 2019. The local market has witnessed improved supply and stability in the petroleum sector after the government made a deliberate effort to allow the retailing of fuel in foreign currency by authorised Direct Fuel Imports (DFI) service stations.
This year, demand for fuel started at a normal level, as the bulk of the local service stations currently sell the commodity solely in foreign currency at prices above US$1,30/litre. Despite this, several service stations still sell fuel in local currency at ZW$110/litre, which equates to about US$0,85/litre using the open market rate.
The rate spread has brought back massive arbitrage opportunities, where fuel sold in local currency is diverted to the black market or to DFI service stations to earn at least US$0,40/litre for the dealers. It is now cheaper for DFI service stations to buy fuel priced in local currency than to import it.
Long fuel queues at various service stations have returned due to the artificial demand, while those receiving subsidised fuel for government agriculture programmes can simply sell the commodity at huge profit margins than use it for production purposes. The huge spread also entrenches rent seeking incentives in one of Zimbabwe’s corruption infested sectors.
Gold exports remain very key to Zimbabwe’s export earnings, netting the country US$982 million in 2020. However, the figure remains a shadow of the over US$1,2 billion, which is illegally exported to South Africa and United Arab Emirates (UAE) among other markets.
Gold deliveries to the central bank fell from 27,66 tonnes achieved in 2019 to 19,05 realised in 2020 largely because of well-oiled smuggling rings and systematic corruption in the marketing of the country’s minerals. Small-scale and artisanal miners sold only 9,35 tonnes last year compared with 17,48 tonnes in 2019.
The major reasons for the fall in deliveries were to do with delays in payments by the central bank and differences in prices offered for spot gold by parallel market buyers and by the government. Besides the obvious benefit of evading local taxes, gold smuggling is a lucrative avenue for laundering foreign currency outside the country since local exchange control regulations make it difficult for investors to move their foreign currency earnings to offshore accounts through formal banking channels.
The increase in the rate spread acts as a disincentive to gold producers who have to liquidate 40% of their export earnings using a pegged exchange rate, which is significantly lower than the parallel market. This will further hurt gold production and the country’s foreign earnings.
The leading source of market instability and cause of inflation in Zimbabwe in the last three years has been money printing. Money supply has been growing at astronomic levels of over 100% due to consumption subsidies, fiscal deficit financing and central bank quasi-fiscal activities among other things.
The consistent growth in money supply meant that there was sustained pressure on available foreign currency and artificial demand for certain products in the economy.
As such, the widening spread between the formal and parallel market rates will lead to price increases in the economy, as producers and retailers peg their prices on the parallel market rate. The coming six months will see heightening money supply growth as the government finances the agriculture marketing season.
The prevailing disparity between the parallel and the formal market rate presents arbitrage opportunities on a number of in-demand commodities and products. Parallel market dealers can make risk free profit by buying products using Zimbabwean Dollars, stock them and wait for further depreciation of the local currency to resale or index in foreign currency using the rate of that day. This common local phenomenon will inevitably lead to shortages of selected consumer goods or further price increases.
Zimbabwe’s central bank has been borrowing heavily from regional financial institutions such as the Afreximbank to stabilise the exchange rate in the hope that the parallel rate and formal rate will converge or at least operate at a spread less than 5%, so as to achieve price stability.
The model is premised on the central bank playing the match maker on foreign currency allocation and exchange rate determination, while on the other hand injecting money in the economy to buy gold among other needs.
Credit has to be given to the central bank on attaining some measure of stability since June 2020 with over US$900 million sold on the auction market to date. However, the central bank can never play the foreign currency allocation and management, exchange rate determination and money supply management roles efficiently at the same time. The roles pose unbridled conflict of interest and are not sustainable for the economy.
It is imperative for the central bank to provide mechanisms for the liberalisation of the foreign exchange market where allocation is independent of central bank control and the exchange rate moves to a managed float. An efficient and market determined exchange rate will crowd in all economic players and provide a path to free movement of foreign currency to the formal market.
Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe Feedback: Email email@example.com or Twitter @VictorBhoroma1.