Economic red flags as SI 127 sets in

IN a 2007/8 price control style, the government of Zimbabwe recently moved its hand to interfere with the markets; publishing statutory instrument 127 of 2021 which details civil penalties for all business players whose actions violate the provisions of the Banking and Use Promotion Act (24:24) as well as the Foreign Exchange Act (22:05).

Eben Mabunda

As per SI 2021-127, entities that do not accept Zimbabwe dollars (ZW$) at the official exchange rate for goods and or services priced in United States dollars (USD) face a maximum fine of ZW$50 000 while those who use forex obtained directly or indirectly from the Reserve Bank of Zimbabwe (RBZ) auction market for purposes other than that specified in their application for forex will be liable to a fixed penalty of ZW$1 million, among other measures.

While the instrument is aimed at curtailing arbitrage and price distortions on the market, its inadvertent effects could potentially register on the Richter scale as an accelerated weakening of the local currency, a decline in economic activity and a devaluation of the Zimbabwe dollar.  It must be appreciated that Zimbabwe’s inflation is highly elastic to the local currency movements and that the pricing psychology is deeply US-dollar entrenched. The introduction of SI 127 has seen some retailers and service providers increase their prices in US dollars and resultantly in the local unit in a bid to beat the disparity between the formal and informal market valuation of the Zim dollar.

In Tuesday’s forex auction results, the Zim dollar weakened further, shedding 0,05% to settle at 1:84,77 against the greenback.  The weekly fading takes the tally to six straight weeks, over which the Zim dollar has been losing ground to the US dollar. Cumulatively, the local unit has lost 3,6% since the beginning of the year.

Remarkably disquieting market undercurrents show a widening variance between the interbank rate and the alternative market rate which is now at 50% from 40% earlier, against a tolerable yardstick of about 20%. As the gap between the two widens, exports are expected to suffer with exporters’ earnings liquidated at a rate which is 50% lower than the alternative market. As exporters bear the cost of higher operating costs, the net effect will be the discouragement of local production. Also, a part of the chain is a likely increase in demand for cheaper foreign imports, further exerting pressure on the formal and alternate markets, devaluing the Zim dollar and catapulting inflation!

Meanwhile monthly inflation accelerated in May 2021, the first time it has taken an upward direction over the past four months influenced by currency trends. The Consumer Price Index, gained 0,96 percentage points to settle at 2,54% in May from April’s 1,58%, while year-on-year inflation stood at 161,91%, down from 194,1% a month earlier, thus maintaining a downward trend since moving in a northward direction in January 2021 to 362,6% from the December rate of 348,6%.

Price surges have come on the back of increased government spending amidst grain purchases at GMB, vaccine procurements and civil servant’s salary increments among other push factors. This results in higher liquidity on the market where too many Zimbabwean dollars chase fewer US dollars triggering a rise in exchange rates. This casts a shadow on the Central Bank’s annual inflation target of below 10 percent by year-end despite having met a 3% first-quarter target.

Notwithstanding, the government has been reviewing fuel prices monthly this year and any further price increases will maintain pressure on the general inflation performance.

To this effect, Equity Axis Economist Zvikomborero Sibanda argues:

“We contend that the exchange rate is not yet stable and that the forex market is far from being efficient and market driven. We thus see a risk of exchange rate weakness as we head into the second half of the year given sharp increases in government expenditure outside of the initial budget…we are not out of the woods as yet.”

The government will have to continue pursuing measures that reduce new money creation, increase mopping up of surplus liquidity and pursue policies that stimulate production.

Mabunda is an analyst and TV anchor at Equity Axis