BY VICTOR BHOROMA
Despite launching the Dutch-inspired Foreign Currency Auction System (FCAS) in June 2020 (almost one year running), the Zimbabwean economy continues to face acute foreign currency shortages on the formal market.
The shortages have helped the parallel market flourish, while creating undesirable arbitrage opportunities in the economy in the marketing of various commodities such as fuel, gold, grain, and others.
The country received relatively favourable foreign currency receipts of over US$6,3 billion in 2020. Commodity exports contributed US$4,395 billion to that figure while diaspora remittances came in second at US$1,002 billion and foreign loan proceeds came in third with US$845 million.
The loan proceeds are mainly aimed at prefunding tobacco production under the out-grower schemes. Foreign direct investments (FDI) inflows plummeted to the lowest level in a decade, contributing approximately US$154 million to foreign currency receipts. Despite the shortages experienced in the formal market, foreign currency receipts are significantly growing each year, with commodity exports remaining strong in the face of economic volatility.
The auction system
The auction system has played its part in ensuring that formal producers and retailers source foreign currency for their foreign obligations and import needs through the banking sector.
This has helped in costing and pricing purposes, thereby providing a small measure of price stability. The auction has so far allocated US$1,3 billion to formal producers and businesspeople in the market versus formal demand for foreign currency exceeding US$5 billion.
This means that successful bidders receive between 20% and 30% of their foreign currency needs off the auction platform with the rest coming from sales and the parallel market.
However, the auction system is far from being efficient in allocating foreign currency in the economy due to several reasons. Critically, the system’s price discovery mechanism is tainted by the intervention of the central bank in pegging the exchange rate which means that holders of foreign currency (mainly exporters) do not see value in offloading excess foreign currency on the market.
This means the auction exchange rate does not reflect economic dynamics such as the current account balance, money supply, foreign investments, and confidence. Secondly the amount to be auctioned is not known beforehand, which means the auction is virtually trading foreign currency which is not available.
This has led to delays that average six-nine weeks in settling winning bids, despite initial promises that bids will be settled within 48 hours.
So far, the backlog is estimated to be over US$150 million. These inefficiencies have given a lifeline to the parallel market.
Sustained trade deficit
Zimbabwe has a sustained trade deficit that averages US$1,5 billion from 2016 to 2020. These figures do not factor in smuggled and under declared merchandise, which means the country is a perennial net importer of various commodities.
The demand for foreign currency to import commodities (fuel, electricity, raw materials, grain, processed food, automobiles and parts, technology etc) far outweighs its supply from export receipts, investments and remittances.
A large portion of that demand (especially from households and the informal sector) is met by the parallel market which settles bids on the spot and has limited regulatory bottlenecks.
The country is not producing enough goods and services to meet local demand at competitive prices. For sustainable economic growth, government policies need to be modelled on incentivising import substitution to save foreign currency.
Self-sufficiency on energy generation and grain production will go a long way in improving the country’s trade position in the short term. A sustained trade deficit creates currency instability.
Lack of confidence
Confidence is the backbone of all fiat currencies and economic growth world over. A fiat currency is money that a government has declared to be legal tender such as the Zimbabwean dollar, but not backed by any physical commodity in the form of gold or silver.
Because the local currency is not supported by any commodity reserves or foreign currency reserves, its value is based on the trust that economic agents have in the economy and its prospects in terms of growth or stability.
It is a tall order for the local currency (no matter its name) to maintain its value if confidence in the local banking sector (especially the central bank) and the government is incredibly low.
Consumers and producers are rational economic players who plan and save in a stable currency (US dollar). This means that costing, pricing, asset disposal, and investment are modelled in the US dollar (then converted to the local currency if need be).
Lack of confidence in the local currency means that any excess liquidity in local currency is quickly converted to foreign currency by the holders to hedge against future losses.
Such conversion can only be done at the parallel market since the auction platform is reserved for formal importers only. Therefore, central bank transparency, monetary policy consistency, respect for property rights (depositor’s funds, earnings and assets), money supply discipline and auction system independence are pivotal to improving confidence in the formal foreign exchange market.
The existence of a weaker local currency in the Zimbabwean dollar (in a dollarised economy) and high levels of inflation create enormous risk-free profits for parallel market traders who simply buy foreign currency at a lower price and sell at a higher price since local currency depreciation is almost guaranteed due to money supply growth.
Trading on the parallel market has limited transactional and compliance costs for holders of foreign currency. If Statutory Instrument 127 of 2021 is added into the fray, parallel market traders make huge commissions from bulk transactions on a daily or weekly basis from businesses that dispose Zimbabwean dollars for their operational needs such as fuel, salaries and other consumables. As long as the weaker local currency is in the equation, there will always be an incentive for the parallel market.
Corruption, high unemployment
Unemployment is extremely high in Zimbabwe and this fuels corruption in the economy. Foreign currency has become a hot commodity in the local market with massive rent seeking opportunities at every level.
The foreign currency value chain involves hundreds of foot soldiers who trade forex at street corners to the public, bankers, importers and exporters of commodities, law enforcement agents, politicians who access cheap foreign currency, privileged businesspeople who access foreign currency off the auction system and the shadowy dealers who connect all the value chain actors to buyers or sellers. All these agents play their part for an agreed commission for the risk involved at their level.
Foreign currency trading provides income streams for various agents in the chain and employment opportunities for the unemployed who act as foot soldiers.
Money changers in the streets are merely customer facing agents in a long chain worth millions of dollars and this is the sole reason why enacting laws will not arrest parallel market trading where collusion and corruption reign supreme. Those mandated to provide efficiency and sanity in the foreign exchange market are also complicit in perpetuating the parallel market.
The market disequilibrium, pegged exchange rates, lack of confidence and auction market inefficiencies can be addressed by the government in the short-to-medium term. Corruption in forex trading is however a result of other complex dynamics that are at play in the Zimbabwean economy, key among them weak institutions and political interference.
The parallel market cannot be eliminated by statutory instruments because the existence of a weaker local currency necessitates its existence in the shadow local economy.
Overall, it is difficult to eliminate the parallel market because the auction market does not operate in a true auction sense where prices are determined by free market forces and the amount to be allocated is known beforehand.
Furthermore, the settlement of winning bids is not done on the spot which means that foreign currency auctioned is not immediately available to the winning bidders. Those in the formal market also realise profits through diverting the little available foreign currency into the lucrative and convenient parallel market as long as the control measures are compromised, and the auction market is inefficient.
Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe Feedback: Email email@example.com or Twitter @VictorBhoroma1.