Foreign exchange rate disparity results in economic growth drag

BY RESPECT GWENZI

  • RATE of currency depreciation at its fastest since March 2021
  •     Demand for forex at peak levels since introduction of Dutch auction
  •  Parallel market premiums highest since August 2020

The foreign currency interbank market remains the biggest market for foreign currency in Zimbabwe. The average foreign currency traded on the market per week has gone up by 27% in the last three weeks compared to the first three weeks of 2021.

On average the interbank market has dispensed US$36,6 million per week since the beginning of the year with the highest allocation having been in the prior week, over which US$47 million was traded. The prior week trading levels represents a 28% variance to the average year to date weekly trading levels.

The chart depicts the different varying bid levels on the interbank market. As shown, the top bid has traded stable at 90 over the last four weeks. The average to bid levels has increased from the March level of about 87 to the current 90.

Higher top bids reflect adverse sentiment such that buyers are willing to bid higher as they anticipate demand shortfalls or an imminent currency weakness.

However, when read together with the lower bid, the weekly top bid outrun gives a more informing position. In the week under review the lower bid performed constant at 82, which is the 23th straight weekly session. The sustained stability in the lower bid, matching lower accepted bid, against top bid volatility, reflects that the portion of buyers anticipating a rate and demand stability has been more confident of their anticipation than those expecting rate weakness,

From the above data, it is deduced that the gap between the lower and top bid is widening. The widening range means volatility in the average exchange rate is likely to prevail. A narrowing range means the market is moving closer to a stable exchange rate with reduced volatility.

Outside of these technical readings, it is equally important to have a microscopic view of the dynamics at play in reality. In an imperfect market, the long consistent trend of stable lower bids may show that there is a segment of the market, which may show insider information on the levels of forex liquidity in the market such that it is very sure that even if it places a lower bid in a market where demand is surging, the respective bid will be matched. In a hypothetical free market scenario where a buyer of forex has low stock levels and wants to replenish with urgency, placement of a very low bid would have higher risks of going unmatched.

In Zimbabwe this scenario is likely, given that the biggest supplier of forex to the market is the RBZ. The RBZ uses its surrender funds to supply almost 50% of the interbank demand. This means the RBZ controls the forex supply side. This control of the supply side gives the Bank room to fix the market. Having procured the funds at average rate it would have set in the market in prior weeks, the Bank has no loss expressing the same at same rates to the interbank.

Once the biggest supplier is willing to sell at certain prices, all else follows suit. Also, given that the interbank trades are conducted only once a week, this gives the Bank time enough to premeditate the next auction and put in place measures to keep the rate stable.

The sustained lower bids would thus show that there exists a section of the market with either insider information on forex liquidity levels, conniving with monetary authorities or reading better the market in terms of supply and demand of forex. However as shown below the reading of supply and demand would drive bids up and not down, as is the case.

The levels of forex demand as shown above have tremendously gone up. The market now demand an average of about US$42 million a week which deduces to US$6 million a day up from US$5 million a day, over the first five months of the year.

What is worrying with the market dynamics is the persistent and widening variance between the interbank rate and the alternative market rate.

The gap between the two rates has widened to about 50% from 40% earlier. The acceptable benchmarks are at about 20%. As the gap between the two widens, exports suffer.

Exporters generally lose about 15% of net export earnings. The magnitude of earnings loss widens with the widening of the gap between the two rates.

Given the structure of the economy, which is skewed towards informal, a majority of business operators are also pricing their goods based on the parallel exchange rate movements.

Exporters thus bear the cost of higher operating costs given the spiking local component of their costs. This discourages production and counters the various initiatives being pursued by the Bank and the Treasury in promoting exports.

This could be one side of the challenge, the other relates to the spike in arbitration. Where rates are as wide as they are, individual entities with access to interbank liquidity will likely arbitrage and buy low on the interbank while selling higher on the parallel market or simply buy low on the interbank and sell goods in Zimdollar, reflecting a higher exchange rate.

There are already reports of such abuse and these are created by an imperfect market. 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.

The growth in month-on-month inflation in April, after months of coming off, shows that 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 excess liquidity and pursue policies that inspire production.

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