HomeOpinionLikely outcome of auction system collapse

Likely outcome of auction system collapse

The Zimbabwe dollar (Zimdollar) pared in the week under review, to record its worst outturn in five weeks. The week’s interbank decline follows a stable outturn in the prior week. The currency lost 0,15% to settle at 85,6 to the US dollar, completing 13 weeks of very mild losses. Cumulatively the Zimdollar has lost 4,6% against the USD since the beginning of the year.

Respect Gwenzi

Financial analyst

The performance is viewed as better off compared to the currency’s average performance in the prior year. Trading data for the week shows that the top bid has remained stable over the last eight trading sessions halting volatility experienced in the past.

Likewise data shows that the lower bid and the lower accepted bid have been stable for over 20 weeks in a row.

The lower accepted bid has over the last 30 weeks paired with the lower bid resulting in a similar outturn.

These trends are significant in that they tell of a market which has established a defined range, but with exchange rate performance skewed in ZWL disfavour, it also defies logic how the two top and lower rates could remain stable over such a long defined period.

We believe that in a market where forex is still scarce, the top and lower bids should tactically move back and forth to reflect positioning ahead of allocations and demand and supply projection.

We have always highlighted in our weekly review of the interbank market that these overlying indicators are worrying.

High predictability on the availability of flows is one big factor which could cause inaction on the two bids.

We previously highlighted that in a market where some players have insider information on the level of supply, lower bids can potentially be sticky at a certain level.

Now with a stabilising top bid, it may also point to an increase in the level of insider information dissemination, or more bluntly market fixing.

These observations become even more important to note  because of the widening between the interbank and the parallel market, which is causing serious concerns in the market.

The parallel market rate is now reflecting a premium of 60% to the interbank market.

Some have argued that the interbank rate needs to be freely floated to close the gap and perhaps restore congruency.

We feel more confident on our view that  manipulation of the exchange rate is happening but at a more sophisticated level.

We believe that the RBZ is the sole player with the ability to control information regarding liquidity and even so has leverage to control price given its grip on forex surrender.

The surrender of funds by exporters happens at a predetermined rate, which in turn the Bank has control over.

The Bank accounts for the majority of funds exchanged on the weekly auction system, having amassed the same through the surrender portion. As in any market, a player with the biggest market share of supply, can influence price and so does the RBZ.

Having amassed funds at suboptimal price levels, the Bank tactically uses the same to suppress rates and offer lower, thus burning those with higher bids.

This means that in successive trades, upper bids will remain suppressed and the average weighted exchange rate will remain lower.

The challenge with this is that not all Zimbabweans have access to the interbank liquidity.

The economy is highly informalised and therefore a substantial section of the economy trades informally and accesses forex via the parallel market.

These parallel rates are successively used as a proxy for pricing products.

Now why is the parallel rate moving? It is moving because it is not subjected to controls as is the formal rate.

It is also highly responsive to money supply dynamics in the economy even as its performance is driven by market imperfections such as information asymmetry.

Since the beginning of the year, base money has been growing exponentially although falling within the RBZ and MPC targets.

We see the injection of close to ZWL$5 billion as out of sync with economic growth.

We project economic growth for the year to come in at 3% and not at 7% which the government projects.

The danger of growing base money faster than the growth in economic activity, is that inflation may rise faster or that the exchange rate may weaken quicker.

The government has tripled its expenditure target for the year and the key drivers are wages and vaccines as well as agriculture support.

These expenditures will likely push costs up and destabilise price stability as revenues lag growth in costs and need to inject new money.

Our over-arching view is that the Dutch auction system is grossly under threat given the widening variance between the interbank and the parallel exchange rates.

It is important to note that in 2020, the market only stabilised following a convergence of the two rates.

Only at rates of 30% premium and lower did the exchange rate begin to stabilise and average flows transacted increase.

What this shows is that players are reluctant to participate on the Interbank if the premium on the parallel market is too high.

This reduced appetite can also force the companies to protect their produce by scaling back on production.

Through multiplier effect, this results in gradual decline in the levels of flows traded on the formal market, resulting in destabilisation of the currency and the productive sector activities.

Companies need to tactically position themselves for this eventuality which now seems more apparent with the widening rates. Given Covid-19, the rate of economic growth envisaged by the government now seems unattainable and therefore the cushion which would typically come with improved production will be very minimal.

Gwenzi is the managing director of Equity Axis, which is a financial media company, specialising in financial research, broadcasting and publishing economic and business updates.

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