BY JOSEPH MVERECHA
I WILL preface this article by making reference to history, though not monetary. It is September 1942; a brutal and defining war is raging in vicious hand to hand battles in the ruined city of Stalingrad (Volgograd), on the banks of the Volga, between Europe’s largest nations, Germany and Russia.
But the German sixth Army under General Paulus was clearly in the ascendant and by September, had gained control of 95% of the city and conducting mopping operations to clean up the stubborn resistance from General Chuikov 62nd Russian Army, desperately fighting on the banks of the Volga.
For the German sixth Army, and their Commander, it was time to celebrate and prepare for victory parades; or was it? Destiny and the turn of tide would be kinder to the Russian Army — they would encircle the Sixth Army, and thereafter march from Stalingrad, to Kursk, Kiev, Warsaw and all the way to Berlin in 1945.
So much for the historical, perhaps a dream also that destiny would be kinder to us, as we march onwards towards macro-economic and price stability. For those of us, who have yearned for price stability — sustained low and stable inflation, the news of annual headline inflation sharp deceleration from 106,3% to 56,2%, (though anticipated because of year-on-year technical base effects) is very good news.
Indeed, we may even dare to beat drums already. But we know, in all battles — from the fall of Jerusalem in AD70 to Stalingrad, Kursk, Kiev — every battle — the war is not won until all vestiges of resistance are cleared and the enemy sues for peace.
The enemy suing for peace, in macro-economic policy parlance, is equivalent to collapse of all the inflation expectations, as a result of sustained coherent policy implementation.
To answer the question of whether it is time to celebrate yet, we must answer the question — have we effectively collapsed inflation expectations?
As necessary to guarantee irrevocable path dependent inflation deceleration to single digit levels, as the ultimate objective.
First, things first, authorities must be commended, both the Reserve Bank of Zimbabwe and the Ministry of Finance and Economic Development for sustaining disinflation policies over the past year that have seen headline inflation decelerating from a peak of 834,01% in July last year to 56,2% this month (July 2021).
Though in part reflecting technical base effects, inflation is indeed trending down and this could be a defining moment in the battle against inflation. It is also the first time, headline inflation is in double digit levels, since June 2019 — 24 months ago, when the annual inflation rate surged from 97,9% in May to175,8% in June.
The annual headline inflation rate is at the level last witnessed in January 2019 and this is good news for consumers and the economy.
It is also correct to assume that hard pressed will likely notice the significance of all this, as the economic situation for millions remains a desperate daily struggle.
Again, the decline in the July annual inflation rate does not mean that prices are going down in the economy — prices are still increasing, but it is the pace of price increases that has slowed. It is difficult to explain to hard-pressed citizens that things are getting better when prices all around are still escalating (Also correct in the text)
Even harder to explain that it is the rate at which prices are going up which has slowed.
The public benefit is really much further ahead — if price stability fundamentals become entrenched, any future civil service or private sector wage adjustment becomes a real wage adjustment, to the extent that that wage adjustment exceeds inflation.
This journey is fairly long, but it is the only viable path for the country. As has always been the case, the pain of adjustment to correct macro-economic imbalances is frontloaded, with benefits realisable beyond the near term, subject to Authorities staying the course.
If the disinflation policies are sustained, the pathway remains for further inflation deceleration with the headline inflation likely within the range of 35% to 40% by December 2021, assuming no new shocks.
This implies a decline in average inflation from an average of 610% in 2020 to 139% in 2021. That would create a very solid platform for sustained inflation decline to within 12 -15% by December 2022 and single digit by first quarter 2023.
It is understandable and at times easy to be overly optimistic following a definite path dependent decline and to think that we are on the verge of single digit inflation already. There is need for both caution and patience — this journey is a little longer than we may think.
Notwithstanding the visible progress, there is likely less than 10% of achieving single digit inflation, even next year. Disinflation can be intractable, particularly in the presence of exogenous, in addition to internal policy shocks. However, if we achieve single digit inflation next year, that would be a welcome miracle.
In light of the progress so far, the most effective approach would be to anchor inflation expectations, which is still high and fuelled by the parallel market premium. Forward guidance is only useful as an anchor for inflation expectations, if the forecasts as communicated by authorities are credible, consistent with developments on the ground and well communicated.
We are in a good space, however, sustaining disinflation going forward is piled with high risks.
The major threats remain the same — a vitiating and sharply escalating parallel market, as driven mainly by the Foreign Currency Auction sub optimal functioning, a pseudo fixed exchange rate and new money creation.
At some point, not far from now, it will be the parallel market that will determine pricing in the economy with damaging implications for price stability.
The point of inflection is sooner, and not later — it might take a month, two or three, but sooner than later, prices will increasingly reflect the premium.
The most consequential aspect of this is also that the longer we hold on to an overvalued exchange rate, the larger will be the adjustment and the larger will be the impact on price formation. The costs on the economy will be significantly large.
The exchange rate is overvalued and this is not sustainable — we have been here before. In the short run, money (not necessarily macro fundamentals), is the only significant variable, as far as the determination of the exchange rate, particularly in a high inflation environment. Since November last year, high powered money increased from ZW$15,2 billion (US$177,5 million) to ZW$24 billion (US$280 million) — a staggering 57,9% increase in six months.
Other countries in the region with low and stable inflation — Botswana, Tanzania, Kenya, Uganda, South Africa, among others, rarely allow high powered money in excess of 10% per year. No country can achieve lasting inflation stability, while allowing double digit growth in high powered (reserve) money growth.
Monetary deposits are overwhelmingly short term, reflecting embedded expectations and in addition the money multiplier is rising, as is velocity of circulation.
Rising velocity of circulation means that real demand for money is falling, and no economy sustains growth beyond the near term with falling real demand for money – we have been here before. Real demand for money and real GDP growth are two sides of the same coin, just as the exchange rate and interest rate are two sides of the same (monetary policy) coin.
As such, recurrent high and volatile inflation for small open economies, (as well as hyperinflation episodes), is always largely a monetary phenomenon working through multiple transmission processes collectively known as the monetary transmission mechanism.
In the main, it is a reflection of too much money in the economy — leading to a build-up of inflation expectations, uncertainty, pressure on the exchange rate and ultimately front-loading repricing and escalation in domestic prices.
Our economy has many complex unknowns. There are threads and patterns we see clearly, but others imperfectly and some are well hidden in the macroeconomic subterranean landscape
However, what is clear and beyond dispute is that, in the current environment, as dominated by inflation expectations, the exchange rate responds disproportionately — more than one for one to any new money injection, leading to exchange rate depreciation and further pressure on prices.
The recent study by University of Zimbabwe Economics Lecturer, Dr Carren Pindiriri on behalf of the Confederation of Zimbabwe Industries, (alongside other studies) has put this issue to rest.
Back to my initial question — the annual inflation rate is headed south, is it time to celebrate?
Unambiguously yes — it is a significant and defining milestone!
But let us also keep in mind that the road to price stability is long, and the climb going forward is no less steep, likely more difficult.
The key is for authorities to stay the course, further tighten fiscal and monetary policy.
They must also revamp the Foreign Currency Auction to ensure it is a truly Dutch auction and not Foreign Currency Auction rationing system.
Will authorities stay the course?
Time will tell.
Mverecha is an economist with a local Bank. He writes in his personal capacity.