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It is time to revamp forex auction system

By Zvikomborero Sibanda

ON July 23, 2020, the Reserve Bank of Zimbabwe (RBZ) introduced a new exchange rate management mechanism in the form of the Dutch Forex Auction System, dumping the fixed exchange rate regime which was in use in the previous months to March.

This policy shift was driven largely by the excessive Zimbabwean dollar (Zimdollar) exchange rate depreciation experienced mostly in the alternative (parallel) markets thereby fueling the price spiral.

In year-to-date (YTD) terms before the auction system, the Zimdollar was down 81% against the greenback and annual inflation was up by over 265 percentage points.

Looking at the same statistics after the auction, the Zimdollar was up 20% in the parallel market as of December 2020.

Inflation nose-dived by 488,97 percentage points to close the year at 348,56% from post dollarisation all-time high of 837,5%.

The stability of the parallel rates is of vital importance to price stability in Zimbabwe since the economy is highly informalised, with nearly 100% of the forex demand by both the public and informal businesses coming from these alternative markets.

Furthermore, due to some periods of illiquidity in the RBZ interbank market, formal businesses will also be forced to augment the limited forex supplies gotten through official channels with sourcing in the parallel market.

As such, the parallel rates have become a pricing benchmark in Zimbabwe.

Hence, whenever there is an exchange rate overrun in alternative markets, citizens experience a significant inflation wave thereby worsening underlying conditions of poverty and inequality within and between communities across the nation.

Despite fulfilling its mandate in 2HY20, the forex auction market is now greatly misaligned with its key purpose of ZW$ price discovery, which is key in dampening inflationary pressures. The percentage difference between official and alternative rates —  parallel premiums —  has significantly widen since the beginning of the year.

Currently, using the RBZ rate, US$1 is trading for ZW$85,7 while trading at an average rate of ZW$150 in the alternative markets, giving a variance (premium) of over 75% against the best global standards of 20%.

This is a shred of clear evidence that the bank rate is now out of sync with market fundamentals.

From this alone, one could safely conclude that there is a visible hand controlling the auction rate. Why?

Recently, the RBZ reported that it is running a huge forex backlog, a time lag between bidders placing their bids and receiving the bid amounts, of over US$200 million.

If the auction market is truly market-driven as reported by the monetary authority, this burgeoning forex supply deficit against rising forex demand should be largely reflected in weekly rate changes.

However, since the beginning of the year, the RBZ rate has barely moved.

By ‘fixing’ the rate, the Bank is doing itself no favours and is hurting businesses and average citizens.

For instance, a lower exchange rate at the auction is fuelling demand as even those who are not in dire need of foreign currency are seeing an opportunity for arbitraging activities — buying the US$ in the cheap market (auction) and sell it in an expensive market (parallel market) for riskless profits.  An inefficient exchange rate mechanism is also disadvantaging exporting companies. According to the RBZ Exchange Regulations, exporters are obliged to cede 40% of their forex receipts at the foregoing interbank rate.

In other words, exporting businesses are subsidising importing businesses that are accessing the ceded forex at the lower forex auction market rate yet they remain with unmet production costs.

The Bank recently announced plans to allow banking institutions that are sitting on about US$1.7 billion forex deposits to start providing forex loans to reduce demand pressure on the auction market.

Viewed from the allocative efficiency lens, this is a noble idea to maximise resource use and increase industrial production and productivity.

In the long run, the increased supply of goods will help in moderating inflation growth and also create employment for disadvantaged demographic groups such as the youth.

However, no one knows how long is the long-run as posited by the founding father of macroeconomics, John Maynard Keynes, that “in the long run we are all dead.”

Furthermore, allowing forex loans reflects policy inconsistency as it will accelerate the dollarisation of the economy when the government is gradually implementing de-dollarisation reforms.

For example, a company that will contract a US$ denominated loan will be forced to sell its final product or service in US$ to insulate itself against exchange rate losses when servicing the loan.

If the product is sold in local currency, then the parallel rate will become the benchmark for setting a price.

In the end, this plan will largely benefit corporates at the expense of average citizens who are being paid in local currency.

In my view, for sustained exchange rate stability to hold, the Bank should revamp its auction system to reflect market sentiment and the government should spend sustainably.

Money supply has greatly increased since the opening of the 2021 agriculture marketing year. The government through the Grain Marketing Board is expecting to purchase about 2 million tons of grains comprising of 1.8 million tons of staple maize and 200,000 tons of small (traditional) grains at a combined cost of about ZW$60 billion. In addition, there is increased spending on the remuneration of civil servants as well as the procurement of Covid-19 jabs.

While the basis for this increase in fiscal spending is justified, it has gone out of proportion with the rate the real economy is ticking.

According to Monetarists, the quantity of money in the economy should always move in tandem with the quantity of output being produced.

However, the economy is currently in Level 4 lockdown with very high restrictions which are subduing economic activity yet market liquidity is heading northwards.

Also, the local currency is facing a huge public confidence deficiency.

Most people are converting their local currency earnings to forex.

Hence, the Bank should craft market-driven confidence-building measures such as persuading banking institutions to give interest on local currency deposits or savings and relatively low interest on local currency-denominated loans.

  • Sibanda is an economist at Equity Axis. — zvikomboreros@equityaxis.net.

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