By Tatenda Nyakufuya
In FINANCIAL markets parlance, “kicking the can down the road” refers to a scenario in which tough decisions that ought to be made are delayed on a continuing basis.
This expression aptly describes the current situation facing the Central Bank with regards to the Foreign Exchange Auction system that is being used to allocate forex in the country.
The powers that be at the auction have tough decisions to make in the very near future lest their toil over the past few months all goes up in smoke.
Granted, the auction has worked well for a certain period of time putting a leash on ZW$ instability, but it is now bedevilled by problems which threaten to implode in its face due to the artificial operating conditions it is mired in. It is a well-known fact in the market that demand for foreign exchange is not matching supply. The prevailing price misalignment in the market has caused the auction to be invaded by marauding bands of briefcase companies out in full force to reap cheap foreign exchange. On the other side, holders of foreign exchange are simply not willing to sell their currency at artificially low rates when they can obtain higher rates through matched structures that evade set regulation parameters. On the part of the auction regulators, there has not been credible price discovery mechanisms and the gap between the official rates and parallel ones has ballooned.
This huge gap has created arbitrage opportunities for players in the market. The auction is fast being reduced into an unsustainable Ponzi scheme by participants. Fly-by-night companies, and to some extent even long-standing ones, have smelt blood and are simply liquidating hard dollar cash onto the parallel market and immediately converting these funds back into inflated nostro balances via the auction due to the huge disparity between the market rates. This phenomenon, commonly referred to as “burning” in the local markets has resurfaced from the grave but this time it includes the Central Bank as the main player in the crux of things.
The auction system is quickly being reduced to an opportunistic casino that is being milked by the market for as long as it lasts. This is so because foreign exchange is available at a give-away price on the auction and for as long this window exists, market arbitrage forces will increase demand for foreign exchange until price equilibrium is restored or at least the gap between the market rate and the official rate has been reduced to realistic levels.
For weeks on end, the Central Bank has published figures to the market showing that it is allocating foreign exchange for fuel and gas purchases. This ought to have resulted in an increase in the number of service stations that sell fuel in the local currency but, alas, that is not the case. Finding fuel or gas that is readily available in local currency is a difficult assignment in the country, just as tough as finding a needle in a haystack. Most fuel companies are pruning cheap forex from the auction and selling their fuel in hard currency. Just before the next auction they offload the forex cash they would be holding in exchange for the local unit to bid once more and crystallise hard dollar profits from this pricing inefficiency. This has resulted in a huge gap on the price of fuel locally. When one has hard cash and requires bulk fuel they can get huge discounts of up to 20-30% below the retail price. It is only a matter of time before foreign trucking companies discover this price anomaly, hoard the relatively cheap fuel compared to their home countries and put pressure on fuel availability in the country creating long queues reminiscent of years gone by.
On the other hand, there is absolutely no incentive for local manufacturing companies to produce goods locally when they can simply import at a discount due to the inefficient pricing at the auction. For most goods at the moment it is cheaper to import than manufacture them locally. Of the several factors that affect production, one is the availability of power. The recent unstable power situation has further increased production costs for locally produced goods. Companies always keep a hawk’s eye on their cost line and will do anything possible to keep this line to the barest minimum levels possible. The high costs of production vis-a-vis cheaper imports scenario has increased demand for foreign exchange from the auction to a level that is not sustainable. Consequently, the demand for foreign exchange, which cannot naturally be met by supply, has created a massive backlog estimated at over US$200 million in the market that is equivalent to a lag of several weeks on settlement. Chances are, company bid limits will be capped very soon decimating some of the confidence that had hitherto been placed on the process.
The auction authorities have pushed themselves into a tight corner by artificially keeping the rate in a fixed range. Although they academically argue that there is no price manipulation on the auction, it is as clear as mud that the rate has been pegged within a certain range. However, the chickens are coming home to roost and only a significant devaluation of the official market will remove the current arbitrage opportunity that has arisen. To put this narrative into a practical example, if someone has US$10,000 which they offload into the parallel market at a rate of say 150 they can subsequently bid for over $17,400 at the auction using the official rates creating a risk free interest in excess of 70% each and every week the auction price remains misaligned. If the current status quo is maintained, it is only a matter of time before the demand for cheap foreign currency at the auction blows up to levels that will render allocations ineffective for genuine businesses seeking to eke an honest living from it.
The auction has largely been dovish on the exchange rate, confining it to levels below 86 for a very long time when fundamentals in the market have been pointing in the exact opposite direction. Rate stability is a feather in their cap but sad to say the official rate is an imaginary rate that does not talk to actual events on the ground. Parallel market rates are galloping weekly and this is a recipe for increased money supply and the dark days of hyperinflation once more. It is now relatively cheaper to borrow local ZW$ dollars and lock the value in US dollars with the interest payments offset by the depreciating local unit. Pressure to borrow from local banks will inevitably increase pushing up money creation levels which hitherto had been constrained by current RBZ efforts. All this borrowed money will in one way or the other find its way towards auction bids further worsening the already precarious situation.
The gap between the parallel and official market rates is an uncomfortable pebble in the shoes of Central Bank authorities that needs to be dealt with as a matter of urgency. For as long as the gap keeps rising, exporters will continue to seek new ways to evade surrendering their forex for a song. The amount available for distribution will keep dwindling by the week through sheer market ingenuity as has been happening in the recent past. Exporters have been accused of altering invoices through the use of offshore agents and that allegation is still a smouldering ember. The old saying is true that there is no smoke without a fire. It takes time before central bank officials discover market mechanisms and the market will always remain ahead of the curve in the search of fair value. The barrage of countless fire-fighting statutory instruments that have been issued recently point more towards a central bank that is reactive rather than proactive.
There are other factors that are increasing money supply in the market that need to be dealt with urgently as well. For instance, the Grain Marketing Board (GMB), has been very active purchasing grain from local farmers. According to local estimates, they have not yet even reached half of their intended target as yet. Farmers are not yet confident in the local currency unit and have quickly moved to lock value in the US dollar.
Official estimates have put the figure that is going to be injected into the market for grain purchases at ZW$60 billion. A huge chunk of this money will chase after the available greenback in the market pushing rates up and further widening the gap on rates. If farmers are blocked from accessing currency from the parallel market through legal technicalities, then authorities need to brace for a whopping ZW$60 billion of bids on the auction.
- Nyakufuya is an ex-banker and businessman