HomeOpinionStaying afloat amid currency volatility

Staying afloat amid currency volatility

By Tafara Mtutu

News of a surge in the United States dollar/Zimbabwean dollar parallel market rates caused a stir in the past few days on social media despite the crackdown on parallel market dealers by the central bank. Zimbabwe’s parallel market has been a thorn in the side of the economy since the country lost confidence in the parity between the bond notes and the US dollar in 2016. The resurrection of the Zimdollar in 2019 and the introduction of interbank auction system in 2020 were all part of measures to formalise the currency market, but the disparity between the parallel market rates and the official exchange rate continues to affect business and industry.

Despite a US$961 million Special Drawing Rights (SDR) allocation by the International Monetary Fund (IMF), parallel market rates have surged beyond ZW$140 to the greenback in recent weeks against an official market rate of ZW$88,55. The ensuing outcry prompted a meeting between the Reserve Bank of Zimbabwe, the Finance ministry and leaders of the local business community, which was held on October 11.

At the conclusion of the meeting, the government committed to continue supporting the foreign exchange auction system, while the central bank resolved to prevent further FX backlogs on the auction system and creating attractive money market instruments as an alternative investment avenue for local currency as opposed to holding US dollars, among other deliberations.

In addition, the Bankers Association of Zimbabwe resolved to improve the facilitation of Letters of Credit, continued due diligence on all bids placed on the auction system and the manufacturing sector undertook to ensure responsible pricing and to comply with Statutory Instrument 127 of 2020, among other commitments.

The fair exchange rate for Zimbabwe’s currency has been a topic of endless debate and methods to find the true value of the Zimdollar relative to other currencies still lack fool-proof solutions. Unlike the valuation of equity and fixed income instruments, the application of fundamental analysis on currency valuations is very limited and technical analysis has been widely accepted in this asset class over fundamental analysis.

However, the economic theory of real exchange rates offers the closest guide to ascertaining the fair value of a currency. The concept of real exchange rates incorporates the price of the same basket of goods in different countries in coming up with an informed idea of whether a currency is over or undervalued. This also forms the backbone of the Big Mac Index or Burgernomics, which is used in gauging the value of currencies in select countries around the globe.

The index uses the US dollar as a base currency and calculates the exchange rate of other currencies based on the price of McDonald’s Big Mac Burger in each country. The Big Mac Index recently incorporated the South African rand and changes in GDP per capita, and the real value of the rand in July 2021 was pegged at10,32 to the US dollar. At this exchange rate, the index suggests that the rand was undervalued by c.30% at the time. However, the exodus of high networth individuals from South Africa, a ripple effect of China’s Evergrande debt woes on emerging markets, and many other country-specific challenges, have kept the country’s exchange rate above R14 to the US dollar, an ode to the shortfalls of the index.

McDonald’s does not operate in Zimbabwe and this limits the application of the Big Mac Index in the Zimbabwean context. However, a close alternative to the Big Mac Index is the Morgan & Co Research’s Colanomics Indicator. The methodology behind this indicator uses the rand as the base currency and the price of Coca Cola’s two-litre PET bottle in southern African economies. It further incorporates the concepts of real exchange rates and cross exchange rates in gauging the effective US$/ZW$ exchange rate. An implied rate of ZW$176,28 to the US dollar is what one gets if they use this methodology. However, these methods are not without flaws, such as the use of only one product instead of a basket of goods.

The disparity largely holds negative implications for an economy from a macro-economic perspective. The pervasiveness of the parallel market in the country implies prevalent smuggling and informal market activity in the country, where foreign currency is purchased on the black market to import or purchase goods without any regulatory and tax burden. Further, the disparity between the parallel market and official market rates has also constrained businesses who sell their goods based on the official rate, while incurring parallel market-driven costs.

We note efforts by the government and central bank to curb the depreciation of the local currency on the black market, such as clearing the auction system backlog, naming and shaming parallel market dealers and taking punitive action again auction system abusers.

In addition, the outcome of the meeting between the central bank and captains of industry should bring about stability, if all parties fully commit to the resolutions. However, we maintain that more still needs to be done to bridge the gap between the two exchange rates.

In the interim, we note the Zimbabwe Stock Exchange (ZSE) and Finsec as alternatives to preserving value through purchasing US dollar on the parallel market. Empirical studies have shown that the depreciation of the local currency often leads to an appreciation of equities on the ZSE. The stock market offers alternative hedging opportunities against local macro-economic risks such as inflation and currency depreciation.

Blue chip stocks such as Delta, OK Zimbabwe, Innscor, and Seed Co Limited have proved to be good investments for holders of Zimdollar balances seeking to hedge against the depreciation of the Zimdollar. The process has also been made easy for investors with as little as ZW$500 through ZSE Direct and offers a much less risky avenue of storing value compared to “mattress banks” which are susceptible to robberies and the elements.

Other alternatives include purchasing real assets such as property and land, provided sellers are willing to transact using the Zimdollar.

  • Mtutu is a research analyst at Morgan & Co. — tafara@morganzim.com or +263 774 795 854.

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