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Economic fundamentals out of order

By Respect Gwenzi

THE debate on economic fundamentals in Zimbabwe has been reignited amidst a reemergence of inflation and sharp parallel market rate depreciation.

Economic fundamentals refers to a set of key economic parametres that have to be achieved in order to set the economy on a sustainable and stable positive growth trajectory.

The two sides of the debate involves key state actors on one side, most prominently, Finance ministry and Central Bank officials and book makers among the general citizens.  The former contends that having achieved benchmark status across a number of fundamental indicators, the economy is now fundamentally set and therefore strong to support economic growth and exchange rate stability.

What is generally agreed on regarding the current economic situation is that the economic situation remains mostly tough for many. There is acceptance that for a wider populace, income levels are very low and this is largely a consequence of two years of value erosion through exchange rate depreciation and its consequent impact on inflation as well tight fiscal measures under austerity.

The country’s economic cake shrunk significantly during the austerity period of 2019 and 2020. Over the subsisting period, the economy shed at least 10% in value each year resulting in a cumulative loss of over US$7 billion.The sharp contraction in GDP value over the two years measured as one of the world’s record worst.

When the economy shrinks, its capacity to generate income spontaneously diminishes and consequently household incomes and consumption levels goes down.

In the case of Zimbabwe above, a rate of GDP decline of over 10% per year over two years meant a very painful experience to general populace.

Now, the debate about fundamentals has turned out to be more interesting because of some of the key changes in the parametres highlighted above, which have evolved over the last two years.

These changes have prompted authorities to prematurely declare that fundamentals are now in shape. Not only do I believe that the declaration about achieving economic fundamentals is premature, I strongly believe that it is flawed and therefore very misleading.

Authorities in Harare argue that economic fundamentals are now right, based on a number of factors and these include a budgetary surplus, a current account surplus, a positive nostro balances growth and declining state borrowings, particularly from the Reserve Bank of Zimbabwe (RBZ).

At face value, the authorities may get away with it and be validated for their baseline approach to evaluating economic fundamentals.

Before I put across my decisive views on the matter, I would take readers back by highlighting that authorities in Harare are aware that there is serious confidence deficit in the country, which in turn is as a result of yester-year experiences, notably during the hyperinflation era.

Confidence, although qualitative, is a key aspect to achieving sound fundamentals and more eminently supporting the exchange rate. Alertness to this dynamic and an urgency of the weakening exchange rate at play, has prompted government to counter the confidence deficiency through selling half-truths on sound fundamentals, as is the case.

Authorities cannot leave out one more day to chances and instead capitalise on the face value “achievement” to drive home the narrative that the economy is now fundamentally sound.

Let me hasten to say above this, that all three key officials, two from the Finance ministry and the RBZ have at one point publicly said the fair value of the local currency was in the region of 1:4 at the time the exchange rate was 1:2.5.

They argued that the economy was very strong and on sound footing such that speculators, bidding against the local unit will be burnt if they take the exchange rate any higher.

In successive months, we have witnessed the erosion of the local currency at a rate that is only closer to the hyperinflation era of 2008.

This result is clear testament that some assumptions made by authorities on economic soundness, were not correct and this takes us back to the key matter of fundamentals.

Fundamentals are not only measured based on static figures but rather on sustainability of these benchmark levels. For example, an economy can achieve a fiscal surplus but not necessarily fiscal surplus sustainability.

Sustainability refers to an ability to repeat the achieved result or better without higher payoffs. If an economy achieves a fiscal surplus through a drastic suppression of costs where revenue is also falling, the achieved surplus cannot be referred to as sustainable, at least, at that respective point.

In the instance of Zimbabwe, a fiscal surplus was achieved in 2019 and 2020. It was significant only to the extend that this was after so many years of rolling deficits. To be able to at least post a surplus, by any means, would have to be celebrated, at that point.

However, in matters of economics, sustainability of any aggregate’s performance cannot be overlooked as it super-cedes the mere attainment of a benchmark over a single period.

As highlighted above, while the fiscal front achieved surpluses in respective years, the outcomes were netted off by demand reduction, which reflected through GDP decline.

This shrinkage in GDP meant in actual fact that the economic capacity to generate further income for the government was shrinking. For example, if GDP is estimated at US$20 billion, it is estimated that it can generate between 20% and 25% of that GDP figure as government income through taxes. So, if GDP grows, holding all else constant, government revenue would also grow.

While a fiscal surplus was achieved in 2019, whose real value was within US$10 million, the economy lost at US$5 billion through GDP contraction and this consequently meant a shrinkage in government revenue, by a higher figure of about US$5 billion.

Equity Axis estimated the 2020 budget to be at US$2,5 billion in real terms, which was almost 50% lower than the 2018 levels. To be able to set a budget of US$2,5 billion meant that the economy was now generating far less in government revenue due to GDP shrinkage.

Further to this, government’s fiscal reconfiguration involved rescaling the expenditure in disfavour of recurrent expenditure. This meant that even as the resources at its disposal were shrinking, allocation for purposes of consumption were reduced. As a consequence, the decline in aggregate demand steepened.

An economy will nothave achieved fiscal sustainability if it only achieves a balanced budget. Fiscal sustainability looks at both fiscal realignment which entails reorganising processes and other expenditures as well enhancing revenue.

Focusing on costs suppression aided by inflation, can not be sustained. Sustainable cost restructuring will involve restructuring the parastatals with a view to make them profitable. This would rescale expenditure and not just cutback civil service wage allocation, an undertaking with catastrophic consequences to service delivery as well as aggregate demand.

Fiscal balance is not the only aggregate being argued for as having ensured achievement of sound fundamentals. Government touts the reducing inflation rate, reducing government borrowing and current account surplus.

The latter is a matter of external dealings, largely in the form of exports and imports. There has been less of government hand in the outcome.

The current account has been boosted not by rising exports volumes, but rather by declining imports. The declining imports are largely in respect of fuel whose consumption under Covid-19 had come off. Further, high fuel prices dragged consumption levels.

Exports have increased in value and not necessarily in volume, this is in line with firm international commodity prices. Of late imports have been increasing as the economy opens up in post lockdown era and this counters the growth in export earnings.

Much of the current account gains are in respect to surging remittances. Remittances have soared on the back formalisation of money transfer channels in the Covid-19 era.

The economy remains largely import dependent while the exchange rate situation makes remittances a fragile aggregate. The true test in respect of achieving sound fundamentals will come through restoration of prior income levels rising GDP, exponential exports volumes growth, defending remittances in post Covid-19 era, import substitution, debt clearance, a market driven currency market, all which are not present.

  • Gwenzi is a financial analyst and MD of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — respect@equityaxis.net

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