HomeOpinionTaming rate volatility: Policy options for Zim

Taming rate volatility: Policy options for Zim

Courage Masona economist
The government of Zimbabwe is grappling with the spiralling black market exchange rate.

Undoubtedly, the sky-rocketing unofficial exchange rate threatens to reverse the gains that the economy has achieved so far.

A raft of measures have been put in place to flatten the black market exchange rate curve.

For instance, the weekly foreign currency auction system was introduced by the government in June 2020.

During that same year, the government also suspended phone-based mobile money platforms and trading on the Zimbabwe Stock Exchange.

In the last quarter of 2021, we saw the Reserve Bank of Zimbabwe allowing members of the public to buy foreign currency from bureaux de change at affordable prices, a move that aimed to cushion citizens from punitive parallel market exchange rates.

All things being equal, we expect to see the black market exchange rate stabilising since the move by the government to allow public members to buy foreign currency from bureaux de change dampens demand for foreign currency on the parallel market.

These measures have not helped much in stemming parallel market exchange volatility.

In my opinion, I believe that the greatest threat facing the economy now is an inappropriate policy response to the rising black market exchange rate.

Interestingly, policy makers must acknowledge that, orthodox economic theory no longer reflects realities in today’s world economies and Zimbabwe is not an exception. For instance, in Zimbabwe, an increase in the supply of US dollars in the market does not necessarily translate to a fall in the price of the USD, as would be anticipated in neoclassical theory of demand and supply. We have an elephant in the room, and this currency issue remains a definite problem which confronts the authorities in the current year 2022.

Informal market
The monetary authorities are faced with a formidable task to contain the runaway inflation which is induced by volatile changes in the black market exchange rate.

Lately, the USD dollar is trading at US$1:Z$230 on the black market, which is more than double the exchange rate pegged at US$1:Z$108 when the foreign currency auction system went on a holiday break on December 14, 2021.

The gap between the official and black market rate is worrying, thus, it warrants the attention of policy makers.

RBZ Chief Dr John Mangudya acknowledged that, there is no country without a parallel exchange rate, but he emphasised that, the best practice is that it should not exceed 40% of a premium between the official exchange rate and the parallel exchange rate.

Indeed this is a matter of concern to the financial system.

This economic quagmire is exacerbated by the high degree of informality in the country.

The Zimbabwean economy is dominated by the informal sector, which contributes about 70% to GDP.

Almost every transaction in the informal sector is payable in USD and the use of the domestic currency is near non-existent.

Therefore, the activities in this sector are divorced from the formal monetary policy, and this renders macroeconomic policies ineffective in Zimbabwe.

In this light, I opine that part of the current macroeconomic instability in our country may be due to a failure to adjust policy for the existence of parallel markets.

The existence of parallel markets reduces the flow of foreign currency to the central bank, hindering the capacity of the country concerned to import through official channels and to service its external debt.

In this regard, achieving an upper-middle income economy by year 2030 will remain a pipe dream if there are no long-term solutions to abate the volatile black market exchange rate.

There seems to be no lasting solution in sight.

However, currency instability is not a noticeable feature only in Zimbabwe’s economic landscape; many countries have been through periods of high inflation, weak domestic currencies and shortages of foreign currency.

The root causes are always similar: a combination of bad macroeconomic policies, fiscal and balance of payments deficits, and excessive monetary expansion.

inflation drivers
Nevertheless, Zimbabwe’s experience is rare in numerous respects. In few countries has inflation spiralled completely out of control into hyperinflation. Similarly, in few countries has currency breakdown been so extreme that the domestic currency was completely abandoned.

Further, the parallel premium (the gap between black market exchange rate and the official rate) is so high in Zimbabwe and unmatched in the region.

Therefore, a closer look at the determinants of the relatively high parallel premium in Zimbabwe relative to the other countries reveals a fundamental difference in exchange rate management.

Before we proffer solutions to close this widening gap, it is imperative to understand the drivers of higher premiums in the parallel market.

This will assist policy makers to cure the real problem facing our economy, and not the symptoms.

It is noteworthy that, as long as households, firms and other investors are unable to make their decisions on the basis of a stable currency, it will be difficult to attract investment, whether domestic or foreign, depriving the economy of foreign currency that would ease pressure on demand for foreign exchange.

Particularly, in Zimbabwe the USD has an insatiable demand.

Apparently, individuals and firms are willing to pay any amount in domestic currency to get the USD, as it is generally believed that only the USD among other currencies can perform the store of value function and the medium of exchange function in the country.

Further, Zimbabwe is a net importer of almost everything consumed in the country, therefore, there is high demand by individuals and firms for forex to pay for imports.

On the supply side, the country has no adequate foreign currency to meet the ever-increasing demand. These are some of the reasons why the parallel foreign exchange market thrives in Zimbabwe.

Policy options
Attempts to seriously address the fundamental factors underlying the parallel market have been made only recently with the beginning of a foreign currency auction system.

However, the auction system has already hit a snag after only one year in operation.

Inadequate supply of forex (structural issues), corruption in the forex markets and delays in the disbursements of auction funds by RBZ are but a few indications that the system is far from restoring unification of the parallel market foreign exchange rate and the official markets.

Successful unification of the parallel and the official markets will require long-term measures, strong and sustainable enough to “destabilise” the parallel market.

Timely and consistent disbursement of auction funds is key in achieving this goal.

Further, a major overhaul of the auction system is required to ensure that it aids in price discovery and authorities have to do away with imposition of bid ceilings.

Beyond the  auction system, the government should foster a more regulated and managed competitive banking sector in order to increase efficiency in the use of the country’s limited financial resources, including foreign currency.

Punitive measures on speculative financial transactions must be enacted and seriously enforced.

However, a permanent solution is to increase the productive capacity of the economy and exports. As a result, the availability of more foreign exchange will reduce the pressure on the parallel market.

  • Masona is an economist and lecturer at Zimbabwe Ezekiel Guti Universitysona@zegu.ac.zw. This weekly column, New Perspectives, is published in the Zimbabwe Independent and co-ordinated by Lovemore Kadenge, an independent consultant, past president of the Zimbabwe Economics Society and past president of the Institute of Chartered Secretaries & Administrators in Zimbabwe. — kadenge.zes@gmail.com or mobile: +263 772 382 852.

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