Victor Bhoroma analyst
The Reserve Bank of Zimbabwe (RBZ) launched the Dutch auction system on June 23 2020 to improve transparency in the distribution of foreign currency locally. Initially the auction exchange platform was supposed to be backed by the Reuters Forex Trading platform (a real-time electronic trading system between banks), but the central bank moved out of it before full absorption.
After a promising start, the auction platform has morphed into an allocation platform where the exchange rate is soft pegged regardless of the level of money supply growth or other economic developments that affect foreign currency pricing. The auction has deviated from the initially stated Dutch auction principles which were meant to instill confidence in the central bank operations, ensure transparency in allocating foreign currency in the economy and allow some modicum of free market price discovery on foreign currency trading.
Allocations so far
From June 2020 to date, the central bank auction allocation platform has allotted US$2,665 billion to slightly under 7 500 beneficiaries in the country. Large businesses on the main auction make up 28% of the total recipients, while small-to-medium enterprises (SMEs) and Individuals constitute the remainder. Amounts allocated range from US$19,2 million for the biggest benefactor to less than US$260 for an individual applicant. In 2021, the auction platform allocated US$1,971 billion to selected bidders with over US$1,645 billion was allocated to large businesses that make up 28% of the total bidders’ count. However, it is worth noting that central bank reports show that Zimbabwe imported machinery and equipment worth approximately US$650 million in a space of 18 months from July 2020 to December 2021. It remains to be seen which economic sector received the bulk of the machinery or equipment.
What is a Dutch auction system?
A Dutch auction is a market system in which the price of foreign currency offered is established after all bids have been received to arrive at the maximum price at which the entire offering can be sold. Bidders submit a bid for the amount they are willing to buy in terms of amount and desired price in this form of an auction. A Dutch auction is also a sort of auction in which the price of an item is gradually reduced until a bid is received. If the price is higher than the reserve price, the first bid is the winning bid and results in a sale. This contrasts with traditional auction markets, where the price begins low and rises as bidders compete to be the winning buyer. The Dutch auction system has been used in other African markets such as Ethiopia, Ghana, Guinea, Sierra Leone, Uganda, and Zambia.
These countries operated with some level of foreign exchange controls but allowed the exchange rate to be determined by forces of demand and supply. If the auction principles are followed, the Dutch auction can restore market confidence in the local economy and stabilise prices. By design, a Dutch auction is supposed to be a price discovery mechanism which gives a signal to bidders that they have limited chance to get foreign currency if they offer to pay less. Below are some of the points of difference between the actual Dutch Auction market and the local allocation system operated by the central bank at the moment.
Auction amount known beforehand
As the general rule on all auctions, the amount to be auctioned needs to be declared days before the bidding opens. It does not matter if the amount is $1 million, or it is $500 million. If there is no foreign currency, there should be no auction at all. This information affects price discovery because if there is more foreign currency available (increase in supply), bidders will offer to pay a lower price and if there is limited foreign currency, bids will be placed higher. Currently, the central does not communicate this information and bidders bid at the lowest price possible. It is apparent that the central bank plays a role in discouraging bidders who offer high prices (explicitly or implicitly). In the end the central bank allocates (on paper) foreign currency that is not available, and the winning bidders have to wait for up to 3 months for settlement while their Zimbabwean Dollar component is lying idle in a suspense account. As a result, the current backlog exceeds US$250 million because there is no foreign currency to settle the supposed winning bids.
Highest bid downwards
A true Dutch auction assigns foreign currency to bidders starting from the highest bid downwards and allows the highest bidders to be allotted their full amount at that bid rate till their requirements are fully met. If there is extra, the allotments move to the second highest offer in that manner. This means that the highest bidder may exhaust the declared amount if supply is limited. The benefit of following such a mechanism is that those who demand more foreign currency and have a significant amount of local currency get more foreign currency. This manages the appetitive to go the parallel market and encourages competition as bidders will not bid at a rate where they make foreign exchange or operating losses. However, the central bank is reluctant to have this implemented because its quasi-fiscal operations entail continuous printing of money and an insatiable appetite for foreign currency in the market.
A true auction can settle within hours provided all the requirements are met as is the case in Ghana where the Dutch auction system is used. However, a 48–72-hour window is within acceptable limits. Currently, the central bank cannot settle within that period to the lowest or mid accepted bids because it does not have the foreign currency it sells to multiple bidders. This means that winning bidders must supplement their foreign currency needs through other sources, and they are willing to pay a premium to have it, lest their business suffers. That premium is passed onto the consumers.
Pro rata rule
Once the highest bidder gets their full lot of foreign currency, the allocation moves to the second highest bid on a pro rata basis till everyone gets their share depending on supply. If supply is limited, the highest bids are settled fully and those on the bottom lose. Zimbabwe’s apex bank allocates portions of foreign currency to several bidders at different bid rates and there have been cases where successful bids from recent auctions are settled before older bids are settled.
Is foreign currency shortage real?
Zimbabwe received just under US$9,7 billion in foreign currency earnings in 2021, up 54% from the 2020 figure of US$6,3 billion. Total export receipts in 2021 jumped 38% to over US$6,10 billion from US$4,43 billion realised in 2020, while international remittances grew by over 40% to US$1,4 last year. The major contributors to export growth being the surge in gold production from 19 tonnes in 2020 to 29.6 tonnes in 2021, the rally in mining commodity prices on the world market and the added value of exporting beneficiated PGM metals. Despite the year-on-year growth in foreign currency earnings starting as far back as 2009, the country is stuck in man-made foreign currency shortages. Pressure on foreign currency is caused by unprecedented depreciation of the local currency (which results from money printing).
Why does everyone want forex?
The local currency is merely a transitory unit of transaction, not a store of value or standard for deferred payments. Exporters and other holders of foreign currency do not participate on the central bank auction platform because they know the rate is manipulated and there is no value for them. The current foreign currency allocation system is not an auction market, and it does not follow the basic Dutch auction principles. It was implemented as a temporary measure, but its management is now creating economic headaches for all economic players (including the government itself). However, this is not by error. It is by design because the central bank (government) largely wants to reserve the ability to print local currency and fund various government programs when it deems fit even if the printing has undesirable consequences to economic stability.
Zimbabwe does not have a foreign currency problem; it has a foreign exchange allocation problem which rests solely on the central bank (government’s) foreign exchange regulations and policies.
Following basic Dutch auction principles on the foreign exchange market would ensure price discovery and confidence, but not necessarily exchange rate stability. Currency prices marginally respond to government policy and global trade movements among other variables. However, exchange rate stability in Zimbabwe is largely a factor of how much money is printed in pursuit of central bank quasi fiscal operations and financing of unbudgeted government expenditure.
Bhoroma is an economic analyst and holds an MBA from the University of Zimbabwe. — email@example.com or Twitter: @VictorBhoroma1.