Victor Bhoroma THE Reserve Bank of Zimbabwe (RBZ) launched the Dutch auction system in June 2020 with the sole aim of improving transparency and efficiency in the trading of foreign currency in the economy.
Thus, the auction system was supposed to be a foreign currency price discovery mechanism which would eliminate the parallel market. This was inconsideration of the inefficiencies and volatilityregularly witnessed on the parallel market where shadowy actors determine the going rate for the day.
The bidding platform was supposed to be the Reuters Foreign Currency Auction Forex System (a real-time electronic trading platform between banks linked to export payments control system), but the central bank changed goalposts and Reuters was never used.
After a promising start, the auction platform has transformed into a foreign currency allocation scheme where the exchange rate is softpegged regardless of the level of money supply growthor other economic developments that affect the exchange rate.
The parallel market remains the main reference in pricing goods and services in the economy despite the enactment of several legal instruments, arrests for traders or threats of arrests for businesses.
The central bank remains the only supplier of foreign currency on the auction allocation platform. The apex bank has allocated US$2,887 billion from June 23, 2020 to date.
This year, a total of US$290 million has been allocated for the importation of various commodities and payment of offshore services (US$1,971 billion was allocated in 2021).
In 2021, Zimbabwe made formal foreign currency payments amounting to US$7 billion(Up from US$4,8 billion in 2020) before informal cross border payments are factored in.
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This means that the country now requires approximately US$650 million per month to make foreign currency payments for imports and other service payments.
The government amended the Reuters Foreign Currency Auction Forex Systemto impose jail terms of up to 10 years for illegal foreign currency traders.
Of late, Statutory Instrument (SI) 127 of 2021 has been used to target businesses that sell above the parallel market rate that the central bank deems acceptable. Despite these moves, the parallel market remains strong and undeterred across the country.
Re-emergency of the parallel market
The foreign exchange parallel market disappeared between 2009 and 2015 when cash shortages vanished under the multi-currency regime. As money supply started to grow with the issuing of Treasury Bills (TBs) and RTGS credits in local banks towards end of 2015, the black market started to creep back to life and was fully unleashed when Bond Notes were introduced in November 2016.
It is imperative to understand the following conditions that promote the thriving of the forex parallel market in Zimbabwe.
Formal exchange rate manipulation
Exporters and other holders of foreign currency such as Non-GovernmentalOrganisations (NGOs), local businesses and householdsdo not sell on auction platform because they know the rate is manipulated and there is no value for them.
Similarly, the current foreign currency allocation system is not an auction market as it does not follow the basic tenets of a Dutch auction market.
The amounts to be auctioned are not communicated before the auction, settlement is not done within two days and selected bidders jump the settlement queue ahead of earlier winners.
However, this is not by error or unintended. The auction allocation is enriching selected private entities and individuals, anditis creating enormous rent seeking opportunities in the market.
It is also deliberate because the government wants to reserve the ability to print money and fund various government programmes through printing the local currency.
As such the government wants to control the pricing of goods and services to manage the impact of money supply growth. Regionally or globally, the government raises its revenues through taxation,grants, and debt (inclusive of bonds or treasury bills).
Lack of confidence Confidence is the backbone of currency stability. Confidence in the local currency is affected by repetitive monetary policy changes, economic policy inconsistencies and historical abuses ofproperty rights by the central bank and government.
Additionally, unabated growth in money supply increases inflation rate, which wipes away currency stability or any measure of stability attained.
Therefore, market agents can only feel safe in holding foreign currency. It will always be a toll order for the local currency (regardless of its name) to hold its value if confidence in the central bank and the government is very low.
To boost confidence, the central bank needs to adopt a managed foreign exchange or auction system where price discovery is market determined and print the domestic currency in sync with economic growth.
This is a fundamental which the central bank must confront and accept. Adopting an inflation targeting policy and building foreign currency reserves to support the local currency stability is the core mandate of central banks world over.
This willrequire the government to spend within taxable revenue limits, allow free movement of capital and adopt consistent economic policies.
If the foreign exchange rate is market determined and stable, the export retention threshold seizes to matter. This will manage also the current artificial demand for foreign currency on the auction platform or the parallel marketand the preference to be paid in foreign currency.
Persistent forex shortage Zimbabwe has a sustained trade deficit that averages US$2 billion in the last 10 years. In 2021 the deficit eclipsed US$1,6 billion before smuggled and under declared merchandise from neighboring countries are factored in.
This means that Harare is a perennial net importer in global trade. Therefore, the demand for foreign currency to import raw materials, petroleum, foodstuffs, consumer goods, and commodities persistently outweighs foreign receipts from exports, investments, and remittances.
The country is not producing enough locally to meet local consumer demand and to generate sufficient foreign currency to oil the local financial market.
The auction allocation platform can only cater for 20-30% of the foreign currency needs of the selected winning bidders, while some have to wait for three months to get allocations.
This means a huge chunk must come from sales proceedsand the parallel market. Unsustainable foreign currency shortages drive exchange rates up.
The most sustainable way to address this trade deficit gap is to address supply side deficiencies in agriculture and re-industrialise the country.
Massive arbitrage opportunities The mere availability of a weaker local currency (bad money) and consistent money supply growth create enormous risk-free arbitrage opportunities for businesses and parallel market traders. This means that foreign currency becomes a hot commodity where buyers and sellers earn more profits than actual producers in the economy.
With a parallel market premium of over 100%, holding foreign currency and settling local obligations in Zimbabwean dollars remains a loophole every economic agent takes advantage of.
Traders consistently hoard consumer goods or commodities sold in a local currency for resale in foreign currency at a later date. Businesses participating on the auction platform can park their local currency for indefinite periods provided they sell their produce in foreign currency or parallel market indexed rates later.
Borrowing in local currency for non-productive purposes will also remain high. This is usually aided by interest rates that fall below annual inflation rate.
Corruption Unemployment levels remain high in Zimbabwe, while wages and salaries have been decimated by inflation. This fuels corruption inboth the private and public sector, and collusion between law enforcement agents or regulators and business.
The foreign currency trading chain involves hundreds of foot soldiers who trade forex at street corners to the public, back-office bankers, importers and exporters, law enforcement agents, politicians, politically exposed persons (PEPs) and shadowy dealers, who act as runners to connect all these actors.
All these actors play their part for an agreed commission for the risk involved at their level. Foreign currency trading provides income streams for various actors in the chain and has become a huge sector in the shadow economy.
The foot soldiers are merely visible agents in a complex chain worth millions of dollars and this is the sole reason why enacting laws will not arrest parallel market trading where collusion and corruption reign supreme.
The past three years have seen serious economic demise due to the re-emergence of inflation, yet a few elites have become millionaires while millions of citizens slid into extreme poverty on the other end.
World over, policy makers aid parallel market trading for personal benefit and exert pressure to maintain the status quo.
The formal exchange rate manipulation, lack of confidence and arbitrage opportunities can be easily addressed by the government in the short term.
Corruption and persistent trade deficits require strong independent state institutions and economic reforms. As is the case with most economic challenges bedeviling Zimbabwe, the buck stops at political will to address the widely known policy loopholes.
It will be very difficult to kill the foreign exchange parallel market if the conditions that create the need for it are left to flourish for known benefits.
Formal businessesare informalising and seeing the benefits of using the parallel market. For the government, a managed floating exchange rate or market determined rate opens floodgates of inflation since it cannot do without money printing.
It also exposes structural weaknesses in the economy. For selected auction beneficiaries, a wobbling auction system is better than nothing. In the end, the central bank plays a balancing act which promotes its own interests, while ignoring the powerful players behind the parallel market.
- Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). Feedback: Email [email protected] or Twitter @VictorBhoroma1.