HomeAnalysisGovt measures fail to stem currency crisis

Govt measures fail to stem currency crisis

ON Wednesday, the US Federal Reserve hiked the benchmark interest rate by 75 basis points; it is the highest raise since 2004.

The move was widely anticipated by market pundits, a projection, which strengthened the US dollar and weakened risky assets, such as, the stock market ahead of the announcement. Likewise, emerging markets currencies weakened with risky assets.

A rate hike tightens US dollar money supply and strengthens the greenback.

As the rationale, the Fed is responding to rising inflation, which is now seen at historically high levels, as well as, what the bank calls a strengthening economy.

The benchmark rate was lowered to zero following the 2008 recession, which necessitated intervention to boost aggregate demand.

The Zimbabwean dollar (Zimdollar) continued on its losing path against the US dollar on the formal markets, the interbank and forex auction. On the auction, the rate fell by maintaining a higher loss margin and valuation compared to the interbank.

At the point of government intervention, the auction exchange rate lagged the interbank by at least 30% but has since sped past the latter.

This means the auction rate is now more reflective of demand and supply given that the interbank rate is informed purely by private market players.

Earlier, we highlighted that while it is important for the interbank to inform auction, the levels of trades on the interbank are not significant enough to truly reflect and represent a market equilibrium.

However, the fact that the auction has been forced to rerate upwards in closer range to the interbank, shows a tendency towards market economics.

In the past, the Reserve Bank of Zimbabwe controlled the auction rate through its grip of the supply side powered by surrender funds.

The bank can no longer control the market given that surrender funds are now being settled at interbank rate, leaving the RBZ with no choice.

If the bank decides to suppress the auction, it does so at a discount, which effectively reintroduces subsidies in the market. In the past, subsidies have led to accumulating government debt, higher money supply levels, arbitrage and speculation. These may re-emerge if the RBZ suppresses the auction rate.

Market instability

The levels of market instability have since increased since the government announced market intervention measures in May. The gap between the formal exchange rate and the parallel rate remains wide at above 50%.

What these statistics show is that the measures introduced by the government have failed to stem a currency crisis.

It is likely that these measures will not be effective in any way in achieving the intended goals.

In our view, the unabated and worsening currency crisis is a culmination of oversupply of local liquidity, panic and negative sentiment among citizens. The Zimdollar does not enjoy goodwill as a currency given historical experiences.

Further, citizens are in panic mode following the measures introduced to save the currencies in May.

There is a huge sell-off on the stock market, which in turn, spurs demand for US dollars in the market.

Panicky citizens prefer to hoard goods and hold a stable currency. The real elephant in the room is the willy-nilly levels of money supply at a broad level.

The levels of broad money supply have rocketed and are now out of control.

This is largely due to the issuance of Treasury Bills sanctioned by the Treasury. The volume of TBs has swelled by more than three times over the last one and half years.

Rather, the RBZ has focused only on controlling base money supply and positing it as the only component of money supply.

On the outlook, the government has fewer choices and these include disbanding the Zimdollar and creating stopgap measures to stem the crisis.

The first scenario is highly unlikely in the short term because of the 2023 elections.

The government does not want to be seen as a failure. Further, it needs monetary control so as to finance its programmes, which will boost its chances of winning the election.

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

Recent Posts

Stories you will enjoy

Recommended reading

You have successfully subscribed to the newsletter

There was an error while trying to send your request. Please try again.

NewsDay Zimbabwe will use the information you provide on this form to be in touch with you and to provide updates and marketing.