Joseph Mverecha
Introduction
Our times are uniquely difficult and have been for a while, with limited respite. The economy is dollarizing rapidly while the local currency is careering listlessly towards the edge of the universe – as happened in 2008. Ahead of us the ferocity of amplified currency volatility in a hyper environment and ever increasing – now daily price increases. We have been through this path before and our footprints in the sand, a decade ago are yet imprinted. Retailers, like spooked Wildebeest are adjusting prices daily – a stampede towards the precipice.
Authorities recently introduced the $10 and $20 dollar notes, notwithstanding abundant evidence to the effect that there was no point introducing higher denominations in an anvil of churning and darkening clouds of adverse inflation expectations. The new $10 note, as expected, is on a one-way journey to the sea, sucked out of the formal system by the nexus of cash shortages and the zooming parallel market for Foreign currency. Until this is resolved through a proper market based Foreign Exchange system, our journey towards both currency and macroeconomic stability is much further than when we began.
There is nowhere to hide for the multitudes, the poor, infirm, and those with chronic conditions. As in 2007/08 the whirlpool of hyperinflation is leaving an acrid trail of devastation and debris in its wake. Everything monetary is heading towards ground zero. It is frightening. Living conditions are deteriorating inexorably. Growing food insecurity, chronic poverty and escalating medication are immediate challenges among both the sprawling urban and rural poor. As the currency vitiates, millions are caught in no man’s land – wretchedly famished and financially incapacitated – precisely the most perfect conditions for the Covid19 pandemic to wreak havoc.
Pensions and insurance investments are losing value yet again. The poor and the salaried are headed for penury. It is a vicious cycle, yet from a policy point of view entirely avoidable. Is it too late to reverse course? Time will tell. In my view a very limited window remains for Authorities to do all that is necessary to preserve the local Currency.
While there are exogenous adverse factors compounding, this is largely the culmination of policy induced distortions, recurrently sustained over the past five years – mainly rooted in our fiscal spending and the corresponding monetization of fiscal deficits. Compounded by a heavy dosage of Central Bank expanded incentive schemes, quasi interventions, a fixed exchange rate and a skewed foreign exchange management framework. This policy combination (a troika of sorts) is guaranteed to sustain heightened pressure on the exchange rate, creating anvil of adverse expectations. Perhaps, analogously, we are today, where the British Military Planners were at the end of day 1 of the Somme Battle during the First World War.
I will detour briefly to history.
It is July 1, 1916, World War 1, the Battle of the Somme. The British Army had been planning for weeks and months for a massive assault on German positions dug in around Somme, to relieve pressure on their beleaguered French Allies involved in a titanic mother of all battles at Verdun.
The British military planners were determined to overwhelm the German entrenched defensive positions with heavy bombardment. Following the morning bombardment on 1 July, 75 000 British soldiers waded into no man’s land towards the German trenches. What followed was a bloodbath of unimaginable proportions – indeed a carnage. The British infantrymen were moored down by German machine gun positions, completely unscathed from the earlier heavy bombardment. The casualties were horrendous. By day end, as many as 57 000 British casualties, including nearly 20 000 dead. It was inexplicable disaster – the heaviest military loss in a single day.
Yet, this was the culmination of a series of strategic errors in military planning and battle plan execution, in particular military intelligence asymmetry, poor coordination among units and adherence to a static battle plan, with no room for flexibility.
A number of the above, particularly poor coordination of monetary and fiscal policy has blighted the transition from the US dollar dominated Multicurrency to local currency. Though prematurely introduced, the Mono currency (local currency) had the potential to subsist, if Authorities had progressed to put in place mutually reinforcing fiscal and monetary policies to support the local currency. But instead, currency stability was heavily undermined by both the rapid build-up in reserve money and the fixed exchange rate policy – both policies judiciously pursued with Vicarage energy. The rapid growth of RTGS balances against the background of declining US dollar Cash and Nostro balances fueled imbalances in an increasingly dichotomous monetary system. Two different streams supposedly flowing as one river, initially officially recognized as one homogeneous river flowing sedately to the sea. But the river was far from serene. Like the biblical Rachel and Leah, the two rivers could not flow in peace and the equilibrating mechanism seeking to establish some truce between the raging rivers was the parallel market, which gained strength following the separation of RTGS and Nostro FCAs in October 2018.
In reality, the economy has been having local currency since October 2015, when RTGS balances surpassed both Nostro and USD cash balances. Initially, it was not a problem then because the surplus RTGS balances were negligible but overtime the RTGS balances swelled, through both TB issuances and Central Bank overdraft financing, precipitating cash and Foreign exchange shortages. Ill-conceived, the bond note introduction led to wholesale panic US dollar cash withdrawal from the formal banking system, the parallel market ensued and re-ignited the latent inflation expectations, now truly entrenching and creating an inferno.
At the beginning of 2019, our macroeconomic (currency reforms) and journey towards a free market economy had a promising beginning. Following the introduction of the interbank market in February 2019, initially the parallel market appeared to trend towards convergence but retreated forcefully, when it became clear that the interbank market was not anything that remotely mirrored the willing buyer/willing seller that had been promised.
Meanwhile, as the economy continues re-dollarizing, inflation and the parallel market headed north in response to reserve money/money supply growth, policy uncertainty and adverse expectations. The challenge with de-anchored expectations is that they lead to a disproportionate, non-linear response to any macroeconomic shock, creating a surge in exchange rate depreciation, beyond levels warranted by fundamentals. This means the most important policy measure Authorities must focus on is what is necessary to anchor inflation expectations. There will be no sustainable production in the economy, as long as expectations are de-anchored.
Then, as now, the Multicurrency remains untenable (I know many esteemed economists differ and they have my respect). The allure of the US dollar is irresistible, like a pot of gold especially against the background of a rapidly deteriorating local currency. But the US dollar cannot sustain the level of transactions for the current level of economic activity, thus will create a hard landing for the economy, if the economy completely re-dollarizes. This is a major risk.
The economy has no access to any external financing, as such exports and diaspora alone will not be sufficient to finance and sustain broad based economic activity. Further, the economy hemorrhages US dollars through many leakages, including high imports, heavy externalization and smuggling. The US dollar is too strong and will bleach industry and the productive sectors – an overvalued US dollar undermines exports growth, at a time when the economy requires FDI, investment and export led growth. The Rand would have been a better alternative and there yet remains a strong case to increase Rand circulation in the economy. But South African Authorities would rather walk to the moon than accept Zim into the Rand Monetary Area – negotiations for joining the CMA will likely take no less than five years, with no guarantee.
The only viable option we have is our own currency – that is, if it can be preserved.
Preserving the local currency is decidedly the most urgent mission of Government, and must supersede all else. But what can be done to make sure the new local currency is given a fighting chance, particularly given the tide of exchange rate depreciation and the panic re-pricing of goods/services at elevated rates and the accelerating parallel market.
Quite a few policy initiatives can indeed be implemented. Perhaps, it is significant to note that, our biggest hurdle has to do with public perception and entrenched fears, both mutating into a whirlpool of severe adverse expectations – de-anchored inflation expectations. This must be addressed as a matter of existential urgency.
First: Control Reserve Money and Money Supply Growth: Singularly, the most important policy measure to give the currency a fighting chance is that there must be a firm determination to control Reserve money and broad money supply growth. It is a watershed period. At this late stage, it is not enough to reduce Reserve money growth. For the next 6 to 9 months, it is critical to halt all Reserve money growth and give the currency a chance.
Our history as a country bears testimony to the journey we have walked over the past two decades. Too much high powered money has far greater consequences for the preservation of currency, than any other variable, creating and fueling the parallel market, which is the major source of inflation expectations. No country has ever escaped the effects of too much money flowing in the economy, with broad money growth at 245% in December 2019, as driven by high powered money. And too much money only comes from one source – the Central Bank, usually as monetization of large recurrent fiscal deficits.
The Central Bank must commit to a Visible money supply control program, with weekly, monthly and quarterly targets which must be adhered and delivered. The Annual money growth rates only to be determined by private sector credit growth.
Second: The Interbank Foreign Exchange Market: Authorities must now ensure that the interbank market functions on a willing buyer/willing seller basis as initially envisaged in the Monetary Policy statement of 20 February 2019. A viable and efficient foreign exchange market will channel resources into the formal market and assuage the tide or pressure for parallel market resurgence. Authorities must immediately the fixed exchange rate (ZWD 25 per USD) which neither provides price certainty nor consistent with fundamentals. It is fueling the parallel market and singularly the most visible anti-production policy. Tobacco farmers and other exporters are having to acquit 50% of their foreign exchange at a fixed rate of $25 per US dollar and yet buy inputs for the next season at parallel rates in excess of $70 per Us dollar.
Similarly, there has to be one price for foreign currency – a uniform exchange rate that applies for all foreign currency transactions, private or official. Equivalently, no one should access foreign currency at preferred rates and there should be zero tolerance aberration.
Third: Review of Surrender Requirements. To their credit, Monetary Authorities have committed to avail 50% of the foreign currency retention to the interbank market. This is a progressive measure and should increase foreign currency availability to the interbank market. However, going forward, there is need to review the surrender requirements altogether to allow higher retention for exporters, who generate the foreign currency. This of course must also take into account Reserve Bank of Zimbabwe and Central Government external payment obligations. Accordingly, a graduated progression is envisaged.
Fourth: Policy Coherence Vs Policy Uncertainty: A major drawback of the current policy framework, is the apparent dislocation and dissonance between Monetary and Fiscal Policy, which has fueled policy uncertainty and speculation. A continuation of this path will guarantee the loss of the local currency, with all the far reaching implications on the economy, output, production and jobs. Authorities must agree on what is best for Zimbabwe, and at present, it is the preservation of currency and put in place mutually agreed immediate measures towards this objective. Neither the Central Bank Governor nor the Minister of Finance will emerge like a colossus from the debris of a collapsed currency. It would be a major catastrophe if Authorities lose the currency for a second time in a decade. Policy coherence and Policy certainty is critical, going forward, followed by seamless implementation.
Fifth: Halt New Currency Printing: Monetary Authorities have now introduced the $10 note and $20 note, as part of measures to ease cash shortages and enhance public transactional convenience. The $10 note is already in circulation, more precisely, has exited the formal system, as expected. If the $20 note is injected, it will flow out the same way into the informal system.
On balance, others things being equal, the amount of cash required for normal transactions in the economy should range from 6.5 – 10% of total deposits in the economy (the currency ratio was 6.5% in 1994). That is assuming normality.
But the economy is experiencing a non-standard currency demand function, due to the current prevailing distortions. As long as this prevails, there is no point in introducing higher denominations as they flow out into the deep sea – the thriving parallel market for Foreign Exchange. No amount of cash injection will resolve the cash crisis, as this is a symptom of underlying structural imbalances and distortions.
In my estimation, Authorities should withhold the $20 note and not inject in circulation as this can fuel further exchange rate depreciation. In addition, Authorities must focus on the root cause and address the underlying root cause of currency deceleration, which is excessive money supply growth. Exerted efforts on Ecocash and Zipit limits and more broadly regulation of mobile money, while important, these initiatives are not the core problem and have limited prospects for stabilizing the currency. Currency stability, is inherently a function of money supply growth and the foreign exchange management system. A decade ago, Monetary Authorities also exerted disproportionate efforts on these issues (2007/08) – closing and suspending RTGS at one point, while the core of the problem remained unresolved. The results of those efforts are known in advance. The hour is now, for Authorities to implement bold steps necessary to stabilize the currency, a pre-requisite for macroeconomic stability, investment and economic growth.
Joseph Mverecha is an Economist with a local Bank and he writes in his personal capacity.
