This article is part 1 of a two-part series which delves into the evolution of money in Zimbabwe. Part 1 focuses on the historical context and current situation from both a local and global perspective. Part 2 looks at available solutions to alleviate the problems faced by Zimbabwe.
Over the past decade, Zimbabwe has endured multiple currency crises which are all rooted in noble monetary expansion initiatives. The resultant money supply growth led to too much money chasing too few goods triggering inflation.
Money is necessary for the smooth running of the modern-day economy. It is used as a store of value, a medium of exchange as well as a unit of account. These essential features of money are not functioning in Zimbabwe and the economy cannot recover until these inefficiencies are addressed.
Zimbabwe introduced a multiple-currency basket of “new money” in 2009 after hyperinflation and subsequent demonetization of the Zimbabwean Dollar. The painful demise of Zimbabwean Dollar inflicted wounds on the Zimbabwean populace which influences their psyche in the current crisis facing the US$ pegged new money in Zimbabwe.
Store of Value
A fundamental function of money is its use as a store of value. Money is not perishable and proper financial planning calls for the need to store value to provide for future needs like retirement. These savings can be harnessed for investment purposes positively affecting GDP growth.
To encourage a savings culture, savers should receive an investment return that compensates them for their risk of forgoing current consumption. Inflation is an undesirable occurrence that debases the value of money.
Money supply in Zimbabwe has been growing aggressively with annual growth rates ranging from 30% – 50% from October 2017. A rapid expansion of money supply is not necessarily bad if complemented by a growth in GDP. The Government of Zimbabwe (GoZ) has however estimated a pedestrian GDP growth rate of 3-5% from 2017 to 2019.
With the Zimbabwean economy growing at a slow rate, monetary supply growth is being caused by credit expansion by the GoZ. Net domestic credit to the GoZ expanded from US$7.1 billion in December
2017 to US$9.5 billion as at August 2018. This domestic debt accrued from persistent budget deficits. The GoZ is in line to breach the country’s laws with specific reference to the Public Debt statutory limit of 70% by the end of this year.
The GoZ was reliant on the banking sector to finance its deficit. CBZ, Zimbabwe’s biggest bank with total deposits of US$2.1 billion had US$995 million or 47% of its deposits placed in Treasury Bills as at 30 June 2018. With a significant portion of Zimbabwean savings being channeled to Treasury Bills their performance significantly influences savings incentives and public outcomes.
A snap survey of Treasury Bills price them at a coupon rate of 5-9% per annum. With the official annual inflation rate for October 2018 standing at 20.8%, savers are experiencing an erosion of their purchasing power. As at August 2018 outstanding Treasury Bills were sitting at US$6.2 billion. Investors in these securities stand to receive about US$558 million in income per year while inflation will erode US$1.2 billion from the value of their portfolio within that same year. The net result is a negative yield of at least US$608 million a year in real-terms.
Zimbabwean money failed as a store of value when people lost all their savings with the Government of Zimbabwe abandoning the Zimbabwean Dollar about a decade ago. New money, which was supposed to break away from the past is also starting to fail as a store of value in this new environment of negative real returns.
Savings are integral to the healthy growth of an economy as they fund industry. The GoZ has once again failed to protect savings through their excessive issuance of Treasury Bills. They have compounded the situation by adjusting upwards prescribed asset thresholds further forcing financial institutions to purchase more Treasury Bills.
New thresholds push prescribed asset requirements from 5-10% to 10-20% of funds under management of financial institutions. It is difficult to fault the purchase decisions of financial institutions when they are compelled by law to purchase Treasury Bills. The risk to savings is extremely worrying given that confidence in the financial system was already declining with the economy rapidly informalizing.
Medium of Exchange
As a medium of exchange, money is used to facilitate trade and the transference of value. To function efficiently, the vale of money should be stable to give both the buyer and seller confidence of the economic value of the transaction. Physical cash has become a commodity in Zimbabwe due to its scarcity leading to the bulk of transactions being facilitated through digital channels.
This digital cash is reliant on centralized digital infrastructure which is prone to downtime locking out access to cash. The centralized infrastructure setup also poses an IT security-risk as the whole country’s finances have centralized points of weakness that can be exploited by hackers. Digital cash is also not readily transferable to other currencies leading to foreign trade headaches
Zimbabwe’s US Dollar pegged c.$10 Billion broad money in circulation is backed by 4% physical notes and coins dominated by Bond Notes. Actual United States currency is scarce in the formal system with the GoZ recently enacting laws to stem rampant trading of the United States dollar against bond notes and digital currency on informal platforms.
The dominance of digital cash also creates problems for a large portion of Zimbabwe’s population who reside in rural areas. Financial inclusion of this demographic is constrained and they often have to travel long distances to urban centers to secure their funds as scarce physical cash from the banks. It has become a common feature for these people to sleep overnight in bank queues.
With the recently introduced 2% Intermediated Money Transfer Tax a new incentive has been created to deal in cash to avoid this tax. With scarce physical currency, the new tax further makes cash valuable further fueling financial disinter-mediation.
As Zimbabweans continue to avoid financial service providers, Banks are unable to perform their money multiplier function of lending out their deposits to other economic agents, stimulating economic activity. Without financial inter-mediation, businesses are starved of critical capital while individuals cannot save.
The net result is an inefficient economy with business gravitating towards informal channels because financial incentives of receiving funding from formal channels are fast disappearing. The GoZ is crowding-out business in the savings market.
The RBZ has instituted measures to ease money supply growth by re-introducing statutory reserve requirements of 5% from 1 November 2018. The statutory reserves have knock-on benefits as money supply is reduced helping arrest inflation.
A comparative study of regional peers yields insights into the adequacy of the 5% reserves. Angola is experiencing a similar inflation profile to Zimbabwe and they have 19% statutory reserve requirements to help tame the IMF-projected inflation rate of 20.5%. With Zimbabwe experiencing the highest inflation rate among observed peers, 5% reserves seem woefully inadequate as the country is coming from an 8-year period of loose monetary policy with no statutory reserves.
Further compounding this is the fact that Treasury Bill maturities for 2019 are estimated at US$2.2 Billion. GoZ should however be wary of defaulting on obligations when due as IFRS 13 calls for fair value measurement of assets.
A default would lead to uncertainty over the GoZ’s ability to repay. Market participants seeking liquidity will be forced to discount their holdings at current values. When compiling financial statements, this discount would need to be factored into the value of all other similar assets in the remaining portfolio leading to potentially devastating losses that will threaten the sustainability of banks most exposed to Treasury Bills.
With physical cash in short supply in Zimbabwe, it would make sense to try boost cash holdings through the issuance of more Bond Notes. In reality, this cash ends up on the informal market fueling physical cash transactions that make tax administration difficult to enforce.
The 2% tax will be avoided, VAT, Income Tax and other statutory obligations could be evaded. The GoZ has experienced persistent budget deficits that have increased sovereign debt to unsustainable levels placing the whole financial service industry at risk.
Revenue inflows need to not only catch up with recurrent expenditure, but also need to finance the legacy debts. The Informalization incentives of the 2% tax pose serious threats to both banks and revenue collection of the GoZ as citizens will try to avoid the 2% tax by trading in cash. A premium is being placed on the value of physical cash due to its potential use to both avoid and evade tax.
Zimbabwe is a net-importer of goods and services with the trade deficit for the current calendar year sitting at over US$2 billion. The RBZ is currently responsible for the allocation of the scarce exported- financed foreign currency. Allocation decisions have caused friction which reached a peak when RioZim, a ZSE-Listed export-focused mining company shut down its operations for a brief period due to foreign currency shortages.
The RBZ, as the only channel for changing digital cash and bond notes to foreign currency, cannot meet all external payment obligations due to the current account deficit. This shortage has led to an informal foreign exchange market which discounts digital cash and bond notes to exchange them for other foreign currency. The GoZ has clamped down on this practice making it illegal with a sentence of up to 10 years to trade in forex.
With the great deal of the population not having access to cash, the select few holding cash will be forced to deal exclusively in cash. Informal market participants will charge a steep premium to facilitate foreign currency trade. The more the GoZ clamps down on forex traders, the less the number of people willing and able to trade forex. The resultant drop in supply will push informal market rates even higher effectively further dropping the purchasing-power of import-dependent Zimbabwean consumers. Zimbabwean industry is incapable of meeting the void left by imports as they have antiquated equipment.
Unit of Account
Money as a unit of account enables an economic participant to take stock of their performance. Every individual or organization has outcomes it aims to achieve over the short-, medium- & long-term.
Resources are allocated to achieve identified goals with outcomes compared to benchmarks to gauge under- or out-performance. When the value of money is volatile, it makes it extremely difficult to function as a unit of account.
On an individual level everyone aspires to have adequate financial resources to meet their needs. To finance this lifestyle requires careful planning and resource allocation. A financially astute citizen should have clear goals and a financial plan which outlines how to achieve these goals taking into account savings and investment alternatives, insurance and risk management solutions, as well as estate and tax planning considerations.
Stability of the value of money is important to allow people to accurately predict future expenses. Inflation constantly readjusts the value of money making it extremely difficult for anyone to adequately plan for their future.
In the current environment of negative real returns, savings are being eroded, insurance portfolios are quickly becoming inadequate, medical aid companies cannot keep up with the costs of critical drugs payable in US$. People’s hopes and dreams are fast vanishing as years of sweat and tears are quickly erased by inflation. Zimbabwean money has failed as a unit of account because inflation has made it difficult to plan for current and future expenses.
Companies have to allocate their resources to meet stakeholder expectations. Shareholders expect a return on their invested capital, employees expect their welfare issues to be addressed, suppliers expect their obligations to be paid when due, customers expect products to be available when required, while the GoZ expects tax and other statutory obligations. Careful planning is required by directors to meet all these expectations.
With inflation in the picture, sales stock can be purchased and sold for an accounting profit yet in real- terms a company can fail to restock due to price adjustments by suppliers. The GoZ loses real value from the date when taxes are collected to the actual date of remittance. Employees salaries are eroded with their welfare coming under threat. Companies also fail to access cheap funding as savings that fund industry are crippled by the skewed incentives that discourage saving.
Zimbabwean savings are harnessed through pension funds, insurance companies, funeral assurers, banks, asset management companies and the Zimbabwe Stock Exchange.
With pension funds now required to hold 20% of their funds in prescribed assets which are currently yielding negative real returns, members interests are under threat as their savings are being eroded in real-terms.
Insurers pool client funds to cover their real insurable interest from identified risk factors. As the value of money is not static, the fair-value of the insurable interest will constantly adjust. Adequate cover would require constant readjustments of both premiums and cover.
With prescribed asset thresholds extending to insurance companies who have to place 10-15% of their portfolio in negative-yielding Treasury Bills, premiums would need to be further adjusted to cover this loss in value. Premium and cover adjustments, however, make no sense as client salaries are static. Fully pricing risk will push insurance to unaffordable levels for most.
With the bulk of customers relying on digital channels for payments, banks are playing a role in accounting for money in the system. This creates a systemic vulnerability for the whole financial system as hacking and theft of sensitive information can put the whole country on its knees.
CABS learnt this the hard way when their system erroneously deposited US$297k into 3 customer’s accounts. 13 staff in the IT department were fired from the bank as a result of this incident. Competence questions raised in this case cast a dark shadow of doubt about the presence of vulnerabilities in the banking system IT architecture in Zimbabwe. In the current era of ransomware, IT security is critical.
Due to experience from the prior crisis, Zimbabweans are well-informed that the ZSE provides a good inflation-hedge. The benchmark ZSE industrial index saw a 143% surge in 2017 followed on by 62% pump from January 2018 – 30 November 2018.
This bull run is being triggered by market sentiment with regards to the real value of money. Investors are piling into shares due to prior experience where shares provided the best protection in an inflationary environment.
The confidence of investors to persistently demand shares at eye-watering price to earnings ratios speaks to their expectations with regards to the value of money. As witnessed in November 2017, an uptick in confidence will trigger a selloff and drop in value of shares on the ZSE. Through the ZSE, the GoZ has a powerful information source of market confidence.
Before proffering solutions, it is necessary to understand the problems affecting the Zimbabwean economy. Money has lost its function as a store of value, medium of exchange and unit of account. Part 2 of this article will delve into needs-backed solutions that will underpin a more vibrant Zimbabwean economy.
This article has been prepared by Raymond Madombwe for information purposes only and does not constitute financial advice. Raymond is a Financial Economist with wide-ranging experience in the financial service industry. This article was prepared with the utmost due care and consideration for accuracy and factual information; the forecasts, opinions and expectations are deemed to be fair and reasonable. However, there can be no assurance that future results or events will be consistent with any such forecasts, opinions and expectations. The author will therefore not incur any liability for any loss arising from any use of this document or its contents or otherwise arising in connection therewith. The author can be contacted on firstname.lastname@example.org