- RBZ has relaxed policy and now allows trade in foreign currency
- A hard peg has been instituted and the consequences are dire for the economy
- We see the measures as a policy indication towards full redollarisation
- Failure to move completely to redollarisation will cause even more harm to the economy
The RBZ on Thursday announced a raft of measures which it said were meant to cushion the economy in the face of COVID19. Globally governments are providing stimulus packages while central banks have adopted quantitative easing to help their economies in the face of the deadly virus. While Zimbabwe badly needs a stimulus even before the emergence of COVID19, the fiscus leg has already been overstretched as evidenced by an entrenching recession. The monetary leg which is supposed to engage in quantitative easing and aid the fiscus is equally exposed. Without enough foreign currency reserves or gold reserves, injecting new money in the same way the US and other countries are doing as a measure to support businesses and the generality, will be harshly met with drastic ZWL loss. Measures such as benchmark rate lowering in a hyperinflationary environment would only encourage rent-seeking. So broadly, under a de-dollarised economy characterized by hyperinflation and a deepening recession, Zimbabwe was in catch 22 situation, something had to yield.
On Thursday the RBZ conveniently seized the moment intervening through various measures, not necessarily to cushion the COVID19 crisis, but to reconfigure the economy completely in the face of a sustained crisis. Among the measures, RBZ said it will now allow holders of free funds to make settlements in lieu of local transactions using free funds. This is tantamount to partial re-dollarisation of the economy barely 9 months after disbanding multicurrency. In our view the biggest takeaway from the interventions announced is that the government is indicating a shift in the policy direction, a move we strongly support. The new policy direction is now redollarisation of the economy and these measures are likely a first step towards the goal. We however opine that if the move is not immediately followed up with enhancements measures the economic situation may further gravitate into a worse off position than it presently finds itself in.
Explaining the policy pronounced measures
When Zimbabwe de-dollarised in June 2019, free funds which are funds sourced from outside either through trade or grants and sitting in Nostro FCAs were no longer permissible for local trade or local transactions settlement. At that point the Zimdollar effectively became the sole legal tender and the US dollar was disbanded. What the RBZ has done is to effectively partially re-dollarise the economy by allowing the USD to trade side by side with the Zimdollar, with a bit of technical differences. The adopted model of re-dollarisation, at this point, is different from that adopted by Zimbabwe in 2008 as it does not do away with the local currency and likewise impose a hard peg of the local currency to the USD, scenarios which creates serious economic challenges going forward.
The two key challenges are that with a pegged exchange rate of 1:25, the forex market will remain in an imbalance position. At 1:25, the interbank has not seen any meaningful trades and imposition of a hard peg would stifle potential forex flows to the market meant for importation of critical production inputs. This may lead to shortages in the economy in about a month’s time from now across a number of goods including food and energy. Without further scrapping of the ZWL, the hard peg will choke imports. Forex earned from direct local transactions will not be sufficient to cover for imports demand.
The other challenge is that a dual currency economy pitting a very weak currency with a very strong one will only drive the value of the former further lower on a relative basis. Part of the problem emanates from the fact that psychologically everyone wants to hold the stronger currency and therefore even after transacting in the local currency one would quickly want to convert into hard currency to preserve value. The ZWL had not found its balance to the USD as yet given the 13 months bout over which it has shed 90% and lost value in successive trading sessions. Exposing it on the same turf with the USD will be very unfair and only result in sharper loss. The only way to insulate the move is by tightly controlling capital flows or even temporarily blocking capital flows. However, without strong macroeconomic fundamentals, this too cannot be sustained.
As the market “redollarise”, demand for USD will spontaneously surge and thus catalyse a ZWL plunge, a gracious exit is however more preferable and more ideal to save companies’ balance sheet and individuals’ deposits averting another 2008. This gracious exit will entail debunking the ZWL immediately without procastinating and ring-fencing the eroded deposits now significantly low at US$1.2 billion given the 1:25 exchange rate.
The announced measures if not further refined are a huge disincentive to exporters and may deter exports going forward. Latest data released by Fidelity Printers shows that gold which is the largest forex earner, recorded a sharp plunge in February 2020 at 1.4 tonnes. This was the lowest performance in 16 months. What this data shows is that performance of the gold sector is directly related to currency dynamics. At Zimbabwe’s lowest point in 2008, gold production touched the lowest point at 4 tonnes before rebounding after dollarization. Producers of gold notably small scale miners are swift to channel their produce to markets where they can obtain the full value of their produce other than selling to RBZ at an almost 25% discount. The imposition of retention given a pegged rate would further negatively impact deliveries through the RBZ.
Given that gold accounts for about 20% of total earnings the net effect on forex receipts into Zimbabwe is adverse. This sample is representative of the broader mining sector and for large scale producers, the best way to preserve value would be to scale down production and increase it in future when the currency issue is solved. Again this reduces potential forex earnings in the short run. Another commodity tobacco, may suffer the same fate with the marketing season just a few weeks away. Although it is not easy to side market tobacco, a pegged exchange exchange at sharp variance to real market rate would deter future production.
Broadly what we will likely see is that the export sector, particularly on the commodities side, will choke and this will be further compounded by the coronavirus induced global economic slowdown. Now having painted the picture on the earnings side, let us look at the likely behavior of holders of forex after they have earned their forex. A peg of 1:25 has failed to stimulate flows onto the interbank market and thus is not representative of the fair value of the Zim dollar. Exporters will thus continue to pursue off-market trades and shunning the official market. Left on its own, the RBZ will not be able to fully satisfy demand given retentions and liquidated funds. Playing at the peg will cause serious market dis-equilibriums and arbitrage and this promotes hoarding among other ills. These arbitrage activities will be further compounded by a low-interest rate in the face spiking Zimdollar inflation.
The settlement of local invoices is another key contentious point. Exporters would be more than willing to settle local invoices in real dollars as it would help them cut local costs by about half. Rather settlement in ZWL will require ceding or conversion at an RBZ predetermined rate of 1:25 unless if it is Nostro to Nostro. Cornered, local providers of services will inflate the USD charge to compensate for the loss in exchange rate. So for a service of US$500, a service provider will invoice US$1000 to retain full value given that the parallel reference rate is almost at double the peg rate. The net loss will have to be carried by the exporter, further discouraging exports. The RBZ will have to allow inter-Nostro transfers for local settlements to protect either side transacting. We are therefore likely to see a proliferation of Nostro accounts which will also make it easy for government to collect USD taxes and subsequently pay its workers in forex.
RBZ is thus fully aware of the implication of maintaining a dual currency system in a volatile environment. The move will simply result in a sharp buttering of the local currency. There is no middle road in this currency game given the context of our economy. The bank is also aware of the consequence of maintaining a pegged currency. It rolls back efforts to drive the economy towards a market-led model. It actually causes serious disjoints and dislocations in the economy which heightens rent-seeking. The move to fully dollarize may, therefore, have to be speeded up as time wasted may have a negative impact on an already distressed productive base.
Equity Axis is of the view that RBZ is well aware of the drawbacks highlighted above and their implications. Against this, we believe what has been pronounced so far is simply an indicator of the policy direction the government is taking. The government is making a u-turn to reverse de-dollarisation. In-fact on good faith, this author was told by the highest monetary authority that the move is meant to help the economy reconfigure and rethink de-dollarisation which this time will not be forced but collectively shared and adopted on a gradual basis. We urge the Bank to move in quickly to close the policy gaps and the only way to do it is through a more effective re-dollarisation and then de-dollarisation after at least 5 years. COVID19 could only be a convenience.