Problems and Perspectives of the Foreign Currency Auction System

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  • The weekly forex exchange auction was introduced to reduce the parallel premium
  • Marred with confidence deficit amid claims of rate manipulation
  • Rising parallel premium promotes opportunities for large scale rent seeking activities

HARARE – Since November 2017 when President Emmerson Mnangagwa took over the helm of power from the late President Robert Mugabe, the government has launched a number of strategic initiatives aimed at ensuring the country’s economic growth, political stability and re-establishing Zimbabwe as a major player internationally.

Certainly, one of the most notable is the introduction of the Reserve Bank of Zimbabwe’s (RBZ) weekly foreign currency auction system in June 2020, replacing the interbank market that came into operation in February 2019.

The forex trading platform based on the Reuters system was introduced primarily to help build market confidence, improve access to foreign currency and stabilize the exchange rate while speculative activity on the black market could subside.

There was a wave of optimism among industry players, including the Confederation of Zimbabwe Industries (CZI) which through vice president Joseph Gunda said that the industry was highly expectant that the auction system would bring about transparency in trading of foreign currency, ensure market-led price discovery and improve availability.

Sustainability of stability questioned

34 weeks later since the first forex auction, questions linger on the effectiveness of the system in addressing some of the issues aforementioned. On a positive, but debatable note, the Zimbabwe dollar recorded a sustainable run of stability against the greenback stretching 21 weeks between mid-August 2020 and late January 2021.

Regardless of that run, questions on the sustainability of the stability still dominate the market, with some observers accusing the Central Bank of manipulating the exchange rate. To this end, there is a general consensus that the forex auction system is not based on free-market principles, as the government officials would like to claim.

In the latest interbank weekly review report, Equity Axis research highlighted the widening variance between the official exchange rate and the parallel rate. The variance has widened from a premium of 23% in October 2020 to 45% in February 2021.

“The parallel rate premium is now being seen moving towards the peak June 2020 levels of 48%, that is around the time just before the weekly foreign auction system was unveiled,” Equity Axis said.

Implications of this widening variance

Scholarly research shows that the development of the parallel market for foreign exchange with a high premium indicates a basic disequilibrium both in the foreign exchange market and trade regimes and, as a result, involves substantial social and economic costs.

The black market premium is directly linked to macroeconomic variables. A rising premium is shown to have negative impacts on official exports and foreign trade taxes, as well as a positive effect on capital flight. It promotes opportunities for large-scale rent-seeking activities while squeezing the tax base in foreign trade transactions.

Government’s role

The government’s restrictions and limitations on foreign exchange are fuelling demand for alternative sources. Thus, the government’s inability to meet the demand for foreign currency and its interference in the operation of the market has a propensity to fuel the creation of a parallel market for foreign exchange.

As part of the controls, RBZ ordered that exporters are required to surrender their export proceeds (partly or wholly) to the government within a specified period of time after which appropriation is instituted. On the other hand, holders of import licenses have access to foreign currency at a cheap official rate.

At the same time, capital account transactions are restricted to a few transactions carried out selectively through a limited number of officially authorized channels. These restrictions have, however, transformed normal economic transactions into privileges, creating economic rents that have benefited both the government officials who implement the policies and the few economic agents who enjoy the privileges.

This is happening at a time when a fraction of the informal sector still highly relies on parallel markets for forex and the subsequent pegging of commodity prices.

Disequilibrium in the foreign exchange market

According to Equity Axis Research, a widening variance between the interbank rate and the parallel rate is seen as a major economic destabilising factor.

“There is room for some demand to go through the parallel market due to forex supply gaps given the narrow variances in supply and demand. Likewise, frequent volatility in ZWL money supply in recent months as shown by a spiking base money supply could also create a ZWL liquidity glut over a short period, thus driving demand for parallel market forex up and consequently impacting the exchange rate,” Equity Axis said.

Foreign currency shortages have been a perennial economic problem for Zimbabwe, and although it has been on up and down since independence, the country has for the large part been living with very high black-market premiums. The adoption of the weekly forex exchange auction was meant to reduce the parallel premium, but the system is marred with a confidence deficit amid claims of rate manipulation by the authorities.

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