Opinion: The balance of risk to the inflation outlook is tilting to the downside

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  • Lower inflation propels economic growth
  • Gradually increasing fiscal spending, a risk to exchange rate and price stability
  • For stability, RBZ should engage in aggressive market liquidity management

Zimbabwe is one of the few countries worldwide battling too high inflation. Though the monthly outturn is hovering in the single-digit territory for 9-straight months now, annual outturn which is still in the triple-digit region remains unsustainable.

Most people, when they hear the word inflation, they relate it with doom. However, low inflation (2 percent at conventional standards) is desirable since negative inflation (deflation) is harmful. When average prices continue declining, it changes the narrative for most consumers as they develop downward inflation expectations which then affect business investment. Also, deflation increases the real value of debt thereby reducing disposable incomes of consumers with high debt levels.

However, too high inflation can wipe savings just as Zimbabwe witnessed during the 2008 hyperinflation as well as the post dollarization period (2019 to 1HY2020) when real wages fell largely thereby reducing the value of savings. Savers will be worse off when the rate of inflation is higher than the rate of interest. Too high inflation may cause an uncalled-for redistribution of income where pensioners lose significantly. More so, high average prices can make the entire economy uncompetitive. For example, high prices in Zimbabwe make Zimbabwean-produced goods and services uncompetitive leading to lower economic growth, lower aggregate demand, and a high current account deficit.

After the dollarization-induced deflation around 2017 to early 2018, inflation in Zimbabwe started to spike around October 2018 when the newly installed National Treasury chief, Prof. Mthuli Ncube, started his 5-year term. Things were tight then, with fiscal space too limited thanks to financial mismanagement in the prior administration. It is the quest to address this quagmire that led to the introduction of many economic reforms including currency reforms. Subsequently, prices started to balloon as the reforms were undertaken without any external support as the norm elsewhere.

Fast forward to the second half of 2020, monetary authorities began to change their policy stance. A conservative reserve money targeting framework was introduced together with a new exchange rate management system (the Dutch Forex Auction System). Also, mobile money transactions, which became an avenue for successful parallel market activity were curtailed. In response, exchange rates in both markets started to stabilize.

Annual average price growth started to recede in response to tight liquidity management and sustainable fiscal spending. Annual prices fell from their post dollarization peak of 837.5 percent in July 2020 to 190.07 percent by April 2021. The monthly inflation rate also scaled down from 35.53 percent registered in July 2020 to 1.58 percent as of April 2021.

In line with the past 9-months development, it is quite logical for many economic stakeholders to continue holding down inflation expectations. However, there are serious downside risks to the current trajectory.

For instance, the economy is expected to receive at least ZW$60 billion in new money injected buying farm produce for the Strategic Reserve in the next 2-3 months. To date, the Grain Marketing Board (GMB), has received at least 60,000 tonnes of maize since the start of the 2021 marketing season on April 1. The parastatal is buying a tonne of maize at ZW$32,000 per tonne. Also, spending on civil servants’ salaries which constitutes about 40 percent of total annual spending is expected to receive another upward adjustment next month. The government is expected to offer a staggered 75 percent civil service salary increment across the board in 2021.

Concerning some of the above monetary developments, the economy has started to respond. Parallel exchange rates which were averaging ZW$120 to the dollar in April are now up to around ZW$130-135 to the American dollar. This gives a black-market premium that is nearly 60 percent above the official rate of ZW$84.6. The huge variance between the black market and the official rate is a testament that forex supply by RBZ on the auction is lagging behind total forex demand by economic agents. According to best international practices and for stability to hold, the black-market premiums should be at most 20 percent above official rates.

Late 2020 to January 2021, the government witnessed a rise in its spending thanks to the payment of annual bonuses as well as increased importation of Covid-19 medicaments. Consequently, base money spiked 16 percent in January relative to the 2 percent jump recorded in December. In response, ZW$ plummeted 8 percent on the alternative market, and inflation (YoY & MoM) as recorded by the Zimbabwe Statistics Agency (ZIMSTAT) surged in that respective month.

The current adverse movement of the parallel rates also shows heightened liquidity levels in the economy. If parallel rates continue to surge, average prices will ultimately burgle significantly. In short, the stability of parallel rates is of equal importance since many businesses are benchmarking their prices to these parallel rates.

Also, the recent upward movement in parallel rates supports the view that the ZW$ is still highly fragile against the greenback. Money supply particularly reserve money (M0) is currently growing at a rate that is much higher than the growth in economic activity in the real sector. Monetarists contend that if growth in money stock far exceeds real output growth, output price will have to scale up to attain equilibrium in the market via the operation of market forces of demand and supply.

Beyond our borders, inflation is also rising thereby likely leading to imported inflation. Take note that as much as the current rise in commodity prices is good for Zimbabwe’s forex earnings, this may result in higher imported inflation. Mineral commodities have contributed about US$3.2 billion of total US$4.39 billion forex earnings in 2020 but these were mostly raw materials. Manufacturers abroad especially in the top commodity consumer, China, are facing higher input cost and in turn, will increase the price of their final output which is Zimbabwe’s imports.

Apart from rising commodity prices, rising global inflation is also linked to the increased stimulus by both fiscal and monetary authorities in response to the impact of COVID-19. For instance, to date, the U.S has spent a staggering US$7 trillion since the virus was detected in the country in February 2020. Due to excess US$ liquidity in the market and economic re-opening from strict lockdowns, consumer prices leap 4.2% in April -the fastest growth since 2008. Many economists are expecting prices to increase further months ahead unless the Federal Reserve changes its dovish (accommodative) policy stance. Since the U.S is the global economic powerhouse, its high domestic prices may have negative spill-over effects on the entire global economy.

In my view, as Zimbabwe braces for the high spending season (second half of the year), the Bank should vigorously engage in tight liquidity management exercises to mop up all excess local dollars in the system. This will be key in maintaining Zimbabwean dollar stability.

To date, the local unit is down 3.5 percent against the greenback with greater chances for further escalation as fiscal spending peaks in the coming months. Excessive money supply growth has been the major driver of exchange rate overrun in Zimbabwe and via pass-through effects led to higher prices since 2019.

Meanwhile, the government has introduced an investment and export incentive scheme (IEIS) targeting export growth. The RBZ was initially entitled to purchase and acquire 40% of all foreign currency earned by exporters while exporters retained control of the remainder. Now under upgraded retention thresholds, the Bank continues with a mandatory 40 percent acquisition on all export receipts but with changes on incremental exports. This is to say, if an exporter exceeds his average export performance, they are now allowed to retain 80 percent of forex on that increment instead of 60 percent.

Also, all companies with a Special Economic Zone (SEZ) status as well those listed on the Victoria Falls Stock Exchange (VFEX) are now entitled to retain about 100 percent of forex earned on their incremental exports. Furthermore, all large-scale gold miners exceeding their average monthly gold deliveries to Fidelity Printers and Refiners (FPR) are now allowed to export their incremental gold deliveries directly (though under the facilitation of FPR).

These new export and fiscal incentives will likely increase US dollar liquidity in the market and provide a cover for the local currency. Generally, high export growth earns foreign currency, reduces current account deficit, increases employment of factors of production and national output.

Having said all that, in my view, the balance of risk to the 2021 inflation outlook is to the downside. The onus is on the Bank to brace itself for the pending efflux in market liquidity (ZW$) emanating from increased government spending.

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