• ZiG experienced its first depreciation in the formal foreign exchange market since its inception
• It eased by 1% against the US dollar on a week-over-week basis, suggesting potential disconnect between currency peg and underlying fundamentals
• The depreciation occurred despite rising global gold prices, which typically should have supported the ZiG's value,

Harare- The ZiG has experienced its inaugural significant depreciation in the formal forex market since its inception, as per the data reported by the Central Bank. On a week-over-week basis, the ZiG was quoted at 13.5812 per US dollar, a 1% devaluation from the previous week's rate of 13.4510 per greenback.

This was the first time the currency has crossed the 1% decline, following a 0.7% drop witnessed on May 9, 2024, where it weakened from 13.4 to 13.5 per dollar and o.6% decline on the 26th of April where it eased from 13.3457 to 13.4218.

Apparently, the ZiG depreciated twice, but the declines were both less than 1% without rounding the figure.

ZiG is pegged to the price of gold, and this depreciation has occurred during a period of bullish sentiment in the precious metals complex. Last week, the spot price of gold rose to $2,328 per troy ounce, up from $2,321.2 the prior week. Typically, when a currency is directly linked to the value of a commodity like gold, its exchange rate should appreciate in tandem with the underlying asset.

This divergence between the ZiG's performance and the strengthening gold market suggests a potential dislocation between the local currency's peg and the actual gold reserves held by the Zimbabwean government. When a currency is pegged to a commodity, its exchange rate is meant to fluctuate in lockstep with the market price of that underlying asset, rather than being solely driven by domestic supply and demand dynamics.

Previously, the major problem surrounding the currency crisis in Zimbabwe was a lack of confidence in the currency due to policy missteps by the authorities. The government now suggests they have enough gold reserves to anchor the currency in circulation, and for the first time, the ZiG depreciating against other currencies, going against expectations.

If the gold reserves are indeed sufficient to support the currency, the first bigger issue then for the latest depreciation becomes the emerging deficit in economic confidence. Even with a gold-pegged currency, due to continued uncertainty around economic policies and mismanagement of funds, investors and traders may still choose to sell off the ZiG, leading to further depreciation.

This dynamic was seen previously in Argentina in the early 2000s. Argentina had implemented a currency board system that pegged the Argentine peso to the US dollar. However, growing fiscal deficits and broader economic instability ultimately led to a collapse of confidence in the peso. Despite rising global gold prices, the peso continued to depreciate as investors sold off the currency, ultimately resulting in the collapse of the dollar peg in 2002.

The key lesson seems to be that restoring confidence in a currency requires more than just implementing a hard peg or linking it to a commodity like gold. Underlying economic fundamentals and policy credibility are critical factors that determine whether an exchange rate system can be successfully maintained over the long-term.

Secondly, given confidence is there as the government suggests, the most plausible explanation for the depreciation of the currency could be concerns about the underlying gold reserves. If there are doubts about the government's ability to fully collateralize the currency with sufficient physical gold holdings, that could undermine the credibility of the currency peg and lead to speculative selling pressure and a weakening of the exchange rate.

In previous analyses published in our flagship financial publication, The Axis, we projected that the reported gold reserves, given the 18-month period over which they were accumulated compared to other monetary instruments like gold coins, are likely substantially less than the 2 metric ton figure claimed by the government.

However, the government still has stated that it maintains adequate gold stockpiles to support the ZiG. This brings us to a third potential driver of the currency's decline - imbalances in supply and demand dynamics.

If there is heightened selling pressure on the currency relative to buying interest, even amid rising global gold prices, that selling pressure could drive the exchange rate lower. The ZiG has a limited utility, as the majority of basic goods and services are still transacted in US dollars.

The pricing of fuel, passports, most airline tickets, and licenses are all denominated in USD, making the greenback the de facto medium of exchange. The ZiG is primarily used to purchase goods in large-scale retail outlets.

This dynamic has resulted in a situation where individuals and entities are incentivized to sell their ZiG holdings to acquire USD for major transactions. The lingering memories of the 2008 financial crisis have also contributed to this risk-averse behaviour, as economic agents seek to hedge against potential ZiG devaluation.

It is important to understand that the exchange rate of a currency is determined by the market forces of supply and demand. Even if a currency is pegged to a commodity like gold, its exchange rate will still fluctuate based on the relative appetite to buy or sell that currency.

If there is a higher selling pressure on the ZiG (i.e., economic agents and institutions seeking to offload their holdings) compared to the demand to acquire the currency, then this excess supply will exert downward pressure on the ZiG's exchange rate, leading to its depreciation.

Therefore, the gold peg does not necessarily ensure exchange rate stability if the underlying supply and demand fundamentals for the currency are imbalanced. The excess selling pressure can overwhelm the gold backing and lead to currency depreciation.

However, as a mechanism to bolster broader usage, the government has recently empowered taxpayers to settle their tax obligations on a 50-50 basis, utilizing both foreign currency and the local currency.

This policy intervention is expected to anchor the performance of the ZiG currency in both the parallel and formal exchange markets, thereby strengthening it against the US dollar.

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