“For exports are the oxygen necessary for economic growth”
Reserve Bank of Zimbabwe put sudden 40% taxation during the early days of January 2021 in the name of export retention thresholds. The taxes were meant to increase the nation’s foreign currency reserves and make the business community accept the local currency.
On 7 January 2021, the Reserve Bank of Zimbabwe (the RBZ), through its Monetary Policy Committee (MPC) amended the monetary policy regime in respect of surrender and liquidation of foreign exchange receipts in a Press Statement issued on 7 January 2021 titled “Resolutions of the Monetary Policy Committee Meeting Held on 7th January 2021”. Through the Statement, the RBZ resolved inter alia:
to remove the compulsory requirement to liquidate all unutilised export proceeds after 60 days, with effect from 7 January 2021; and
to increase the export surrender requirement from 30 % to 40% on all export receipts, with effect from 7 January 2021
Why 40% retention tax?
Previously, foreign currency retention thresholds were that 30% of foreign currency receipts of exporting service providers would be liquidated at the point of depositing funds in their domestic foreign currency accounts (FCAs).
This meant that 30% of the foreign currency received through exports would have to be converted to the local unit on receipt at the prevailing rate of exchange on the Reserve Bank of Zimbabwe (RBZ) foreign currency auction.
The removal of the compulsory requirement to liquidate all unutilised export proceeds after 60 days was a positive step for the business community
However, the increase of 10% in export thresholds terminated the goodness of the 60-day liquidation requirement as exporters are not given an opportunity to utilise their funds for the greater good.
In trying to mend the economics of the country, the retention threshold posed a threat to both micro economics and macro economy at large.
Why 40% tax
From the initial start of the 40% retention tax to exporters, the Central Bank had a positive outcome in both the functioning of the auction system and economy at large.
One of the reasons for the increase of retention thresholds was to weaponise the auction system. The auction system was set in June 2020 to provide foreign currency to a number of selected companies. However, in a country suffering efficient foreign currency reserves, one of the ways to fuel the auction system was to take part of the exporter’ earnings and put it in the coffers of RBZ.
The central Bank further aimed to promote local products. Local products are considered expensive compared to imported products due to a variety of factors. In order to counteract this, companies substitute locally produced raw materials with imports. However, from an economic perspective, this does not drive up the economy. Rather, it makes a nation a net importer, which leads to trade deficits. As a protective mechanism, the Central Bank up ticked the retention thresholds to 40%. Most companies require foreign currency to do their operations. Therefore, if they have insufficient foreign currency, they are forced to buy locally produced products and services which is good for economic growth.
Further, the other reason was to promote the use of local currency, the Zimbabwe dollar. Introduced on 2020 as the legal tender, the 40% was meant to let business community accept the use of the local currency in conducting operations.
Promoting economic growth by means of driving on an exponential increase in exports diversification was another reason. These all sounds correct and productive on paper, but, considering the volatility in the economic environment, the measures gave birth to a headless child.
The other side
The main problem to the retention tax is the incapacitation of the auction market. The system itself is under-equipped. It is not ready to face its battles of providing a flow of forex to the drying throats of companies.
Number of days stretching to over six weeks is a testimony to the inadequacy of the system. Since its birth, the auction system has been lagging behind in availing allotted funds. Many companies depend on forex to sustain operations. Sacrificing 40% to be given in local unit hinders growth. Mining outfit, RioZim and National Tyre Services are some of the companies that faced production challenge due to forex issues.
Secondly, disparities between the parallel market and RBZ auction rate poses a great danger to companies. The black market is almost twice of the RBZ rate. Currently, a single United States dollar is trading at ZWL115 against nearly ZWL250 on the parallel market. Considering inefficiency of auction system, companies are losing half of the value they are working for as some are forced to source funds on black market.
Besides that, raw materials sold locally uses the parallel market rate. As the local unit is depreciating at an unanticipated race, companies who sell raw materials are likely forced to dump the RBZ rate and use the parallel market rate to charge for their products. This means that company’s losses 20% of their 40% given in Zimbabwe dollars. A disaster.
Effect on Macro-economic activities
Though the move for 40% was motivated by the greater good, the RBZ read its impacts far but not further. Firstly, the tax is starving importers. Not all raw materials are locally produced. Most of them are produced abroad and they require the scarce available greenback. This doesn’t improve economic growth. Secondly, if 20% of the company’s proceeds are already lost due to currency fluctuations, the exporters a running a big loss. Companies are set up with the aim of making a profit. This forces the business community to inflate their product prices in local currency, father fuelling currency instability which the RBZ is trying to starve.
On the other hand, consumers are also forced to run away from highly priced local products and smuggle goods from South Africa, Zambia and Mozambique through the Malaicha buses and porous border posts. This again, affects the Central Bank’s aim to support locally produced products. This translates to shooting oneself through the foot.
If locally produced goods become expensive, customers will distance themselves from such products. This makes a firm run losses. Similarly, if the company losses every 20% of its 40% retained at local currency, basically it will see more profits in selling products locally than abroad.
This means companies will divert from exporting products to just selling locally. The 40% retention threshold has a possibility of forcing exporting companies to retard from exporting if local sales are considered beneficial.
If exporting tea, gold or any commodity will lead to a 20% deficit in every trade, which is not there in local trade, therefore, producers will go for where there are no costs. This inturn, reduce exports which is bad news for an economy. Other than that, the taxation promotes illicit trade such as smuggling of minerals and other commodities outside. Another bad news for an economy as well.
Why exporters mater at macro-economic level
The dollar is the most important currency in the world today. It is a reserve currency. This means that international trades happen either in dollar or gold. Essential commodities like oil and gold are priced only in terms of dollar or gold. Hence all countries need dollars for their survival.
Exports are the only way to earn dollars. It is for this reason that exports are considered to be vital to the solvency of a nation. A thriving economy can suddenly implode in the absence of dollars. This is because they will not be able to import essential commodities. Hence, exports are considered to be the lifeline of ant economy. This is why governments all over the world create special schemes to spur exports.
Exports lead to domestic production. Domestic production requires domestic labour. Hence, exports lead to an increase in employment in the nation. Apart from direct employment provided by exports, there is also a spill over effect.
This means that once export workers get paid, they also spend their money to consume goods and services. This leads to even more job creation. As a result, the entire economy develops. Economists often cite the example of China while explaining this point. The unemployment rate in China has been drastically cut down after the export-oriented policies were brought into place.
Exports are a very important tool to spur economic growth in a country. This means that exports can also be used to recover from recessions. The logic behind this is simple. During the recession, there is a negative sentiment in the entire economy. Factories and offices stop giving wage increments. As a result, consumers start deferring their purchases. The result is that a vicious cycle ensues and production comes to a halt.
During the same time, other countries around the world are not suffering from a recession. Hence the consumers in these countries are willing to spend. It is here that exports come into play. Exporters from recession prone countries can send their goods to nations with favourable economic climate. This will increase the local GDP and reduce unemployment. This puts the economy upward.
Exports themselves are a component of aggregate demand (AD). Rising exports will help increase AD and cause higher economic growth. Growth in exports can also have a knock on effect to related ‘service industries.’ For example, the success of gold exports at RioZim will help the local economy with local clubs and shops benefiting from increased spending. Similarly, a fall in exports, during a global economic downturn can have a big negative impact on an economy.
Also, the strength of exports has a large role in determining the current account deficit. For the past one and half few decades, Zimbabwe has had a persistent current account deficit, which many attribute to the nation’s relative poor export performance. Year on year, Zimbabwe has been facing a trade deficit, positioning it as a net importer.
The bottom line is the RBZ needs to put in charge policies that are tasteful to the exporters to alleviate its currency dilemmas.
What Zimbabwe needs to do
From an economic point of view, the core problem facing Zimbabwean exporters is the shortages of foreign currency. Zimbabwe needs to look for a bailout loan from lending banks internationally and fill in its coffers like what Zambia, South Africa and Greece recently did. However, this requires a number of reforms, politically and economically. Zimbabwe needs to divert to clean politics that accommodates divergent views and political parties. Also, the nation owes billions of dollars to multilateral lenders that needs to be addressed first.
Secondly, abolishment of the 40% retention threshold seems healthier for the betterment of the working environment. Although the Central Bank is trying to raise foreign currency etcetera, if the taxes are harming intended beneficiaries, then they should cease to exist. If not ready for such a move, the RBZ can either reduce from 40% to less than 20% as the captains of industry advocated for last year.
Like other countries, Zimbabwe need to promote exports. Almost every country offers financial incentives to exporters. Countries like China have Special Economic Zones wherein exporters are not charged any tax. Similarly, other countries have special banks and insurance agencies promoted by the government to facilitate export growth. Zimbabwe need also to promote these for the best of the economy.