On Monday government announced an indefinite suspension of statutory instrument 122 of 2017 formerly known as SI64 before amendment. SI122 is a trade policy restricting the importation of various goods and the implication of its reversal is profound. The restrictive trade policy measures were first introduced in 2016 with the intention, according to government, of protecting local industry and value chains feeding into it, through reduced external competition. It was hoped that restricting imported products would help local production grow and in turn drive GDP while reducing the negative external trade balance through substitution.

As a background, what triggered SI64 is likely to have been an urgent need to preserve forex in light of what was then an unsustainable trade deficit as well as the need to foster a viable and competitive industry, which could contribute to future growth national product. Zimbabwe’s trade deficit between 2010 and 2015 averaged $3 billion per annum while in 2017 it came off to $1.7 billion, the lowest deficit since dollarization. However this decline was mainly as a result of export growth which came in at 31% year on year. Although an outturn of $5.4 billion in imports for 2017 was below the post dollarization average it represented a growth of 4% on the 2016 level. So instead of achieving lower imports after SI64 promulgation the aggregate’s performance was worse off. It also suffices to say the overall weight of the protected goods was very insignificant in the scheme of imports.

The policy thrust was however very visible and effective in terms of the scaling up local production through induced demand. In CZI’s 2017 report, it was reported that production in volume terms across the manufacturing sector went up by 5%. Companies in protected sectors such as food processing covering products such as cooking oil, milk and bread evidently grew volumes to full capacity between 2017 and 2018. The growth was to some extend beginning to translate downstream within value chains especially in commodities with linkages to manufacturing.

While this productivity growth was to be celebrated, sustainability of the policy hinged on Zimbabwe’s ability to sustainably earn forex via exports so as to cover for inputs with imports components. With an adverse net trade position, sustainability of the trade restrictions was doubtable from the beginning. With the growth in aggregate demand, companies began to demand more forex to import inputs for use in production and these have of late been mainly hamstrung by forex shortages. The forex crisis has since worsened and allocations to importing companies by the central bank which is managing the scarce forex, have since been going down. So in time, the growth in demand which was outrightly in surging RTGS form, outstripped supply which in most part had a USD import component and the net was a market disequilibrium and pressure on parallel exchange rate.

Should not growth in aggregate demand be celebrated as it drives economic growth?

As I have highlighted in my previous reports not all demand is good and same goes for economic growth or growth in sales volumes. Some growth is way beyond sustainable as was the case in the just ended financial year, where most companies reported double digit growth in volumes and consequently profitability. If volumes are growing at above average rates it implies production has to keep pace, and given the import component of some key products, it also means high utilization or demand for forex.

Factors of production of energy nature such as electricity and diesel are top imports at number 1 and 4 respectively, accounting for over 30% of total imports by value. Other top imports are inputs utilized in bread production and cooking oil manufacturing, these being wheat and soya bean oil. So as aggregate demand growth was celebrated, the cost in terms of imports was often overlooked. What was worrying in this case was the deliberate demand inducement by government through increased money supply. It is however also key to note that some real growth came especially from the mining sector where key exported commodities recorded volumes growth. The scrapping of SI122 of 2017 is therefore an admittance by government that it erred in terms of the extent to which it created additional money in the economy.

Be that as it may, the turn in inflation in 2017 was not without context. In 2016 we highlighted the possible price push impact of SI64, which would be driven by constrained localized supply. With limited foreign competition there was always a possibility of price manipulation or natural price firming driven by prevailing fundamentals such as relatively higher cost of utilities and production costs, among others. That these costs are way above the regional averages would normally result in higher prices for the locally produced goods and this price increases would be reflected through inflation.

So the emergence of inflation in 2017, before the sharp tumbling of RTGS relative to dollar which caused price distortions, could be traced to SI64 adoption. While protectionism can be effective in driving local production and gradually reduces unemployment, its timing is significant. Protectionism should normally be pursued in periods of growth and stability such as the 2016 trade protectionism pursued by the US. Pursuance of such a policy measure should also follow other indicators such as industry capacity to absorb, forex earnings, the cost of local production and ability to substitute. Most of these factors were negative in the case of Zimbabwe at the time the policy was pursued with the only immediate push being to temporarily stem forex shortages and in part drive local production.

For companies that were producing some of the de-specified goods, it would mean laying off part of the workforce, loss of market share and further cost pressures driven by low fixed cost absorption. It would also result in serious downstream effect in value chains sectors such as agriculture whose produce is relied on for production. Most local companies have been or were beginning to get involved in contract farming along value chains and products such as wheat and soya bean were receiving attention. Farmers in these subsectors would lose out if financing is cutback or if local production of final product subsides as is the unintended expected outcome. It is not likely that the policy lifting will be reversed in 2 years and over that period a lot of ground gained in terms of local production will be forgone.

On the short end there is room for market equilibration through improved product supply, however prices cannot be expected to remain stable or at pre crisis levels even after allowing for the flow of some restricted products. We are likely to see the emergence of a strong informal market at the expense of formal market. Mainstream companies have little offshore funding save for those with regional exposure and alternate forex generating businesses such as retailers OK, Pick n Pay and Choppies. For most companies funds either at the retail end or the production side, their funds are with local banks and therefore remain subjected to the mercy of the central bank. It is also likely that pricing for most of these consumptive products will follow parallel exchange rates unless big retailers are prioritized in terms of forex allocation. If allowed it would become difficult for the informal sector to compete or charge higher prices.

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