In what could be a surprising u turn, the Government fixed the exchange rate on 26 March 2020, whilst opening up for the usage of free funds for domestic transactions.
This comes exactly fifteen days after the Minister of Finance and Economic Development, Professor Mthuli Ncube and the Central Bank Governor, Dr Mangudya, jointly committed to supporting effective de-dollarisation, anchored on strengthening the managed floating exchange rate system during a press statement on measures to stabilise exchange rate and reduce inflation on 11 March 2020.
Whilst the Government’s justification for fixing the exchange rate and allowing usage of free funds locally may sound sensible in light of the need to support pricing stability during the Covid-19 induced lockdown, which was initially effected on 30 March 2020, it is the same interventionist policies, which got us into the economic mess we are in today.
This gave rise to growing voices calling for quick return to the market based exchange rate policy. Whilst it’s comforting to learn that the Government finally listened to the market through the introduction of Foreign Currency Auction System on 23 June 2020, it is more important that supportive measures are implemented to minimise risk of failure like what happened in 2003, when the same system was introduced.
The Foreign Currency Auction system is intended to address the allocative inefficiencies characterising both the interbank market and the fixed exchange rate policy, typified by widening disparity between official and parallel market exchange rates.
Even before fixing the exchange rate at US$1:ZWL25, the gap between the official and parallel market rates was widening at an accelerating pace, ostensibly due to tight control of the exchange rate by Reserve Bank of Zimbabwe (“RBZ”).
As at the date of fixing the rate, the Zimdollar (ZWL) was trading at an average of US$1:ZWL26, against parallel market rate of around US$1:ZWL40. By 23 June 2020, when the fixed exchange rate system was abandoned the parallel market rate had depreciated to US$1:ZWL100.
A similar trend was observed when the exchange rate peg (1:1) was initially abandoned on 22 February 2019.
The official rate jumped to U$1:ZWL2.5, while parallel market rate depreciated to US$1:ZWL3.5. This is what they call exchange rate overshoot effect and underlies the danger of maintaining a fixed exchange rate.
Interesting even the parallel market is proving to be an inefficient price discovery mechanism due to widening rate disparities. Surely how do you explain the difference in exchange rate from US$1:60 to US$1:ZWL100 in this market.
This leaves us with no option to but to support the newly established foreign currency auction system, and a return to the multiple currency system, on which the former shall be anchored, as a better alternative to the current systems.
Whilst I previously voiced my concern over continued use of the multiple currency regime, before its abandonment, as high preference for US$ in the currency basket was accelerating ZWL depreciation, it’s important to accept that it’s now too late to insist on ZWL mono currency regime, as it is currently under serious pressure due to its rapid depreciation. This state of affairs is now threatening complete rejection of the ZWL by the market. As such we should now be more concerned about salvaging the ZWL before the economy slips into costly redollarisation.
Admittedly, stabilising the local currency today requires adopting a measure of multiple currency elements, anchored on the dual pricing system. In short, the only way to salvage the ZWL today is to create demand for it, which entails an efficient foreign currency auction system.
This may require enforcement of the dual pricing system, which will only work if supported by an allocatively efficient foreign currency auction system.
Allocative efficiency is necessary to ensure that those who accept ZWL are able to exchange it for foreign currency needed to meet their import requirements, in the foreign currency auction market.
Due to its low preference as a store of value, ZWL usage will be preferred more for transactional purposes, much to its relief.
This means businesses, which accept the ZWL, will only comply if they are convinced that the chances of securing foreign currency from auction system are high. Importantly, this speaks to the need to adequately beef up the supply of foreign currency in this new market.
Whilst, Zimbabwe has been perennially facing foreign currency problems, exacerbated by inordinately increasing demand for, the situation is exacerbated by inefficient allocation of this scarce resource.
In what can be viewed as a reaction to the market concern over the allocation of foreign currency surrender portion from export proceeds by RBZ, which ranges between US$2-3 billion, RBZ is now expected to release a significant amount of this to liquefy the auction system.
This supported with lines of credit that the Central Bank advised has arranged is expected to give a major boost to the auction market, thus giving some comfort to generators of foreign currency, mainly exporters .
The injection of foreign currency surrender portion by RBZ means weaning off the so called “essentials”, mainly fuel and electricity, from largely currency subsidies, which were destablising our currency.
Whilst it would appear from the initial results of the new foreign currency trading system, that the auction system has started off well, it should be emphasised that our economy is not sitting in the right space giving no room for failure of the foreign currency auction system.
The fact that total of US$10,34 million was allotted on the first day of trading is approximately half of the average daily foreign currency inflows of US$20-25m, indicate that there is huge room for improvement as regards foreign currency allocation. However, the biggest elephant in the room is lack of confidence.
As such, there is need for policy makers and leadership to summon a spirit of honest, seriousness and transparency in everything they do. We really need to redouble efforts to restore confidence in the market.
However, as they say success breeds success, the performance of the coming trading sessions, is key to resuscitation of the much needed confidence to stabilise the currency and prices.
For now, it is important to concentrate of proferring advice on measures to strengthen the foreign auction system, which is the subject of my next instalment.
Persistence Gwanyanya an Economist, Chartered Banker and Trade Finance Specialist. He is also the Founder, Futurist and Vision Consultant of Bullion Group. Feedback whatsApp +263773030691 or email [email protected]