No economic growth without forex reform

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Victor Bhoroma
A CLOUD of uncertainty hangs over Zimbabwe’s foreign exchange market as the country nears harmonized elections to be held by August next year.

The disparity between the market exchange rate for foreign currencies and the manipulated formal exchange rate tells a story of excessive government control over the economy despite the consequences of such control on livelihoods and business .

Currently, the prices of foreign currencies are widely varied, with the auction rate set at 1 USD for ZW$458.4, while the interbank rate is set at ZW$465.4.

On the open market, the rate accelerated to ZW$800 for e-money and ZW$700 for cash (Zimbabwean dollar notes).

Repeated failures
Zimbabwe has not had a consistent currency or a consistent exchange rate policy for decades. The auction system (launched in June 2020) failed to create effective currency allocation or instill confidence in the market.

At the heart of the failure is the fact that the auction allocation mechanism does not follow the basic principles of a Dutch auction market on which it was modeled.

Amounts to be auctioned are not communicated before the auction, settlement is not made within 48 hours as communicated at launch, allocations to winning bidders are only partially made (at the discretion of the central bank) and selected bidders jump the settlement queue ahead of previous winners.

Similarly, the interbank market which was reintroduced in May 2022 (after failed attempts in August 2008 and February 2019) did not help attract willing sellers to the market due to obvious central bank manipulation. .

In recent history, the Zimbabwean economy collapsed in 1999-2000, 2006-2008 and 2019-2020 due to hyperinflation induced by excessive printing of the national currency.

At the heart of the foreign exchange problem is the government’s desire to control central bank monetary policy and to print money to finance various government projects or programs.

The preference for trading in hard currency and cash indicates a lack of faith in the central bank’s unsound and inconsistent policies over the years.

However, the absence of exchange rate reform has profound consequences for the whole economy.

Impact on the viability of agriculture
Zimbabwe has been food insecure for several years. The country depends on other African countries (South Africa and Zambia) and other global suppliers, such as Brazil and Russia for food security by importing grain worth at least $1 billion per year.

The exchange rate remains one of the major constraints faced by local farmers buying inputs and incurring costs in foreign currencies. Producers of cotton, maize, soybeans, wheat, sunflowers and traditional cereals must work with producer prices set by the government in local currency.

The effect of inflation means that the viability of agriculture is compromised by late payments.

Currently, the government pays ZW$75,000 plus US$90 for traditional cereals and maize, ZW$171,495 plus US$90 for soybeans and ZW$205,795 plus US$90 for sunflower.

Due to the disparity between different exchange rates and the depreciation of the local currency, producers began to demand full payment for products delivered in foreign currency.

The source of the problem is the spread between the auction rate and the open market rate. A liberalized and truly reflexive foreign exchange market can address these challenges facing farmers and restore the viability of agriculture.

Tobacco farmers who are paid 60% of their deliveries in local currency will also be happy to see a market-determined exchange rate.

Impact on industry competitiveness
Locally produced products already face competitiveness challenges in the export market due to high production costs in the economy. The 40% surrender requirement on all exports eats away at the slim profit margins made by exporters.

This situation is aggravated by the fact that 20% of foreign currency sales deposited with local banks are converted into local currency using the indexed interbank rate.

Producers are now diverting most of their produce to the informal market (Cash and Carry Tuck stores) where they can be paid in US dollars in cash, while avoiding strict exchange controls and tax obligations.

With production costs aligned with the parallel market, producers have no incentive to fully meet their tax obligations, fully formalize their operations or increase their productivity. This has hampered government efforts to formalize the economy and plug tax leakages in the market. There would be no need to evade foreign currency taxes, store loads of foreign currency in business premises, offload excess local currency or even adopt multiple pricing models if the exchange rate was close from that determined by the market.

This means that the existence of a local currency (without a market-based exchange rate mechanism) acts as a global tax on all exports from Zimbabwe. Exchange control measures are also hurting exports of manufactured goods at a time when Zimbabwe must prepare for the African Continental Free Trade Area (AfCFTA).

Impact on the growth of the mining sector
Minors are currently demanding a review of the retention threshold. The current export retention regime allows exporters (including miners) to retain 60% of export earnings and return 40% to the central bank.

If the 60% is not used within four months, the central bank will confiscate an additional 25% to bring the total redemption requirement to 65%.

Due to the wide gap between the formal pegged exchange rate and the market rate, miners lose 35% of their revenue due to redemption requirements or $0.35 for every $1 of exports.

With miners paying taxes, fuel, electricity and almost all consumables in foreign currency, foreign exchange regulations are a punitive tax on business viability and a deterrent to further investment in mine development or beneficiation.

Impact on financial services
Deposits in Foreign Currency Accounts (FCAs) with local banks have increased significantly to over US$1.8 billion over the past two years due to high levels of local currency inflation and lack of confidence in the formal exchange system.

This underlines the pace of re-dollarization of the market. However, the central bank is concerned that commercial banks will not lend these depositors’ funds to the productive sector to stimulate economic growth.

Actual lending in the economy has fallen from over US$1.7 billion in 2014 to less than US$700 million in 2021. Local banks have borne the brunt of currency fluctuations in the past, with the sector suffering significant losses when all loans advanced in US dollars. have been converted into local currency in accordance with the law.

Lack of clarity on currency reforms, legal tender, inefficient foreign exchange system and low confidence in the central bank mean banks will take a cautious approach to foreign currency lending. This resulted in a significant drop in interest income and the closure of various bank branches across the country.

Impact on work, households
Zimbabwe has been hit by a catastrophic brain drain with critical skills leaving the public and private sectors for neighboring countries and greener pastures overseas.

The main challenge is that wages and salaries cannot keep pace with inflation and exchange rate movements that determine prices.

Purchasing power and living standards have plummeted, leaving many households in abject poverty. A stable exchange rate and careful money supply growth can address this skill-destroying emigration while improving household disposable incomes.

Impact on electricity production
Zimbabwe canceled 6-12 hour power cuts to manage domestic demand, with a peak deficit of over 500 MW. Part of the deficit is increased by imports from Mozambique, Zambia and the Southern African Power Pool (SAPP).

The electric utility repeatedly cited exchange rate discrepancies between the approved rate of 0.9 KW/h, the effective rate if the market rate is used, and the discrepancy with the cost of generation or import of electricity from the region.

Power outages are costing the country millions daily and threatening economic growth goals, but a lasting solution remains elusive.

Overall, the Reserve Bank of Zimbabwe is very conflicted over foreign exchange management because on the one hand it needs cheap foreign exchange from exporters to pay its debt and finance government foreign expenditure (continuation of quasi-fiscal operations), while on the other hand on the other hand, it has to manage the inflation rate willy-nilly by manipulating the exchange rate.

To ensure monetary stability, the central bank should end all quasi-fiscal operations that will allow it to curb money printing and institute a market-determined exchange rate by allowing commercial banks to be matchmakers on the interbank market (as is done in most African countries).

Inevitably, the exchange rate will rise to match the domestic currency available or in demand, but will stabilize if money printing is stopped.

Commercial banks should be allowed to adjust exchange rates according to supply and demand mechanisms in the economy without any central bank manipulation.

In conclusion, the central bank should not be allowed to incur resource-backed foreign debt without parliamentary approval, as this leads to conflict over how to settle the debt while allowing the exchange rate to be determined by the market.

A pegged exchange rate remains the main obstacle to sustainable economic growth and a pain the government avoids at all costs, even if it means sinking into record debt levels that far outweigh the benefits of pegging the exchange rate. exchange rate.

  • Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). – [email protected] or Twitter @VictorBhoroma1.

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