Financial Gazette (Harare)
3 May 2006
editorial
Harare — IT has always been said that it is only sex and inflation that are characterised by a rising rate of interest.
Inflation, which the authorities in Zimbabwe have acknowledged is a millstone around the economy, rose to a frightening 913.6 percent in March. And the outlook remains very bleak.
It is frightening not because the rise had been unexpected but because it is said that if you see the evidence of accelerating inflation it may be too late to prevent it, which is why other economies believe in pre-emptive actions. As it is, Zimbabwe is now much further away from reducing the rate of inflation to single digit levels than it was when the economy touched off the long running meltdown.
And as if to confirm the anxiety caused by the rising inflation, the Reserve Bank of Zimbabwe last week responded by hiking the overnight accommodation rate to 850 percent for unsecured lending and 800 percent for secured lending as it struggles to maintain a tight monetary policy and positive interest rates.
We have no quarrel with pursuing a tight monetary policy to tame inflation which interferes with the efficient allocation of resources by confusing price signals, undercutting a focus on the long run as well as distorting incentives. We are only too aware that inflation imposes a speed limit on economic growth, which is why economic experts are agreed that curbing inflation is probably the most important factor in producing a growing economy.
And from its intervention last week, it would seem that the central bank, which controls the country's financial levers, seeks to achieve price stability by holding the line on inflation as the key to economic stability, surplus and security.
However, we are afraid there is always a dark side to the high interest rate regime adopted by the central bank, particularly in Zimbabwe where the economy has been growing slower than the real interest rates. This means that the national debt has been growing faster than the government's ability to pay it back. As it is the government domestic debt currently stands at an incredible $15 trillion from just over $3 trillion in January 2005.
The International Monetary Fund has argued that those in debt usually welcome inflation because it makes existing debt -- if it has a fixed rate -- cheaper to service and repay. However, the surge in inflation does not, in this case, provide the government with a reprieve. It is not going to float the government's debt problems away because only unanticipated inflation reduces debt since creditors negotiate the terms of each loan with a keen eye for anticipated inflation to ensure a reasonable real rate on their money. Suffice to say that the rise in inflation has long been anticipated.
So, apart from the fact that government cannot raise interest rates up to a certain level without disrupting financial markets, what are the implications of a high interest rate regime to Zimbabwean government debt? That is the question given that in Zimbabwe there has been a persistence of budgetary shortfalls during a long period of peace in which governments traditionally pay off debts and save for the future.
The stubborn budget deficits are a reflection of government's failure to live within its means, which forced it to borrow in a desperate bid to survive. If deficit spending remains the norm rather than the exception, how does the situation develop from here even with the aggressive interest rate policy, if government does not rein in its profligacy? Will the RBZ get its desired results?
The picture is radically altered if the more-than 300 percent recent increase in the civil service wage bill is factored in. This is a straight increase in government recurrent expenditure totalling $60 trillion in the next eight months which can only stoke demand-pull inflation, coming as it does at a time when the economy has hit historic contraction. Thus the domestic tax revenue base is ever dwindling resulting in meagre tax receipts. To make matters worse, the local tax rates have for a long time been in that territory where the law of diminishing returns has taken over, which means there is very little room to manoeuvre.
Thus the government will either have to seek recourse to the domestic markets to finance the wage increases or the central bank's printing machine has to run twenty-four-sevens. And that would be a recipe for disaster. It would be tantamount to watering a waterlogged garden, risking impairing the quality of the crops as nutrients are leached away because there is already excess money in circulation. We do not have to belabour the fact that this leaves Zimbabwe in a catch-22 situation because money supply growth will not be consistent with real economic activity. Yet there can never be a vibrant economy without sound money. Economic reality is unequivocal on that.
In our own estimation, nothing can be more telling than the fact that, despite employing the interest rate policy to fight inflation, the government has all along been chasing its own tail. This only adds urgency to the need for fundamental structural reforms in the economy, the extent of whose mess is underlined by the fact that even after the 300 percent salary hike, most of the civil servants still remain below the conservative breadline of $35 million.
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