4 July 2014

Zimbabwe: Dealing With the Liquidity Crunch

THE country continues to experience a slowdown in economic activity across all sectors of the economy.

There is visible deterioration of economic fundamentals and economic stress signals in the country evident through a number of factors.

The Bankers' Association of Zimbabwe's (Baz) senior economist Sanderson Abel describes liquidity as the ability of an economic agent to exchange his or her existing wealth for goods and services or for other assets.

Two important concepts are important in the definition of the liquidity concept.

"First, liquidity can be understood as a flow (as opposed to stocks concept.) This means liquidity refers to the unhindered flows among the agents of the financial system, with a particular focus on the flows among the central bank, commercial banks and markets," he said.

"Secondly, liquidity refers to the ability of realising these flows. Inability of doing so would render the financial system illiquid. Hence, an asset is liquid if it can be bought or sold quickly at low transaction costs at a reasonable price.

Liquidity also refers to the availability of instruments (market and non-market) that can be used to transfer wealth across time periods. An asset is liquid if it allows agents to consume inter-temporally as they please."

Abel said the factors responsible for the economy's stress signals include worsening current account balance and deterioration in the balance of payments, low aggregate domestic demand revenue underperformance, worsening capacity utilisation levels, de-industrialisation, company closures and increasing joblessness, shrinking deposits in the economy as well as liquidity challenges.

"Liquidity encompasses three forms: market, funding and accounting liquidity.

Market liquidity is the ease with which an asset can be converted in to a liquid medium, mainly cash.

Funding liquidity refers to ease with which borrowers, both firms and individuals can obtain funding in the form of credit.

Accounting liquidity is institutional, especially a bank's balance sheet health, with regards to short term (cash like) assets. This determines the ability of a bank to meet its obligations when they fall due.

When the three forms of liquidity do not work in tandem they may induce an economy wide shock that result in a financial crisis and in some cases bank runs. During a liquidity crunch obtaining credit becomes difficult and when available, interest rates and collateral requirements are high," he said.

He said the adoption of the multiple currency system in January 2009 was followed by persistent liquidity shortages and these compounded the challenges in the banking sector to a large extent.

This adverse development has had debilitating effects on government's initiatives to firmly steer the Zimbabwean economy onto a recovery path.

This reflects the negative effects of repeated disruptions to the traditional mechanisms of liquidity creation and transmission, both at the aggregate and individual levels.

"It is important to note that, within the auspices of a multiple currency regime, where the Reserve Bank does not issue currency, liquidity sources are limited. In this respect, the country's liquidity situation is contingent upon developments on the external sector front.

Other than domestic deposit mobilisation, which, to a large extent, is currently limited, the major sources of liquidity are:

Export earnings;

Diaspora remittances;

Offshore credit lines;

Foreign direct investment inflows; and

Portfolio investment inflows."

Abel said the negative impact of the prevailing liquidity challenges have also been felt on the inter-bank market, a key component of the money market and the starting point of the monetary transmission mechanism. Regrettably, the potency of policy initiatives geared at enhancing access to finance has been severely undermined by liquidity constraints that have remained an albatross around economic recovery efforts.

Lack of Balance of Payments and budgetary support as well as limited access to offshore lines of credit have also compounded the liquidity conditions.

"Liquidity is important in an economy because the functioning of the entire financial system, the implementation of monetary policy, the efficiency of payment systems, and the borrowing conditions of households and firms depend both on an adequate amount of liquidity in the economy and on its adequate intermediation through the banking system," he said.

The Monetary Policy Statement issued by the RBZ in January 2014 identified that the liquidity problems currently affecting the country presents themselves in a vicious cycle.

The circle identifies the following as the challenges; lack of competitiveness of the products, declining capacity utilisation, low export earnings, low liquidity levels, increased banking sector vulnerabilities, and limited deposits and credit availability. Abel describes this as the vicious circle of liquidity.

"The question is; how do we break the circle? This vicious circle shows that the liquidity problem currently affecting the economy pervasively permeates the financial, export and manufacturing sector," he said. "Growth in exports of goods and services has remained low while at the same time, imports have accelerated as domestic industry production has declined.

Expansion in imports, as against static exports, means that the current account is widening and the economy is thus hemorrhaging liquidity. The challenge is that there are no incentives for exporters.

He said the lines of credit are few and high priced due to the risk premium attached to the current external debt and arrears.

"The current debt overhang of US$6,1 billion continues to be an albatross on the neck of the economy, hence the need to continue to adhere to the various programmes which government has initiated with the support of multilateral financial institutions," Abel said.

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