29 August 2014

Zimbabwe: RBZ Cannot Implement Monetary Policy

Earlier this week, the newly appointed Governor of the Reserve Bank, John Mangudya, quietly released his first monetary policy statement.

The lengthy document touched on many issues including the functions of the Reserve Bank of Zimbabwe (RBZ) under the 'multi-currency system', an unorthodox monetary regime under which specified foreign currencies are officially accepted as legal tender.

RBZ's role was spelt out as being the banker to the government, regulator of financial institutions, manager of exchange control and lender of last resort.

What was conspicuously vague in the statement is how exactly the central bank will directly influence the price and quantity of money in the economy.

Since the classic definition of monetary policy refers to the actions of a central bank to influence interest rates and money supply, effectively the RBZ said little about monetary policy. One cannot fault the central bank for this anomaly.

It is an expected consequence of using other countries' currencies. In a normal setup, the central bank's ability to implement monetary policy rests on the fact that it is the issuer of the money in the first place.

Since for now the RBZ has given up this role by adopting a multi-currency regime which relies on other countries' currencies, it is hamstrung from acting in the usual way.

Normally, a central bank would buy or sell short-term government bonds, thus increasing, or decreasing, money available to the banking system and the wider economy.

In our case the option of buying bonds is not available as the central bank simply does not have the money. Selling bonds is also to a great extent not tenable.

Government bonds should normally be readily acceptable at low interest rates as they are considered free of default risk. After all, since the central bank is the issuer of money, in the worst case scenario it can always just print the money required to settle the bonds on maturity.

In Zimbabwe, this risk-free tag does not apply because the bonds would be denominated in foreign currency which the RBZ cannot print to meet payments on maturity. For this reason there has been a general reluctance amongst financial institutions to take up government paper.

A case in point is the treasury bills issued to settle RBZ's debt to Meikles Limited. The company has reportedly been having difficulties in selling the bills in the market.

In the absence of the traditional tools of monetary policy, the RBZ statement centred on other means to help improve the tight liquidity situation in the country. Because the economy uses foreign currency, the only available sources of money supply are outside sources.

Specifically, to increase the supply of money in the country one would need to improve the export earnings, increase foreign investment, solicit more donor funds or attract more diaspora remittances.

A list of what the monetary policy statement called 'policy advice' was given. Included in it was the need to increase foreign direct investment and improve on clarity of investment regulations.

Indigenisation, one of the controversial policies blamed for dissuading foreigners from investing in Zimbabwe, was discussed. While the monetary policy statement called for more clarity on the policy, it failed to acknowledge that, clarity aside, the policy does just not appeal to investors.

Perhaps one reality that most Zimbabweans are reluctant to face is that having your own currency allows you certain flexibility, policy-wise. Hyperinflation left most people in the country with a deep distrust of the monetary authority and it will take time for this stance to soften.

When it does, Zimbabwe will need to re-introduce its own currency. This exercise is perhaps best done in phases and may have to involve running a parallel system for a while.

Once confidence is restored, the RBZ can then go on to carry out appropriate monetary policy necessary for creating liquidity and stimulating growth while keeping inflation in check.

Aside from restoring the central bank's ability to implement monetary policy, the goal of increasing foreign currency inflows should still be pursued. Zimbabwe remains heavily reliant on imports even for basic foodstuffs.

This situation will need to change because in the long term it is not sustainable. Exports and tourist earnings must be increased. Investment inflows will also have to improve. Capital inflows can help jumpstart the economy, as has been happening in neighbouring countries such as Mozambique and Zambia.

In the short term even donor funds should be a focus point. Donors typically put money directly into areas such as education and health. This allows government to concentrate expenditure on other areas. In the long run however the hope is that we do not remain a country that survives on hand-outs.

In conclusion, the recently released monetary policy statement exposed the limitations of the multi-currency system. Although it allowed for an immediate return of stability after hyperinflation, it is at best a stop-gap measure that will eventually have to be let go of. Short of that the institutions that are responsible for driving policy, such as the RBZ, will continue to be incapacitated.

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