22 February 2019

Zimbabwe: Markets Serene After RBZ's Monetary Policy Measures

Photo: The Herald
Reserve Bank of Zimbabwe Governor John Mangudya.

Markets largely remained unperturbed following monetary policy measures announced this week that saw the central bank abandon its fixed exchange rate management system for a managed floating approach to address underlying currency volatility and inflationary pressures in the economy.

The new managed floating exchange rate system will see the RTGS dollar - a mix of electronic balances, bond notes and coins -- being traded in the inter-bank market.

In a managed floating exchange rate system, a central bank intervenes to stabilise a country's currency.

Rates on the parallel market were unchanged yesterday with traders quoting a rate of around US$1:4 $RTGS.

The stock market was closed owing to the holiday yesterday, but analysts say they have to monitor trades on the interbank market.

However, alternative market traders were at work, buying and selling money at between US$1:$rtgs3,8 and US$1:$rtgs4.

Central bank chief John Mangudya on Wednesday moved to stem currency volatility and inflationary pressures in the economy, emanating from valuation distortions between the electronic balances and the US dollars.

The central bank boss said interest rates would be determined after an exchange rate between the RTGS dollar and greenback has been established.

"The establishment of an exchange rate between the US dollar and the RTGS dollar is the first phase. When we have a benchmark rate, then we will move to establish an interest rate," Mangudya told businessdigest after his policy presentation.

Lending rates were set at 18% more than two years ago when the country was enjoying low inflation.

Annual inflation last month rose to 56,9%, the highest record in a decade, but Mangudya says the rise in prices is fuelled by the exchange rate premium on the parallel market that he has set out to shut down.

Ashok Chakravarti, an economist, sees the parallel market crumbling over time.

"The parallel market will collapse over time," he said after the MPS presentation.

"Don't forget the parallel market consists of small trades. This interbank market is going to have US$4 billion. That is substantial volume. No parallel market can compare to that. If you put volumes like that and the lines of credit that the Reserve Bank will need to back the market, the exchange rate will decline and the parallel market will disappear."

Economists say an interest rate hike is inevitable.

Godfrey Kanyenze said Mangudya would have to raise interest rates.

"I think Mangudya was very explicit about using all the available monetary policy tools at his disposal. There is therefore scope to raise rates in light of rising inflation," he said.

Mangudya, who introduced bond notes in 2016 on the basis the surrogate currency had a par value to the US dollar, acknowledges the need for a new exchange rate between the two units.

"The economy took a different course of direction from a positive economic trajectory to an inflationary environment. This situation needs immediate redress in order to restore value for money. The foreign exchange premiums on the parallel market which ranged from 1,40 to 1,80 to the US dollar in September 2018 increased to the current levels of between 3,00 to 4,00," he said. "This movement in forex premiums has had negative pass-through effects on inflation, which increased, particularly from the September year-on-year level of 5,4% to 20,9% in October and closed the year at 42,09%."

Kanyenze said the central bank had responded to market dynamics in a state of flux. "The float is what the market wanted," he said.

"The challenge right now is that government and the central bank in particular have always argued that they cannot introduce a new currency and until they rein in all the fundamentals."

Kanyenze said government had opted for an easy way out of the currency crisis.

"They could not redollarise and they have now chosen the easy way of introducing a new currency," he said. "Do we have sufficient reserves of forex? It's a demand and supply issue. He (Mangudya) says we have lines of credit, but he should show us the colour of the lines of credit. Apart from lines of credit, do we have reserves?"

The distrust around the local currency is expected to play against the unit.

"We are likely going to see huge demand for strong currencies. There will be demand for good money, not bad money," Kanyenze said.

However, Colls Ndlovu, a former South African Reserve Bank economic analyst, said government did the same thing in 2008 in the midst of hyperinflation and it failed.

"Just in case folks out there start jumping up and down ululating and eulogising at the forex trading liberalisation policy announced by the RBZ, a cursory look at the country's recent monetary history shows that this very policy failed miserably in May 2008 leading to the complete and contemptuous demonitisation of the defunct Zim dollar whose value depreciated to absolute zero," Ndlovu said.

"Against the backdrop of the foregoing, the question which arises is: why did that forex liberalisation policy fail so dismally? The answer is that it failed so miserably simply because (as usual) the RBZ does not want to solve the real problem savaging the Zim economy.

"The real problem of the economy has nothing to do with production in isolation. It has everything to do with the country's monetary policy and currency, over and above many other issues. The RBZ does not want to restore credibility and trust to the currency. Lenin once said that the best way to destroy a country's economy is to debauch that country's currency.

"The local Zimbabwean quasi-currencies were long debauched. Right now the new policy of marinating a rotten chicken (bond note) and offering it as a new cuisine (RTGS$) is a classic example of the RBZ's complete incapacity to solve the currency crisis. Money works on the basis of trust and confidence given by the markets (consumers, buyers and sellers), not official shenanigans."

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