Zimbabwe-China Currency Swap - What Does It Mean for Harare?

opinion

Finance minister Mthuli Ncube's recent announcement on the signing of a currency swap agreement between Zimbabwe and China has drawn mixed responses from various economic players in Zimbabwe.

On one side is the line of thought that says the arrangement may benefit only one side, namely China, because of the trade deficit between the two countries that is favourable to China.

Some have gone as far as describing the move as a sign of desperation due to the absence of the usual balance of payments support flows from such institutions as the International Monetary Fund, the World Bank and the dearth of adequate foreign direct investment (FDI) inflows.

The argument is that the authorities should rather focus on addressing economic fundamentals first.Our view, however, is contra the above and follows the line of thought that the currency swap route is in fact an ingenious way of partly tackling the challenges the country currently faces.

It bodes well for the country's economic revival and may be deployed as part of the solutions.We will elucidate below the justifications for this view, least of which is the fact that done well, Gersham's Law (where good money chases away bad money) as being proffered by other commentators, will not apply to the swap scenario because, in fact, foreign currency holders (renminbi) will be chasing (demanding) the local currency (ZW$).

In fact, the opposite of Gersham's Law will take place.We argue in support of this latest move by the Ministry of Finance for the following reasons:

l The swap agreement targets Chinese investors wanting to invest in Zimbabwe.

That alone takes away the risk of these investors being averse to exchanging their currency with the local currency given they have to meet local operating costs.

This is an automatic supply of renminbi against the Zimdollar. The issue of country risk, confidence and uncertainty is already priced in their investment decisions upon taking the Zimbabwe route.

As a matter of fact, the minister is spot-on in wanting to spread this structure to other currencies covering other traditional sources of FDI.

When one looks at it carefully, by matching inflows to outflows of currency, that is incoming investors to outgoing payments, it should boost confidence to investors as foreign currency supply is enhanced to meet their foreign remittances;

l The motivation for this arrangement is born out of the country's international isolation. This is a fact on the ground that requires a solution. Zimbabwe is a going concern so an innovative solution is mandatory. The inflow of renminbi in exchange for Zimdollars benefits the country on two fronts:

l Reduce the demand for USD to cover payments going to China by substitution of dollars with renminbi.

l Boost demand for local currency as Chinese investors must cover operating expenses locally. This automatically partially dampens the US dollar premium against the local currency.

This in many respects is actually equivalent to a substitute way of obtaining balance of payments support to the extent of the trade deficit between Zimbabwe and China.

That structure can be spread to other currencies subsequently. The fear that this arrangement benefits only China is therefore misplaced.

When one takes a long-term view, the resultant inflows of renminbi, swapped for Zimdollars, by boosting local production, should reduce that trade imbalance as Zimbabwe begins to manufacture the products locally and even export them regionally.

There is a long-term benefit to Zimbabwe instead.

l A review of the published statistics (United Nations COMTRADE) between China and Africa in general and with Zimbabwe in particular completes the picture and justification of the route adopted by the authorities.

Firstly, China has overtaken the United States of America as Africa's biggest trading partner with trade volumes rising from US$10 billion in 2000 to US$107 billion by 2017.

There is an overall annual trade deficit for the continent against China of US$20 billion.

The continent has an unfavourable trade balance against China and an inward flow of investment from China should correct this position in the long run.

Secondly, Zimbabwe's overall balance of payments position over the last 40 years from Independence in 1980 shows that a trade deficit has existed and ranged from below US$100 million in the early 1980s, risi a peak of US$2,5 billion in 2013 before improving down to USD$307 million in 2017 and projected to hover below the US$500 million by 2020.

Zimbabwe is therefore, a perennial trade deficit country and only by improving its exports performance going forward can this situation be completely reversed.

More importantly, the following facts are key considerations:

l The Zimbabwe-China trade statistics show that annual trade between the two countries has reached US$1,2 billion with Zimbabwe exporting tobacco (topping US$200 million), cotton and various minerals while importing electricals, automotive parts and household merchandise.

l Zimbabwe has a debt of US$1,8 billion with China.

l In the past decade Zimbabwe has been a recipient of Chinese investments and examples include the US$200 million Long Chen Plaza by Anhui Foreign Economic Corporation, the Golden Peacock Villa Hotel in Mutare by Anjin Investments, The National Defence University in Harare and, more notably, the Kariba South Power Plant commissioned in 2018 for US$530 million, the US$1,4 billion earmarked for Hwange Power Station and the proposed 600-megawatt Gwayi power plant.

These inflows can be swapped with local currency and provide foreign currency liquidity to meet outgoing payments of renminbi.This should lift pressure on the US dollar demand and the resultant exchange rate.

The case for the Zimbabwe-China currency swap is compelling given the above reasons.

A review of the international landscape also reveals that currency swaps are a widely used facility with over 20 countries in the world having signed currency swaps.

Notable among these are Japan on the international arena while, in Africa, Nigeria and South Africa have currency swaps.

This is the reason Zimbabwe should explore the possibility of entering into further swap deals for more currencies, barring the current Western sanctions environment, and carefully selected agreements can be put in place to further prop up the country's foreign currency management.

Ugaro is an economist, a former expatriate banker based in several SADC countries and currently works as a corporate advisory services consultant. He is a member and past vice-president of the Zimbabwe Economics Society.

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