Unsustainable fixed exchange rate – bulawayo24 news
Zimbabwe’s export earnings for the first 9 months of 2021 jumped 38% to US $ 6.10 billion from US $ 4.43 billion achieved during the same period in 2020. Notable improvements have been made. achieved in international remittances which increased by more than 53% and export earnings which increased by 36% supported by the firming of commodity prices. Growth is expected to take Zimbabwe’s official foreign exchange earnings to a record high of around US $ 8 billion in 2021 (from US $ 6.29 billion in 2020). Despite the annual growth in export earnings, the country is stuck in a relentless artificial shortage of foreign exchange. The shortages created an undesirable system where the buying and selling of foreign currency became a big business with a higher return than most formal businesses. Likewise, shortages create unhealthy arbitrage opportunities in the market, causing price instability. A significant portion of earned foreign exchange is diverted to the informal market and escapes the economy through Illicit Financial Flows (IFFs) due to current inefficiencies in the foreign exchange market.
Illicit financial flows (IFF)
Zimbabwe is estimated to lose over US $ 1.5 billion each year due to IFFs which could potentially benefit the country in terms of tax revenues and downstream payments in various value chains. The flows manifest themselves in the smuggling of minerals, foreign exchange outsourcing and tax evasion by local and foreign companies. The fixed exchange rate where exporters and traders realize losses if they convert their income into local currency through the fixed auction rate exacerbates this endemic problem. The rate also acts as a tax on foreign currency deposits in the local financial sector.
There is a positive relationship between poor economic governance and illicit financial outflows, with the export of illicit funds often requiring the use of illegal means involving systematic corruption.
FCA Balances and loans
Deposits in US dollars in foreign currency accounts (FCAs) increased from 352 million US dollars in January 2020 to more than 2.4 billion US dollars in October 2021. Depositors are not encouraged to convert these funds to a rate lower than the rate accepted by the market. The funds also remain inactive as banks demand guarantees (guaranteed by law) that foreign currency borrowers repay them in hard currency to avoid a repeat of 2009 and 2019 when borrowers repaid their foreign currency denominated debts using a depreciated local currency. This would not be the case if the forex market was determined by the market through a managed float mechanism. Therefore, the absence of a market-determined foreign exchange market and inconsistent monetary policy negatively impact the local credit market. Various sectors of the economy would benefit from the unused funds to increase production, re-equip and meet domestic demand.
Increase in external debt
Due to the disparity between the formal fixed rate and the free market rate, the central bank and the Treasury are the main and only providers of foreign currency on the auction platform. The central bank went so far as to acquire collateralised lines of credit (external debt) from AfreximBank and other financiers to support the auction allocation mechanism. This would not be necessary if the exchange rate was market determined, as it would attract private funds from exporters, local businesses, non-governmental organizations (NGOs) and households who benefit from more than $ 1.3 billion. Americans in diaspora remittances. The central bank is also committing millions of dollars in foreign currency for the repatriation of dividends from foreign corporations and multinational corporations (MNCs) operating in Zimbabwe. This role would easily be fulfilled by commercial banks if the auction system were market determined. In addition, the government would be able to use a significant portion of the over $ 1 billion in foreign exchange tax revenues it earns by paying living wages for its troubled civil service to restore normal public service delivery, by especially in schools and health care. With external debt now exceeding US $ 10.7 billion (excluding central bank debts) before the Comprehensive Deed of Compensation Debt of US $ 3.5 billion owed to former farmers trade is not taken into account, it is not sustainable for the central bank to incur more external debt to support the auction system or subsidize various importers at the expense of exporters and the economy in general.
Fixed rate and inflation
The central bank revised its end-of-year inflation target upwards for the third time to 53%, from a previous forecast of 10% at the start of the year and 25% -35% expected in August 2021. The main source of inflationary pressure in the local market is the growth of the money supply which leads to an artificial demand for foreign currencies in both formal and informal markets. The central bank needs foreign currency to service its external debt obligations (among others), so it is caught in an endless spiral of printing. The central bank has only a limited interest in letting the auction rate be determined by the market, as this will involve paying more for the 40% of export earnings retained by the bank. Going forward, money supply growth is expected to keep annual inflation in double digits.
Fixed rate and agriculture
Local farmers have started to demand payment for products delivered in foreign currency due to the sharp depreciation of the Zimbabwean dollar. The government had set high producer prices for the 2020/21 crop marketing year to improve productivity and avoid parallel marketing of grains. However, the gap between the auction rate and parallel rates discourages farmers who are rarely paid locally. This means that agricultural productivity depends on an efficient exchange rate which ensures the viability of farmers.
Indexed rate and competitiveness
The huge gap between the free market rate and the auction rate means that the government now has import subsidies for various importers and the central bank is also subsidizing citizens to access cheap foreign exchange for the economy. domestic consumption. This framework creates an uneven operating environment in various sectors of the economy, with exporters (especially miners and tobacco producers) feeling robbed. For every US dollar in export earnings, exporters now lose at least 20 cents by ceding 40% to the central bank under current export control regulations. This is before various taxes, levies and license fees charged in foreign currencies apply to exporters. This means that the fixed exchange rate acts as a tax on all exports. Exchange control measures are also discouraging exports of manufactured goods at a time when Zimbabwe must prepare for the African Continental Free Trade Area (AfCFTA).
Support the parallel market
So far, the auction platform has allocated US $ 1.9 billion to formal producers and businessmen in the market since June 2020, against formal demand for foreign exchange exceeding US $ 5.5 billion. US dollars in one year. This means that successful bidders only receive 20-30% of their foreign exchange requirement after about 2 months, while daily earnings and parallel market increase the difference. The export figure does not take into account contraband goods that are not declared to customs or goods that are under-declared in order to pay less duty.
Zimbabwe earns more foreign exchange (per capita) than its regional peers such as Namibia, Botswana, Malawi, Zambia, Mozambique, Tanzania and Kenya. These countries do not experience endemic currency scarcity because they have market-oriented foreign exchange markets. It should be noted that foreign currency is a scarce resource that must be shared across economies on the world stage, however sharing can only be effective if it is accompanied by a market determined rate where margins buying and selling are very thin to close huge trade-offs. opportunities for the elite in Zimbabwe. To address the above inefficiencies, the central bank must pre-state the exact amount of foreign currency available to bidders at auction and commit to settling the winning bids within 3 days (T + 3). This means that the weekly auction should only be done if the winning bids from the previous week are fully settled. The bank should also eliminate producers and retailers (especially oil players) who sell their products exclusively in foreign currencies and convert the proceeds into local currency to re-bid.
The central bank must learn from the mistakes of the past where exchange rate fixing resulted in market instability and unintentional consumer subsidies amounting to billions of dollars. Exporters and holders of foreign currencies should be allowed to exchange their foreign currencies at market-determined rates when the auction market is decentralized from central bank control. The central bank should emulate the basic principles of central bank intervention (open market operations) to mop up excess liquidity in order to manage inflation instead of pegging the exchange rate, which has never been a lasting intervention. Inflation is largely a function of the money supply in Zimbabwe and the biggest guarantor of stability is the central bank itself, not a controlled rate. In conclusion, the current currency allocation platform must be operated as part of a true Dutch auction system to ensure sustainability.
Victor Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). Comments: Email [email protected] or Twitter @ VictorBhoroma1.
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