Currency reforms: The journey so far

Source: Currency reforms: The journey so far – The Zimbabwe Independent

BY RESPECT GWENZI

In February of 2019, Zimbabwe escalated a currency reform programme initially meant to scrap a USD anchored multicurrency for the Zimdollar. The multi-currency regime had been in place for 10 years running from 2009 to 2019. In this piece we look at the currency reform journey, the achievements, the shortcomings, the lessons that can be learnt so far and the possible outlook for the present currency regimes. When Zimbabwe formally introduced the multicurrency system in 2009, inflation which was rocketing at a world record, immediately stabilised. The supply of goods and services in the economy, which had dried up, started improving. A deposit base, which had been grossly eroded to nil, started building up in the financial system. Almost all spheres of the economy were reignited anchored on currency stability.

For most companies, a USD regime provided superior and stable high margin earning, given that the USD was very strong against regional currency. Earlier under dollarization, most regional currencies weakened on the backdropped of a commodities bout on global markets, thus driving the relative value of the USD firmer. A number of listed companies reevaluated their regional strategies and almost all decided to retrace back home and this was irrational. Companies such as hospitality entities RTG and African Sun among a host of others, used only the present reality of stable currency and superior earnings to justify foregoing regional exposures. Foreign currency losses on income earned in regional entities, induced by the firm USD discouraged diversification, while encouraging concentration of investments in Zimbabwe.

Despite the positives highlighted, Zimbabwe continued to attract less Foreign Direct Investment compared to regional peers such as Mozambique, Zambia and South Africa. Although earnings were stable, the low base effect reduced the economy’s ability to comprehensively address an overhanging multilateral debt with IFIs. The country had long defaulted on debt clearance to the World Bank, IMF, AfDB and Paris Club lenders among others. While some of the debt has now been cleared, a good fraction remains outstanding and yet even with the lenders that the country is now up date, new debt issuance will depend on clearance of all other debt to some players. Failure to unlock the debt conundrum has resulted in high country risk profile and expensive debt into the country. This would also go on to contribute to a high cost base in the production of goods.

The multicurrency regime however boosted portfolio investments onto the stock market. The ZSE offered risk-free USD denominated earnings. This meant that there were no possible losses induced by currency conversion. The level of foreign participation which has since fallen to below 15% touched a high of 65% under dollarization. This meant that 60.5c out of every US$1 traded on the stock were new flows coming from foreigners. Foreigners are now predominantly sellers, with the level of inflow coming in far less than the local contribution and also lower than the foreign sell off levels. Foreigners have faced challenges in remitting dividends and capital gains on disposals of shares. A weakening economy also lowered company valuations and thus dragging down the overall allure of Zim equities.

An earlier approach to cautiously manage expenditure to revenue generated by the State, resulted in a much healthier fiscus position, but this only ran up until 2013. What had been the linchpin of dollarisation, began to crack as government found ways of inducing money supply despite maintaining the USD tag to the economy. Government would issue Treasury Bills to finance its over-expenditure and over time, the gap widened. The Treasury also borrowed from the Central Bank. By issuing excessive Treasury Bills beyond the fiscus’ ability to repay, a cycle emerged where TBs were rolled over on maturity thus increasing their size and the level of new money into the economy. The interplay of TBs and their effect on dismantling the USD currency regime has been a constant topic on this platform for a number of years and we will not delve much into it here.

Zimbabwe became a dumping ground for cheaper imports and billions were shipped out through trade. In 2019, when the Zimdollar returned with massive devaluation, the trend reversed and imports became more expensive. The aspect of export competitiveness is often not properly analysed. Other factors that can reduce export competitiveness include the cost of labour, the cost of production, route to international markets, scale, cost of capital among others. It is therefore not exclusively true that the wide trade gap was due to the effect of using USD.

Since the return of the Zimdollar, the country has made some mistakes and scored very few wins. Treasury authorities and some prominent economists and government advisers all believed at first that the Zimdollar could hold at very conservative levels to the USD. None among the policy makers and their advisers saw the Zimdollar trading at beyond 1:10 to the USD. A proper currency modeling and evaluation of economic fundamentals would have given a more realistic prediction. Failure to read the fundamentals well resulted in a misleading currency value prediction by government. These economic fundamentals included the level of money supply, debt, production and production growth levels, employment, inflation, balance of payments as well as sentiment. Earlier government had promised that it will not introduce the Zimdollar until fundamentals are ok but went on to introduce the currency without these necessary fundamentals in check.

The net result was a disproportionate decline in the Zimdollar value. Panic along the way also meant that the government would invoke circuit breakers on the currency market, which in turn would derail currency liberalisation, encourage gross subsidies and arbitrage and ultimately disrupt and dampen the currency market. Flows to the interbank market thus grossly lagged demand resulting in wider black-market premiums. While liquidity levels on the interbank market have improved, the black-market premium remains grossly high.

The situation on the ground presently looks encouraging and improved but a fundamental move effected mid-way into 2020 is often overlooked. The economy yet again reversed the currency regime from mono currency to dual currency. Authorities decided to bring back the USD and increased market liberalisation taking away pockets of arbitrage and subsidies, in turn lowering the fiscus pressure. Part of the present stability is due to a high degree of market liberalisation which has helped come up with a more inclusive exchange rate on the interbank. Further part of the stability is due to a steadfast budgetary balance with minimal over-expenditures.

As we move forward, it is imperative to draw lessons from these experiences for posterity. It is highly likely that these scenarios will repeat in future and all economic players should learn. In understanding these past experiences, government, corporate bodies and other parties are best positioned to model the likely future outcomes. A liquidity growth that outpaces the growth in production is inflationary. A gross budgetary imbalance financed through domestic borrowing given declining production levels has the propensity to drive inflation up and in turn destabilise the economy.

A trade imbalance can destabilise a currency’s value and reduce foreign currency reserves. Our view is that Zimbabwe is still in the woods and the current fragile stability can only be strengthened through pure application of conventional economic practices, clearance of debt, moral suasion, economic and political reforms.

Gwenzi is a financial analyst and MD of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — respect@equityaxis.net