Editorial Comment: Black market impact on inflation minimal

Source: Editorial Comment: Black market impact on inflation minimal | The Herald

The 50 percent pay increase for public servants now coming into effect not only benefits the largest group of employees in Zimbabwe, who after all have to buy food and clothing, pay rent or mortgages, and generally cope on the pay, but will also help move the rest of the economy forward.

As usual, those who do not study the fundamentals of the economy immediately screamed that the pay rise would be inflationary. This has been shot down by those who do monitor the fundamentals and the causes of inflation.

Most inflation in Zimbabwe arose from cost push, primarily driven by the exchange rate. That is, as producers and retailers had to pay more for imported raw materials and goods they had to pass these rising costs onto the more final consumer.

There are other rising costs in overheads, such as higher private sector wages, rising energy costs and the like, but generally these are covered by growing revenue and in most business plans overheads are considered for all practical purposes as a fixed percentage of the revenue. 

In any case they are supposed to be covered by the business expanding, which dilutes the overhead costs among more products made or sold.

However, that driver of inflation was largely put into neutral by September last year when the new foreign currency auction system had produced stable exchange rates and, even more importantly, was supplying almost all the foreign currency needed by productive sectors and the more critical consumer sectors.

It was that combination of stable rates and availability that almost immediately saw inflation crash to low month-on-month levels. 

Previous attempts to set an “official” rate by diktat had failed because so little currency was available at that official rate. By putting in a market-based system the monetary and fiscal authorities got a rate that made sense and automatically sorted out the supply side by matching it to demand.

So 95 percent of foreign currency trade is at the auction rate.

The exchange rate is now easing slightly each week, but this movement is closely in line with the month-on-month inflation, in fact slightly below it, so is following that movement rather than creating it. 

The difference is vitally important and all it is telling us is that buyers now reckon the rate has reached the correct and real level that reflects the true value of the US dollar. So rates will move, but roughly in line with the net difference between US and Zimbabwean monthly inflation.

The second cause of inflation is demand-pull, that is too much money chasing too few goods. 

Again this is not a factor that the pay rise will feed. For a start the pay rise is coming out of tax revenue, not from the Government borrowing or printing money. 

So new money is not being created, just existing money being better distributed. In fact it is being funded by the higher taxes paid by those in the private sector who have already had their pay rises and that need is one reason why public service pay rises tend to come a little later than private-sector pay rises.

The Government needs the extra taxes to pay its staff more.

The Confederation of Zimbabwe Retailers has noticed, and welcomed, that the largest single group of shop customers will be able to buy more. And no doubt that will also make the factory owners who now produce the vast majority of products on our shelves happier as well. 

But since all industries still have a lot of spare capacity, as the Confederation of Zimbabwe Industries moodily notes at regular intervals, boosting output is not a problem.

Rather than having to ration goods using price, which is what causes demand-pull inflation, producers will be able to spread their overheads over a higher output as they use their capacity more efficiently, which will allow them to control their costs a lot better.

In any case, as Minister of Finance and Economic Development Mthuli Ncube has noted, the level of the pay rise basically compensates public servants for existing inflation. 

The underlying rate, when the average month-on-month figures from September last year are annualised, is close to 50 percent and this will be seen next month when the calculations for the annual rate no longer include the first seven months of last year.

As monthly inflation rates continue to creep south, on average, Minister Ncube is still expecting something a little under three percent by year end, reflected in an annual rate of 35 percent at worst, so public servants are getting a real pay rise, although a fairly modest one, as well as catching up with the private sector.

The basic reasons why the pay rise will not be inflationary is largely because the Second Republic fixed the fundamentals. The first was the switch to the global norm of fiscal discipline. 

From the start of the Second Republic the Government has only spent what it gets in taxes, with borrowing limited to that portion of capital spending that produces near instant revenue to cover that cost and repay the lenders.

In other words, the Government is not printing money. Even the modest injection of new $50 notes is just a convenience for those who still use cash, not extra money. 

When banks buy their allocations from the Reserve Bank they have to transfer the equivalent to the Reserve Bank, which will then, as Minister Ncube put it, cancel that digital money. The net result is no new money, just slightly less digital money and slightly more banknotes. The sum of the two remains the same.

That fiscal reforms then allowed the critical monetary reforms, the switch to the market-based auctions. There is still some control at the auctions, basically through the priority lists and the rules that demand buyers use actual funds they possess rather than borrow. 

But that means that almost all the stuff that most people buy has its foreign currency component funded from the auctions, and there are laws, now tightened with civil penalties that are so easy to implement, to force buyers to use the price they pay for auction money in their costing formulas.

The third set of reforms dealt with the private sector. It is now rather easy to expand a business or start a new one, and becoming easier all the time as the Government sees production as the engine of growth, in fact the only engine of growth. 

That in turn creates new real wealth, which admittedly the Government can and does tax, but that means its tax revenue, which it uses to fund its payroll, is real money as well and so it can pay its staff more without fuelling inflation.

The black market still exists, and its rates will always be a little higher as it funds the high-end luxury imports, the drug dealers and those wanting to externalise their money, but no longer has any impact on the real economy or the prices people pay for the things they need to live a rather comfortable life. So its impact on inflation is trivial.

So the public service pay rise does not feed inflation. 

All it does is fulfil Government promises that as more taxes arrive in its bank accounts its staff get their fair share, and the Second Republic likes to make promises it can deliver on, and will provide a modest boost to the real economy, allowing it to expand production.