Source: Murmurings of disquiet in the policy corridors – The Zimbabwe Independent September 28, 2018
That the current exchange rate regime in the market is not sustainable is beyond doubt even for the policy-makers in their private meditations.
Just before he was sworn-in, the new Finance minister Mthuli Ncube boldly stated his intentions to phase out the bond notes by December 2018. Just coming in from the private sector, he had not carefully thought of the consequences of his emotional utterances, neither had he mastered the art of differentiating policy statements from personal opinion.
And ever since those utterances, including his recent statements during the United States trip, that he would rather see the bond notes off sooner rather than later, the bond note has taken a huge beating. It has nosedived 20% in two weeks.
The chasm widens
At a time when banking deposits of about US$6,5 billion were being thinly supported by official nostro and cash balances below US$300 million, the Reserve Bank of Zimbabwe (RBZ) introduced bond notes in November 2016. The motive was to physically monetise the chasm between electronic balances and the real US dollar in cash and nostro balances. The size, extent and reach of the informal sector in Zimbabwe, compounded by the reality that the majority of Zimbabweans live in rural areas with few electronic payment platforms, created the urgent need to find physical money to support the US$6,5 billion deposits then floating in the market without nostro or cash back-up. And the bond note was born!
Unfortunately, that chasm between the electronic monetary balances and the real nostro or US dollars supporting the same has continued to widen. With banking deposits now sitting at about US$9,5 billion and being supported by virtually nothing meaningful in the nostros, the chasm is huge for a country whose current account deficit has averaged US$1,8 billion per annum since 2010. Although officially the RTGS balances and bond notes are 1:1 with the US dollar, the market realities have created huge premiums on the US dollar.
There is abundant evidence that broad money supply is growing at an unsustainable rate. Driven largely by fiscal excesses and, equally culpable, a banking sector that has been on lending overdrive, at its peak clocking loan-deposit ratios of 87% in 2011, the stock of money is increasing much faster than GDP growth. For the past four years, cumulative GDP growth has been only 7,8%, yet in just one year, broad money supply grew by 40,8% June 2018.
This confirms that there is a significant amount of unproductive money being generated in the economy which is not linked to productivity and that is a source of instability on the asset and goods prices in the economy. In fact, the continued depreciation of the exchange rate reflects this, probably the reason why Ncube intended to announce his arrival with a fiscal shock.
The sources of broad money supply are, predictably, the usual suspects. Government debt assumption alone for poorly run parastatals has injected over US$2,3 billion into the economy through issuance of Treasury Bills (TBs) to creditors of RBZ, National Railways of Zimbabwe, Ziscosteel and Civil Aviation Authority of Zimbabwe, among others. On the other hand, significant TBs issuances to fund the high budget deficits and the imprudent use of direct government overdraft facility at the RBZ have combined to create a liquidity swamp in the economy.
Evidence is everywhere that there are excessive amounts of unproductive money being generated in the economy, and the performance of the banking industry provides some insights. On the back of a stagnating economy, declining loan-to-deposit ratios and RBZ capped lending interest rates, the banking industry has surprisingly been reporting amazing record profits! More than anything else, it is a sign that broad money supply is increasing unsustainably and, in real terms, the bankers know very well their profits count for nothing and they will lose most of it to inflation.
History has taught us before, and Venezuelan banks can confirm it now, that lenders lose value the most when inflation spikes. And the banking sector in Zimbabwe knows it is now a moment of when, not how.
Bond notes are currency
The continued growth of bond notes has created a policy challenge, and options of phasing out bond notes have been dominating policy utterances. The policy admission is that the current exchange rate of 1:1 is not sustainable and is creating huge distortions in the market, resulting in the RBZ assuming a pivotal role in the allocation of foreign currency.
These RBZ gymnastics have, undoubtedly, kept inflation at bay. Inflation rate for August at 4,83% indeed confers a worthy gymnastics medal to the RBZ in the face of such challenges. However, in its private lamentations, the RBZ knows very well that this is not sustainable and a solution to the fiscal excesses has to be found urgently.
Unfortunately, phasing out the bond notes by end of December, though possible, is not an option, neither is it necessary. The fact that virtually all bank deposits are only convertible for local purchases means, by observation and deed, that the Real-Time Gross Settlement (RTGS) balances are already a local currency in electronic form, with the bond notes and coins being its physical manifestation.
No depositor can withdraw US dollars from the bank at will or make international payments from their bank balance unless they get allocated foreign currency under a special arrangement from their bank. This confirms, unambiguously, that the US$9,5 billion deposits in the banking sector, though technically considered US dollar, are practically electronic bond notes. To phase out bond notes, therefore, means phasing out all the monetary balances in the economy and replacing them with some other currency.
From the strict sense and definition of currency, the bond notes are already another currency within the current multi-currency basket. There would, therefore, be no logical reason to scrap it and replace it with “own currency” because it is already our own currency!
The current illusion that we have US dollars as the anchor currency is confounding even the very policy-makers that are trying hard to believe it. One thing is certain, though, and it is that sooner or later, the government will need to allow market forces to determine the exchange rate. And that point will mark the confirmation or crystallisation of the loss of value for the RTGS balances that have, over the years, been thought to be US dollar.
Rand adoption: Catch me if you can
The other option to deal with bond notes as proposed would be the adoption of the rand. Granted, there are a lot of technicalities and conditionalities, but at the end of the day, something has to happen to the US$9,5 billion in banking deposits today to be convertible to rands.
One certain outcome is that the US$9,5 billion deposits cannot be all convertible to rand at the US dollar market exchange rate because our deposits are not US dollar in the practical sense. Therefore, only that which is freely convertible, thus the nostro balances and US dollar cash, will only be able to be converted to rand without loss of value. The rest of the monetary balances, about US$9,2 billion, can be convertible, but at a huge loss.
The previous de-monetisation from the Zimbabwe dollar to the US dollar in 2009 can give us a good perspective into what can possibly happen when adopting the rand. At the time that de-monetisation was conducted in 2015, only US$20 million was set aside to compensate all banking sector deposits as at December 31 2008! The loss of value was catastrophic to say the least.
To imagine that the whole country, including government, individuals, corporates and pension funds had money only to the equivalent of US$20 million is not an amusing joke. Yet, when evaluated in the right context, it reflected the basic fact that the government has no financial resources, in US dollar terms, to compensate the depositors and therefore had to do with what was possibly available at the time.
Adopting the rand will suffer the same fate. The basic fact remains that the central government has no foreign exchange reserves of its own to use in de-monetising the US$9,2 billion deposits in a way that will result in depositors preserving the value of their money.
Therefore, without any doubt, the adoption of the rand will see massive value erosion on the current stock of money in the economy. Of course, options exist whereby government can auction, to the highest bidder, its valuable assets such as NetOne, POSB, Agribank and so on to raise foreign currency to subsidise the de-monetisation exercise to reduce the conversion losses. That said, one thing that is definite is that such wholesale privatisation will not be able to raise US$9,2 billion, or even a tenth of it.
There are other options such as securing external loans to fund the de-monetisation exercise. Still, the fact remains that no financier would be willing to fork out US$9,2 billion to finance a de-monetisation process that, on its own, does not guarantee that the adoption of the rand will result in Zimbabwe generating surplus on the current account in order to service this debt.
In any case, the country already has about US$11 billion in outstanding external debt that has been long overdue. Therefore, it is possible to adopt the rand, but with consequences on loss of value to depositors. Of course, the deposits already do not have the value they purport to have, but the wholesale conversion will precipitate and crystallise a steep loss of value.
Loss of value: A fact of life
Whatever currency regime the policy-makers will opt to pursue, one fact remains still that there is going to be loss of value on the stock of money in the economy for others, while others will create immense wealth and savings.
The government, which is the biggest borrower in the market with TBs of about US$8 billion floating in the market, will be the biggest beneficiary of the currency changeover or whatever will happen to the bond note. As the exchange rate continues to depreciate, the real value of debt and indeed government indebtedness will continue to fall. It would therefore be in the best interest of the government to see a real exchange rate that reflects the true value of our local currency. This, inadvertently, whittles down the real value of domestic debt.
Ncube and his permanent secretary, George Guvamatanga, know pretty well that the government has no capacity whatsoever to pursue a currency regime that will obligate it to settle, in real US dollar value, its current domestic debt obligations. Therefore, whatever currency regime the policy-makers will settle for, it will be one that recognises that the current stock of money is not US dollar and with that, loss of value will be crystallised for those with bank balances while the borrowers will heave a huge sigh of relief.
Back to you, Mr President
President Emmerson Mnangagwa has tackled many issues boldly since he assumed office, including the prosecution of high-profile corruption cases and appointment of newer blood in ministerial positions. One issue sticking out as a sore thumb is the currency question.
Bold decisions outside the politburo and central committee will need to be made to tackle the currency issue. It will make him unpopular in party circles for a year or two but, in the fullness of time, he will be remembered as having departed from the Robert Mugabe rhetoric that put politics ahead of the economy.
In Ncube and Guvamatanga in the Finance ministry, he has a good pair of honest and pragmatic hands that can deliver the economic stabilisation programme that eluded the previous administration for almost three decades. And if he has to act, he has to do it now while still fresh with a five –year mandate before it is too late.
Muchemwa is an economist and MD of Oxlink Capital (Pvt) Ltd. He writes in his personal capacity.