Deflation a major threat to economy

via Deflation a major threat to economy – The Zimbabwe Independent October 23, 2015

THE ZIMBABWEAN economy recorded the world’s deepest deflation rate in the month of September, a development analysts see as an intensifying threat to the country’s long-term growth potential.

Taurai Mangudhla

Zimbabwe’s year-on-year inflation for the month of September stood at -3,11%, shedding a 0,34% point on August 2015, recording the world’s deepest deflation as shown by figures on New York-based Trading Economics.

Zimbabwe’s deflationary performance was deeper than countries like Cyprus and El savador which recorded deflation of -2,50% and -2,25% respectively in September. Significant deflation was also recorded in Afghanistan in the month under review at -1,94% and Mauritania at -1,90%.

Trading Economics provides its users with accurate information from official sources only for 196 countries, including historical data for a number of economic indicators, exchange rates, stock market indexes, government bond yields and commodity prices.

Leading Oxford University-owned research unit, NKC African Economics (NKC), said the country’s inability to control deflation was damaging to the economy in the medium to long term.

“Irrespective of the many positive steps seen over the past two years in Zimbabwe’s monetary sphere, the inability to curb deflation — in the absence of a sovereign currency and benchmark interest rates — is to the detriment of Zimbabwe’s medium to long-term economic growth potential by eating into its productive sector,” says NKC in its latest commentary on Zimbabwe’s economic performance.

“As commented before, declining consumer prices — associated with the strength of the US dollar against the South African rand as well as slack domestic demand — is having an adverse impact on local productive capacity,” said the research unit, adding Zimbabwean companies producing food and consumer goods are having a tough time competing with cheaper imports from South Africa despite protectionist measures helping them.

“For example, ZimStat’s measurements of consumer and producer prices show that the local output cost of foodstuffs increased by 3% between March 2013 and June 2015, while the average retail sales price of the benchmark food basket declined by 7,7% over the same period,” added NKC.

NKC’s observation was based on a recent International Monetary Fund (IMF) publication, released earlier this month, which said deflation in Zimbabwe was expected to continue into next year, projecting an average inflation rate of 0,2% during 2016.

“Base effects will kick in from November this year to help ease the deflation trend heading into next year, and positive y-o-y (year-on-year) numbers are expected during H2 of 2016,” says NKC.

Oxlink Capital MD Brains Muchemwa said dealing with inflation was much easier than deflation.

He said in a market characterised by liquidity problems, deflation creates serious viability challenges for companies, which may end up downsizing or shutting down.

“That companies end up closing means more unemployment and less spending power, thereby pushing prices further down. Like I said, the current deflationary environment is a self-feeding vicious cycle that is posing huge challenges and resulting in rising unemployment, worsening corporate gearing levels and falling real asset prices,” said the Oxlink Capital MD.

“The falling real asset prices, more so on forced sale, have been seriously exposing bank balance sheets on foreclosures. Although the falling prices are attracting mixed feelings, it is important to understand that the excessive gearing levels saddling our corporates require that prices stop falling further to allow them to service their debts otherwise the market is heading towards mass bankruptcies.”

Muchemwa added that government had no capacity to intervene to reverse deflation because of its inability to expand money supply through quantitative easing.

“What is now important is for policy-makers to accept that we are in a deflationary environment and act accordingly in terms of policy. Unfortunately the government has no capacity to fight deflation due to its inability to quantitatively ease the markets without a local currency.”

Unlike most central banks, the Reserve Bank of Zimbabwe’s role in monetary policy matters is limited after the adoption of the multi-currencies in 2009.

Other central banks tend to resort to quantitative easing, the expansion of money supply in the economy to achieve various monetary policy objectives.

Zimbabwe National Chamber of Commerce CEO Takunda Mugaga said deflation was having a negative impact on the real estate and financial sector of the economy.

Mugaga said the trajectory of price levels was obviously a source of concern as it impacts negatively on investor sentiment with most investors shunning markets with negative inflation given that it has a depressing impact on turnover.

“Deflation will also expose banking institutions given that they are charging exorbitant rates in a deflationary environment. this means the banking players have to urgently revise their interest rate in order not to continue sinking on non-performing loans,” said the ZNCC executive.