Between a rock and a hard surface

JOSEPH MVERECHA

If you would rather be in anyone’s shoes now – they are certainly not those of the Minister of Finance and Economic Development Mthuli Ncube. President Mnangagwa has thrust upon him, the (near impossible) task of charting Zimbabwe’s recovery and growth path, as though guiding a ship sailing through turbulent and stormy waters, towards a distant shore called Vision 2030, middle income economy status. In the process he must first reconcile two mutually divergent macro and micro circumstances which are urgent – to liberalise the exchange rate (as per the dictates of sound macroeconomic policy) or will he hold on to the fixed par value of 1:1 (as necessary to preserve value of savings). The two are mutually exclusive. What will he do or what will be his approach? Cambridge trained, affable, quizzical and brilliant in brass, Prof. Ncube easily passes as one of Zimbabwe’s finest economic brains with a rich international experience and astounding CV. In the field of finance and economics, he is more than a mere mortal, but the task ahead will test him to the limits of his pedigree.

There are, of course, other important macro policy issues – surging inflation, fiscal consolidation (budget deficit reduction), re-engagement and external arrears clearance, policy consistency, institutional alignment, state enterprise reforms, business costs alignment, doing business reforms and a host of other issues that must be broadly addressed in the 2019 and 2020 fiscal budgets. A number of the issues are articulated fairly substantively in the Transitional Stabilisation Plan (TSP). They demand immediate action and it is fair to say he has full grasp of the difficult decisions that are necessary to get the economy back on track for sustainable growth.

Headline inflation will no doubt give him some headaches. One of the main reasons Authorities have stuck implacably to a 1:1 par value is ostensibly, to contain domestic inflationary pressures. But with headline inflation hurtling into space at 20,85% in October, the V11 evidence is now there for all to see, that the horses have bolted and are galloping furiously into the open vlei, leaving an acrid trail of mayhem in the economy. Demand for local payments in foreign currency is increasing, not just pharmacies and medicines and yet nearly 97,5% of salaries are RTGS. He will have to battle the scourge of inflation persistence over the next 18 to 24 months.

In addition, he has on both hands an overflow of Treasury bills – likely in excess of $2,1 billion maturities per annum over the next two years. This too is critical and requires urgent interventions. For Zimbabwe, as elsewhere, decisions decide destiny. Just thinking, had we decided as a country to borrow from abroad in respect of the July 1997 War Veterans disbursements, as had been recommended by the Central Bank and not resorted to printing – would our destiny have been different – maybe not. But I think the country could have avoided the currency collapse on November 14, 1997 which set in motion a trail of events leading to the demise of the currency a decade later. Maybe a discussion point for another day.

Now, with respect to my first question, what will the Minister do, to reconcile two diametrically opposed scenarios? What are his chances of reconciling the two? Perhaps as good a chance as trying to reconcile a Hassidic Jew and an Islamic brotherhood over the Tomb of the Patriarchs!

It is a case of Heads, you lose and Tails they win. There are risks everywhere and there is no light at the end of the tunnel – even of a train coming in your direction.

What happens if the Minister liberalises the exchange rate? Because the RTGS and Bond Notes are defacto local currency (and there is a sea of swirling RTGS against very limited foreign currency) – he knows the currency will be in free fall because there are no fundamentals to back it. To what level, no one knows yet? Would the current rates prevailing in the parallel market constitute some permanent equilibrium? No one can say for certain.

But for the Minister of Finance, several problems will emerge, in particular the loss of value of all savings (initially pegged at 1:1). His Excellency the President has pledged to preserve value of all savings. In Russia, we know what happened when the currency crisis erupted in August 1998 – the rubble value fell dramatically 5 times from 6 per US dollar to 30 per US dollar inside 12 months. Inflation rose sharply to 84% while food prices skyrocketed 100%. The value of Ruble savings evaporated leaving large swathes of the population surviving on penury. No doubt the President wants to avoid such a scenario.

But that is not the only problem. All the NGOs bank balances, (originally deposited in foreign currency) and the Corporate FCAs substituted for TBs under the RBZ debt assumption bill, all the international airlines balances and other international payments obligations – all these will “harden” i.e. convert to hard currencies at 1:1, translating from contingent liabilities into immediate non funded Foreign currency liabilities on several Bank balance sheets. This will immediately exact a charge on Bank capital and amplify banking sector vulnerabilities, cascading into unknown consequences for the economy.

So what happens to the economy if the Hon. Minister persists with the unsustainable 1:1 peg? We have been here before as a country. We fixed the exchange rate at 55/US dollar in 2000. The consequences of that are well known. By end of December 2001, the parallel market was 6 times the official and nearly 27 times by December 2003. All mines had closed, except 3 Platinum Mines (which had been given dispensation to retain part of their export proceeds in foreign currency). As for the gold mines, they were mostly completely waterlogged, receiving 100% of their export proceeds, as it were in local currency.

Then came Governor Gono and the introduction of an Auction System for Foreign Currency in January 2004 and the Auction commenced with an exchange rate of Zw$836/US dollar – which worked fairly efficiently and effectively until money printing and the apparition of fixed exchange rate reappeared in May 2005.

Thereafter, the deadly combination of a fixed exchange rate and runaway reserve money printing, compounded by a myriad of distortions, all but guaranteed and accelerated the demise of our currency by 2007/08. So for policy makers, there is a clear history of that too. But there is one exception to the current – the psychology of adverse expectations now is a stand-alone elephant in the room. Whereas in the past, adverse expectations steadily evolved overtime, initially slowly and then gathering pace, (we did not lose the currency overnight) – this time the adverse expectations are front loaded. No one wants to lose again for a second time.

It is a public trust deficit that unfortunately for the Minister, can only heal overtime with consistent performance and constant communication of his goodwill and where his measures will take the country. Especially his strategy on communicating visibly the sacrifices that Government will make towards stabilizing the economy. He is still at ground zero there – his raft of measures recently, in particular the 2% tax – necessary as it is, for closing the fiscal deficit – the public views this as testimony that Government is not yet carrying any cost of adjustment. The tax is entirely unavoidable but it is painful for the public. Maybe, the Minister may choose to lower PAYE and Corporate tax in the 2019 budget, partly to ameliorate the “double” taxation that is visited upon the heavily taxed workers and the corporate sector. He has a unique opportunity to assuage the tide of public perception in his budget presentation. Going forward, what options are available to the Hon. Minister of Finance in this very difficult scenario? Surprisingly, quite a few indeed. I have listed some below without much details:

1. Control money supply growth
The total money supply in the economy (total deposits as at September 30 2018) amounted to $10,122 billion. This amount (in RTGS balances) is inclusive of US$2,4 billion RBZ Overdraft to Government. On current month on month growth rates, the total deposits may not exceed $11,2 billion by December 2018.

These deposits were $8,1082 billion in December 2017 and $5,633 billion in December 2016. RTGS balances escalated sharply in 2016/2017 while the bond notes were introduced in November 2016 and the parallel market commenced in December 2016 (but the parallel market activity was still minimal initially).

It is fair to make the assumption that individual and corporate sector balances as at December 31 2016 were broadly consistent with economic activity, in as much as there was no parallel market then. But even the amount of US$5,633 billion is very large and cannot be guaranteed at 1:1.

Where can Zimbabwe secure such an amount to guarantee deposits of $5,6 billion or $11,2 billion deposits by year end? Even if we mortgage all the known minerals deposits in the country, might there be chance to raise that amount? Even if there was a country with a largesse that extends to the heavens and is willing to offer Zimbabwe such an amount, is there wisdom in mortgaging resources for future generations because our generation has unbridled spending – ourselves and our Government. I think history would judge us harshly. Incidentally which amount includes perhaps millions of dollars created through rampant “burning” in the parallel market!

2. Issue long dated Paper (in Local Currency)
As Government has commenced (and must sustain fiscal consolidation, State enterprise reforms, re-engagement, etc), the proposal is for Government to issue a total of $4,5 billion in different tenure long dated paper (5, 7 and 10 year paper) through an open Auction system.

First, the Government must establish a primary market (primary dealers for market making) and thereafter an active secondary Bond market for Government paper. The paper must have all the requirements to qualify for prescribed asset status. The rates applicable can be negotiated after allowing “price discovery”. The Minister’s biggest adversary here is the yield curve.

The total amount issued must cover, among the core:
i. Maturing TBs in 2019 ($2,1 billion)
ii. Government OD at RBZ ($2,4 billion)

The Government creates a Sinking Fund administered for the purpose of redemption at maturity, creating confidence in the market. This will help in influencing the yield curve.

The assumption is that by neutralising $4,5 billion out of a total of $11,2 billion (deposits estimate by December 2018), this will imply a balance of $6,7 billion in the economy.

Ceteris Paribus, the parallel rate will likely decelerate sharply to less than half of its current levels (because part of the current escalation in the parallel rate is due to uncertainty and replacement pricing). If the parallel rate declines by half, it means the value of RTGS balances has doubled without incurring foreign liabilities. The parallel market will further wilt, as long as there is no creation of new money, i.e. restrict new money creation only in respect of Credit to Private sector.

3. Phased and Graduated Liberalization of the Exchange Rate
Once the parallel market has decelerated, Government could commence a phased and graduated liberalization of the exchange rate, and there are several models that can be considered, including a time bound two tier exchange rate system with a clear convergence path over 3 years.

Additional policy measures
Other micro and sectoral policy measures which could be considered include:
i. Increase the FX retention for Gold miners to 75%
ii. Create an active interbank market for foreign exchange (a dual exchange rate for official and a commercial may be instituted with a convergence path over 2/ 3 years)
iii. Fuel companies and Banks must explore a rand denominated fuel facility (syndication of banks). This could save in excess of 20% US dollar hard currency fuel purchases
iv. Increase rand circulation in the multicurrency basket, e.g. paying small scale artisanal miners in rand (not US dollars)
v. Paying tobacco farmers in rand (not bond notes)
vi. Accumulate Gold as hard currency reserves (set aside 10% of Gold output every month)
vii. Sustain SI164 repeal (newly announced measures must continue into 2019)
viii. Explore a Bilateral payments arrangements with SA (in rand) for selected imports, including drugs and fuel.

As the economy gains more confidence, building up FX reserves, the official rate and the commercial rate are set on a convergence path over 3 years, to coincide with introduction of the local currency Notes, again commencing only with the lowest denomination – the $2 dollar note and moving on to a higher note, only once the public has gained complete confidence thereto – Step by step introduction of own currency over a 10 year horizon.

Joseph Mverecha is an Economist with a Local commercial Bank. He writes in his personal capacity.

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