Uncertain times, uncertain measures: (Why) is investment weak?

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SAMUEL MAPURANGA

 “The state of long-term expectation, upon which our decisions are based, does not solely depend, therefore, on the most probable forecast we can make. It also depends on the confidence with which we make this forecast—on how highly we rate the likelihood of our best forecast turning out quite wrong. If we expect large changes but are very uncertain as to what precise form these changes will take, then our confidence will be weak. […] The state of confidence, as they term it, is a matter to which practical men always pay the closest and most anxious attention. But economists have not analysed it carefully and have been content, as a rule, to discuss it in general terms.” — Keynes (1936), argued on how uncertainty over economic policies plays a key role in economic outcomes. The role of uncertainty has been long recognised in economics, particularly in investment decisions, which are generally defined as decisions to incur upfront costs in expectations of future returns. Zimbabwe’s history is marred with policy inconsistency in almost every economic sector.

Uncertainty has long been a central concept in economics. At the micro level, economic agents prefer to postpone consumption and investment decisions when uncertainty is high. This rational individual response, in turn, can result in insufficient aggregate demand and consequently in an increase in unemployment at the macro level. In Zimbabwe, concerns over uncertainty have focused on the policy aspect of uncertainty as it has been argued that policy uncertainty may have contributed to the slow recovery from the economic quagmire and further causing economic deterioration.  At the same time, continued political turmoil in Zimbabwe has created more political uncertainty, social and labour unrest which has possibly contributed to business decisions being put on pause.

While many Sub-Saharan African countries have experienced economic policy uncertainty, Zimbabwe stands out in the recent decade. Past events – such as the military assisted take-over that propelled Pres. Mnangagwa into power in November 2017, the subsequent detention crackdown on opposition figures and civic leaders, major economics overhauls – such as the re-introduction of the Zimbabwe dollar have brought policy uncertainty to the forefront of public perceptions. Subsequently, uncertainty has a negative impact on business investment by discouraging or postponing investment.

In this regard, economic policy uncertainty affects Zimbabwean firms and potential investors in the real sector in the three following aspects namely; fixed investment decisions, employment decisions by companies and leverage strategies. Fixed investment decisions have been the theoretical focus of the effect of uncertainty in economic decision. Hiring and firing have also a high degree of irreversibility in Zimbabwe given the stringent labour law. Finally, the decisions on leverage are a proxy for confidence about the state of the economy in the future. Therefore, uncertainty has a negative impact on business investment by discouraging or postponing investment. Economic policy uncertainty hinders investment. As such policy makers should strive to reduce policy uncertainty.

High inflation episodes and Economic Stabilization.

Just when economists thought that hyperinflation was something from the past, it has aroused again: since November 2017, Venezuela joined the hyperinflation club. In September 2018, Venezuela’s year-on-year inflation reached 488,865 percent. This exponential increase in prices was accompanied by a massive contraction of economic activity, although this fall had begun before the hyperinflation process initiated. The social implications of this economic collapse have not been different: poverty indexes increased, eradicated diseases proliferated and, for the years 2017 and 2018, emigration became the highest recorded worldwide, according to the United Nations. Until today, the Venezuelan society has not envisioned a solution to these problems. Like Venezuela, Zimbabwe’s inflation continues to grow exponentially year-on-year, with economic experts signalling that the country has crossed over into hyperinflation environment. The country’s recent re-introduction of the Zimbabwe dollar, its high interest rates and tight liquidity situation seems to be hurting business severely and exacerbating the recession-hit economy’s woes.

Zimbabwe’s inflation rate surged to 176% in June. The high rates of inflation have contributed to the contraction of the economy, which has declined by about 30 percent since 2013. Moreover, the nation is experiencing acute foreign currency, portable water, fuel and electricity shortages at a time prices of basic commodities are skyrocketing. The country is experiencing severe load-shedding with most parts of the country going without electricity for more than 16 hours a day. This all points to a further deteriorating economic crisis.

Given past circumstances, policy makers might wish to know (or perhaps remember) how they can get into these situations, but also, and more importantly, how to avoid them. In this sense, it is important to bring out what is called the hyperinflation cycle. Hyperinflation cycle seems to be a phenomenon that, more than regional, occurs in economies with high presence of natural resource rents (and potentially higher State intervention in the economy) and where economic freedoms have been diminished, especially those related to property rights and the ease of doing business and economic exchange. The cycles also coincide with contexts in which socioeconomic conditions such as employment and real wages deteriorate, where the rule of law and democratic accountability are subdued, the instability of the government increases and there is a greater presence of military personnel over political issues.

Although external factors matter, their role may not have been as important as domestic factors, especially those inherent to economic policy: high fiscal deficits, in some cases financed with external debt at the beginning and with seigniorage afterwards; inability to maintain a certain exchange rate regime and restrictions on transactions in the financial account of the balance of payments are the variables whose performance coincides with the advent of a hyperinflation cycle. Hyperinflation cycles end when there are improvements on three essential fronts: (a) the fiscal and monetary mix: fiscal accounts are closer to equilibrium and base money growth decreases substantially; (b) the interaction with the external sector: barriers to international trade diminish and the exp/imp capacity of the economy increases, the burden of foreign debt on exports regularizes, the resounding level of devaluation of the currency is stopped, hand in hand with less variability of the foreign exchange rate; (c) the structural factors: economic freedoms increase and there is improvement in government stability and quality. It is of paramount importance to note that finance minister Prof. Ncube has been working on critical path to restore normality in the economy.

Achieving macroeconomic stabilization in Zimbabwe.

Most successful stabilization programs are characterized by fairly broad-based reform agendas. Institutional reforms as well as a program of fiscal stabilization and price liberalization are pursued at the same time. To restore confidence and establish credibility, thus, a dramatic shift in policy is needed. Fiscal and monetary tightening is critical for a successful stabilization program. Again, a sharp reduction in the fiscal deficit is needed to end periods of very high inflation.

Institutional reforms, such as improvements in the rule of law, reforms of the public sector, the central bank, and the labour market, are key and complimentary tools in achieving macroeconomic stability in Zimbabwe. These reforms help in making the stabilization package credible thus boosting confidence of domestic and external investors. Achieving sustained growth in Zimbabwe will thus require—in addition to stabilization—comprehensive structural reform and better governance over the medium term.

In July, the monthly trade deficit increased to US$217 million as exports fell by 30 percent to US$240 million. The ongoing output collapse in the country is consistent with the past performance and from cross-country experience, which shows that very high inflation is usually accompanied by a sharp output contraction. However, it is believed that in a successful stabilization, output recovers quite quickly—usually within the first year or two of stabilization. In Zimbabwe, we may surmise that there can be an initial positive output response if inflation is brought down rapidly and prices are liberalized because the damaging effects of uncertainty and price distortions would be greatly reduced. However, sustained output growth after stabilization will depend on addressing fundamental structural problems. Public enterprise and civil service reform, central bank reform, as well as public expenditure and tax reform will be important to sustain the fiscal adjustment and stimulate output growth. Improving governance, including by protecting private property rights and increasing policy predictability, will be essential for reinvigorating investor confidence.

Zimbabwe’s situation with respect to agriculture—a key sector of the economy—may be unique in that property rights issues relating to security of land tenure remain unresolved and may not be easy to resolve even if consensus can be reached on stabilization and other structural reform policies. At present, commercial bank lending to the sector remains limited in part because existing arrangements, do not provide adequate security of land tenure. A broad-based agreement among stakeholders on land tenure may be needed to achieve sustained growth in agriculture and in the economy more generally.

The role of external support in economic recovery and stabilization.

The lack of external financing is an issue for Zimbabwe however, not a deterrent for the implementation of a stabilization program. Even with limited external support, decisive policy action can lead to positive stabilization gains. External support in the form of close policy advice and technical assistance is an important instrument in achieving stabilization. While Zimbabwe started its significant stabilization program even without large amounts of external financing, the nation can benefit from nonfinancial forms of external support, for example the IMF staff monitored programme (SMP). Overall, and in most cases successful stabilization should be followed by external financial and technical support, if not in the first year of stabilization, then in subsequent years. Despite, the issue to attract capital remains a challenge.

The international experience also suggests that private capital flows tend to follow successful stabilization. Thus, better policies and stronger governance, over time, attract private capital. The issue of reforms cannot be overemphasised. As reforms progressed, foreign direct investment (FDI) tend to increase gradually from negligible levels.  Another key factor is the availability of natural resources. Zimbabwe need to leverage on its significant natural resources and in particular attract FDI. Hence, for Zimbabwe, strengthening relations with donors and mobilizing external financing would ease the burden of the initial adjustment needed for a strong, upfront reduction in inflation. The more financing that is available, the less drastic the initial fiscal adjustment needed to obtain a given reduction in inflation and the greater the room to address the possible social dislocation from the reduction in the size of the public sector (including public enterprises). External policy advice and technical support would also be essential to implement a broad based stabilization package.

Again, longer term financing would also be needed to support a medium term structural reform program to address the extensive distortions and ensure that the stabilization is sustained. At the same time, if a credible stabilization package is implemented upfront and followed by reforms to restore investor confidence, Zimbabwe’s economy is sufficiently diversified and its long-term potential strong enough to be able, most likely, to attract significant private capital inflows over the medium term.

Analysts believe that that periods of high inflation can last for a considerable time and there is little to prevent inflation from spiraling higher and higher if no reforms are undertaken. Periods of very high inflation have typically been characterized by widespread economic distortions, including very loose fiscal and quasi-fiscal policies, relative price distortions, segmented foreign exchange markets, declining domestic financial intermediation, and poor governance. They have also been associated with a sharp and sustained decline in economic activity. Gains from stabilization—in the form of a rapid decline in inflation and recovery of output—can be achieved relatively quickly once a broad-based package of policies is implemented. An appropriate stabilization program needs to tackle the underlying causes of high inflation. A large fiscal adjustment upfront that especially reduces quasi-fiscal activities—is at the core of such a package. Economically, policy makers need to continue with a comprehensive and credible policy package to stabilize the economy. A package that include several mutually reinforcing actions centered on fiscal tightening, and price and exchange regime liberalization.

Achieving sustained growth in Zimbabwe will require—in addition to stabilization—better governance and comprehensive structural reform over the medium term. Improvements in governance, including a more predictable policy environment and a strengthening of property rights, will be essential to restore investor confidence. Structural priorities include public enterprise reform; civil service reform to sustain a real reduction in the government wage bill; expenditure management and tax reform; central bank reform and recapitalization; and land and agriculture reform. Strengthening relations with creditors and donors would help mobilize external financial and technical support for the domestic reform efforts needed for Zimbabwe to achieve stabilization, sustained growth, and poverty reduction.

Conclusion

Zimbabwe’s economy is likely to benefit from implementation of structural reforms that can raise productivity and output without adversely affecting the fiscal position.Primarily, a comprehensive streamlining of Zimbabwe’s licensing and permit procedures, and better coordination among regulatory institutions is likely to result in significant growth dividends with minimal initial fiscal outlays. Therefore, product market reforms deserve a centerstage in Zimbabwe’s priority reform arena. Such reforms are likely to improve the overall business environment and help growth through accumulation of production factors as well as higher productivity.

Samuel Mapuranga writes in his own personal capacity. Feedback: Email – smapuranga15@gmail.com; or Twitter: @Sa_miiM.