There’s nothing surprising or fundamentally new about the monetary and currency reforms that the Reserve Bank of Zimbabwe (RBZ) introduced in the 2019 Monetary Policy Statement.
I have restricted my focus to an interpretation of the monetary policy measures, unpacking the rationale and underlying policy objectives of the monetary measures, without looking at the effectiveness or implications of the changes.
I would personally describe the changes in two ways.
Market actors to unresolved structural imbalances such as foreign currency shortages, low foreign currency reserves and an overvalued exchange rate can see the reforms as an official recognition and formalisation of monetary developments that had already established an existence either as an inadvertent and unforeseen consequence of previous monetary actions or as a “rationale” response.
For instance, I prefer to see the establishment of the interbank foreign exchange (forex) market as the formalisation of the parallel market which came into being in 2016 when the RBZ technically de-dollarised the economy through the introduction of bond notes, supported by a US$200 million nostro facility of Afreximbank.
The same can be said of devaluation. After two years of adamant resistance, the RBZ has eventually succumbed to a series of speculative attacks on bond notes and RTGS (Real Time Gross Settlement) balances, and adjusted the peg to US$1:RTGS$2.5 from a parity position as a way to mitigate a structural currency crisis.
I’ve deliberately used the term “adjusted the peg” instead of liberaliing the exchange rate because it is not a “free float” as officially claimed.
Neither is it a “dirty float” manipulated from time to time by the monetary authorities to ensure that it fluctuates within a narrow band of pre-determined lower and upper limits.
If the exchange rate was a free float, devaluation would have been followed immediately afterwards by a depreciation, which would have brought it closer to the parallel market rate of around RTGS3.5 for every dollar, reflecting the country’s low forex reserve position.
On the contrary, the RTGS dollar has maintained a stable exchange rate in the official market and this reflects all the typical characteristics of a peg.
Although many people might be surprised by the rather absurd phenomenon of RTGS as a currency, it has been so since 2016 when the RBZ started creating unfunded transferable balances, ie, “nostro” balances not funded by cash US dollars.
From that point on, RTGS changed from a mode of transaction to a currency in itself.
In effect, the monetary authorities found RTGS to be a convenient instrument to informally reassert their seignorage power to “print money” and overcome the money supply constraints of dollarisation.
Through this seignorage power, transferable balances surged to nearly US$10 billion last year from around US$7 billion in 2016. The explosion in transferable balances was mostly a result of imprudent monetary and fiscal policies as well as speculative dealing in the forex black market.
As expected, the plan which initially appeared attractive and expedient soon plunged the monetary authorities into a dilemma.
Continuing with dollarisation meant they had to find the cash US dollars to fund the balances. Abandoning dollarisation means they had to officially recognise the black forex market and devalue the balances under a new currency regime.
For obvious reason, the RBZ has opted for the latter option, which is merely a formalisation of a market created and propagated by forex speculative dealers with full public acceptance and participation through a parallel market arrangement.
Similarly, bond notes, which were purportedly backed to the last cent by the Afreximbank nostro facility at inception, also ceased to be a fiat currency of nostro dollars (USD balances) and became a currency in themselves in 2017 when the RBZ failed to provide cash US dollars on demand due to depleted reserves.
The only difference between now and 2016 is that RTGS and bond notes are now officially recoginsed as currency. The bond note has changed from a fiat currency of nostro dollars to a fiat currency of RTGS dollars. The USD has also been turned into a fiat currency of the nostro dollars sitting in nostro foreign currency accounts.
According to this view, the new monetary changes are an “official recognition” of monetary phenomena, which already existed informally or a “shock correction” of unresolved monetary imbalances, which had reached unsustainable levels as the RBZ had not adequately addressed them on October 1, 2018.
The concept of “shock correction” does not always imply market-induced reform. In our case, it insinuates either a disruptive self-correction of monetary imbalances such as an overvalued exchange rate and unfunded transferable balances or a forced reform in cases where the imbalances had reached where “something’s gotta give”, what we can call the breaking point.
We can also look at the reforms more as an attempt to address the unintended consequences of monetary measures introduced on October 1, 2018 than a phased implementation of planned monetary reforms.
For instance, currency reforms had been deferred to three to five years to allow monetary and fiscal authorities to address fundamentals, in this case building reserves to at least three months of import cover.
The forex black market and its exchange premiums were overlooked. Since it was not considered a macroeconomic threat at the time, inflation was not adequate attention.
Paradoxically, the three issues have shown wicked tendencies through unintended consequences such as black market exchange rate-based pricing — what can be called “USD price benchmarking”— and informal re-dollarisation, which we can be viewed as “informal currency” reforms.
Put another way, most of the issues that the monetary and fiscal authorities neglected or overlooked on October 1, have been addressed by the market informally, resulting in “shock reforms”, which effectively undermined the official short-term stabilisation programme.
Speaking during the Daily News Monetary Policy Breakfast Review last week, RBZ governor John Mangudya admitted that the monetary measures have been designed to contend with unintended or unforeseen consequences when “the trajectory changed”.
“We thought we were going to have a better last quarter (of 2018), but it became inflationary,” Mangudya said. “The trajectory changed.”
By implication, the current monetary reforms were not originally part of the short-term stabilisation plan and have been tailored to deal with what are generally known as wicked policy problems — challenges that are generally difficult to solve and often trigger unintended consequences.
With roots in the currency crisis, inflation and informal re-dollarisation and large forex spreads between the formal and informal markets have shown wicked tendencies. Since October 1, 2018, inflation has changed from a monetary to an exchange rate phenomenon. Whereas the separation and “ring-fencing” of bank accounts into “nostro FCA” and “RTGS FCA” was purportedly intended to “support (stabilise) the multi-currency system”, it was widely construed as a technical reintroduction of local currency.
Convinced that the RBZ had no reserves with which to defend its 1:1 peg, speculators responded with “shock devaluation”.
In the same way, various market actors also stampeded to hedge themselves against loss of value through USD price benchmarking based on moving black forex market exchange rates. Thus, any depreciation of the bond note/RTGS balances that occurred in the underground market is being passed through to and reflected in formal sector prices.
Although the RBZ calls this multiple pricing, the correct term is USD price benchmarking or exchange rate-based pricing, a phenomenon where prices creep in line with movements in the exchange rate. Import-depended sectors such as the pharmaceutical and automotive industries resorted to direct USD pricing.
Through these developments, hyperinflation has returned while the economy has progressively re-dollarised informally.
Thus, instead of stabilising the multi-currency system, the separation and ring-fencing of bank accounts paradoxically plunged the economy into hyperinflation and deepened the currency crisis through a shock devaluation.
The current monetary measures can therefore best be described as “fire-fighting”.
The monetary authorities are trying to build “sandboxes” around all highly inflammable points of the crisis.
The original plan was to continue with the multi-currency system until they had successfully “stopped the bleeding” in the economy, to use the words of Mthuli Ncube, the minister of Finance. From a fiscal perspective, the original plan was focused on achieving three objectives: narrowing government deficit, reducing government debt and reducing trade deficit.
In fact, the whole plan was all about fiscal consolidation, dragging government out of debt and stabilising fundamentals by increasing government revenues and expunging its debts.
The monetary authorities were mostly concerned with building foreign currency reserves in order to support the multi-currency system and pave the way for longer-term currency reforms.
The plan caught fire within weeks and gutted the economy, prompting the current fire-fighting measures.
While the monetary and fiscal authorities have not really abandoned their original plan to defer currency reforms to three to five years and focus on fiscal consolidation in the meantime, they had to find a way to stop informal re-dollarisation and USD price benchmarking.
The most convenient way has been to recognise RTGS and bond notes as currency and embrace devaluation for two reasons.
On one hand, they want every economic actor to use RTGS dollars for all domestic transactions, restricting US dollars to a reserve currency.
What is not immediately apparent is whether the RTGS dollar is merely a new addition to the multi-currency system or whether the multi-currency system has been completely abolished.
One the other hand, the monetary authorities want all those selling or looking for foreign currency to use the interbank forex market.
The devaluation policy has also made it possible to establish a forex interbank market.
Contrary to belief, both devaluation and the forex interbank market are not equal to liberalisation.
Rather, the two measures are meant to deal with one of the most adverse consequences of the separation and ring-fencing of bank accounts. Since October 1, 2018, nostro balances have been accumulating in nostro FCAs and remained dormant since the two ring-fenced accounts could not trade with each other.
In just four months, nostro balances hit US$600 million, which the RBZ had no access to.
Apart from what it bought from exporters through statutory surrender requirements, the RBZ limited access to foreign currency, leading to critical reserve depletion.
The monetary authorities had to find a way of opening the nostro balances to forex trade and created a market — the interbank market — in which they are the biggest participant.
The whole idea is buy the bulk of the foreign currency in the interbank market at a controlled exchange rate in addition to what they acquire through revised export surrender requirements, hoping to progressively build reserves through the two instruments.In other words, the design of the monetary reforms has to a larger extent been influenced by unintended consequences of earlier policy actions or issues that were previously glossed over.
Little wonder, currency devaluation and inflation control are now a key part of the revised short-term stabilisation programme, now built around five action areas:
• To stop informal re-dollarisation
• To stabilise prices
• To gain greater access to nostro balances through the interbank market
• To build reserves in preparation for the introduction or real local currency
• To paralyse the parallel forex market.
In the next article, I will analyse whether the monetary authorities will be able to achieve these policy objectives, pointing out the challenges and suggesting alternative options.
n Mugowo is an economist and researcher. He is currently the Managing Consultant of Ziostats P/L, the thinktank of Ziopra consulting Group. He can be reached at email@example.com. Twitter @mugmugo.
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