Markets are usually efficient in the long run and are generally accepted as the most efficient way to allocate resources, but that theoretical efficiency can be devalued by the expectations of the majority, a lack of conceptual thought, and the manipulations of a minority.
If this was not so then there would be, for example, no bubbles in stock or property markets when prices rise far above the fundamental value of the assets being traded and which precede inevitable collapse to something more rational. These bubbles are largely caused by a herd mentality, an illogical belief that a short-term historical trend will continue into the indefinite future, and a lack of clear understanding over what exactly is being bought and sold.
We are now seeing the same sort of problems in Zimbabwe with supplier pricing and the antics of the parallel foreign currency market. Driving most price rises and most expectations is what is known as the parallel exchange rate. And before people start treating this rate as the result of a rational market they should first consider exactly what it measures.
The actual rate is set by supply and demand of free foreign-exchange funds. These are funds outside the control of the authorities, unlike export earnings. The bulk of such free funds available in Zimbabwe are diaspora payments, those remittances sent home by Zimbabweans working outside the country. Most such payments come through money transfer agencies such as Western Union and enter the market through informal trading with a fairly well-developed hierarchy of traders accumulating the tens of thousands of small sales into large blocks of funds of more use to those who want to hold US dollars or legally export US dollars.
The exchange rate for such free funds will in many circumstances in many countries be higher than the exchange rate set by a market bridging exporters and importers. In South Africa during the apartheid era there were, in fact, two official currency markets for the commercial rand, which matched export earnings and importers demand, and the financial rand, which matched capital inflows with demand for capital transfers out of South Africa. For a couple of decades the financial rand had the worse exchange rate, with the gap growing as international financial and investment sanctions on the apartheid regime dried up the inward flow of forex capital and increased the demand by emigrants and others wanting to get their money out.
In Zimbabwe at the moment the free-funds exchange rate is rising, sometimes with sudden jumps, as people with large holdings of RTGS dollars want to move into US dollars, regardless of the price, and a herd mentality by others that this is the only way to go. If this was all there was to it, remembering that free funds inflows are actually quite a small percentage of total forex inflows, then this market would just be a way for those getting small remittances from a wealthy granddaughter to maximise the basket of groceries they could buy and for those who find dealing in volatile mining shares boring to gain more excitement.
However, what is in practice happening is that this rate is driving a good fraction of commercial transactions with the new interbank market being side-stepped. That is made possible first by the export retention incentive scheme, allowing exporters and producers of export products, such as gold miners and tobacco farmers, to retain varying percentages of their forex earnings in nostro accounts. In theory they are supposed to use these nostro accounts to pay for their own foreign inputs and sell the rest on the interbank market. In theory and fact they cannot transfer these sums in their nostro accounts to other Zimbabweans or Zimbabwean entities.
In practice they pay an external supplier for goods and services for someone they have been introduced to and in theory are paid for those goods and services by the end user. Often there is a middleman who takes another slice of profit. These deals are legal, although defeat the whole purpose of reforms, and are priced at the parallel rate which is not set by commercial trading but by free-fund trading. That produces distortions into the markets and also allows markets to be manipulated easily since the rate is set by a small fraction of the dealings, not by the whole market.
There are other pressures as a result. It is known that some producers of export goods are not rushing to sell what they have mined or grown, but instead are selling just enough to meet cash-flow requirements while waiting for what they assume will be a better price. Again this is legal. A gold miner, for example, must sell to a subsidiary of the Reserve Bank of Zimbabwe but is not obliged to sell immediately. A tobacco farmer these days is almost always under contract, and cannot side market, but there is no delivery date in the contract. And many exporters hold on to their forex retentions as long as possible.
But counter pressures are now being felt. The fiscal reforms of the last nine months mean that money supply is not growing. Indeed terms of purchasing power and in terms of US dollar equivalent the money supply is contracting sharply. The value of the whole pool of RTGS dollars is now around 45 percent of what it was worth nine months ago, taking into account inflation. Or that entire pool would buy one third as many US dollars as the official interbank rate, or around one fifth at the parallel rate. By any standard this is a drastic reduction in effective money supply.
It also highlights the dramatic difference between what is happening now and what happened in the 2000s. Right now money supply in nominal terms is hardly rising, as the present Minister of Finance and Economic Development is not wandering along Samora Machel Avenue hawking Treasury Bills, and in effective terms has fallen to between 10 percent and 20 percent of Gross Domestic Product, depending on how you measure. In the 2000s Gideon Gono set his printing presses howling as he tried to keep money supply growing in effective terms to fill an ever rising Government budget deficit.
Already this difference is being felt. Many individuals and businesses are finding their biggest problem is a shortage of RTGS dollars, even if they want those dollars to buy US dollars. Reports are surfacing that some allocations of forex are not being taken up because the applicant has inadequate supplies of RTGS dollars.
Borrowing is being resorted to in these circumstances, but interest rates are going to rise as demand exceeds the supply. It is fairly obvious that those who expect a crashing exchange rate, high inflation and low interest rates have missed the point that only two of those are possible at any one time. Banks, which for a few years have been making record profits dealing with sovereign debt are now going to have to sweat a bit more. Rising interest rates also mean that they will have to make larger provision for default, so margins will be tight.
In the actual real market places signs are already emerging. Retailers are finding more expensive brands and product lines hardly move. In most supermarkets there is an almost continuous queue waiting for in-house bread at $2,50 a loaf, rather than for the unsold loaves baked by the members of the baking cartel, who shamelessly make their cartel official by calling it the Master Bakers Association, being sold at $3,40 a loaf.
And, most strikingly, we have just had our largest industrial company, Delta, reducing the prices of its non-alcoholic beverages because hardly anyone was buying them. Admittedly they did not reduce the price of their beers, where they have for all practical purposes a local monopoly only limited by the cost of imports, while in soft drinks they face competition from the local bottler of another range of global brands plus extra competition from local brands. While the precise formula for coca-cola is a closely guarded secret, 15 minutes accessing the internet will find half a dozen formulas for a drink that comes rather close. What Delta found is that brand loyalty is weakening, that consumers do not think in US dollar equivalents and that even little inexpensive semi-luxuries, and soft drinks are not essential for life, are dropped from shopping lists when money is tighter.
The RBZ and the Finance Ministry can accelerate their necessary reforms by making markets more efficient. The February Monetary Policy Statement in effect created an official two-tier forex market by suggesting Bureaux de Change could be reactivated, giving an official market for free funds. But that has not been implemented.
The Interbank market needs to be invigorated, so it does become in fact as well as theory, the market for all commercial currency dealings. And leakage between the two markets, in whatever form, needs to be plugged. This is not impossible, although more difficult than expected. But it must be done.