As we have been warning, a bubble was forming in the US dollar exchange rate, and this week the really big bubble in the vendor market, more formally if wrongly called the parallel market, duly burst as the Reserve Bank of Zimbabwe finally made many of the required and desired changes in monetary policy.
In three days the US dollar banknotes sold on the streets lost almost half their value, and by Wednesday we had reached the interesting point where the rate between bond notes and US dollar banknotes was actually below the RTGS$ to US dollar interbank rate, meaning that in certain cases, if admittedly rather special circumstances, a US dollar was actually cheaper on the pavement than in a real bank.
There were many who thought we were at best wrong and at worst off our head when this column warned about the coming bubble, since “everyone knew that exchange rates must continue rising”. But remember where you first read about the bubble.
The interbank rate, on the other hand, remained rock steady in the days after the decision by the Reserve Bank to end the multi-currency regime, quadruple overnight accommodation interest rates, pump half the surrendered export earnings into the interbank market and remove $1,2 billion from circulation.
There must be three good reasons for that sudden stability despite a dramatic shift in several RBZ positions for in a “normal” economy, far tinier shifts cause far more waves, rather than total steadiness.
First the interbank rate is closer to the real value of the Zimbabwe dollar than the pavement rate.
Secondly unlike the spivs who exploit the low-volume low-margin vendors, who in turn cope with herd mentality by panicky Zimbabweans, the very sober dark-suited women and men in corporate and banking offices were not going to panic. They almost certainly want to look at all angles, and think through all implications, before making a move.
But the absolute steadiness also strongly implies that the Reserve Bank itself, which is still easily the dominant seller on the interbank market, was driving very very carefully to keep everyone else calm, cool and collected. It is an interesting signal. At the very least the granite steadiness of one willing-buyer willing-seller market compared to the wild volatility of the other must start raising questions over which is the “real” market setting value, and hopefully be the start of that cultural shift required to think about the interbank rate being the actual rate.
But it will probably take several days for the interbank market to start reacting to the raft of monetary measures.
What will happen to the rate in the very short term could be problematic as buyers and sellers test the waters. But it is still our opinion that the Zimbabwe dollar is undervalued when looking at the fundamentals and that in a normal country with an identical set of fundamentals it would be trading somewhere between four and five Zimbabwe dollars to the US dollar.
Three of these fundamentals are not new.
The total holdings of foreign currency potentially available for sale on the interbank market is now over US$1 billion although the bulk is still in private nostro accounts. But that is a lot of forex.
Secondly money supply is still very stable. There are still only around 10 billion Zimbabwe dollars in existence, and while all are technically in the money supply, the majority are not available for immediate circulation, that is available for transfer or spending at 8am tomorrow morning. That puts a limit on how much can be spent on buying forex.
Thirdly the rigid fiscal discipline of the Government has become the new normal, something many still need to adjust to after 38 years of borrow-and-spend and print-and-spend. Even the recent promise of President Emmerson Mnangagwa and Minister of Finance and Economic Development Prof Mthuli Ncube to increase civil service pay will not stop primary budget surpluses each month. The rise in prices, which triggered the need to adjust pay, is also pouring more VAT and transaction tax revenue, despite drops in business volumes, into Prof Ncube’s accounts and other tax revenues must be rising. So he has extra money to spend on pay but it is the safest bet in town that his extra spending will be slightly below his extra tax revenue. So the Minister is not going to be increasing money supply.
As an aside it was interesting that the Government call for the private sector with its rising profits to pay its own workers more came from the Finance Minister. Someone needed to say that but Prof Ncube will also be collecting more PAYE when it happens, and so can put more into his own payroll.
The new fundamental now in place was the signal by the Reserve Bank, through its quadrupling of overnight accommodation rates, that interest rates need to rise fast, making borrowing a lot more expensive and banks a lot less eager to lend willy nilly. It had become increasingly obvious that many net exporters were hanging on to their nostro money and borrowing cheaply to pay local bills, while net importers were gearing up to borrow a lot more at then prevailing cheap rates to buy forex to service existing foreign debts and to credit suppliers and build up stocks of imports. The interest rate rises must make both sets of borrowing a lot more problematical, so increasing the potential supply of forex for the interbank market and decreasing the pressure to buy that forex.
The bundle of monetary measures this week is a big step forward in moving Zimbabwe towards a normal economy. RBZ Governor Dr John Mangudya has been very careful in the steps he is taking. To be fair, he probably has to be as he is dealing with perceptions created by the hyperinflation era, which causes far more irrational market behaviour from a scarred and scared public than would be “normal”. And for much of his first term the fiscal indiscipline on the other side of Third Street meant he had to carry a heavier load and take on responsibilities central bank governors are not normally required to perform.
Even this week’s measures were made more acceptable, and the end of multi-currency legal tender was a big move for the public to swallow in light of so many bad memories, by showing that the looming disaster moving closer in June was obviously a more clear and present danger.
Zimbabwe is now moving faster towards using markets properly to set pricing but those markets need to be very tightly monitored to prevent cheating and indiscipline. In fact a lot of public reaction to this week’s moves was to wonder how long it would take the less desirable operators to find a way around the measures; clearly all authorities have to watch out and plug the loopholes as they appear.
And in the end our progress does require very careful co-ordination of fiscal and monetary policies, each building on the successes of the other. For example, prioritising import spending, largely done by the RBZ when we pretended an RTGS dollar was equivalent to a US dollar, can be transferred to markets with fiscal policies, through the setting of differential taxes, used to modify those markets to ensure essential goods and productive imports dominate. The RBZ can then concentrate on ensuring that the markets then work properly, transparently and honestly, which might require very tight regulation considering how many wide boys operate in Zimbabwe, wanting to make a buck by rentier behaviour rather than making and selling stuff people need and want.
The move towards the normal economy we all need so we can move forward fast to prosperity is now progressing at a fair lick. Success at each stage will breed success.