eBusiness Weekly
Clive Mphambela
Last week, Reserve Bank of Zimbabwe Governor, Dr John Mangudya, unveiled what is by most accounts, the most progressive Monetary Policy Statement of our recent times.
Not only did Dr John Mangudya preface his policy pronouncements by a rare acknowledgement that previous policy direction has not been effective, but he also highlighted the fact that he was grateful for the massive levels of stakeholder inputs that he has received in the run up the Monetary Policy Statement (MPS) release.
The Monetary Policy came at a time when the dislocations in the economy have become unsustainable and taking corrective action was no longer a matter of debatable choice, but a serious case of survival of the economy.
This explains in large part, the cautious approach that the Governor took, and therefore the large amount of time he held out in releasing the monetary policy. He needed — and was absolutely right on this — adequate time to digest the implications, direct and indirect, of the policy interventions that he was bringing to the market.
This is what a central bank governor does and this is why the job of the central bank chief is not an easy one. Major policy shifts entail a careful analysis of possible challenges that can emanate from the policy.
That being said, good and positive as the 2019 MPS has been, debate rages on and it is a long way from going away. The main policy thrust of the MPS was the reestablishment of the Interbank Foreign Exchange Market. Well, calling it an Interbank market is not quite correct, since the thrust and real intention of the policy is to reintroduce a formal foreign exchange market with a multiplicity of players.
The Reserve Bank through the MPS and subsequent Exchange Control Directive SU 28 /2019, wants to set up a framework for the formal trade of foreign currency through a market based mechanism. This is a fundamental shift.
After a 20-year absence, the foreign exchange market is Back!! Hooooray indeed. But I urge caution. It’s not going to be easy. For the reasons I now outline below.
- Systems and Processes
The fact that the market has not really traded for so long means various systems and processes that used to exist in the market twenty years back are no longer in place. Significant re engineering of processes and systems has to happen and very quickly across banks, customers, bureaux de changes, and even the RBZ itself. This is especially important.
- Skills
Foreign Currency dealing skills and product development skills need to be refreshed. This market is a whole new ball game for a lot of players on both ends of the markets and there is need for retooling the skills set within corporate treasuries and across bank treasury departments.
- Micro Market Rules for the Foreign Exchange Market
The policy pronouncement made by the Reserve Bank is very good. There is now an urgent need to build supporting micro market ground rules to support and oprationalise the foreign exchange market. Such a framework is urgent and necessary because of the reasons I have already outlined above. Below are some of the proposals that have come from colleagues in the economics profession and I am in full support of this thinking.
The interbank market has lain dormant for the better part of two decades now. It follows that we cannot just rush into it and I applaud the RBZ’s cautious and deliberate approach. Some time is definitely needed to study the supply and demand dynamics in the context of the new market framework as clearly outlined in the RU/28 2019. The RBZ is keenly aware that there exist inherent risks in jumping straight into an open and uncontrolled trading environment. To manage these re-entry risks, some of which are outlined below, it is pertinent to establish a set of trading rules that will ensure an efficient interbank market.
Some of the Risk Factors that may inhibit the efficient working of the Market
Bid and Offer Mechanism
An efficient inter-bank market presupposes that all buyers and seller will present their bids to the market through their authorised dealers, a price is then fixed by a the actions of these willing buyers and sellers, and all transactions are cleared at the end of the trading session. During any trading day, the market must therefore clear in the sense that the prices offered and the bids made will be at a level where trades actually happen. If however, there is a pipeline of buyers and sellers who have un-requited transactions at the end of the day, this means that the market mechanism is flawed and trading is not occurring according to rules that promote proper forex price discovery and market clearance. This factor needs to be addressed as a matter of course.
Discretion of Authorised Dealers
The current system that has been introduced under which authorised dealers, re given discretion on who to allocate the limited forex as currently put forward may not deliver a proper market mechanism. This mechanism is fraught with the potential risks for rent seeking and other unfavourable dealing practices by market participants. Authourised dealers must initially be expressly prohibited from dealing for their own account or from given preferred access to their own customers, shareholders or nominees in terms of foreign currency allocations. This has the potential to severely distort the market and inhibit its proper function of price discovery and resource allocation. Available forex on the interbank market must be equally available to all potential buyers at the best rates possible on either side. This doesn’t necessarily mean that rates should be higher and higher.
Potential for abuse of the system by market participants-Both sellers and Buyers
Suppliers of forex as well as buyers should not be able to manipulate the foreign currency trading system. Care should be taken, particularly if authorised dealers/clients are multi banked, or the clients are part of a group or conglomerate structure. This can put undue pressure on the market by players putting multiple bids onto the market through multiple channels.
The Asymmetric Distribution of Liquidity in the Banking System is a Problem
The Asymmetric distribution of both Nostro$ and RTG$ liquidity in the banking system is a potential source of instability for this market. As things currently stand, it is very possible for all foreign exchange offered for sale through banks and ADLAs to end up not actually liquefying trades on the foreign exchange market, but the funds can end up satisfying a restricted set of clients within a few particular banks. This will inhibit proper price discovery and efficient allocation function of the market. There is also need for safeguards by the system to prevent silos of liquidity moving from underfunded bank to liquid banks in an uncontrolled manner and the Reserve Bank’s major role in the formative stages of this market is to ensure adequate balance so that the market doesn’t introduce systemic risks.
A micro market framework for foreign currency trading is therefore a necessary step and one hopes the authorities and its stakeholders are seized with coming up with such a framework.
The next critical step to be taken by the Reserve Bank is to actually allow price discovery to happen. The policy framework speaks of creating a platform for willing buyers and willing sellers. This must be in deed as well as in script.
We are very well in tune with Dr JPMs presentation and understood fully the reasons why the RBZ believes that the exchange rate should not be allowed to immediately move to ZW$3,5 where the Psychological level is currently at market wide.
However, we are not entirely convinced that his main concerns revolving around rooting out speculators are supportive of the broader objective which is to kick start and sustain an efficient market based mechanism for foreign exchange in the country.
By the nature of markets, speculators are an integral part of markets but they remain a small number. What is important in our view, which is informed also by the research and engagements that have been done and a broad interpretation of the psychology of markets, it is more useful to have the market established first and then finetune it later.
Suppose hypothetically the Reserve Bank has some US$400 million at its disposal. It can employ two different strategies but with two very different outcomes.
The first option is drip feeding/seeding the Forex Market at RTG$2,5 for as long as possible.
The second, is to allow the Market to set its own level market rate first and then the RBZ can come in to liquidate excess demand at a cut below that market everyday.
The first strategy, which is the one the RBZ has currently chosen has a number of major flows. The Bank has adopted a stance that aims to support the market from the bottom. Rather I think it would be far more cost efficient and more effective if the RBZ instead supports the market from the top, after allowing it first to set its own entry level rate. Here are the reasons why.
Market participants, both banks and their exporting clients will not bring money into the market at RTG$2,50 until the other reference rate ie the RTG$3,5 in the alternative market also succumbs and gets lowered to the same level. Alternatively, the “official rate” or RBZ desired rate must creep up to close this gap.
If the official rate is held down at RTG$2,50 — the parallel market pressure will persist. Desperate importers will continue to go out to this market and exporters will also take their chances and will find ways and means to filter money into the parallel market. The parallel market will therefore not die.
There is also the risk that despite official rates being managed lower at around RTG$2,50, the whole of industry and commerce will continue to price goods and services at the higher rate because in their minds, that is where their replacement costs are marked at. Being rational economic agents they will not want to trade at loses and want to hedge replacement cost risk.
Sooner rather than later the RBZ will probably run out of the support dollars at RTG$2,50 and this will happen unless the RBZ can use other tools and incentives to encourage export proceeds and free funds to come to the market at the RTG$2,50. This will hold true until and unless a day comes when RBZ is able to satisfy all the market requirements demand at RTG$2,50. which I think is not possible or even desirable since the objective is to have a mechanism setting the rates with RBZ managing the peg. If the RBZ insists on the RTG$2,50 chances are that the big bank will most likely remain the only seller of foreign exchange and the market mechanism will not take off, thus defeating its own efforts.
The second strategy, of allowing a negotiated entry by exporters at the psychological rate that is in the market at the moment has a number of advantages.
Trades will clear on both sides immediately from market available funds on a Willing Seller Will Buyer Basis. This establishes the credibility of the market.
When trades don’t clear. RBZ can then inject funds to support the price from the Bid, in other words, Bidders will be encouraged to submit bids at lower rates as opposed to higher rates to discourage escalation in the rate. This kind of rate manipulation is both desirable and feasible.
The RBZ can still keep its war chest of Foreign Currency to support critical imports such as fuel, and other strategic needs at the RTG$2,50 rate until convergence happens. This will allow these quasi public goods to get the benefit of the soft rate as opposed to simply transferring value into private hands at RTG$2,50.
This is especially true if we bear in mind that most goods and services in the economy are already pegged at equivalent rates of between RTG$3,50 and RTG$5,50 and businesses are unlikely to reduce prices anyway even if they get new money at the RTG$2,50. If injecting money into the market at RTGS$2,50 will not result in prices being reduced, then the strategy is inefficient.
The RBZ may consider conducting surveys of major exporters to find out directly from them, what rates would encourage them to begin the process of bringing liquidity onto the market. However, exporters must also be made aware that it is in their interests to liquefy the market with export proceeds since this may actually unlock further opportunities for surrender requirements to be reviewed downwards in future.
The writer is an economist and the views expressed in this article are his personal opinion and should in no way present views of any organisations that the writer is associated with.
