What is the true US dollar exchange rate?

10 May, 2019 - 00:05 0 Views
What is the true US dollar exchange rate?

eBusiness Weekly

Clive Mphambela
The designation of local bank balances, bond notes as well as electronic mobile wallet balances as RTGS dollars earlier this year, opened a new chapter in the journey towards currency reforms. However, the false start of the free float foreign exchange market has caused multiple tier exchange rates to persist in the market. These financial market distortions, which are now a major source of vulnerability for the economy and a substantial hindrance to growth, should be addressed. But how?

When the Monetary Policy Statement was issued on February 20, 2019, there was widespread celebration that finally, the central bank was acting in rooting out financial markets distortions.

The monetary policy, whose thrust was to introduce market driven reforms particularly to the foreign currency market by liberalising the exchange rate gave much hope that the existence of a plethora of financial market distortions across the Zimbabwean economy was now going to be a thing of the past.

Three months after the event, hope seems to be dissipating.

The markets are back in hysteresis and the upheaval and the distortions seem to be getting worse, with all the attendant problems for pricing and inflation in the economy.

This should be a cause for concern for economic policy makers.

Why is the multiplicity of exchange rates harmful?
Many suppliers of goods and services are employing different and variously derived exchange rates to price goods and services.

This is causing economic inefficiencies and opening up consumers to abusive pricing practices by unscrupulous businesses.

At the same time, some legitimate businesses are also having challenges pricing their goods correctly because of the numerous exchange rate benchmarks in the economy.

Just as an example of the extent of the confusion, recently the table on the right, was circulating on various social media platforms.

A quick analysis of the various exchange rates, all of them valid for various purposes, is quite revealing.

Firstly, one quickly notes that the true and real exchange rate between the US dollar and the RTGS dollar is nowhere near the extremes. If the exchange rate is supposed to reflect the real value or purchasing power of money, it becomes reasonable to assume that the true exchange rate for RTGS dollars to the US dollar is somewhere between RTGS$2,5 and RTGS $3,5 per US dollar.

Why then is there a big difference between the Old Mutual implied rate, which is calculated by taking the closing price of Old Mutual shares on the Zimbabwe Stock Exchange and comparing that price to the closing price of the Old Mutual Shares on the Johannesburg or London Stock Exchanges.

The answer is that the people buying such highly priced shares are desperate to take their money out of Zimbabwe and are therefore paying a huge premium to exit the market. The primary reason is that when these investors invested years ago, they had already made substantial capital gains in hard currency and they can afford to price these gains into the exchange rate that they are paying to exit the market.

On the other hand the street rate between US dollars and RTGS is high primarily because:

  1. Parallel market dealing is illegal so there is a legal risk premium attached to the trade which adds onto the fair rate.
  2. There is a risk premium attached to informal deals because one can get duped or scammed. Some people have been sold fake money for example.
  3. There are too many layers of transactions between trades. Each dealer takes a margin on the trade before the money gets to the end user.

Economists call these aggregation costs. Small amounts of money are put together to make larger trading parcels and these costs add up, affecting the rate. That’s why the street rates are high.

Why the official interbank market rate is not working
These psychological exchange rates that are pervading the market are perpetuating distortions. Because the interbank market rate is not the only reference rate, the existence of these other unofficial rates becomes problematic.

However, more importantly, businesses will price goods at the exchange rate that they are most likely to obtain currency to replenish stock. This is why the interbank exchange rate is not working.

On February 20, 2019, the Reserve Bank of Zimbabwe (RBZ) announced its Monetary Policy Statement which contained two major measures.

One was the announced re-denominating of the existing RTGS balances, bond notes and coins in circulation as RTGS dollars, effectively a local currency and the other main measure involved the establishment of an interbank foreign exchange market which according to the policy, was going to operate on a willing buyer and willing seller basis.

It was hoped that these measures would deal a lasting blow to the pricing distortions in the economy. However, the experience over the past few weeks has been less than encouraging.

While the introduction of a “floating exchange rate” allowed the devaluation of the local RTGs and bond note, making locally produced goods more competitive against imported goods and devaluation is expected in the medium to long term, to help improve the economy, but the measures have not done away with multiple tier pricing challenges.

In fact in some instances, multi-tier prices have become worse, with the divergence between prices determined at official rates and parallel rates becoming more pronounced.

In many instances, businesses have simply gone back to the old USD based prices of three or four years ago and simply now mark these “USD” prices to the daily open market exchange rates.

There are significant concerns that the interbank market has not operated as expected.

The first signs of trouble appeared when the RBZ instituted a direct targeting of the exchange rate as was evidenced by the initial re-pegging of US$1,00:2,5RTGS$, which rate was not market-based and a far cry from the RTGS$3,50 to 4,00 which was already obtaining in the market.

This immediately set up the new market for failure as no exporter would feel the need to trade out of US dollars at RTGS$2,5 per dollar, when there was a psychological opportunity to access the parallel markets and get better value.

Currently, RBZ has been employing moral suasion tactics on banks that have disallowed the exchange rate to move freely, beyond certain levels.

Further to these distortions there are other sectors such as gold miners, who are being given preferential exchange, which are higher than the prevailing interbank market rates.

The controls on the interbank market are thus sustaining the existence of a more lucrative parallel foreign currency market where, unfortunately, the majority of the formal businesses do not participate, thus starving them of the much needed foreign currency.

The slow implementation of the willing-buyer, willing-seller framework on the formal foreign exchange market has thus become a cause of concern for market players, as this is causing serious undesirable consequences, relating to continued sustenance of the parallel market where formal businesses do not trade.

This development will negatively affect formal business operations, threaten business viability, resultantly may lead to company closures and loss of employment.

Failure to allow free operation of the interbank market is worsening the already fragile foreign currency supply situation, as exporters and those with foreign currency are unwilling to dispose it at controlled rates and are finding alternative markets to dispose their foreign currency.

This is further eroding market confidence, and may result in failure to realise the good intended results of the measures which relates to improved foreign currency availability, hence, may lead to delay of economic recovery process.

The only way to get the market to discover the true exchange rate is to allow all players to trade officially at whatever rate they want to trade at but through the banking sector and other official channels. We need to move foreign exchange trading from the streets into the banks and bureau de change. That move will see rates quickly drop as supply increases.

However, authorities must also ensure that in the process, there is a real and permanent incentive for sellers of forex to hold RTGS dollars.

In other words, a stable exchange rate, reasonable interest rates on RTGS savings, low inflation and confidence, become key considerations in determining the true value of the exchange rate between RTGSdollars and the US dollar.

The writer is an economist. The views expressed in this article are his personal opinions and should in no way be interpreted to represent the views of any organisations that the writer is associated with.

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