The month of May 2019 was a very eventful month indeed in as far financial markets in Zimbabwe are concerned. Top among the events of the month was when two weeks ago, the Reserve Bank of Zimbabwe governor, Dr John Mangudya, unveiled a new set of measures to guide the fuel market.
Fuel traders were effectively directed to now access foreign currency requirements directly from the interbank market, a move which, by most accounts, was a very progressive additional step in the ongoing monetary and foreign exchange market reform agenda.
The move came at a time when the stubborn dislocations in the economy had become unsustainable and taking corrective action was no longer a matter of debatable choice, but a serious case of survival of the economy.
However, the central bank chief has always been wise to take a very cautious and measured approach to reforms, which often-times require to be well thought out and deliberate. This explains in large part, therefore the large amount of time the Reserve Bank often holds out in releasing the monetary policy statements and other reviews.
The governor needed — and he seems he was absolutely right on this! — an adequate amount of 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 care full analysis of possible challenges that can emanate from the policy.
The main policy thrust of the MPS was the re-establishment of the Interbank Foreign Exchange Market with the medium term view of reintroducing a formal foreign exchange market with a multiplicity of players.
Thorough the 2019 MPS and subsequent Exchange Control Directives and Statutory instruments that have been issued to fine tune the market, there is a gradual but fundamental shift to a market based mechanism for foreign exchange trading. These policy moves by the central bank can only augur well for the economy.
It is crucial to realise that after a 20 year absence, the foreign exchange market is finally coming back! It is not going to be an easy adjustment, especially for a market that was now used to the central bank providing everything by way of foreign currency allocations. It is not going to be an easy ride for the reasons that we have previously outlined.
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 needs to happen and very quickly across banks, customers, bureaux de change, and even the RBZ itself. This is especially important
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. We need to accept that the new market order and indeed the state of the economy now demands enhanced skills across the spectrum of market players.
The need for micro market rules for the foreign exchange market
There is now an urgent need to build supporting micro market ground rules to support and operationalise the foreign exchange market. Such a framework is urgent and necessary because of the reasons we have previously shared.
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 laid dormant for the better part of two decades now. I follows that we cannot just rush into it and the central bank as already alluded must be applauded for the cautious and deliberate approach.
Some time is definitely needed to study the supply and demand dynamics in the context of the new macro-economic environment.
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 the 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 level where trades actually happen.
If however, there is a pipeline of buyers and sellers who have unrequited 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.
Authorised dealers must initially be expressly prohibited from dealing for their own account or from give 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 sets 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.
We now need a set of “FX Micro Market Trading rules as soon as possible” which will guide all market participants.
I think also that we need to migrate forex trading to an electronic FX platform that gives equal access to all APPROVED willing buyers and willing sellers of foreign exchange within the context of sound exchange control framework.
Obviously it will be a free for all, but should be guided by well-defined market entry and participation rules.
The electronic platform should however be fully transparent and should take into account our common concern relating to the asymmetry of US dollar nostro holdings as well as RTGS liquidity holdings in the market.
In the current “inter-bank” market, there is really nothing to prevent those banks with rich nostro reserves from potentially rigging the exchange rates in order to favour their own clients whilst discriminating against those banks with limited nostro holdings who constitute the majority of banks.
An electronic trading platform with strong governance rules at micro market structure level supported by robust exchange controls would get rid of this asymmetry straight away and create a transparent, efficient foreign exchange system.
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 and thus living to the true meaning of willing buyers and willing sellers.
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.