ECONOMIC MUSINGS: EXCHANGE RATE OUTLOOK
LESS IMPORTANT IS THE LEVEL, MORE IMPORTANT IS THE STABILITY
Zimbabwe’s economy finds itself plumb in the midst of a transition. We have moved from a multicurrency system to a local currency and have shifted from a fixed exchange rate of 1:1 to a free-floating system in an interbank forex market that is still very much in its infancy after several years of inactivity.
In many respects, the markets are still trying to establish a fair level for the local currency’s exchange rate to the US Dollars and other currencies.
As we digest the recent policy shift, looking at events post the pronouncement and casting our eyes further forward into the future, it is perhaps important to note one key point regarding exchange rates:
The level of a currency’s exchange rate is of relatively less importance to an economy’s performance than its stability. Japan for instance, the world’s third biggest economy, has a currency that has traded around 1:100 to the US dollar for the more than a decade.
While it is understandable that people are fixated with the level of our USD/ZWL exchange rate given its immediate impact on livelihoods, our view is that it’s not so much the level of the rate, but finding relative stability around whatever level the free market determines that matters to long term economic performance and people’s welfare.
With that, let’s unpack developments post the recent policy pronouncements and try to see what lays in wait.
In the two weeks post the policy pronouncement, the exchange rate in the alternative market has retreated from 14 to around 8.5 whilst the rate on the formal market has edged up to similar levels, reaching convergence.
The move to 14 was largely driven by uncertainty stemming from talk of the re-introduction of the local currency which had gathered pace in the few weeks prior to the policy pronouncement. It was unclear to the market how this process would shape up. Statements by local policy-makers on the strength of the local currency negatively affecting the competitiveness of our exports were construed by some as suggesting the local currency, when introduced, would be initially pegged above the South African Rand level of circa 14 to the US Dollar. Others yet feared the complete demonetization of local RTGS dollar and bond notes, similar to 2009 when Zimbabwe Dollar balances were whipped out. With the policy announcement, some of this uncertainty lifted and the rate dropped to around 8.5 in a classic case of “buy the rumour, and sell the announcement”.
The two questions uppermost in the minds of many is whether this correction in the exchange rate will be sustained and if this will filter through to the real economy and result in a decline in the prices of most goods and services, which had shot up with the spike in the exchange rate.
Let’s try and address each in turn.
In analysing the issue of exchange rates, its best to differentiate between immediate/short-term fluctuations and the medium to long-term trend. In the short-term, exchange rate stability will, to a large extent be driven by market confidence. Over the medium to long-term, the trend in the exchange rate will be driven by Zimbabwe’s money supply growth, government spending, aggregate demand and our international trade performance.
Now that there is clarity on the mechanics of Zimbabwe dollar re-introduction, and that is all priced in, the next question is how effective are the new measure in availing forex to all importers (both large corporates and SMEs). If importers are able to obtain forex through formal channels at current exchange rates, that builds confidence, meaning they are less likely to resort to the alternative market and start driving up the exchange rate.
The challenge is that the formal market still has frictional issues that need sorting out before it can generate the forex volumes to satisfy importers forex demands. Firstly, banks are still fairly rigid and less agile than informal traders in their Zim dollar settlement channels. In the forex market, nuance is everything. A further bottleneck is that some banks are only buying currency from their existing clients and not trading with “walk-in” clients.
Bureau de Change businesses, whilst less stringent in terms of their KYC, are still restricted to selling travel allowance and various subscription payments.
Important to note is that around 60% of our imports are from South Africa. In addition, Zimbabwe generates sizable amounts of South African Rand (between USD500 million to USD1 billion worth of Rand annually by some estimates) through illicit gold exports.
Given the frictional issues in the formal market, the concern is that importers may not initially obtain their forex requirements in full through the interbank market, grow impatient and revert to the informal market for intermediation to tap into the Rand flow from the illicit gold trade. With Zim dollar pricing for goods and services still pegged around 1:15, there remains headroom in the short-term for the exchange rates to rebound initially on the alternative market, with the interbank market following suit.
Over the medium to long-term, the trend in the exchange rate will be driven by the afore-mentioned factors, namely money supply growth; government spending vis-à-vis revenue; aggregate demand and our international trade performance. A brief look at each:
Local policy-makers seem intent on containing money supply growth – the total RTGS balances within the economy have remained flat at just under ZWL10 billion for the best part of a year. In short, the central bank has not been printing money. Kudos – they must stay the course!
In addition, the central bank has raised the overnight accommodation rate to 50% per annum. This should see banks increase their lending rates to levels above 50%, likely around 70%, making borrowing more expensive. This should curb the growth in bank loans to the private sector, one of the factors alluded to have been driving speculative demand for forex. Further, through the legacy debt assumption, central bank targets to mop up close to ZWL1,2billion from the market. This should result in further tightening of market liquidity and contain money supply growth.
For the first time in a long time, government is not spending beyond its means. This 2% transaction tax, whilst vilified and painful to the populace, has effectively sorted out government finances. The first quarter of 2019, government recorded a budget surplus of ZWL443.1 million. However, we feel there is yet room to trim some of government’s expenditure.
The levels of local wages and salaries have not kept pace with increases in the prices of goods and services. At most, incomes would have increased by 100% over the past year and a half – and that’s being very generous. On the other hand, prices have gone up at least seven-fold during the same period. Whilst total demand within the Zimbabwe economy is augmented by diaspora remittances which average around USD1 billion annually, this figure only comprises around 6% of total national income. It therefore stands to reason that real disposable incomes have declined given the current price levels.
In terms of international trade, initial numbers published for the first six months of the year indicate that there has been a marginal decline in exports of 4% on 2018 levels to USD922 million in the period February 2019 through April 2019. The current account narrowed to –USD231 million during the same period. Imports are down significantly 35% from last year to USD1,153. Given our heavy reliance on imports of consumer goods, and the decline in aggregate demand stemming from lower real disposable incomes due to exchange-rate-induced inflation, we expect a contraction in imports.
Zimbabwe’s power crisis poses serious threat to industry and exports. We see output and exports also contracting from 2018 levels given the power crisis and our below average 2018/2019 agriculture season. Its yet unclear which of these two, exports or imports – record the greater contraction.
Assuming recent trends in the above fundamentals persist, we can expect a macro landscape over the next twelve months or so that is characterised by restricted money supply growth, government spending confined to fiscal revenues, a reduced level of imports and exports. Three of the four elements are in place for a stable long-term exchange rate environment, which informs our bullish outlook on exchange rate stability in the medium to long-term.
Given the foregoing, what happens to prices of goods are serves in the greater economy? To try and form an opinion on the trajectory of price levels, its useful to see things from the perspective of corporates and entrepreneurs in Zimbabwe.
With the carnage that was experienced in the forex market over the past month and a half or so, the mindset within Corporate Zimbabwe currently is a defensive one – avoiding losses by pricing defensively to cushion oneself against further weakness in the local currency. The original fall back was to decline payment in Zimbabwe dollars and insist on receiving US dollars. That avenue is closed now. Sales have to be in Zimbabwe dollars. With sales likely to slow down given the contraction in demand, at some point the focus moves from loss avoidance to profit generation. After all, overheads have to be met and salaries need to be paid regardless of sales volumes. Meanwhile between the formal and informal markets, the exchange rate finds a level.
Our view is that once the focus of corporate Zimbabwe shifts to profit generation, it will, by necessity, require that pricing be reviewed to induce sales.
One of two things has to happen for corporate sales to rebound – an increase in disposable incomes and or a downward movement in the prices of goods and services. Whilst we can expect an upward review of incomes in the economy, we do not anticipate said increments to match the levels of inflation that we have witnessed.
As such, we foresee corporates being compelled to review their price levels downwards so as to induce sales, which requires a rethink around the appropriate level at which they buy forex. Assuming monetary authorities refrain from printing money and thus maintain a tight rein on money supply growth, it is difficult to see anything other than a correction downward of prices in the medium term given that currently the pricing is anchored on an exchange rate of circa 1:15.
Having regained full control of monetary instruments through the re-introduction of the Zimbabwe dollar, the monetary authorities now hold full sway as to the level of the stock and cost of money in the economy. Currently we sit around ZWL10 billion. Our projections on the exchange rate and price levels are thus premised on the authorities staying the course on fiscal and monetary discipline.
Local policy makers have made their move. Like a doctor, they have made a prognosis and prescribed a cocktail of “medicine” that is certainly unpalatable, but, in the main, appears apt for the condition at hand. It does require fine-tuning as we go. But like any patient, one cannot say with certainty that by such-such a time, the condition will have cleared. Rather, it is to say, take the medicine, come back for a review after X amount of days, by which time, we expect the patient to be feeling better.
+263 772 288 049
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Stephen Mashozhera, CFA
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7th Floor, Finsure House, Cnr Sam Nujoma St
Kwame Nkrumah Avenue, Harare, Zimbabwe
Telephone: +263 242 253 661-3
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