Zimbabwe’s liquidity crisis — an economy under stress

IN THE last couple of months, Zimbabwe’s economy has suffered a crippling liquidity crisis which threatens the country’s fragile recovery.

Lance Mambondiani

Since the adoption of the multi-currency regime, most companies are under-capitalised and struggling to pay their bills.

The banking sector, itself in dire straits, lacks capacity to lend to businesses to buy new equipment or fund their working capital.
For the ordinary people, it is not easy to generate a dollar without the privilege of a diamond claim.

A fuller assessment of the liquidity problems suggests fragility of macroeconomic fundamentals in the absence of the stabilising effect of strong monetary policies.

A largely externalised policy space has confined the central bank to a bystander, seeking the comfort of “miracle money” as some form of money supply.

A supermarket economy
In a dollarised currency regime, the major source of liquidity is export-led growth as a stimulus for new money to create economic equilibrium.

Statistics suggest that imports of largely consumptive goods have grown faster than exports, widening the current account deficit and resulting in a liquidity trap.

The manufacturing industry has struggled to raise money on the domestic market and local products have been unable to compete with cheap imports from abroad.

The result has been a yawning trade deficit which manifests as a liquidity crisis. The massive de-industrialisation of the manufacturing sector, nonexistent balance of payment support and low foreign direct investment means the country is hardly able to create its own liquidity.

Even before the adoption of the multi-currency regime, for the past 50 years, the country has always lived with an underlying balance-of-payment problem.

Without substantial foreign investment inflows, sustainable economic growth is near impossible regardless of how well the economy is integrated.

Net foreign direct investments figures (as a percent of GDP) have recorded an all time low, with negative inflows at -25,9 in 2009, and -21,1 in 2011. This is attributed to a polarised environment and uncertainties created by the indigenisation policy. Other sources of liquidity and broad money supply such as offshore lines of credit, remittances and private equity funds have simply not performed well enough to be a relief.

The causes
A complex cocktail of various economic factors may have made a liquidity crisis inevitable.

Since dollarisation, monetary authorities have had no capacity to determine the “Currency in Circulation” (M1), which is essential in measuring liquidity and money supply.

This was an accident waiting to happen. Zimbabwe has a history of significant informal transactions outside the banking sector.
According to a recent AfDB report, the informal sector accounts for approximately 65% of all business transactions in the country, the majority of the populations remain unbanked.

The bulk of the bank deposits are largely short-term in nature, with the banking sector used as a transitory facility to receive and withdraw salaries or pay bills.

An overload of bank rhetoric from the regulators seems to suggest to the public that Zimbabwean banks are either on the brink or fundamentally unsafe. Liquidity is largely about confidence.
A sudden loss of confidence, whether rational or irrational, will result in liquidity difficulties.

Another significant problem is the central bank’s loss of lender of last resort function. With loan to deposit ratios above 70%, a prevalence of short-term deposits and very little of long-term savings, liquidity ratios are inevitably stretched.
Without the lender of last resort function, it seems implausible to suggest that banks would have a high risk of “moral hazard” with liquidity management.

The risk of banks undertaking imprudent liquidity risk management and holding lower levels of liquidity due to the expectation that the central bank will support in the event of a market-wide stress should be nonexistent especially when banks expect no such help. The result is a cash hold where banks do not lend to each other or their customers – because when you suffer a liquidity crisis you are on your own.

Addressing the problem
The banking sector has been in a policy whirlwind since dollarisation. The regulatory authorities have not been very helpful in restoring public confidence since the 2003-2004 financial sector crisis.

In most developing countries such as Zimbabwe, the banking sector is significant for many reasons; they dominate the financial system and contribute significantly to economic growth.

Banks are also the most important source of finance for the majority of firms due to underdeveloped capital markets.
Addressing the liquidity crisis will require strengthening the banking sector and creating

conditions that induce long-term deposits in the domestic market.
The payment system should encourage the use of alternative payment solutions, discourage cash transactions and increase the capacities of the RTGS system.

New liquidity policies will require banks to place less reliance on short-term wholesale funding particularly from foreign sources
and the restoration of the RBZ’s lender of last resort function.

There is also need for a higher amount and quality of stocks of liquid assets, which may include a greater proportion of assets held in the form of government debt.

The authorities simply have to do more to encourage FDI and private equity investments to stimulate economic activity.

Ultimately, companies will also need to realise that the economic space has changed and the deindustrialisation of the economy is unlikely to reverse even if liquidity were to improve.

To address the liquidity trap, companies cannot survive on antiquated business models which fail to account for the real threat of a globalised world market where cheaper products will inevitably land on the doorstep.

In the end, the liquidity crunch is macroeconomic in nature and will endure for as long as economic fundamentals remain in disequilibrium.
Dr Lance Mambondiani is a Development Economist and a Zimbabwean Banking Expert.

He lectures International Finance & Development University of Central Lancashire Business School. Contact email lancem@btinternet.com . Twitter @DrMambondiani

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