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Preserving stability: Work cut out for central bank

Business
“The core function of a central bank is to provide financial system stability, exchange rate stability, and price stability,” former Nigerian central bank governor Sanusi Lamido Sanusi once said.

“The core function of a central bank is to provide financial system stability, exchange rate stability, and price stability,” former Nigerian central bank governor Sanusi Lamido Sanusi once said.

Financial Spotlight: Omen Muza

When I recently came across this statement again in an old copy of Forbes Africa, it got me thinking about how our own central bank is doing in respect of these three pillars of economic stability.

Financial sector stability

According to the Reserve Bank of Zimbabwe (RBZ)’s January 2017 Monetary Policy Statement (MPS), “the banking sector continues to remain safe and sound”.

The apex bank has got key indicators to back this assertion, such as a capital adequacy ratio of 23,7% against a regulatory threshold of 12% and a liquidity ratio of 61,91% against a regulatory minimum of 30%.

Additionally, the banking sector recorded a net profit of $181,06 million as at December 31 2016, an increase of 42,36% from the $127,47m reported for the corresponding period in 2015.

All operating banking institutions recorded profits during the period, with the increase in profitability largely driven by lower loan loss provisions in line with improved asset quality, lower interest expenses, as well as continued realignment of cost structures at most institutions.

With such numbers, one can safely conclude that the RBZ is doing quite well in terms of financial sector stability, despite the continued existence of factors such as non-performing loans, foreign currency shortages and cash shortages that are chipping away at the edifice of stability.

Exchange rate stability

The exchange rate risk attributed to the strength of the United States dollar against the South African rand has always been of significant concern to Zimbabweans due to its adverse impact on exports, but now that we have a local currency (of sorts) of our own in the form of bond notes, exchange rate risk is perceived to have a much greater impact on overall economic stability.

Understandably, calls for the RBZ to put in place measures to deal with the growing parallel market as the bond note/US dollar parity appears to be failing to hold, are growing louder by the day.

The reserve bank attributes this emergent threat to “lack of discipline and confidence” causing some traders to have multi-tier pricing systems on some products.

RBZ governor John Mangudya railed against the “bad intention by some traders . . . to frustrate or discourage consumers to use plastic money with the intention to externalise cash and to trade bond notes in the parallel market for foreign exchange, again with the bad intention to externalise cash”.

In the January 2017 MPS, the central bank insists on preservation of the parity of the bond note to the US dollar and directs “financial institutions to strictly observe the policy to deposit bond notes into US dollar accounts without requesting the banking public to differentiate between bond notes and US dollar cash”.

Ironically, the banking public is on the forefront of differentiating between bond notes and US dollar cash and does not need the guidance of banks on that issue, hence acts such as hoarding US dollar cash while spending bond notes.

Due to deepening hard currency shortages, the banking public is actually ready to pay the necessary premiums in order to secure US dollar cash either as a store of value or for import transactions.

The fact that the formal banking system is unable to meet the hard currency needs of importers is, therefore, a serious threat to exchange rate stability as the pent up demand could begin to explore alternative/underground sources.

While interventions such as the $15m facility for cross-border traders and the seasonal impact of the tobacco marketing season are expected to improve availability of foreign currency and meet some of this demand, they may not be enough to ensure long-term sustainability of exchange rate stability without meaningful growth in productivity.

In terms of the price of loans — interest rates, that is — the apex bank has tried to sustain stability by capping interest rates at 12% with effect from April 1 2017, but banks seem to think they can’t adequately price prevailing risk at that level. This, we have heard, could result in banks lending less and investing more in Treasury Bills (TBs) instead.

Yet, in addition to their crowding out effect on private sector credit, these instruments are increasingly being seen as a source of considerable instability in the future.

Price stability

In February 2017, annual inflation crept back into positive territory at 0,06% after many months in negative territory. Pursuantly, Tinashe Kaduwo, an economist at Equity Axis, highlighted the risk that official figures may not be capturing the correct trends in the market and understating actual developments in the economy.

His argument — which I buy into — is that cash shortages and the subsequent introduction of bond notes have created serious distortions in terms of pricing in the market, characterised by multiple prices: cash price (US dollar), cash price (bond note), transfer price (real time gross settlement), transfer (swipe) and transfer price (mobile money such as EcoCash and other similar products).

This price instability gives a real sense of foreboding that inflation will rise significantly, spurred by underlying challenges in the economy.

Unbudgeted expenditures by the government, consumption-driven issuances of TBs crowding out the private sector in terms of access to credit and investment, and a local currency in the form of bond notes are all major sources of risk for higher inflation.

The RBZ’s work is cut out for it but lack of political will hamstring efforts to ensure price stability, especially with government under pressure to spend ahead of the 2018 elections.

Zero-sum-game?

The central bank appears to have done a fair amount of work to ensure financial sector stability, but clearly more work is still required to secure exchange rate and price stability, the lack of which could ultimately threaten financial sector stability.

This reminds of the wise one who once said that much work is lost for want of a little more. And the RBZ must be reminded that “you can’t have price, exchange rate and interest rate control at the same time,” according to Sanusi, the feisty chap who was the World Central Bank Governor of the Year 2011, Sub-Saharan Central Bank Governor of the Year 2011 and African Central Bank Governor of the Year 2010.

Omen N. Muza edits the MFSB. You can view his LinkedIn profile at zw.linkedin.com/pub/omen-n-muza/30/641/3b8 or initiate contact on [email protected].