FINANCE minister Mthuli Ncube has identified some twins as major sources of economic vulnerability. The twins – “fiscal deficit” and “current account deficit” – have resulted in an increase in government debt and foreign currency shortages. The minister and his team, led by Finance secretary George Guvamatanga, should be applauded for the right diagnosis. There can never be problem resolution without proper diagnosis.
guest column: Daniel Ngwira
Government has been spending more than it generates. This has resulted in unsustainable budget deficits, which the market had no capacity to fund. The result has been for government to resort to its overdraft facility with the central bank. Government has been issuing Treasury Bills (TBs) and bonds to finance the budget deficits. From January to August 2018, government issued a record-breaking $2,5 billion TBs and bonds. For the periods 2016 to 2018, Zimbabwe substantially underperformed other low-income countries and sub-Sahara African low-income countries in terms of budget deficits.
It is worth noting that financial indiscipline resulted in unsustainable deficits, which were financed by the government overdraft facility and TBs and bonds, thus resulting in exponential money growth. There has been a phenomenal rise in the level of domestic debt post-2013, with fears that by the end of December 2018, the public debt statutory limit of 70% will likely be breached. The growth in broad money supply (M3) has pushed up inflation and parallel market rates. There were too many “local dollars” chasing too few United States dollars.
The minister correctly notes that the flooding of government securities into the market was a threat to macro-economic stability due to money supply growth. To avert a possible crisis, government should restructure the profile of the TBs by lengthening their maturities through negotiations with holders of the said TBs. The maturities for 2019, are expected to be $2,2 billion. On a positive note, the minister stated that government would be moving away from incurring extra-budgetary expenditure through the issuance of TBs. Rather, TBs will only be issued to finance the budgeted financing gap.
In addition, government will move away from private placement to an auction-based system of issuing government paper. Given the robust background the minister has in the academic world and in developed markets, and that he is resourced with a permanent secretary who is a former bank treasurer and financial trader, it is no surprise that he mentions that the auction system will help building up the yield curve. The yield curve is very important and does help sound economic decisions based on it. The shape of the yield curve provides an idea of future exchange rates.
For instance, a normal yield curve may point out to longer maturity bonds yielding higher than shorter bonds, while an inverted yield curve depicts shorter term yields being higher than longer dated paper. This may be a sign that a recession is looming. In addition, the auction system will help build confidence and foster transparency. In the end, the cartel system of trading TBs will be a thing of the past.
Further, the minister emphatically stated that all the quasi-fiscal activities were to be discontinued because they were imposing extra-budgetary commitments, thereby worsening the financing gap. I hope this is the last time we are going to talk of the despised quasi-fiscal activities in this country. We have not learnt much from Reserve Bank of Zimbabwe governor Gideon Gono’s days. Moreover, Ncube indicated that government will be decreasing recourse to central bank lending from the 20% of prior year’s revenues statutory limit to a maximum of 5%, only limited to smoothening cashflow mismatches. Indeed, this is the spirit behind an overdraft facility; to smoothen cashflow mismatches as opposed to relying on it for long term funding.
The minister noted that the demand management measures implemented over the years to redirect the use of foreign currency to productive sectors have not been effective. These measures included changes to the customs duty regime as well as use of import licences to control imports. The Treasury chief noted that during 2017 and 2018, there was a substantial rise in the importation of non-productive goods, especially motor vehicles. As a consequence, in order to redirect the use of foreign currency towards productive sectors, customs duty on vehicles and selected goods will be in foreign currency.
While there has been an outcry from the public on this matter, it should be noted that the government is not much interested in raising foreign currency on the goods, but rather, it is interested in restricting importation of those goods. There have been concerns that government lacks policy consistency in this regard as on one hand it maintains that the bond note is at par with the US$ whereas on the other hand, it is rejecting the bond note for the greenback. There is lack of consistency here. What government is trying to do is to discourage the importation of those goods so as to save foreign exchange reserves.
In the same vein, government has directed that taxes be paid in the currency of trade. What must be noted is that when companies collect the value-added tax (VAT), they are doing so as agents of government. The rationale behind demanding VAT in the currency of trade is that the principal, on behalf of whom companies were collecting VAT, was being paid in bond note transfers while the US$ was being channelled to promote the parallel market. This act, in itself, helped drive up parallel market exchange rates. When an agent acts on behalf of the principal, they must act in the best interest of the principal. This has not been the case. Instead, we have seen the agency problem being at play as the agent sought to act at the expense of the principal. To safeguard his interests, the principal decided to demand his payment in the currency of trade. In financial management, the agent is always subordinated to the principal and the principal would ordinarily employ all the necessary measures to ensure that their interests are safeguarded. No one is supposed to benefit from executing their duties of collecting taxes on behalf of the State. With this principle, it should be noted that there is nothing amiss when the government decides to collect taxes in the currency of trade. This move could go a long way in diffusing the demand forces in the alternative markets.
While there are many measures the minister has proposed to cure, the twin deficits, I have focused on the major ones. Budget deficits drive growth in broad money supply.
In turn, broad money supply pushes up inflation and the parallel market exchange rates. An effective cure of the twin deficits will definitely help in stabilising the economy and thus put the country on a growth and development trajectory. For instance, balancing the budget will entail no pressure in the growth of M3 and as such it could result in less pressure being exerted on the parallel exchange rates.
On the other hand, the measures to curtail the use of foreign exchange reserves could result in a drastic reduction in the current account deficit. This may result in a reduction in the shortages of currency and consequent reduction in parallel market exchange rates.
I know people wanted to hear the I know people wanted to hear the minister say the bond notes are history, but rest assured that bond notes are not the problem. The real problems is the twin deficits. I know people wanted to hear pronouncements that the exchange rate between the bond note and the US$ was no longer fixated at parity level, but what one needs to understand is that the citizenry may be better off if liberalisation of the exchange rate is done after government has stabilised the economy. The safety of investments is paramount and any government wishing to attract investment needs to consider this. I am a strong proponent of free market forces, but in this instance, I do understand why that had to wait.
Other measures taken by the minister such as reduction of pay for senior government officials are more symbolic than substantial. The reduction of the marginal tax from 50% to 45% may result in the disposable incomes of these officials rising. At the same time, there was an overreaction on the traffic fine maximum of $700 by the Treasury. While it must be noted that the rise in fuel prices as a result of the additional taxes of 6,5 cents and 7 cents may have inflationary pressures, I would have thought the 2% tax was enough to help government reduce the deficit rather than lumping more taxes on economic players.
In conclusion, that the minister quoted John Stuart Mill by stating that: “I have learned to seek my happiness by limiting my desires, rather than in attempting to satisfy them” is beyond symbolic. To get out of the current problems we are facing as a country, government needs to be financially disciplined so that it can reduce the budget deficits or balance the budget while at the same time, there will be need for both the government and citizens to conserve foreign exchange reserves by focusing on strategic imports only. This could result in reduction in trade deficits.
Daniel Ngwira is a finance expert and a researcher. He can be contacted on 0775018636 or email@example.com