MPC interest rate decision threatens forex auction system

The escalating global inflation and its impact have cascaded to the domestic market. According to the Reserve Bank of Zimbabwe (RBZ) there has been a negative impact on domestic costs of production and de-stabilisation on the foreign exchange market.

By Michael R Nhete Since the start of the Russia-Ukraine conflict we have seen an increase in global inflation which has resulted in a rise in prices the world over.

The conflict has directly affected global oil and gas prices, which has spilled to other goods and services.

The escalating global inflation and its impact have cascaded to the domestic market. According to the Reserve Bank of Zimbabwe (RBZ) there has been a negative impact on domestic costs of production and de-stabilisation on the foreign exchange market.

Despite a decrease in the month-on-month inflation from 6,99% to 6,31% in February 2022 to March 2022 respectively, annual inflation has increased from 66,11% to 72,70% for the same period.

Through the Monetary Policy Committee, the RBZ has put in some additional measures aimed at reducing inflation and parallel market foreign exchange activities.

It is, however, important to give a critical and concise evaluation of these measures to see if they will achieve intended goals.

One of the measures put in place was the hiking of the policy rate from 60% to 80%, which forms the basis of lending rates for all banks.

In principle, this makes the cost of borrowing more expensive thereby reducing speculative borrowing that fuels the parallel foreign exchange market.

It also reduces money supply leading to a decrease in inflation.

However, the expensive borrowing costs reduce funding for the productive sector consequently making the economy fail to achieve the envisaged economic growth rate of 5,5%.

For the companies that manage to borrow at these exorbitant rates, they will pass-on the cost to the customers or ultimate consumer further fuelling inflation.

Due to lack of active alternative external capital raising instruments like commercial paper, private sector bonds and bills, most companies rely on bank loans.

Internally generated funding, such as retained earnings are being eroded by inflation thereby leading companies to resort to constant borrowing from banks at exorbitant rates.

The other measure that the RBZ has taken is the reduction of quarterly reserve money growth target from 7,5% to 5% for the quarter ending June 2022.

Generally, this measure reduces money supply in the economy resulting in a decrease in inflation.

However, the reduction in money supply tends to slow down economic growth since liquidity oils all investments in the economy.

Taking a putative conceptual analysis on money supply, it can be realised that the reduction of money supply to some extent fuels inflation in the Zimbabwean context.

Looking at the M1 money supply composed of curreny ie notes and coins, demand deposits and other liquid deposits, any direct reduction in the currency would directly result in an increase in the cash/rtgs pricing differential.

This is because goods and services in Zimbabwe are cheaper using cash than electronic money.

Furthermore, the foreign exchange rate for cash is more favourable than for electronic money.

In that regard, if the money growth reduction is exclusively placed on M1 notes and coins, the demand for cash will increase thereby widening the cash/RTGS price differential and fuelling inflation.

The RBZ further liberalised the foreign exchange market by allowing banks to conduct foreign exchange transactions on a willing-buyer-willing-seller basis. This is a clear indication of the collapse of the auction system.

The liberalisation has the antagonistic effect of fuelling inflation against the other measures put in place from a conceptual perspective.

Over the years, there has been an undoubtable manifestation of the pass-through effect of exchange rates to domestic inflation in Zimbabwe.

Under the willing-buyer-willing-seller, due to the ever-increasing demand for and shortage of foreign currency, the bank foreign exchange rate will increase, thereby paralysing all efforts to keep inflation under control.

The major contributor to global rise in inflation is the rise in oil prices linked to the Russia-Ukraine conflict.

It’s high time the Zimbabwean government started joining the international community in finding alternative energy and investing in Go Green campaigns.

While this is a long-term initiative, in the interim the government needs to revise further the tax on fuel, offer incentivised lending rates to the productive sector and encourage banks to come up with incentives under the liberalised exchange system to discourage the use of the parallel market.

Companies need to move away from relying only on costly bank loans for funding. They need to find alternative funding options like issuing commercial paper or corporate bonds and bills, while the monetary authorities put in place measures that support the issuance of these financial instruments.

  • Michael R Nhete is a member of the South Africa Institute of Financial Markets and holds a Master of Science degree in Finance and Investments. He can be contacted on [email protected] or 0773778826

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