FOLLOWING the prior two week’s movement of about 30% in the adverse direction, the auction market rate continued to tumble. The rate came off by 12,5% in last week’s auction, which again was out of the historical weekly averages.
Before last week’s decline, the auction rate had eased by an average of 2,8% from the beginning of the year. This week’s loss is the second highest since the beginning of the year. The current trend reflects fundamental shifts in the trading of forex in Zimbabwe.
The top bid moved up by 31 basis points to ZW$331, while the lower and lower accepted bid moved to ZW$280 from ZW$220 in the last auction.
The margin between the top and low bid came in at 51 down from 80 last week reflecting narrowing volatility. The narrowing volatility is fully reflected in the narrowing margin of weekly loss.
The weighted average exchange rate consequently came in at ZW$290,90 closely trailing the interbank market. The interbank rate has become more prominent following the pronouncement of measures to curb exchange rate spikes and resultant economic instability. The interbank rate closed Thursday at ZW$296 barely reflecting a marginal 2% premium to the auction market.
The authorities previously hinted that the auction market will follow the interbank, which in turn will play the role of price discovery in the market. Since then the premium between the two markets has narrowed from 64% to 2%.
Last week, we argued that the variance between the interbank and the auction rate will cause sustained losses, which in essence will come in as government subsidies.
Expunging of this gap means that the subsidy is totally averted. Subsidies are unsustainable as they are financed from the budget or through deficits, thus causing potential economic instability in the long run.
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What needs to be ascertained is whether the synchronisation of the auction market and the interbank can be sustained. If it is sustained, it effectively ushers in a fully liberal exchange rate in Zimbabwe.
In the past, we have argued that the auction market exchange rate was dictated by the Reserve Bank of Zimbabwe through market manipulation tactics.
This led to the demise of the retained model, which now appears to be altered. At this point it can be said with a degree of precision that the price of forex on the formal markets is determined by market forces.
Why is price discovery important? Price discovery is a key element of a sustainable exchange rate mechanism. It is the norm in free markets and allows for a more fluid trade between the country and the rest of the world.
The challenge that we anticipate on the currency market is that the interbank, which is now dictating the pace of exchange rate movement, pushes only a tiny fraction of trades compared to the auction market and worse still the overall foreign currency payments in the entire system.
What this could result in, is a distortion of the market and unjustified increases or decreases. To avert this, transactions values allowed on the interbank market will have to be increased from current levels.
Further, RBZ will have to remove or adjust compulsory acquisition of foreign receipts and allow exporters to directly trade all their flows through the interbank. This would result in the harmonisation of the two markets, a wider market with higher supply and demand levels, effectively determining the market rate.
Considering that the auction market has been following the interbank and that the 2 rates are now in sync (if sustained) it no longer benefits the RBZ to force exporters to surrender their receipts at present levels. The market will actually benefit from a more representative exchange rate. At this point the only benefit accruing to the Bank, through the retention is that the gets to influence allocation as the biggest supplier.
The Bank surely wants this leverage on flows but it is not good for the market. On the outlook, we anticipate that the prevailing instabilities on the currency market will carry on. This is because we believe that the challenges are of a fundamental nature. The fiscus, which is touted as in check, is not entirely as stable. The borrowings of government, although reduced, are still contributing to the chaos.
- Gwenzi is a financial analyst and MD of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — [email protected]
