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Zim foreign exchange market: A case of tail wagging the dog

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TINASHE KADUWO

IN functioning economies, or under normal circumstances so to speak, governments and authorities should not be unduly worried about the parallel market and the exchange rates prevailing in that market.

The parallel market rate is determined mostly by speculators and rent-seekers in a shallow and illegal market which constitutes a tiny proportion of the foreign exchange market. Their activities are usually inconsequential in the bigger scheme of things.

Since the quantity of foreign exchange available in that market is small in relation to the demand of the desperate economic agents that want to buy foreign exchange at any cost, the exchange rate is necessarily high. It cannot serve as a reference for the local currency exchange rate. When that becomes the scenario, then it is the case of the tail wagging the dog as we are witnessing currently in Zimbabwe.

The recent published list of companies and individuals as well as arrests of traders pushing huge volumes of foreign currency in the parallel market shows that the country’s parallel market is now sizeable and an exchange rate pacesetter.

Rationally, the parallel foreign exchange market needs to be avoided by decent economic agents.

However, in Zimbabwe the structure of the now highly informalised economy that has resulted in currency mismatch when earning and spending is fuelling the parallel market activity.

A majority of Zimbabweans earn in local currency, but over 80% of their consumption basket is priced in foreign currency, the United States in particular.

This implies that most individuals are forced to demand US dollars to meet their consumption needs. A quick survey shows that even those basics and near- basics, they are all cheaper when purchasing using hard currency.

As such, the parallel market will continue to exist as long as the local currency is not convertible or easily acceptable, economic productivity remains low and the country does not earn enough foreign exchange from export of goods and services and capital inflows. 

Yesterday government issued a statement with various developments and measures in the Zimbabwean foreign exchange market that have elicited various and varied reactions from stakeholders.

Shedding light on issues relating to the foreign exchange market, external reserves and local currency exchange rate instability is therefore necessary. Foreign exchange is relevant in the context of world trade, payments and capital flow into and out of a country. It is the monetary instrument for the settlement of international transactions and for financing imbalances in a country’s external payments position vis-à-vis other countries.

So it thus forms a major component of a country’s external reserves which according to the International Monetary Fund (IMF) consists of “official public sector foreign assets that are readily available to, and controlled by the monetary authorities, for direct financing of payments imbalances, and directly regulating the magnitude of such imbalances, through intervention in the foreign exchange markets to affect the currency exchange rate and/or for other purposes”.

These assets have the feature of liquidity and are represented by convertible currencies such as the US dollar, British pound sterling, Chinese Remnibi, Japanese Yen and the Euro.

From Minister of Finance Mthuli Ncube’s statement issued yesterday, Zimbabwe has US$1.2 billion in official reserves which includes the US$961 million recently availed by the IMF. Individual reserves are about US$1.8 billion held in depository institutions, mostly banks.

The Reserve Bank of Zimbabwe (RBZ) Act enjoins the central bank to use its best endeavour to maintain external reserves at levels it considers to be appropriate for the economy and the monetary system of the country.

In light of this, the RBZ has strived to carry out this mandate by using supply and demand management strategies, particularly foreign exchange conservation and control measures as well as interventions, to ensure adequate supply of foreign exchange.

This is especially so because foreign exchange is a scarce resource that needs to be efficiently managed if the country is to achieve macroeconomic stability, and avoid chronic balance-of-payments and external reserve problems.

It must be stressed that it is only foreign exchange, in the form of convertible currencies or internationally acceptable currencies – not Zimdollars – that can be used for international transactions.

The main sources of foreign exchange supply to a country include foreign currency receipts from exports of goods and services, monetary gifts and inflows of capital from abroad such as loans and investments and diaspora remittances.

It is from these earnings that the demand for foreign exchange is met to spend on foreign imports of goods and services, including foreign travel, education medical treatment abroad, monetary gifts to foreigners, and loans and investments abroad.

The implication of this is that for Zimbabwe whose currency is not convertible or serve as international currency, it must necessarily earn foreign exchange through high productivity and export of goods and services, receipt of monetary gifts or receipt of foreign loans and investments in order to import needed goods and services for development and enhancing the welfare of the citizens.

Also, high levels of foreign exchange earnings and external reserves are the backbone of the local currency exchange rate. They ensure stability of the rate, while low levels weaken the Zimdollar.

However, it must be noted that the RBZ does not produce foreign exchange; it is what is earned by the country that the bank strives to manage and use to stabilise the exchange rate.

As such, ensuring adequate amount of foreign exchange earnings requires developed domestic production structures, diversified economy and export orientation, and a conducive macroeconomic environment with a stable political climate as a catalyst.

For quite some time now, there have been issues about these which predate the present administration. The genuine government efforts to achieve headway on these have tended to be undermined by both endogenous and exogenous shocks in the past years which pushed the economy into recession in 2018, 2019 and 2020. The shocks affected foreign exchange earnings, external reserves accumulation and therefore the exchange rate stability.

Furthermore, the Covid-19 pandemic and its containment measures in the form of economic lockdowns and restrictions on international travel and business resulted in recessions for different countries.

Again, the external sector aggregates of the Zimbabwean economy experienced serious deterioration due to the economy’s continued heavy dependence on the primary commodities for export earnings and external reserves accumulation.

Now, the nature of the exchange rate and its fundamental determinants also need to be clearly understood. The value of a country’s currency is determined by the strength of the economy in terms of its production capacity and productivity, structure, and diversification of the export production base.

A vibrant and diversified productive real sector of the economy saves a nation the disbursement of scarce foreign exchange for the import of finished goods and production inputs, especially where these could be produced locally, and reduces pressure on foreign exchange demand.

In the same way, an export-oriented production base contributes substantially to foreign exchange supply which in turn strengthens the local currency. But in Zimbabwe these conditions don’t exist. Hence, government’s focus on the parallel market.

The main sectors of the economy have all not been helpful in stabilising the exchange rate. The manufacturing sector imports most of its raw materials and equipment, but ends up with little value addition to GDP and insignificant export earnings.

Although the agricultural sector contributes over 18% to GDP, its contribution to foreign exchange earnings is also low. The production system is highly import-dependent. As the country’s capital goods industry is comatose, nearly all machinery, equipment and spare parts used by the production sectors that are in-ward looking, are imported, putting much pressure on available foreign exchange.

Another fundamental factor is the excessive demand for foreign exchange in relation to supply. The truth about an excess demand for foreign exchange is that a sizable part of it is not genuine as it is aimed at transferring funds out of the country to enable the importation of unnecessary finished goods and promote capital flight – illegal financial outflows and money laundering. Hence, some of the measures by the government to curb and control unnecessary imports are most welcome.

It is important to stress that considering that the local currency is not convertible, foreign exchange and exchange rate management over the years has been quite challenging and it remains.

Command and control policies being implemented by the government have created arbitrage opportunities which are sustaining growth of the parallel market. The parallel market has now become a significant component of the economy and reference point of the exchange rate, a clear case of the tail wagging the dog.

*About the writer: Kaduwo is a researcher and economist. He writes in his personal capacity. Contact [email protected]: Whatsapp +263773376128

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