‘Controls are bad for the economy’

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Comment: Clive Mphambela
Adam Smith, the celebrated economist and philosopher once said, “It is not from the benevolence of the butcher, the brewer or the baker, that we expect our dinner, but from their regard to their own interest”.

Free markets work best when let be. Government must only intervene to address occasional market failure. Our Government should by now understand that controls, much as the intentions maybe noble, are ultimately bad for the economy. Controls more often than not end up harming the consumers they seek to protect. Controls by any name must be avoided at all costs.

As elections beckon in the next few months, there is an increasing disposition or temptation by our Government to try and influence and even control various prices in the economy. From interest rates to bank charges; from fuel prices to soap prices

Just to put things into perspective a little bit, let us recall that two or so years back, the Reserve Bank of Zimbabwe started to force interest down through various directives to the market. The idea was that lower rates would increase demand for productive credit in the economy, serving to stimulate productive sector lending by the banks.

The thinking was largely correct except the RBZ missed two critical elements in implementing the price control policy. Firstly, the risk dynamics in the economy were in fact becoming worse as demand for local products was increasingly becoming subdued and other factors made private sector lending unattractive for banks. Secondly, against the background of falling interest rates, there was a heightened financing of the fiscal deficits via issuance of treasury bills by the central bank.

These conditions meant that banks naturally gravitated towards lending to government as TBs are not only more liquid than loans, but are also zero risk weighted on bank balance sheets. To understand this simple argument, suppose a bank has $20million dollars which it needs to allocate to either loans to corporate borrowers at a maximum of 12 percent per annum or to buying treasury bills at say 10 percent annual yield.

The banks choice will be very easy; it will lend to the Government at 10 percent and forego any lending to the private sector. Loans to the private sector, even if secured by mortgage property carry a higher risk weight on a bank’s balance sheet. At the same time lending to the Government via Treasury instruments carry a zero risk weighting. TBs also qualify as liquid assets on a bank’s balance sheet, whilst loans do not. Loans are also difficult to trade out of in the event of a bank facing short term liquidity challenges whilst Treasury bills have a ready market.

This decision path is one which ;largely explains why bank lending has progressively been skewed towards government securities and the genesis of this problem was largely due to controls on lending interest rates which were instituted by the central, bank. It is therefore very plausible to argue that interest rate controls, which are a form of financial repression, have only served to reduce credit available to the private sector, by tempering with the risk reward trade-off that banks would use to evaluate credit applications. This is not withstanding the rapid expansion of money supply in the banking sector. Banks are simply not going to be lending at the current interest rates levels.

Controls have also harmed the foreign exchange market in a big way.

Whilst basic economic tenets dictate that the bond note and the US dollar cannot reasonably trade at the same exchange rate, because of the polar differences in the two currencies, we have enforced controls at a one to one exchange rate. The consequences are everywhere for us to see. There are now multiple exchange rates in the economy. There exists a rate between large denomination US dollars cash notes and smaller denominations.

There is a price to be paid for soiled notes versus clean notes, older series notes versus later series notes, bond notes against US dollars, bond coins against bond notes, US dollars against RTGS money, and US dollars against mobile wallet money. All this confusion in the market is due to the fact that we have tried to control that which we should not control.

Foreign currency has run out of the formal market and is being peddled in the informal sector, with serious consequences on the broader economy. Last week in my article, I posited that the current state of the foreign exchange market is harmful because it rewards importers and speculators whilst severely punishing exporters and genuine producers and other generators of foreign exchange.

Lastly the discord in the various exchange rates in the economy has led to price distortions in the consumer goods market. These distortions are the ones that are now prompting the authorities to try and intervene in the pricing and availability of goods. Unfortunately, we seem to be walking the same bumpy road that we walked ten years ago. The results will soon be telling.

Government is best advised to stay away from controlling prices, but regulating in order to facilitate free trade. Market mechanisms should by and large work for the better of the economy. Adam Smith’s wisdom in this respect is both priceless and timeless.

The writer is an economist. The views expressed in this article are his personal opinions and should in no way be interpreted to represent the views of any organizations that the writer is associated with.

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