The road less travelled: Necessity of macro, currency reforms

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Joseph Mverecha
Introduction
The Central Bank announced new monetary policy measures on the 1st of October, among them the separation of Nostro FCAs from local RTGS balances.

The Minister of Finance and Economic Development also announced, in tandem, new fiscal policy measures, including variation of the electronic transfers tax from 5 cents per transaction to 2 percent of value of each transaction.

The minister further refined this tax and included some adjustments and exemptions. This has torched a raging debate, angry consumer outbursts and consternation since the policy announcements.

In addition, developments in the economy have continued to evolve quite dramatically with widening disinter-mediation characterised by rejection of RTGS, bond notes and ecocash payments.

Or where they are accepted, the prices of goods and services have escalated sharply and astronomically in tandem with the parallel market rates. As expected, the parallel market rate has not relented following the formal separation of Nostro FCAs from local RTGS, fuelled by both speculation and the mismatch between RTGS balances and Nostro balances.

Many threads are emerging from both policy statements but a few below are most prominent:

(a) The parlous state of our fiscal finances was laid bare and is now transparently in the open. It makes for grim reading, like a credit card of a bipolar regressive patient under multiple cocktail treatment.

Thanks to the Finance Minister and Governor of the Reserve Bank, all Zimbabwe now aware of the full depth of the fiscal crisis that we face and the implications on the economy if no corrective and remedial measures are implemented.

As much as $9,5 billion domestic debt, of which Treasury Bills debt amount to $7,6 billion, with a staggering US$5,5 billion Treasury bills contracted in the last two years. It is breathtaking!

The Government Overdraft at RBZ amounts to US$2.3 billion while the fiscal deficit for the first half of 2018 was US$1,3 billion (no doubt inclusive of election expenditures).

So economists had always known that this is the elephant in the room, but perhaps most had not had opportunity to see the full extent — it is a massive elephant and the room itself is bursting.

The swirling dam of RTGS, Overdraft and Treasury bills continues to swell, thanks to the high budget deficits, recurrently monetised via the RBZ Overdraft or Treasury bill issuances. This is at the core of our macro and currency challenges, which requires urgent redress.

But it is no longer a single elephant — it has generated its nonstationary cousins more intransigent haughty and iridescent — a whirlpool of adverse expectations and amplified distrust — more inimical to corrective measures, big bang or gradualism.

So the beginning point maybe the need to recognise that it is no longer one elephant in the room.

The Minister of Finance has his task well cut out and he is correct in appealing for all hands on the deck.

(b) Local Currency: The country now has its local currency and that currency is RTGS and bond notes. The currency has a fixed exchange rate to the US dollar (1:1 parity) ostensibly to ensure price stability — although the domestic prices, like swift dromedaries have bolted and now galloping wildly into the open fields, leaving in its wake, an acrid trail. The country, de-facto now has a legal tender. We may call it RTGS FCA or some other name but that does not diminish the fact that it is local currency.

I may give my friend Muchavanzei Maimonidzi Munhundowarwa from Matsine, a foreign name like Binwende Kabore or Moussa Diakite, but that does translate him into a Burkinabe or Malian. It is the culmination of a long journey that goes back to mid-2015, when the RTGS balances began to surge past both Nostro and cash balances — indeterminate balances at the beginning, over the months following, these balances began to swell with monthly budget deficits.

But then, people could largely get any amount of cash they required from their banks and companies could still make FX payments without delays, so the public continued placidly with their mundane daily activities, quite unaware that a foreign exchange and cash crisis was steadily and imperceptibly brewing.

In reality, from the moment RTGS balances surpassed both Nostro and cash balances — Authorities had infact created local currency, howbeit at very low and indeterminate levels. Had these RTGS imbalances been maintained at low levels, oscillating at miniscule differentials with Nostro balances, a crisis would not have arisen. But the RTGS balances swelled and by early 2016, signs of stress began to show, initially unrecognisable but in May the RBZ introduced a game changer: Bond Notes and the ensuing panic withdrawal of cash — the fragile balance between Nostro balances and rtgs came crushing down like a deck of cards.

(c) Disintermediation. By far and away, the most immediate concern for authorities is the widening disintermediation characterised by some shops and companies rejecting bond notes/RTGS; demanding payment in hard currency, escalating of prices denominated in RTGS/Ecocash/Bond Notes and suspension of business activities. Suddenly there is an unseasonably high number of closures for “stock take”.

It is like a patient bleeding profusely and gasping for oxygen at the same time. It is a uniquely difficult season. Information asymmetry exacerbates the challenges, with wildly exaggerated parallel markets fuelling the pandemonium.

Panic buying has been the order of the day, creating artificial shortages and further imparting upward price pressures. “Go to Zimbabwe (Lebanon) and cry” would have been the prophetic words of Jeremiah the Prophet.

(2) Way Forward: Imperatives For Macro and Currency Reforms

The economy is on the watershed, delicately poised — either for full scale recovery and thereafter sustained growth towards the upper middle income status, in line with H.E vision 2030, or an irretrievable slide beyond the precipice. The evidence is beyond dispute.

No need for sectoral analysis or a catalogue of some companies touted as increasing capacity — this is not sufficient to assuage the huge tide against us. There is need for collective responsibility and acceptance of our reality.

The Minister of Finance needs our support for the bold and necessary measures to address the core challenges. His message is very clear. The task ahead is abundantly difficult and will imply a lot of pain and sacrifice by all for macroeconomic stability. It is the road less travelled.

The earlier we take the austerity medicine, the better for all of us. We can shoot the messenger if we want and already some groups are itching for a fight to reverse the recently announced 2 percent tax.

That will not change the fact that this painful adjustment has to come, one way or the other. We can no longer continue to live in a mirage of us dollar environment when infact, 99 percent of the money supply is domestic, and strangely we call it US dollar. It is a luxury the nation cannot afford.

The earlier we face our reality, the sooner we can condense concrete remedial measures, embedding the principle of shared adjustment costs.

Shared costs of Adjustment: In my opinion though, the Minister needs to make a step further. He must concretely and clearly articulate to the public the critical expenditure reforms that he will institute, including line for line expenditure cuts, on Government travel, fuel and other allowances, ministry posts duplications, restructuring and privatisation of SOEs, the so called Ghost workers, cutting off middle men milking Treasury in respect of Government purchases, both local and imports.

This has to be a line for line interrogation of every expenditure, not per se targeting the easier route of job cuts.

That way, the public gets to see that he is not just asking the public to sacrifice in higher taxes while leaving wholesale, currently high and untenable fiscal expenditures to perpetuity. This must not be a one sided adjustment, otherwise, the nation faces a summer and autumn of discontent.

Communication: He must go a step further and assure the public that the costs of adjustment will be borne evenly by all stakeholders and not just the workers and tax payers, as presently seems the case.

But having said that, there is simply no escaping higher taxes in the economy, though what he could have done is to lower PAYE to give workers a respite and increase indirect taxes as he has done, to cover the burgeoning informal sector whose contribution to tax revenue has, hitherto, been marginal.

There are no miracles to balancing the fiscal budget and certainly no complex mathematical algorithms or higher order differential equations. It is the same simple principles everywhere, i.e. efficient and effective revenue raising and expenditure cuts to right size the economy without paralysing Government operations. This is most urgent, to address the communication gap that has been invaded by social media.

Addressing dis-intermediation and a strong currency:

Is there anything that can be done about the current widening dis-intermediation in the economy and the strong dollar (because the 1:1 parity has been maintained)? Much indeed.

Though I am afraid, my views are in the minority. I must accept that. I believe we will never recover our economy to full strength under a dollarised or fixed parity environment. This is because, production is a function of the real exchange rate and the US dollar is overvalued for this economy — untenably overvalued.

Domestic production includes exports and exports depend on the real exchange rate. The case of Greece reeling under a strong Euro is quite illuminating.

Others believe that export incentives in local currency terms can spur exports. Well and good. But I doubt the efficacy of the newly found strong correlations between exports and monetary incentives, as representing causality and effect. Industrialists, ofcourse love the incentives — who would say no to more money on the platter. But what is good at the micro or firm level is not necessarily good at the macro level. Co- movement is not synonymous with causality.

To arrest the current widening disintermediation, I propose that Authorities reconfigure the currency basket to relieve pressure on both the US dollar (which is scarce) and the local currency (which is swirling like the Kariba dam).

How do we do that? A multi-pronged approach is necessary. Firstly, now that the exchange rate parity whose main objective was to keep prices at bay, is as ineffective as the Maginot line was in stopping the Germany Army pouring through the Ardennes forests into France in May 1940, there is no point in maintaining the parity, seeing that prices are escalating anywhere.

Rather, a managed float adjustment will take away the steam from the parallel market and restore some sanity.  A managed float adjustment allows the economy to “glide” towards a new equilibrium with minimum upheaval as against the “pell mell” descend much like a million hoof beats of wildebeests crossing the crocodile invested Mara river in Kenya.

The markets are best left uninterrupted but financial markets need firm leadership — not controls but leadership. Secondly, the next step would be to secure a rand facility — my guess is, as much as 5,5 billion to infuse the economy with a large dosage of rand presence including paying civil servants salaries in rands.

This will increase rand circulation in the multi-currency basket, relieving pressure on the US dollar RTGS and thus slowing the rate decline.

This will be augmented by ensuring that the public can make domestic settlements via rand straight through processing via the Central Bank.

The third step will be to issue long dated paper of varying maturities — that is, 5,7 and 10 years paper to drain RTGS liquidity as well as TB maturities. This way, the “fuel” of the parallel market is extinguished allowing the financial markets to adjust to normalcy with enhanced financial intermediation and growth of the economy.

A strong Independent Central Bank

The Minister of Finance and Economic Development has alluded to the need to strengthen the Monetary Policy Committee for effective monetary policy oversight, beyond the near term.

That is a step in the right direction but it is not enough. What is required for Zimbabwe is a strong, independent Central Bank, with a specific mandate only for price and financial stability, with zero tolerance for Central Bank activism that is adding to the pool of RTGS balances under the guise of stimulus measures.

Nowhere in the world has Central Bank expanded interventions in the economy facilitated economic growth and Zimbabwe will not be the first to succeed through this approach.

The economy’s capacity for medium term growth is a function of supply side factors — investment in technology, capital, labour and how these factors are combined for production of goods and services.

This may sound theoretical but no country has ever succeeded any other way, from Japan and Germany after The Second World War to South Korea, Taiwan and emerging Asian economies that have succeeded in increasing productivity and output, with corresponding growth in per capita incomes. None have achieved that through recourse to multiplied Central Bank quasi interventions.

The Central Bank must be modelled after the Bundesbank, which underpinned stability and growth of the Germany economy after the Second World War — the Wirtschaftswunder or economic miracle from 1948-1973.

Central Bank financing must be limited by statutes to less than 5 percent of last year’s revenue. The Government must adopt a nominal money anchor rule for containing inflation, with the Central Bank being given explicit annual money supply targets, in terms of both narrow money (M1) and Broad money (M3) growth. (For example money supply growth of 10 – 12.5 percent per annum).

This is very important for public confidence and restoration of credibility in monetary management – our country lost its currency in 2007/08 due to excessive monetary printing — we must regain our currency through excessive monetary restriction.

The public must see year to year growth in money supply restricted by statutes and the Central Bank adhering to those explicit targets and making bi annual presentations to Parliament on money supply growth, with transparency and accountability.

Joseph Mverecha is an Economist with a local Commercial Bank. He writes in his own capacity.

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