Fixed Exchange Rate: More harm than good

The Reserve Bank of Zimbabwe suspended the new managed floating exchange rate and introduced the fixed exchange rate of 1 US Dollar to 25 Zimbabwean Dollars on the 26th of March 2020. Two weeks earlier (on March 11), the treasury department had announced the introduction of a managed floating exchange rate so as to bring the urgently needed efficiency and transparency to the interbank market. The short lived managed floating platform was managed by the Reuters System which had been on trial since December 2019. The suspension of the managed floating rate is part of the measures supposed to provide price certainty and stability to the economy in the wake of the Corona Virus pandemic. Since then prices have been skyrocketing with Month-On-Month (M-O-M) and Year-On Year (Y-O-Y) inflation for April expected to eclipse the 25.59% and 676.39% recorded in the previous month. Prices for basic commodities have been chasing the parallel market rate where 1 US Dollar is now fetching 60 Zimbabwean Dollars on the open market.

The central bank has pointed to the need to improve efficiency on the interbank market in its last 2 monetary policy statements even though there has been no report on the amount of foreign currency retained by the bank from exporters or foreign currency it injecting onto the interbank market for any period. As of December 2019, only US$1.5 billion had been traded on the interbank market versus local demand exceeding US$7 billion per year. In its Staff Monitored Program (SMP) report on Zimbabwe in April 2020, the International Monetary Fund (IMF) pointed that the central bank was responsible for the hikes in foreign currency exchange rates on the parallel market through subsidies and gold incentives that lead to growth in money supply and pressure on the limited foreign currency.
Part of the recommendations from IMF point to the need for liberalization of the foreign exchange controls as the key to financial market and economic stability. Similarly the central bank was advised to discontinue its Gold incentive scheme and funding of various subsidies in the market. The central bank was urged to develop a schedule for the removal of foreign currency allocation via the priority list and allow exporters to sell the surrendered portion on the interbank market through their respective banks. The Bretton Woods institution also recommended the removal of restrictions set on the rate at which banks can transact and the amount traded by account holders in order to make commercial banks market markers in the determination of interbank rates.

Zimbabwe operated on a fixed exchange rate of 1 US Dollar to 1 local unit from November 2015 when bond coins were introduced to February 2019 when the interbank exchange market was introduced. The period saw the re-emergency of the parallel exchange market and unabated growth in reserve money supply from US$3.058 billion (November 2015) to US$8.844 billion (February 2019). This growth in money supply was not backed by any significant growth in economic output. Fast forward to 2020, the fixed exchange is back in the market to the dismay of all exporters, consumers and industry. On its part, Industry needs more than US$300 million per month for its import and debt repayment needs. Interbank market inefficiencies mean that industry players rely on the parallel market for their foreign currency needs and inevitably factor the cost on the final products.

The Confederation of Zimbabwe Industries (CZI) has called for the creation of a two tier exchange rate management system with a crawling peg combined with a market tier to guarantee formal access to foreign exchange for all businesses. The lobby group has pointed that the fixed exchange rate is responsible for creating price distortions in the market that undermine economic instability and give room for the central bank to print money in order to incentivize Gold producers among others. The Zimbabwe National Chamber of Commerce (ZNCC) earlier stressed that fixing the exchange rate is counterproductive as it weighs on exporters and the interbank while propping up smuggling of minerals and other export commodities. ZNCC echoed similar sentiments with the CZI in recommending that the central bank moves back to a managed floating exchange rate with regular reviews to prevent a widening gap between the parallel and interbank market. Further, the regular exchange rate reviews should take into account commercial banks input and inflation rate.

The central bank is caught in a conflict of interest where increase in Gold deliveries is positive to the bank since it is the sole buyer of the precious metal in the country, hence incentives are key in driving production up. On the other hand the central bank's mandate is to manage inflation through controlling money supply, which is primarily caused by the export retention and Gold incentives schemes instituted by the same institution. The recently announced incentives will see the central bank injecting close to Z$3 billion per month in the economy, while the fixed exchange rate is negatively impacting official Gold deliveries and increase smuggling out of the country. The central bank through Fidelity Printers and Refiners (FPR) is paying US$47 per gram (with 45% of it paid in Zim Dollar at the interbank rate) while the parallel market is paying US$40 per gram in cash. As a result Gold producers stockpile their produce or divert it to the parallel market for instant payments. This means that Zimbabwe will not benefit significantly from the rally in Gold prices which eclipsed US$1748 per ounce and US$56 per gram on the world market.

The fixed exchange rate is close to 60% lower than the parallel market rate, hence all exporters and foreign currency holders direct their hard earned dollars to the highest bidder. This means that the foreign currency shortage will deepen further and put pressure on the local currency. This will lead to further depreciation of the Zimbabwean Dollar and ultimate failure of the De-Dollarization plan. The Tobacco marketing season opened on April 29 with farmers not happy with the central bank retention threshold of 50% and the fixed exchange rate which significantly eats into their hard earned income. The complaints will lead to rampant side marketing of the golden leaf and reduction in the number of contracted farmers.

The most sustainable way to increase gold deliveries is to increase the export retention levels to the over 70% that prevailed in 2018. This means that the central bank would not need to provide any incentives in local currency to the miners. Gold incentives are acting as a double edged sword that strokes growth in reserve money supply and hyperinflation which reduces incomes for labour and business. Additionally there is no place for a fixed exchange rate when demand for foreign currency outstrips its supply. The rate can only be fixed provided producers are able to access foreign currency at a cheaper rate or when supply for foreign currency is abundant. The central bank should revert back to the managed floating exchange rate under the Reuters System while ending Gold incentives and suspending various subsidies that create the need for printing more money. The fixed exchange rate has not stabilized prices for goods and services in the market during the lockdown period since supply was heavily constrained by disruptions in global supply chains. A fixed exchange rate only serves the central bank's appetite to retain foreign currency from key exporters (miners and tobacco farmers) at a cheaper price but overall it causes more harm than good to the fragile Zimbabwean economy.

Victor Bhoroma is a writer and freelance economic analyst. He holds an MBA from the University of Zimbabwe (UZ). For feedback, mail on vbhoroma@gmail.com or follow him on Twitter @VictorBhoroma1.