Money supply pushes the exchange rate to unsustainably low levels

RESPECT GWENZI
A 3.07% FALL in the value of the local unit, the Zimbabwe dollar (Zimdollar), was in line with the previous week’s loss. This is the third worst performance since the beginning of the year.

Since January, the auction market has completed a total of 11 sessions and the average weekly loss over the period was 2.5%.

Cumulatively, the Zimdollar has lost 27.4% since the start of the year, which is almost close to what the embattled currency has seen in all of 2021.

For the 12-month period to December 2021, the Zimdollar lost 28.8%, meaning that last year’s loss of last year will be surpassed by the first week of April.

trade weekly losses

This is both worrying and alarming, given the implication of monetary stability on Zimbabwe’s overall economic stability. The import of the currency’s weak performance is that it reflects weak economic fundamentals, monetary expansion and high inflation prospects.

The highest bid level fell from 150 to 155 last week. The best offer has increased in each respective session since the beginning of the year, except in one.

Cumulatively, the best offer has increased by 29 points since the start of the year. The lower and lower accepted bid has moved in sync since the start of the year and this week rose three points to 134.

The spread between the highest and lowest bid stood at 21 points, which is unchanged from last week. The interaction between the lower and higher supply failed to give us any indication of the future direction of the market.

However, the upward move in unison shows that the outlook should remain pessimistic as the stock market falls.

The effect of large jumps in the exchange rate is that inflation will tend to rise at faster rates. We now expect inflation close to 100% by April based on bottoming movements in the exchange rate.

A 30% fall in the formal exchange rate should result in a movement of at least 20% or more in inflation. Much of the impact on inflation will come from the evolution of the parallel exchange rate.

It will become increasingly difficult to control inflation levels above 100%, as history has shown. Although the government has declared successive surpluses, it has been more aggressive in the treasury bill (TB) market and this is reflected in the growth of the broad money supply.

Open market borrowing is used to siphon off excess liquidity from the market as well as to fund government programs, such as ongoing infrastructure projects.

The projects are massive and contractors benefit from a preferential exchange rate on their invoices.

So while the government has done a lot to maintain a stable level of reserve money, its appetite for debt primarily through Treasuries and bonds has been misplaced, reminiscent of the behavior of yesteryear.

The latest data from the Reserve Bank of Zimbabwe shows that the broad money supply (M3) increased by 113% between January 2021 and January 2022.

On the other hand, TB and bonds held by commercial banks and other depository corporations totaled ZW$78.9 billion in January 2022, compared to ZW$18.6 billion in January 2021, a growth of 324%.

This debt, measured in US dollars at the average exchange rate for the period, amounts to US$650 million. This represents about 16% of the national budget for the respective year of 2022.

The impact of such an accumulation of debt is the growth of the money supply of the local currency. This is the reason why the exchange rate is overwhelming and approximates around US$1 to ZW$300 in the parallel market.

This brings us to another dimension of the monetary crisis. The Zimdollar trades at almost twice the official rate, on the parallel market.

This is largely due to manipulation of the formal rate by the RBZ. How this is done is well documented in our previous posts.

The central bank manages liquidity through a weekly auction, instead of decentralized minute-to-minute trading with licensed financial institutions.

Liquidity is managed by a mandatory redemption requirement targeting exporters, making the central bank the largest currency provider.

The trading system punishes the best bids as the lowest bids are met. The RBZ can tactically use its liquidity to satisfy very low bids and leave the rest to other players, thereby driving the weighted average exchange rate. This would continue to notify all interbank transactions for a week. It is an imperfect forex management system, even if the RBZ positions itself as both a player and an arbiter.

This conflict gives him the possibility of declaring funds, which he does not currently have, creating serious arrears, speculation and a lack of confidence in the system.

  • Gwenzi is a financial analyst and managing director of Equity Axis, a financial media company offering business intelligence, economic research and equity services. —[email protected]

About the author