CTC calls for exchange rate liberalisation

26 May, 2023 - 00:05 0 Views
CTC calls for exchange  rate liberalisation

eBusiness Weekly

Martin Kadzere

Two of Zimbabwe’s economic commissions have urged the Government to fully liberalise the exchange rate to allow market forces to determine prices and attain efficiency.

This comes as the country is experiencing massive increases in prices, probably at the worst rates since the hyperinflation era of 2008/09 due to distortions resulting from the exchange rate disparities between the official and the parallel market rates.

However, some analysts say while liberalisation appears to be the viable option to deal with the distortions, this could be tantamount to setting the economy on fire as this could trigger hyperinflation given the huge gap now between the exchange rates.

The “most viable pathway to get out of crisis” was to fully dollarise the economy, some say.

While the official rate is determined at the Willing Buyer Willing Seller platform, which largely tracks the auction system, black market rates, usually two to three times higher than the official are widely preferred for transactions.

However, it is a criminal offense for businesses to peg prices using the black market rates. Businesses are permitted to peg prices in both US dollars and local currency after the Government allowed the use of multiple currencies until 2025.

But the Zimbabwe dollar prices should be pegged using the official exchange rate while businesses are also allowed to add the legal 10 percent rate difference.

In a recent joint study on price increases, the Competition and Tariff Commission (CTC) and the National Competitiveness Commission (NCC) said full liberalisation of the exchange was unlikely to lead to increases in prices as manufacturers are pegging prices in the United States dollars and are indexed to the parallel market rate.

“The sharp depreciation of the local currency against the US dollar (the law)…

which compels firms to trade using the official exchange rate has chocked smooth production and trade in the economy. The price distortions have stifled trade and firms feel the exchange rate loss of using the official rate, given that the margin between the official and alternative rate is now more than 100 percent,” the study said.

Economics professor Gift Mugano—himself a liberalisation advocate – said the current challenges were emerging from distortions that have created huge arbitrage opportunities, which could be stopped by liberalising the exchange rate.

But the only challenge which we now have is that it is too late,” said Prof Mugano.

“We should have liberalised when we launched the auction system because at that point the official and parallel market rates were close. We could have easily closed the gap.

“Liberalisation has its challenges because it can cause hyperinflation. We just have to dollarise maybe short to medium term, while making observations and making a de-dollarisation strategy. But that doesn’t mean we must keep it as it is.”

The International Monetary Fund (IMF) recently warned Zimbabwe against adopting a gold-backed digital currency to deal with macroeconomic challenges like volatility in the exchange rate, saying it should rather liberalise its foreign exchange market.

The central bank introduced gold-backed digital tokens to reduce demand for US dollars.

They can be purchased by individuals for a minimum price of US$10 and US$

5 000 by corporations and other entities and will eventually be used for transactions.

“A careful assessment should be conducted to ensure the benefits from this measure outweigh the costs and potential risks including, for instance, macroeconomic and financial stability risks, legal and operational risks, governance risks, cost of forgone forex reserves,” an IMF spokesperson told Bloomberg on May 9.

Stunning currency depreciation

The official exchange rate depreciated against the US dollar from $671,45 in

December 2022 to $1 888 as of Tuesday this week. Meanwhile, on the parallel market, the local currency depreciated from $930 to about $3 500 against the greenback during the same period.

Zimbabwe’s dollar alongside Ghana’s cedi, and Sierra Leone’s Leone were among Africa’s most devalued currencies against the United States dollar in 2022.

Prices tend to be adjusted in line with the movement of the exchange rate, as businesses follow a cost recovery model. The official rate tends to move upwards on a weekly basis on the auction market, thereby impacting inflation developments.

The month-on-month inflation rate (blended), thus moved from -1,6 percent in

February 2023 to 2,4 percent in April 2023. Some of the manufacturers demand payment in US dollars.

If payments are in local currency, they are indexed to the parallel market rate. As such, the exchange rate distortions are mirrored in the prices of selected commodities.

“The difference in the exchange rate induced price distortions in the economy is resulting in different prices for the same commodities in the formal and informal sector,” the study said.

“The official exchange rate is overvalued and has an effect of making commodities more expensive using US dollars in formal shops as compared to the informal sector. The result is that rational consumers do not purchase products in the formal retail shops using the US dollar as it is expensive.”

The informal sector sources products in US dollars and the transactions are on a cash basis.

The ability to source in US dollars has prompted some of the local manufacturers to favour supplying informal traders compared to formal traders, as some commodities can only be found in informal retail shops. The formal retail shops are mainly sourcing their products in local currency and settlement of accounts can be done in 15-60 days, which then discourages manufacturers and wholesalers to supply to the formal markets, especially when the Zimbabwean dollar is losing value.

The Government has since described this as sabotage because the producers were accessing foreign currency at the official rate but are offloading their products to informal traders.

Given that informal sector payments are quick and are on a cash basis, they benefit from US dollar discounts when purchasing product to get to the final consumer.

This makes products sold at the informal trading shops cheaper. At the same time, products sold at the formal retail outlets in Zimbabwean dollars would be more expensive in the local currency as companies would be hedging for any loss in value due to exchange rate movements.

Implication on pricing

“The implication on pricing is that informal sector prices will remain relatively and in some instances they will actually go down due to discounts. However, formal sector prices will continue increasing as a way of hedging against the ever-increasing parallel market exchange rate. The implication of the currency dilemma is that this increases the demand for the US dollar in the parallel market for consumers to purchase goods in the informal market. This results in dollarisation as people will be preferring to transact in the informal sector, which is cheaper where the United States dollar dominates compared to the Zimbabwe dollar,” the study noted.

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