Forex auction may eliminate rate disparity

03 Jul, 2020 - 00:07 0 Views
Forex auction may eliminate rate disparity

eBusiness Weekly

Golden Sibanda
Players in industry and commerce say the foreign exchange auction system, which replaced the interbank market just over a week ago, offers an opportunity for stabilisation of the Zimbabwe dollar and elimination of distortions in the economy caused by exchange rate disparities.

Without adopting an auction system, industrialists saw little prospect of economic turnaround anytime soon, while the outbreak of Covid-19 made it worse in that the economy is now expected to shrink 15 to 20 percent this year.

The auction, administered by the Reserve Bank of Zimbabwe, replaced the interbank market that had dismally failed to tame drastic fall of the Zimbabwe dollar since its introduction last year, at a rate of $2,5 to US$1.

Amid free-rising inflation and depreciating Zimbabwe dollar, came the seismic force of the Covid-19 outbreak, which forced the authorities to fix the exchange rate at $25 to US$1, but this was short-lived.

The fixed exchange rate regime only lasted for as long as the gap between the official rate and the open market rate was still small, after which the market started experiencing severe foreign currency shortage.

The holders of foreign currency started withholding their funds citing sub-economic rates leading to even more astronomical rise of open market rates and inflation.

In the absence of a predictable and market-led exchange rate, the market started using a forward pricing system that resulted in prices far above the prevailing open market exchange rates to hedge against future rate and price increases, giving inflation further impetus.

Inflation has since risen to 785,6 percent as of May 2020 from a lowly 5,39 percent in 2018 when Zimbabwe started on deep economic reforms, including scrapping the decade old multi-currency regime in place since 2009.

The measures, dubbed transitional stabilisation programme (2018-2019) were aimed at rebalancing misaligned macro-economic fundamentals.

Faced by prospects of further market instability, rising inflation and volatile parallel market exchange rates, authorities took the decision to adopt the auction system to give market guidance of a systematic rate.

But captains of industry said judging on past experiences, it was clear the success of the auction system depended largely on two things; a true auction system and iron-clad control of fiscal and monetary discipline.

The country’s largest industrial lobby group, Confederation of Zimbabwe Industries (CZI), said in a commentary titled “Foreign Exchange Auction Policy Response Paper” that the new auction system introduced a fortnight ago was not a first in the country, but the second after the one that failed between 2004 and 2005, and “we know why?”

Weighing in on the same issue the Zimbabwe National Chamber of Commerce (ZNCC) said the auction system, while it has taken to a flying start following to successful auctions and still too early to call, the auction should not be used as a foreign currency allocating tool, but as a price discovery mechanism.

CZI said the auction system, which came into effect last week, was adopted to foster transparency and efficiency in the allocation of foreign currency.

A weighted average rate is calculated based on allotments after each auction and used as the ruling exchange rate until a new rate is determined at the next auction.

CZI said there were two key advantages of the regime; being the fact that auction was better than a dealer market because it is far more difficult to manipulate and that the dealer market can set a price without transacting a single dollar. In an auction, actual transactions set prices.

“For the auction to work and to influence the price of foreign exchange in the economy, it must be perceived to be predictable. We know that the auction market in 2004 degenerated into an allocation system, not an auction. So how can we know that it is perceived by the market as an auction?”

“Perhaps the most important thing is to ensure that indeed the highest bidder wins and this may be complemented by a small team of observers at each auction to validate auction results. In order to enjoy political support, it is important that the market exchange rate, once discovered, remains stable.”

And in order to keep the rate stable, CZI said, it was critical to ensure strict maintenance of money supply control and enhancing market confidence in the long term prospects of the Zimbabwe dollar stability.

“We all know that no currency can remain viable unless it is perceived as a store of value. We also know that the market has currently no confidence in the Zimbabwe dollar, so how might we restore confidence?” CZI asked.

CZI suggested that authorities needed to signal to the market that their intention was to move to a positive interest rate environment by the end of 2020 and guide stakeholders to plan with this target in mind.

“We also know that most stakeholders do not understand that positive interest rate means positive with respect to future inflation not historical inflation. So maybe we need to consider a publicity campaign so that stakeholders start to understand this,” CZI suggested.

The industrial lobby group also said it was key to take that the market believes inflation will keep rising and authorities had it within their powers to kill the impetus for inflation to keep galloping by exercising fiscal and monetary discipline, so the auction doesn’t follow the route of 2003.

CZI contends that the divergence of views created an opportunity for authorities to raise funding by issuing out inflation linked bonds, adding the market will pay a premium for the bonds because they believe that will keep rising.

“These bonds will also send a strong signal to the market that the fiscal authorities are committed to stabilisation.”

“Using such bonds to fund Government expenditures provides the authorities flexibility to raise interest rates aggressively and kill inflation.

“Inflation linked bonds can also be used by businesses to finance their operations in a high interest rate environment,” CZI posited in its paper.

The industrial lobby group said the introduction of the auction system was a noble initiative, but its success and effectiveness lay in effective implementation. CZI stressed the point that it was critical to ensure collective efforts so that the country does not go the same way it went back in 2004.

“Interference with the market mechanism and monetary indiscipline lead to inefficiencies that will cause the total collapse of the auction as well as the failure to defend the local currency,” the industrial body noted.

ZNCC chief executive Takunda Mugaga said it was important that authorities are not seen to be funding unproductive activities in the allocation of forex at the auction, which would kill confidence.

But he praised the trend thus far, which has seen the bulk of resources going to raw materials.

“It is the movement that we see week in week out that is going to attract more players, especially from the supply side. If the market is starved, the system will collapse because the market will just see it as a platform to masquerade.

“It is also important to tell the Reserve Bank that the foreign exchange auction regime should not be viewed as an allocation mechanism; let it be more of a price discovery platform or mechanism for the exchange rate.

“We want to see a situation where auctions are going to be operational, not only at central bank level but even at the bank.

“You should be able to go to Steward Bank and see an auction being active there; so it has to be decentralised,” Mr Mugaga in an interview with this paper.

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