eBusiness Weekly
Clive Mphambela
Financial market distortions remain a major source of vulnerability for the economy; a substantial hindrance to growth. When the monetary policy stamen was issued on February 20, 2019, there was wide celebration that finally, the central bank was acting in rooting out financial markets distortions.
The monetary policy, whose thrust was to introduce market driven reforms particularly to the foreign currency market by liberalising the exchange rate gave much hope that the existence of a plethora of financial market distortions across the Zimbabwean economy was now going to be a thing of the past.
Seven weeks on, that hope has dissipated, the markets are back in hysteresis and upheaval and the distortions seem to be getting worse, with all the attendant problems for pricing and inflation in the economy, this should be a cause for concern for policy.
As we progress to put in place an economic revival plan for Zimbabwe, in line with the Country’s Vision 2030, we must bring into sharp focus the issues around financial markets and their stability in the new dispensation.
The upheaval in the markets which manifested itself last year largely as a surge in inflation in October and a dislocation in the foreign exchange markets which has spilled into the real goods market in the form of multi tier pricing, must be tackled head on if we are to put the economy on a sustainable path to recovery.
We have seen a rapid decline in real asset valuations in the property markets, we have seen the contraction of private sector credit and we have seen the resurgence of inflation, all being signs that things are not as good as they can be.
The reason market distortions become topical is very simple. When prices of financial and real assets exhibit very high variability, it also means that the returns for investors in those asset classes also are very variable. This is the essential definition of risk in the economy. When prices are changing rapidly, whether up or down, that usually indicates fundamental problems in the market.
In trying to understand the causes of observed market distortions, we need to do a bit of root cause analysis to answer the question: what are some of the causes or sources of the various market distortions?
One of the major sources of market distortions in the financial system was the existence of the multiple tier pricing of Treasury bills issues by the central bank.
There are many distinct classes of Treasury Bills that have been issued over the past few years. Some are classified non tradeable TBs which is a bit of a misnomer because TBs are by nature supposed to be most liquid of assets in any financial system. Some TBs were issued as capitalisation or lending instruments for state or quassi government entities, while others were issued as marketable securities. Some classes of TBs were issues as currency in settlement of debts.
All these factors have contributed to the absence of a vibrant secondary market in these key instruments. It is difficult in a market without a visible yield curve to accurately price such instruments. One measure to deal with this historical aberration is to reintroduce a proper functioning interbank market for these financial instruments, underpinned by an open tender system for the issue of Government securities.
This will in the very near future, not only deepen the market, but the presence of a discernible yield curve will enable other financial instruments to be designed around the yield profile.
Directed interest rates – Directed interest rates are also contributing to price distortions, particularly on bank lending portfolio. Interest rate caps have tempered with the risk versus return trade off on bank lending portfolios. When such interest rates caps are imposed the natural result will be credit rationing. This is because banks price their loans at the margin and as bank margins get squeezed to unsustainable levels banks will begin to seek to lend only to higher quality borrowers.
Marginal clients become too risky as banks are unable to recoup potential losses at lower rates so they stop giving credit to those borrowers perceived to be of higher risk. That is why there has been an apparent credit squeeze. I have argued in many past writings that the apparent decline in lending by banks over the last three years or so has not been as a result of crowding out per se but a result of these pricing distortions being imposed by persuasive regulation. Interest rate caps are a serious form of financial repression and are not good for the markets.
Multiple currencies and multi tier pricing
On February 20, 2019, the Reserve Bank of Zimbabwe (RBZ) announced its Monetary Policy Statement which contained two major measures. One was the announced re-denominating of the existing RTGS balances, bond notes and coins in circulation as RTGS dollars, effectively a local currency and the other main measures involved the establishment of an interbank foreign exchange market which according to the policy, was going to operate on a willing buyer and willing seller basis.
It was hoped that these measures would deal a lasting blow to the pricing distortions in the economy. However the experience over the past few weeks, has been less than encouraging.
Whilst the introduction of a “floating exchange rate” and allowed the devaluation of the local RTGs and bond notes, making locally produced goods more competitive against imported goods and the devaluation is expected the medium to long term, to help to improve the current account position of the economy, the measures have not done away with multiple tier pricing in the economy.
In fact in some instances, multi tier prices have become worse, with the divergence between prices determined at official rates, and parallel rates becoming more pronounced.
In many instances, businesses have simply gone back to the old USD based prices of three or four years ago and simply now mark these “USD” prices to the daily open market exchange rates.
Operational challenges in the Interbank Market
There are significant concerns that the interbank market has not operated as expected. The first signs of trouble appeared when the RBZ instituted a direct targeting of the exchange rate as was evidenced by the initial re-pegging of US$1,00:2.5RTGS$, which rate was not market based and a far cry from the RTGS$3,50 to 4,00 which was already obtaining in the market.
This immediately set up the new market for failure as no exporter would feel the need to trade out of US-Dollars at RTGS$2.5 per Dollar, when there was a psychological opportunity to access the parallel markets and get better value.
Currently, RBZ has been employing moral suasion tactics on banks that have disallowed the exchange rate to move freely, beyond certain levels. Further to these distortions there are other sectors such as gold miners, who are being given preferential exchange, which are higher than the prevailing interbank market rates.
As such distortions that existed during the pre-monetary policy era. The controls on the interbank market are thus sustaining the existence of a more lucrative parallel foreign currency market where, unfortunately, the majority of the formal businesses do not participate, thus starving them of the much needed foreign currency.
The slow implementation of the willing-buyer, willing-seller framework on the formal foreign exchange market has thus become a cause of concern for market players, as this is causing serious undesirable consequences, relating to continued sustenance of the parallel market where formal businesses do not trade. This development will negatively affect formal business operations, threaten business viability, resultantly may lead to company closures and loss of employment.
Failure to allow free operation of the interbank market is worsening the already fragile foreign currency supply situation, as exporters and those with foreign currency are unwilling to dispose it at controlled rates and are finding alternative markets to dispose their foreign currency.
This is further eroding market confidence, and may result in failure to realise the good intended results of the measures which relates to improved foreign currency availability, hence, may lead to delay of economic recovery process.
The writer is an economist. The views expressed in this article are his personal opinions and should in no way be interpreted to represent the views of any organisations that the writer is associated with.
