Since the introduction of the local currency in the form of bond notes in 2016, Zimbabwe has struggled with coming up with an exchange rate discovery mechanism.
There are multiple exchange rates existing in the economy. The Willing Buyer Willing Seller (interbank) rate was on May 7, 2022 declared as the official exchange rate to be used by economic agencies.
Through Exchange Control Circular No, 3 of 2022 to Authorised Dealers, the Reserve Bank of Zimbabwe (RBZ) advised the market that “going forward, the pricing of goods and services shall be based on the prevailing interbank market rate plus a margin of up to 10 percent.”
The interbank rate came as a replacement to the use of the Foreign Currency Auction System Exchange Rate as the official exchange rate to price goods and services.
Use of the auction rate as the legal exchange rate to price goods and services had come through Statutory Instrument 127 of 2021 which ruled the auction rate as the “ruling exchange rate.”
Ruling exchange rate means the rate determined in the last foreign currency exchange auction.
SI 127 went on to say “a natural or legal person shall be guilty of a civil infringement if he or she sells, displays or offers goods or services for sale at an exchange rate above the ruling exchange rate, or imposes (for the predominant purpose of encouraging payment in a foreign currency) a premium on Zimbabwe dollar payments or allows a discount on foreign currency payments”.
But as said earlier, the auction system exchange rate has since been replaced by the WBWS interbank rate as the ruling exchange rate.
Then there is the widely used parallel market exchange rate, to make them three.
Several methods, including the interbank market in 2019 and pegging at $25 per US dollar in 2020, have been tried, and the results have been the same, a disparity between the official exchange rate and the parallel market exchange rate (PMR).
As of July 19, 2022, the official exchange rate stood at 403 1787, a significant depreciation from an exchange rate of $108 per US$1 at the beginning of the year.
The auction rate and the interbank rate have since converged.
However, the PMR has significantly depreciated from $220 per US dollar at the beginning of the year to anything beyond $800 per US$1 as of July 19, 2022.
This means the PMR is at approximately 100 percent premium to the official exchange rate.
The absence of a single foreign exchange reference rate makes it difficult for economic agencies to navigate the economic terrain.
A distorted exchange rate makes pricing of goods and services difficult.
An ever depreciating exchange rate, makes it difficult for businesses to forecast and plan their next step.
As they operate under foreign currency distortions, businesses don’t know if they will record foreign exchange losses or not and what impact that will have on profitability.
The risk caused by uncertainty about future profits can be assumed to represent a cost to businesses.
With the exchange rate fast depreciating and the resultant inflationary pressures worsening, there are calls from some quarters that the exchange rate be completely floated.
There is strong belief that both the auction system and the WBWS foreign exchange trading systems are restricted by the central bank, something monetary authorities have denied.
In an interview last year, RBZ governor Dr John Mangudya denied the apex bank, or himself, had a hidden hand in determining the exchange rate.
The governor insisted that the exchange rate, at any given time, is market driven. He argued that the price of the domestic unit is established via a price discovery mechanism.
While the RBZ might not have directly controlled the auction exchange rate, its actions meant otherwise.
For example, by selling foreign currency that it did not have, the central bank was indirectly supressing exchange rate movements.
By accepting bid spreads that were too wide between the highest bidder and the lowest bidder, the central bank was essentially encouraging lower bids and in the process supressing exchange rate movement.
Rational economic agency would not bid higher if supply is guaranteed even at much lower exchange rates.
A random pick of an auction held on November 16, 2021 had the lowest bid allotted of 99 and Highest bid of 120.
Such lower bids were accepted and allotted foreign currency despite the fact that the central bank did not have sufficient dollars to meet the requirements of successful bidders.
This was obviously not sustainable as the auction system started experiencing crippling backlogs.
Successful bidders at the auction would wait for even more than two months to have access to the foreign currency allotted at the auction system. This resulted in failure to pay suppliers on time and the subsequent impact on production.
The result is a situation that has been described by many as unsustainable. There are now growing calls that if the central bank can’t meet foreign currency demand and can’t deal decisively with the exchange rate disparity, it must concede and float the local currency rather than continue with government decrees.
A floating exchange rate is a system where a country’s currency price is determined by the foreign exchange market, depending on the relative supply and demand of other currencies.
A floating exchange rate is not restrained by trade limits or government controls, unlike a fixed exchange rate or a managed or controlled one as is the case with the auction system or the interbank rate.
In theory under a floating exchange rate system, the rate is determined by daily supply and demand of the currency. But that is hardly the only case. There are many other factors that can affect the exchange rate when floated.
For instance, market sentiment towards the economy of a country affects how strong or weak the floating currency is perceived.
For example, a country’s currency is expected to depreciate if the market views the country’s growth projections as negative. Disasters and speculation can also determine the movement of the exchange rate.
The existence of speculation can lead to exchange rate changes that are unrelated to the underlying pattern of trade. This will also cause instability and uncertainty for firms and consumers.
Large inflows or outflows of foreign currency are also key determinants of a floated exchange rate.
If authorities decide to float and the local currency depreciates, the country’s exports would become cheaper, resulting in an increase in demand and eventually attaining equilibrium in the BOP.
A country’s macroeconomic fundamentals affect the floating exchange rate in global markets, influencing the flow of portfolios between countries. Thus, floating exchange rates enhance the efficiency of the market.
Furthermore, given Zimbabwe is suffering from economic issues, such high inflation, floating exchange rates may intensify the existing problems. For example, depreciation of the Zimbabwe dollar already suffering from high inflation will cause inflation to increase further due to an increase in demand for goods. Moreover, expensive imports may worsen the country’s current account.
The lack of control associated with a floating exchange rates can limit economic growth or recovery. For example, if the Zimbabwe dollar rises against the Rand, it will be more difficult to export to South Africa from Zimbabwe.
Under a free float, the cost of exchange risk will also be greater. Thus, if exchange rates were permitted to float, the additional cost would force marginal firms out of the exporting or importing business, eliminate marginally profitable exports, eliminate imports that are marginally cheaper than domestic substitutes, and discourage marginally profitable foreign investments.
Because floating exchange rates can be prone to large fluctuations in value causing uncertainty for firms, investment and trade may be adversely affected.
The Ministry of Finance Economic Development released a statement this month saying Government had noted “with great concern that some suppliers who supply goods and services to government institutions are channelling the funds they receive to the illegal foreign exchange market, thereby contributing to exchange rate and price instability”. If these institutions have enough local dollars to cause havoc in the market, they can equally pose the same challenge when the exchange rate is floated and they are allowed to freely participate.
The impact, however, will not be as bad as when they go through formal channels where there is some sense of information symmetry.
On the parallel market, the reverse is true. The black market is fraught with information asymmetry with the exchange rate not properly discovered.