ANALYSIS OF THE RECENT MEASURES TO STABILISE THE EXCHANGE RATE AND CONTROL INFLATION, AND MONETARY POLICY COMMITTEE PRESS STATEMENTS AND THE POTENTIAL EFFECTS ON THE ENGINEERING, IRON AND STEEL SECTOR
The developments that have taken place over the past 3-4 months in the country, have seen the country experience high inflationary pressures calling for Government’s attention. Inflation increased to 30.7% and 191.6% on a month-on-month and year-on-year basis for June 2022, respectively. The following summarises some of the challenges noted over the recent past:
- Increasing premium between the official and the parallel market rate.
- Demonstrations by health sector workers.
- Policy inconsistencies
- Increased demand for USD denominated wages and salaries
- Recent surge in inflation emanating from both RTGS and USD prices
- Eroded confidence amongst economic agents as a result of past hyperinflation experiences has resulted in rational demand for US Dollars as a store of value.
- a skewed preference for US Dollars for commercial transactions
- parallel market bench-marking of prices
- increased demand for foreign exchange to support domestic transactions as opposed to foreign exchange demand to fund external transactions.
- Exchange rate depreciation both on official and parallel rates, among others.
In an effort to address the above challenges, the Minister of Finance and Economic Development and the Reserve Bank of Zimbabwe Governor on the 27th of June 2022, both made press statements on policy measures to build confidence in the multicurrency system.
2.0. Major highlights from Press Statements
2.1. Resolutions of the Monetary Policy Committee (MPC):
2.1.1 Interest Rates and Statutory Reserves
The MPC reviewed interest rates and statutory reserves with effect from 1st July 2022
- Increasing the Bank policy rate from 80% to 200% per annum;
- Increasing the Medium-Term Accommodation interest rate from 50% to 100% per annum;
- Increasing the minimum deposit rate for ZW$ savings from the current 12,5% to 40% per annum and increasing the minimum rate for ZW$ time deposits from 25% to 80% per annum; and
- Maintaining the Statutory Reserve Requirements at the current levels of 10% for demand and call deposits and 2.5% for savings and time deposits
2.1.2 Analysis of the measures and their potential effects on business:
The bank policy rate refers to the interest rate at which the central bank is willing to lend money to commercial banks and is used by the central bank as an instrument of monetary policy. Through it, the central bank influences short-term interest rates and the money supply in the economy.
The increase from 80% to 200% on policy rate by the central bank is meant to take into account the noted annual inflation rate of 191.6% for June 2022. However, in their quest to curb speculative borrowing, the increase in policy rate, has a direct effect on the interest rates charged by commercials banks on lending. Commercial banks, will therefore lend out at a rate above 200%.
Such rates will result in unbearable costs of borrowing for engineering iron and steel firms, thereby stalling production and any investment decisions. Companies in the sector will also find it difficulty to finance their working capital and capital projects. This in turn is expected to humper negatively on the implementation of our recently developed Engineering, Iron and Steel Sector Strategy.
In addition, companies with overdrafts will be faced with higher costs because they must now pay more interest and tend to spent more of their earned incomes towards servicing of debts, thereby suffocating other key areas of business such as day-to-day operations and payment of wages and salaries.
Since our sector is also heavily dependent on construction activities, reduction in investment decisions by both the firms and households, is likely to result in reduced demand for our sector products and services, both in terms of the engineering services as well as iron and steel products. The subdued demand may ultimately force prices to fall.
Some of the companies’ customers are likely to default as customers with debts have less income to spend because they are paying more interest to lenders and ultimately sales fall as a result. In the event that companies continue to borrow at the exorbitant interest rates to finance their working capital or capital projects, they are likely to pass on the burden to consumers by increasing prices. However, only companies facing an inelastic demand (whose demand/ revenues will not significantly change when price changes) have this latitude to increase their prices.
Although the interest rate on deposits have increased, the rates are not matched with inflation rate, hence companies have no incentive to save because the projected annual inflation rate of 191.6% is way higher than the annual savings interest rate of 80%. In this case, savings will drop to less than half in a period of a year and no significant savings will be mobilised in the interim.
2.1.3. Liquidation of Unutilised Retained Export Receipts
In order to enhance the circulation of foreign currency in the economy, as well as to support the willing-buyer willing-seller foreign exchange market, the MPC resolved to maintain the current export retention thresholds across the various sectors of the economy and that 25% of the unutilised export receipts shall be liquidated at the willing-buyer willing-seller exchange rate after 120 days from the date of receipt of the export proceeds.
This policy measure speaks to continued export retention thresholds announced previously. However, the newly announced liquidation of 25% of the unutilised export receipts, will likely lead to a goldrush by companies to ensure they utilise their receipts before they are liquidated at the interbank rate. This policy measure, will force companies to make rushed decisions to utilize their funds in an effort to avoid interbank liquidation.
This in turn will reduce the overall foreign currency balances and ultimately deplete drastically overall foreign currency savings held with the banks by companies. The policy may also threaten exportation of goods and services by companies, emanating from fears of loss of value, should they fail to utilize the funds within the stipulated time frames.
2.1.3. Introduction of Gold Coins as a Store of Value
Companies need to consider the value of the coin compared to the amount paid to buy the same coin. However, given the recent policy inconsistencies, recently witnessed over the past periods firms may be sceptical to take up the coins. Suffice to note that the price of gold is determined internationally, hence to some extent, it may be a safe way to store value. Companies will tend to benefit more if the international price of gold increases and lose out when the price falls below the current prices.
It is important to also understand the modalities on how these coins will be liquidated and the period allowed to liquidate such. The return to holding the gold coins will make them lucrative or not, other wise firms may prefer to hold on to their money with less risk of losing value.
2.1.4. Forward Market for Foreign Currency
Measures are yet to be announced.
2.2. Additional Policy Measures to Build Further Confidence in the Multicurrency System
2.2.1. Entrenching the multi-currency system in law
Maintenance of multi-currency system based on the use of the USD and Zimbabwean dollar. Government decided to embed the multi-currency system and the continued use of the US dollar into law for a period of 5 years. The policy entails that the use of USD continues to be a recognised currency and companies are allowed to price their goods and services in either USD or RTGS prices (at not more 10% above the prevailing interbank price). This policy will see most firms pricing their products in USD and only use RTGS and bond notes to facilitate change. It is, however, important to note that this policy stance will result in continuous pressure towards USD wages and salaries in order for workers to cope with this development. Most transactions for the workers require USD i.e., transport, fuel, rentals, groceries, medical bills, etc.
2.2.2. Entrenching the inter-bank market exchange rate in law
This policy stance comes at a time when the country has been continuously faced with foreign currency shortages and the premium between official rates and parallel rates has more than doubled. It is anticipated that at interbank rate exchange rate, the foreign currency shortages will remain. The use of USD prices will further put an upward pressure on the parallel rate, emanating from the increased demand to meet USD transactions.
Should the interbank rate be allowed to freely- float, the rate is likely to depreciate towards the parallel rate in light of the willing-buyer willing-seller. Depreciation of the RTGS will further lead to RTGS inflation. Thus, companies will further shun away from the use of RTGS tilting more to USD. Therefore, in the short to medium term, RTGS prices will vanish from the shops, remaining with only USD, thus at that juncture the economy will have fully re-dollarised.
2.2.3. Measures to Stabilise the Price of Fuel, Maize Meal and Bread in the Market
Government instituted the following actions:-
- Downward review of Government Fuel Levies
- Release of Fuel from the Strategic Fuel Reserve
The observed increasing trend in fuel prices over the past months, will continue to push up the prices of goods and services in the market. The imported inflation emanating from fuel increase will further worsen the inflationary pressures in the economy. The release of fuel from strategic fuel reserves is only a temporal measure which can not be sustained into the future. Therefore, price increase emanating from global price increases are expected into the foreseeable future, hence the resultant inflation can also be anticipated.
2.2.4. Measures on Maize and Wheat
The recommendation that millers should source their own grain stocks whenever possible will result in exchange rate pressure, if these millers consider importing. Given that the past farming season was not a success, millers will require foreign currency to import. If this is not provided through the official channels, millers in their quest to access forex to import grain, will then source forex at parallel market, thereby fueling the parallel exchange rate.
2.2.5. Review of the Remuneration Framework and Service-Wide Conditions of Service
The recently announced remuneration framework and service-wide conditions of service by the Minister of Finance and Economic Development, as usual, will result in increased inflationary pressures together with pressure on RTGS-USD exchange rate.
Although, there is consideration for housing guarantees across the civil service, the accompanied interest rates will deter uptake of loans. Therefore, neutralizing the anticipated benefits that could be anticipated from a boom in housing construction to the engineering, iron and steel sector.
In conclusion, the recently announced press statements are bound to further worsen the prevailing macroeconomic environment through worsening inflationary, exchange rate and USD wage/ salary pressures. Our humble view is that it is more likely that in the short to medium term, the economy will fully- redollarise, owing from the three pressures (inflation, exchange rate and USD wage/salaries).