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Anybody who knows some macroeconomics (monetary policy hopefully) around?
I think I understand this, but I'm not quite sure--could somebody help me?
FinGaz
RBZ grapples with impossible trinity
Nelson Banya
2/3/2005 7:27:01 AM (GMT +2)
THE Reserve Bank of Zimbabwe's (RBZ) success in extinguishing the
economic turmoil precipitated by the International Monetary Fund's (IMF)
withdrawal of balance of payments support in the late 1990s, hinges on the
inflation, interest and exchange rates - the seemingly impossible trinity.
In his fourth quarter monetary policy review announced last week, RBZ
governor Gideon Gono stressed that the central bank would rigorously pursue
a disinflation programme, seek to stabilise the exchange rate and
progressively reduce interest rates, concurrently.
Since the inception of the economic recession, Gono's predecessor
Leonard Tsumba had struggled to find a proper prescription to the three
macro-economic fundamentals, that seem to require totally different
approaches to rein in.
The incumbent RBZ boss, whose inflation-targeting plan has seen the
annualised rate of inflation decline from a peak of 622.8 percent in January
2004 to 132.7 percent by December 2004, appears to have struck the right
chord and has set a year-end target in the 20 percent to 35 percent range.
On the interest rate front, Gono announced further rate cuts, with the
central bank's key policy overnight accommodation rate being slashed by 15
percentage points from 110 percent to 95 percent with effect from February
1.
The RBZ also announced the discontinuation of the dual interest
policy, with rate convergence expected in June, when the productive sector
facility (PSF), under which funds were lent to producers and exporters at a
concessionary 50 percent, is expected to be wound up.
There will be progressive cuts until June, when the rate is envisioned
to be down to 70 percent. Penal rates for unsecured borrowing are 10
percentage points higher than the rate for secured borrowings.
Banks' minimum lending rates, which averaged 400 percent in April last
year but have recently receded to levels around 140 percent, are expected to
be dragged further down in the aftermath of the central bank's intervention.
The exchange rate, which was devalued by as much as 600 percent in
2004 after the introduction of managed foreign currency auctions by the RBZ,
is critical in the disinflation programme and, for the first time since he
introduced quarterly monetary policy reviews, Gono did not announce a new
floor rate.
He, however, adjusted incentives availed to exporters for enhanced
foreign currency generation and also sought to converge the various schemes
under the "carrot and stick" package of incentives.
Exporters who remit their export proceeds within 90 days will retain
70 percent of their earnings in their foreign currency accounts (FCAs) and
sell the remainder at the ruling auction rate. Remittances after the 90-day
period, following the granting of an RBZ waiver, will see exporters
surrendering 15 percent of their earnings at $824 to the United States
dollar, 35 percent converted at the ruling auction rate and the remaining 50
percent retained in FCAs.
The foreign currency auctions have been critical to the eradication of
inflationary exchange rate volatility - a common feature before last year -
while the progressive reduction in interest rates, after the 2003 spike,
which saw rates going up to as high as 900 percent, has brought about
increased levels of productivity.
The central bank's robust liquidity management programme, through
various money market instruments such as RBZ Bills, RBZ Financial Bills,
Special Zimbabwe Treasury Bills and ZTB Open Market Operation (OMO) Bills,
has been critical in reining in money supply, a major inflation driver.
Broad money supply growth receded from 490.9 percent in January 2004
to 219.4 percent in November. Gono said the December outturn of 150 percent
was expected. The money supply growth is expected to further come down to 60
percent by the end of 2005 and 14 percent by mid-2006.
The RBZ is, however, faced with a poser - keeping the market short, as
it did for long period in 2004, inevitably results in firming rates on the
short end of the market.
The Zimbabwe Financial Holdings (Finhold) economics department has
also cautioned that the low interest rate policy pursued by the central bank
could work against its disinflation crusade through the inflationary
expansion of credit.
"It is our view that the low interest rates the central bank is
advocating for may actually encourage credit expansion and again militate
against the RBZ's initiatives," Finhold said in its analysis of the monetary
policy review.
Finhold further points out that going forward, the 2004/2005
agricultural season would be critical in the achievement of the inflation
target for 2005.
"Not only will a good harvest reduce pressure on food imports, it will
also limit domestic food price increases and thus dampen food inflation."
Food inflation has the biggest weight of 33 percent in the consumer
price index (CPI) basket.
Wage increases in 2005 would also be critical and analysts have
cautioned that labour might not be willing to cooperate with the central
bank on its pleas for moderate increments.
Witness Chinyama, an economist with Kingdom Financial Holdings, said
the major challenge for the monetary authorities in 2005 would come on the
exchange rate front.
"The missing link in the governor's policy arsenal is the
unavailability of effective policies to enable the external sector to
generate more foreign currency from known sources.
"The known sources of foreign currency are export earnings, capital
inflows such as loans and unrequited transfers, private and official, as
well as foreign direct investment. The plan, however, targets one source of
foreign currency - exports. It should be noted that the export sector alone,
even if it is served with the best exchange rate policy, is not able to
generate enough foreign currency to service the domestic economy, that is
monthly national requirements plus reserves that need to run into several
months of import cover," Chinyama said.
Last year, the country realised foreign currency inflows amounting to
US$1.71 billion, up from US$301 million in 2003. The RBZ is now targeting
inflows of US$3.050 billion this year, an all-time peak of US$3.9 billion in
2006 and US$4.5 billion in 2007.
Zimbabwe, which realised its highest level of foreign currency
inflows - US$3.88 billion - in 1996 has monthly requirements of at least
US$250 million. Last year the country raked in a monthly average of US$142.6
million.
Proceeds from minerals - mainly platinum, gold and nickel - tobacco
and remittances from non-resident Zimbabweans are expected to continue
boosting inflows.
Chinyama said the re-engagement of the international community and
clarity on the country's investment climate were prerequisite if Zimbabwe
were to get meaningful capital and foreign direct investment to further
bolster the foreign currency situation.
"Flows from multilateral financial institutions are locked up in the
provisions of the Zimbabwe Democracy and Economic Recovery Act (ZDERA)
(passed by the United States in 2001). In addition to smart sanctions that
have seen the assets of top government officials being frozen and their
trips abroad being curtailed, the economic sanctions bar Zimbabwe from
receiving financial aid from multilateral financial institutions and the
IMF. Foreign direct investment flow might not improve because foreign
investors normally use the Bretton Woods institutions as the international
commissioner of oaths to assess the sovereign risk of a country," Chinyama
said.
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