Inconsistent Central Bank Policymaking is Driving Forex Market Instability

By Zvikomborero Sibanda

Policy inconsistency is one of the major factors affecting Zimbabwe’s economic performance since the attainment of independence in 1980. From the monetary front, policy consistency is key to building the resilience of the financial system and the public’s confidence in the banking sector.
This requires the monetary authority, the Reserve Bank of Zimbabwe (RBZ), to adhere to its prior commitments or abide by its policy pronouncements. Lack thereof results in an economy making financial decisions that are ultimately based on speculation.
For the RBZ, inconsistencies have become more pronounced post-full dollarization period (2009-2018). In 2019, the government embarked on currency reforms which led to the reintroduction of the Zimbabwe dollar (ZWL).
Starting in February 2019, RBZ dumped the fixed exchange rate regime and introduced the RTGS dollar comprised of electronic balances, bond notes, and coins. On the first day of official trading, the RTGS dollar was going for RTGS/USD 2.5. However, by June 2019, the RTGS dollar had lost about 62% of its value, trading at RTGS/USD 6.6. In alternative markets, the local unit had lost about 61% from an average of RTGS/USD 3.3 to RTGS/USD 8.5.
The massive RTGS dollar deterioration led the finance minister, Prof. Mthuli Ncube, to introduce a full-fledged local currency overnight. This was done through the promulgation of statutory instrument 142 of 2019 (SI 2019-142) which made the ZWL (formerly RTGS dollar) the sole legal tender for all transactions in Zimbabwe.
Since no meaningful economic reforms were implemented to support the de-dollarization of the economy, authorities resorted to the use of force. According to the RBZ, this strategy was working as financial dollarization began to decline.
In 2020, the Bank confirmed that de-dollarization was on track emphasizing that it could take about five (5) years to fully de-dollarize the economy. The RBZ statistics revealed that the proportion of foreign currency (forex) deposits to the total money supply declined to 37% in 2019 while forex loans to total banking sector loans and advances fell to 22%.
Buoyed by the foregoing metrics, the Bank announced that the country was on the right trajectory to de-dollarization. But a few months later, forced de-dollarization began to backfire.
Between June 2019 and February 2020, the local unit shed 63% of its value against the US dollar in the official markets from ZWL/USD 6.6 to ZWL/USD 17.95. In the parallel market, ZWL shaved 78% of its value from an average of ZWL/USD 8.5 to ZWL/USD 38.
In March 2020, the Bank switched back to a fixed exchange rate regime, fixing at ZWL/USD 25, and also allowed the use of US dollars as legal tender under the guise of fighting the COVID-19 pandemic.
While the official rate was fixed for three (3) months, the ZWL lost about 53% of its value in the alternative markets. With businesses indexing ZWL prices to parallel rates to reduce exchange losses, price inflation wreaked havoc.
In June 2020, the Bank introduced another exchange rate management mechanism -the Dutch Forex Auction System. This system coupled with sustainable ZWL liquidity growth and fiscal discipline by the Treasury had managed to clamp parallel market exchange rate deterioration thereby reducing inflationary pressures. However, after six (6) months the Bank’s quasi-fiscal operations (QFOs) regained momentum and started to destabilize exchange markets.
Fast forward to 2022, ZWL deterioration and price inflation remained highly elevated. Between January 2022 and May 2022, ZWL lost about 56% of its value against the US dollar in alternative markets from ZWL/USD 220 to 500. This forced the government to announce vast measures to boost confidence and macroeconomic stability.
These measures included the entrenchment of a multicurrency regime into law and tax increases on electronic USD transactions and USD cash withdrawals to stabilize and increase the use of local currency. In all these policy maneuvers, authorities maintained that Zimbabwe was undergoing de-dollarization reform.
However, barely two (2) years after the February 2020 monetary policy statement by the Bank and the May 2022 measures by the government, the economy has rapidly re-dollarized. For instance, the 2023 monetary policy statement disclosed that about 64% of total banking sector deposits in 2022 were made up of forex accounts (FCAs).
Also, ZimStat’s classification of individual consumption according to the purpose (COICOP) survey undertaken in 2022 established that about 78% of transactions were conducted in forex. In addition, the Confederation of Zimbabwe Industries (CZI) surveys indicated that about 60% of local companies’ forex was generated from domestic forex sales in 2022. All these metrics show that Zimbabwe is gravitating toward full dollarization.
Many sectors of the economy such as fuel, petroleum products, and housing are now exclusively dealing in forex. Private sector companies are charging exorbitant ZWL prices benchmarked at parallel market exchange rates and awarding discounts to USD sales as strategies to encourage USD transactions. Government ministries, departments, and agencies (MDAs) are also gradually dollarizing their services while Treasury is embracing more USD taxes.
As all economic agents are busy chasing the stable USD, it is the local currency that disproportionately suffers as it gets dumped into the market. This explains why the ZWL exchange rate continues to plunge against the USD.
Last year, the local unit shaved about 84.1% of its value against the USD in the official interbank market from ZWL/USD 108.67 in December 2021 to close December 2022 at ZWL/USD 684.33. Since the start of 2023 to date, the local unit has lost about 25% of its value against the USD in official markets. The unending ZWL decline will continue fuelling the dollarization of the economy.
Cognizant of the foregoing, authorities have now modified their official position. Recently, the central bank through its Governor indicated that it is happy with partial dollarization – a mix of USDs and ZWLs (We will evaluate partial dollarization on another day).
The Bank’s support for partial rather than full dollarization is informed by the costs associated with the latter such as loss of ability to print money (seigniorage revenues) to support and manage general economic activity.
Nevertheless, it remains to be seen if the Bank will be able to avoid full dollarization (financial and transactional) at a time it envisages the use of US dollars as part of legal tender for the rest of the National Development Strategy (NDS) period.
History shows that de-dollarization only occurs when authorities implement prudent market-driven policies and reforms. Recently, the Treasury announced a reform agenda -economic, governance, and land tenure reforms. It is currently engaging its creditors and development partners to reach a consensus on an arrears clearance framework and debt resolution – a welcome development.
If strictly implemented, these reforms will play a crucial role in reopening blocked concessional external credit lines and overseas development assistance, mesmerizing foreign investors, thwarting structural rigidities which are subduing market competition and innovation, boosting local production and productivity as well as increasing market confidence in the ZWL. This is key if Zimbabwe is to successfully de-dollarize its economy.
While authorities have displayed varying de-dollarization positions since the promulgation of SI 142 of 2019 which shows inconsistent policy-making, rapid re-dollarization being experienced in the economy was inevitable.
This was due to perpetual ZWL fragility and incessant ZWL price growth largely emanating from the prevailing fragile political environment, embrace of command economics, corruption, impunity, fiscal indiscipline, poor exchange rate management, weak oversight institutions, illicit financial flows, and poor social protection.
As such, there is a need for increased political will to rebuke the status quo and implement necessary reforms to redress the aforementioned challenges.