By Victor Bhoroma| The Reserve bank of Zimbabwe (RBZ) is cautiously yielding to free market demands for the complete liberalization of the foreign exchange market and scrapping of various consumption subsidies that were being funded via exporters’ hard earned foreign currency. The central bank re-introduced the Foreign Currency Auction System (FCAS) on the 23rd of June 2020. The auction system was once trialed in 2004 and abolished after less than 2 years in October 2005 after it failed to increase foreign currency inflows, boost confidence, stabilize inflation and eliminate the parallel market. The system also failed to bring stability to the waning Zimbabwean Dollar which had depreciated to US$1: Z$26 000 on the official market then. Within the auction system’s 22 months lifetime, year-on-year inflation had raced from 133% in 2004 to 586% in 2005. Industrial organizations such as the Confederation of Zimbabwe Industries (CZI) had recommended an auction system as a way of allowing market discovery of price, thereby bringing the much needed stability to the foreign exchange market.
Fast forward to June 2020 and the auction system is back with minor adjustments on the trading rules. However the objectives are a carbon copy from 2004. The new auction system will be carried out on every Tuesday of the week with bids starting from US$50 000 up to US$500 000 per each bidder per auction. The central bank has pointed out that authorized dealers will be allowed to serve importers in between the trading days using the established mid-rate from the last trading date. Further, a crawling rate which will be adjusted from time to time in line with economic fundamentals will be used to the privilege of the government.
The foreign currency auction is a welcome move in the road to free market policies in that the central bank has acceded to market determined allocation system, however the following concerns may contribute to its failure.
Forex supply puzzle
The now defunct interbank market started on a promising note in February 2019 with market players satisfied with the level of trading that was happening. At some point, average foreign currency traded reached US$8 million per day. In total over US$1.5 billion was traded on the interbank in 2019 against demand that eclipsed US$7 billion. However its major undoing was the covert management of the exchange rate by the central bank. The central bank was caught in a conflict of interest where it had to access foreign currency from exporters at very cheap rates, thereby allowing them to print a limited amount of Zimbabwean Dollars to compensate for expropriated foreign earnings (Export surrender requirements). Further the bank also needed to provide incentives for its quasi fiscal activities such as the Gold support scheme. On one hand the central bank had to manage inflation and stabilize the exchange rate through dumping foreign currency on the interbank from time to time. The same foreign currency was also needed to settle external debts. The conflicted role of the central bank complicated exchange rate policies and dried up the supply side. The horses bolted when the apex bank fixed the exchange rate in March 2020. Exporters and various entities are now holding on to over US$1 billion in their FCA accounts as they did not see value in liquidating using a fixed rate. The same also happened to miners, tobacco farmers and other exporters. The auction system will therefore need to be provide fair value to exporters, or else exports will slump and exporters will under declare their export earnings.
Lifeline to the parallel market
The new auction system could have been structured with any other modalities, but not with trading on a single day of the week while hoping to eliminate the parallel market. World over, trillions of dollars are traded each minute to meet the demand of buyers and sellers. Limiting bids to one day of the week gives a lifeline to the parallel market who will continue to get a huge chunk of the available foreign currency through offering better rates than the one established on the auction system in the previous week. It is inevitable that supply will not be able to match demand as long as the rate does not freely float to the seller’s satisfaction.
Bidding floor too high
The bidding floor of US$50 000 per bidder will succeed in eliminating rate manipulators and speculative buyers but it will also sideline smaller and genuine importers who fall under the Small to Medium Enterprises (SMEs) cluster. These smaller importers have to see value in the auction system to cultivate confidence. Small bidders may submit joint bids but those can only be effective if foreign currency was enough to cater for all buyers so as to be shared equally amongst all the parties. Using a mid-rate of US$1: Z$50, the smallest bid would need Z$2.5 million and not many SMEs can have as much balances in local currency.
In the end the plus 80% that fail to meet the bid floor will continue to give a lifeline to the parallel market. Earlier February this year, the central bank noted that 50% of the Z$34.5 billion in the economy belonged to less than 200 corporates and most of these firms have been using their reserves and proceeds to hedge against inflation by buying foreign currency. As such there is a danger that the auction system will serve the same few corporates with deep pockets and alienate smaller buyers.
Import Priority list
The now defunct interbank market ended up serving a few importers who were deemed the priority list by the central bank. The same can also be said of the whole foreign currency allocation mechanism at the central bank up to this day. From an economic point of view, manufacturers who import raw materials and value add those to produce basic commodities and agricultural inputs can be classified as the priority list. However the key questions is who determines the priority list, how transparent is the allocation processand do priority importers use the foreign currency to import the said priorities? The new auction system is thus susceptible to the same pitfalls that sank the interbank market.
Crawling Rate insistence
The Zimbabwean government gets the lions’ share of the foreign currency available locally and from any other external sources. It is also the biggest importer of various commodities, as such it has a vested interest in ensuring that the rate is kept at a lowest level possible. Equally important to the government is the need to protect the waning Zimbabwean Dollar and save face through managing inflation thereby covertly managing the exchange rate. It is inevitable that the rate that is determined by the government will most likely be the ruling exchange rate and this defeats the purpose of open market price discovery. The government doesn’t generate foreign currency (save for tax payments paid in foreign currency), therefore it should be comfortable to allow the rate to reach the equilibrium level so that sellers offload their earnings while retaining value.
To be efficient, effective and transparent, the central bank needs to decentralize the auction system to a level where commercial banks set the pace of trading while it regulates. The auction system is a noble idea on paper but it is very susceptible to the pitfalls that affected the interbank market which are mainly to do with lack of confidence by market players, limited supply and covert management of the ruling rate by the central bank. With precedence set through civil service salaries being paid in foreign currency, not many private players will be able to fend off labour demands to be paid in foreign currency. In the end the government has to be clear on whether it will allow market forces to determine the exchange rate for the local currency while the printing machines at the central bank are decommissioned or the market completely adopts the US Dollar by rejecting the local currency. The latter is very much in motion now, as such the auction system has to deliver at all costs.
Victor Bhoroma is a freelance economic analyst. He holds an MBA from the University of Zimbabwe (UZ). For feedback, mail on [email protected] or follow him on Twitter @VictorBhoroma1.