MPC Interest Rate Decision Threatens Forex Auction System

Michel R Nhete

By Michael R Nhete
Since the beginning of the Russian-Ukrainian conflict, we have witnessed an increase in global inflation which has translated into higher prices all over the world.

The conflict has directly affected world oil and gas prices, which have spilled over into other goods and services.

Rising global inflation and its impact have spilled over into the domestic market. According to the Reserve Bank of Zimbabwe (RBZ), there has been a negative impact on domestic production costs and a destabilization of the foreign exchange market.

Despite a drop in monthly inflation from 6.99% to 6.31% from February 2022 to March 2022 respectively, annual inflation rose from 66.11% to 72.70% for the same period.

Through the Monetary Policy Committee, the RBZ has put in place additional measures to reduce inflation and foreign exchange activities in the parallel market.

However, it is important to give a critical and concise assessment of these measures to see if they will achieve the intended objectives.

One of the measures put in place was the raising of the key rate from 60% to 80%, which constitutes the basis for lending rates for all banks.

In principle, this makes the cost of borrowing higher, thereby reducing the speculative borrowing that fuels the parallel foreign exchange market.

It also reduces the money supply, which leads to lower inflation.

However, high borrowing costs reduce financing to the productive sector, preventing the economy from achieving the envisaged economic growth rate of 5.5%.

For businesses that manage to borrow at these exorbitant rates, they will pass the cost on to customers or the end consumer, further fueling inflation.

Due to the lack of active alternative instruments for raising external capital such as commercial paper, bonds and private sector bills, most businesses are dependent on bank loans.

Internally generated funding, such as retained earnings, is being eroded by inflation, leading companies to resort to constant borrowing from banks at exorbitant rates.

The other action the RBZ has taken is the reduction of the reserve currency’s quarterly growth target from 7.5% to 5% for the quarter ending June 2022.

Generally, this measure reduces the money supply in the economy, which leads to a decrease in inflation.

However, reducing the money supply tends to slow economic growth since liquidity oils all investments in the economy.

Taking a putative conceptual analysis of the money supply, one can realize that the reduction in the money supply to some extent fuels inflation in the Zimbabwean context.

If we consider the money supply M1 composed of currencies, i.e. notes and coins, demand deposits and other liquid deposits, any direct reduction in the currency would directly lead to an increase in the differential of cash prize/rtgs.

Indeed, goods and services in Zimbabwe are cheaper in cash than in electronic money.

In addition, the exchange rate for cash is more favorable than for electronic money.

In this regard, if the reduction in monetary growth is exclusively placed on M1 notes and coins, the demand for liquidity will increase, thereby widening the cash/RTGS price gap and fueling inflation.

The RBZ further liberalized the foreign exchange market by allowing banks to conduct foreign exchange transactions on a willing buyer and willing seller basis. This is a clear indication of the collapse of the auction system.

Liberalization has the antagonistic effect of fueling inflation in relation to other measures put in place from a conceptual point of view.

Over the years, there has been an indisputable manifestation of the pass-through effect of exchange rates on domestic inflation in Zimbabwe.

Under the willing buyer and willing seller regime, due to the ever-increasing demand and shortage of foreign currency, the bank exchange rate will rise, crippling all efforts to keep inflation under control.

The main contributor to the global rise in inflation is the rise in oil prices linked to the Russian-Ukrainian conflict.

It is high time for the Zimbabwean government to join the international community in finding alternative energies and investing in Go green campaigns.

Although this is a long-term initiative, in the meantime the government needs to further revise the fuel tax, provide incentive lending rates to the productive sector and encourage banks to offer incentives in the framework of the liberalized foreign exchange system to discourage the use of the parallel market.

Businesses need to stop relying solely on expensive bank loans to finance themselves. They must find alternative financing options such as issuing commercial paper or corporate bonds and notes, while monetary authorities put in place measures that support the issuance of these financial instruments.

  • Michael R Nhete is a Fellow of the South African Institute of Financial Markets and holds a Masters of Science in Finance and Investments. He can be contacted on [email protected] or 0773778826


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