Zim tops exchange rate troubled states

Consumer price inflation appears to have peaked in all regions, in most regions it remains elevated by recent historical standards—and a key drag on growth.

Zimbabwe has been named among 24 countries that are most affected by economic challenges rooted in the distortionary impact of the parallel market for foreign currency, causing persistent macroeconomic instability.

According to a report released by the World Bank last week, as of March 31, 2023, the Southern African country was ranked seventh on the list of the 24 nations seriously afflicted by the malignant wide exchange rate disparities, behind Iran (1 195 percent), Lebanon (616,7 percent), Yemen (392 percent), Syria (150,2 percent), Argentina (87,1 percent) and Ethiopia (84,1 percent).

The southern African country’s currency, which at the time had an exchange rate disparity of 72,1 percent, has suffered considerable damage from the twin effects of economic collapse and debilitating Western sanctions, since the turn of the millennium.

Following its land reform programme at the turn of the millennium, to resettle the landless majority, Zimbabwe has faced persistent economic challenges that include high inflation, diminishing production, economic contraction, slow growth, loss of employment and stunted job creation, low investment as well as limited access to affordable long-term financing.

Zimbabwe has also been seriously weighed down by the negative impact of the Western economic embargo, especially by the USA, Britain, and the European Union in general, over alleged human rights abuses and manner in which it repossessed land from former white farmers, which has restricted trade with major global markets and isolated Harare from global financial disintermediation.

With the country believed to have lost more than 50 percent of its Gross Domestic Product (GDP) over nearly two decades, Zimbabwe saw inflation hit record levels, 500 billion percent in August 2008, according to the International Monetary Fund (IMF).

Along with the closure of many businesses, the hyperinflationary period over the decade to 2008 caused the collapse of the country’s domestic currency and the self-dollarisation of the economy, which was made official in February 2009.

But Zimbabwe could not sustain a multicurrency regime, dominated by the greenback, which Harare briefly scrapped in 2019 amid a US dollar liquidity crunch and unavailability of correspondent banking relationships with foreign banks due to Western sanctions, making forex cash imports impossible.

The economic challenges over the roughly two-decade-long period also meant Zimbabwe’s economy did not perform well enough to generate the kind of foreign currency required to meet both its domestic transactions, as the exclusive legal tender, and external obligations.

Notably, Zimbabwe had been forced to dumb its domestic currency in February due to hyperinflation.
Floated at $2,5/US$1, the Zimbabwe dollar now changes hands at anything above $5 500/US$1 on the parallel market and about $4 88/US$1 on the official market.

Authorities have since rolled out a series of measures to address the distortions caused by disparities between official and parallel market exchange rates, with little success.

These include refining the foreign currency to a true Dutch Auction System, for price discovery, transfer of external debt payment obligations from the Reserve Bank of Zimbabwe to the Treasury to avoid the creation of money, and promoting the use of the Zimbabwe dollar in local currency.

Disparities between official and open market rates; given that in terms of the law, traders are required to only add a prescribed margin per product, which should tally with the US dollar price of the particular product when the crossover rate, plus the margin, is calculated, have always created distortions in local pricing models.

For instance, traders have lately found it difficult to determine local currency prices that match the correct US dollar prices at the official exchange rate, without running the risk of losses caused by arbitrage opportunities arising from the exchange rate differentials.

Businesses ended up inflating the prices above prevailing parallel market rates to compensate for the potential real value loss if say a customer chose to have the US dollar price converted to local currency at the official rate.

However, inflating local currency prices puts traders at risk of violating standing regulations that compel businesses to comply with the stipulated official exchange rate pricing models.

According to former World Bank president, David Malpass, the deterioration of economic conditions over the past few years and the growing depreciation pressures facing developing countries have led to a rise in the number of countries with active parallel currency markets.

“Currently, around 24 emerging and developing economies (EMDEs) (Zimbabwe included), have active parallel currency markets.

In at least 14 of them, the exchange rate premium—the difference between the official and the parallel rate—is a material problem, exceeding 10 percent.

“The economics of parallel exchange rates is clear: they are expensive, highly distortionary for all market participants, are associated with higher inflation, impede private sector development and foreign investment, and lead to lower growth.

“They benefit the group that has access to foreign exchange at the subsidised rate, paid for by everyone else (which may include the World Bank Group and its stakeholders). Hence, there is also a strong correlation, if not causation, between the existence of parallel rates and corruption,” Malpass said.

He said the IMF policies call for addressing exchange rate distortions, but progress has been limited in several countries with wide spreads, including Argentina, Ethiopia, and Nigeria.

In some countries, authorities have embarked on a unification process, but are reluctant to move quickly enough because vested interests will be giving up a subsidy. The gradual approach to FX unification often results in no unification despite repeated Fund arrangements.

Malpass said the parallel exchange rate markets can also significantly diminish the impact of World Bank projects. A primary problem is the lack of value-for-money when financing projects that have local currency expenses.

“When World Bank dollar-denominated loans are converted into local currency at the overvalued official rate, fewer local-currency resources are available than if the exchange had happened at the parallel market rate.

“This reduces the development impact of World Bank operations. For example, if the World Bank operation is financing cash transfers for the poor paid in local currency, this means fewer people will enjoy the benefit.

“A related problem is that the government incurs higher foreign-currency debt to achieve a given level of local-currency spending on the project, making future debt service payments more burdensome and increasing the risk of debt distress.

“On a larger scale, there is a risk that sizable World Bank financing that provides funding through the parallel market regime perpetuates it.

“We have taken a set of measures at the World Bank to discourage the subsidized rate, or at a minimum mitigate the impact of parallel exchange rates on our operations.

“This is to ensure that our financing benefits rather than harms people in developing countries. First, we do not provide budget support assistance to countries with sizable and persistent foreign exchange rate premiums, unless the distortion is addressed through a programme of exchange rate reforms in collaboration with the IMF,” Malpass.

He said for its own funding packages, the World Bank will try to ring-fence available resources and protect the value for money for its investment loans.

This can be done by requiring that loan resources be used only to finance “foreign expenditures,” and the government should finance any “cost of local expenditures” from its own resources.

Further, he said another way was to ask the government to provide counterpart financing to partly compensate for the exchange premium between the official and the parallel foreign exchange rate in countries where the cost of the policy is most apparent and distortive.

“We have committed to being clear and transparent in all our loan documentation (which is available online) on the issue of parallel rates in affected countries, where we highlight and quantify the scale of the distortion and the impact on the economy, and summarize the policy dialogue with the authorities on this issue,” he said.

During her tenure as World Bank Chief Economist, Carmen Reinhart initiated a pilot data-collection program on parallel exchange rates to help highlight the potentially distortive effects on country statistics from parallel markets.

The World Bank is endeavouring to account for the emergence of multiple markets in currency conversions in the World Development Indicators (WDI) economic series.

And although information is sometimes incomplete and measurement is challenging, this initiative represents a step toward enhancing transparency and strengthening the quality of data.-ebusinessweekly