Fiscal stress driving parallel market rates amidst reserve money growth

Money supply management has once again come under scrutiny, with experts warning that the continued expansion of reserve money is exacerbating the depreciation of the local currency, particularly on the parallel market.

During the recently concluded Zimbabwe Economic Development Conference (ZEDCON) held in Victoria Falls, CZI economist Jimmy Psillos, highlighted the growing fiscal strain, attributing it as a primary cause of the country’s ongoing currency instability.

“Zimbabwe is under fiscal stress, resulting in money supply growth, driving parallel market rates. In March, reserve money was ZiG 4,9 billion, and by June, it had ballooned to ZiG 7,2 billion,” Psilos stated during the conference.

This sharp increase in reserve money, according to experts, has contributed significantly to inflationary pressures, pushing parallel market rates higher as businesses and individuals seek to hedge against the devaluation of the ZiG.

The parallel market, informally known as the black market, has consistently offered more attractive exchange rates for foreign currency, in contrast to the official interbank rates, which often lag behind market realities.

The increase in money supply comes at a time when the Government is grappling with a multitude of fiscal challenges, including ballooning public expenditure, dwindling revenue streams and a rising import bill.

The business sector is therefore accusing the Government of printing money, leading to an oversupply of the local currency, which is driving demand for foreign currencies on the parallel market.

Economist, Enoch Rukarwa, believes the exchange rate model locally is a function of numerous exogenous and endogenous factors spanning from real observable factors, behavioural factors and event circumstances.

“Partly our exchange rate challenges are a function of fiscal stress, whereby the Government funds its expenditure through a monetary policy solution. A typical case in point is when Government contractors are paid, the alternative market exchange rate scales up.

“A viable solution under the circumstances where the Government is pursuing a contractionary monetary policy, is to moderate and lower Government projects or to fund such through Private Public Partnerships (PPPs) and Built, Operate, Transfer (BOTs),” he said.

The tendency of Government payments to contractors driving parallel market rates higher, is a direct consequence of the Government injecting liquidity into the economy through deficit financing. This additional liquidity finds its way into the alternative market as contractors and businesses, seeking to preserve value, convert their payments into USD.

As a result, the demand for foreign currency spikes, further weakening the ZiG.

In order to mitigate these pressures, Rukarwa advocates for a more structured approach to public expenditure, particularly suggesting a shift towards PPPs and BOTs as alternative financing mechanisms.

These models would allow the Government to provide for a more sustainable path for financing key infrastructure projects without adding further strain to the local currency.

Economist, Dr Prosper Chitambara, echoed similar sentiments with both Psilos and Rukarwa, emphasising that Zimbabwe’s fiscal challenges are at the core of its economic troubles.

According to Dr Chitambara, the increase in reserve money is directly linked to the pressure on the exchange rate.

“It is not just reserve money that has been increasing; our import bill has also been increasing, which again puts pressure on the USD demand, and that demand has not been matched by available supply on the interbank,” Dr Chitambara explained.

Zimbabwe’s trade imbalance has become a significant contributor to the growing demand for foreign currency. As the country’s import bill continues to rise, the strain on the exchange rate has worsened.

Many businesses, unable to secure enough foreign currency through official channels, have turned to the parallel market, where they can often access the hard currency required to pay for imports, albeit at a much higher rate.

This growing gap between demand for foreign currency and available supply has worsened the situation, particularly as the import bill continues to rise.

Zimbabwe’s dependence on imported goods, especially essential commodities like fuel, raw materials for manufacturing and food products, has left the economy vulnerable to exchange rate volatility.

The inability to generate sufficient foreign currency through exports only deepens the crisis, as the inflow of USD into the country remains far below the required levels to meet the rising demand.

Dr Chitambara also highlighted the impact of rising domestic debt, which he believes is adding to Zimbabwe’s macroeconomic instability.

“Our domestic debt has been increasing and again that tends to have a destabilising effect on the macroeconomy and the exchange rate,” he said.

Zimbabwe’s domestic debt burden, driven by years of fiscal deficits, has left the Government in a precarious position.

The need to service both domestic and external debt has placed additional strain on public finances, limiting the Government’s ability to invest in productive sectors of the economy or stabilise the local currency.

As the debt burden grows, so too does the Government’s need for liquidity, which often leads to more borrowing or printing of money, both of which further fuel inflation and weaken the exchange rate.

Ultimately, Dr Chitambara concluded that Zimbabwe is in a precarious position.

“We are under fiscal stress, we are also in debt distress, and our trade position is under stress due to rising imports,” he noted.

This combination of fiscal stress, debt distress and trade imbalances has left Zimbabwe in a state of economic fragility. Policymakers are now faced with the daunting task of addressing these interconnected challenges.

Some have argued that tightening fiscal policy, reducing Government spending and encouraging export growth could help stabilise the situation. However, with limited fiscal space and a growing need for social spending, the Government’s options are constrained.

The Reserve Bank of Zimbabwe has tried to contain inflation through a contractionary monetary policy, raising interest rates to curb liquidity growth and stabilising the exchange rate.

However, without addressing the underlying fiscal issues, such as excessive Government spending and the rising import bill, these measures have had limited success in curbing parallel market rates.-ebsinessweekl