January 2008

A NEED TO DEAL WITH CAUSES OF INFLATION

Inflation in Zimbabwe has been declared “enemy number one” as the scourge continues to rampage the collapsing economy. The Central Statistical Office put the year-on-year figure for November 2007 at 26,470.8% but independent economic analysts and financial institutions — including the International Monetary Fund — estimated the figure at over 100,000%.

“At an annual rate of 26, 470.8 percent, in November, 2007, inflation continues to be arguably the most devastating macroeconomic imbalance in the country, as its adverse effects are cutting across all sectors,” the governor of the Reserve Bank of Zimbabwe, Gideon Gono said.

Inflation was pegged at 7,982.1% in September. The government withheld inflation figures for October, in a move observers interpreted as meant to shield the Harare administration from embarrassment for its failure to stem runaway inflation, which has come to symbolise the country’s unprecedented economic meltdown.

There is urgency for a political solution in order to revamp Zimbabwe’s collapsing socio-economic sectors. As the governor of the central bank noted, “The economy is estimated to have declined by about 6 percent in 2007. This contraction in economic activity has been mirrored in output decline in all sectors of the economy with the exception of a marginal increase in agricultural output.”

Gono then went on to hike interest rates to 1,200% from 975% saying rising inflation meant the central bank would have to constantly realign interest rates in order to “discourage speculative borrowing and inflationary credit expansion”.

The concept is a sound one, and is often effective; however, the other economic repercussions are devastating. A very great number of Zimbabwean businesses were under-capitalised and subsisted only through reliance upon borrowings, and there were very few which could remain viable when debt servicing was at as high as 1,200%. The high costs of borrowings motivate delayed settlement of foreign debt and accelerated collection of export proceeds, whilst discouraging currency speculation and forward cover of liabilities.

Most of Zimbabwe’s industries have since the beginning of farm seizures in 2000 either scaled down operations to about 30% of capacity or shut down altogether, in a country where unemployment is more than 85%.

Essential medicines, spare parts, fuel, electricity, forex and just about every basic survival commodity — and now cash is also in short supply in Zimbabwe.

Unfortunately, because the ZANU (PF) regime controls the central bank, there is no sign the problem will be solved soon. As of September 2, 2007, government’s domestic debt was Z$8.1 trillion, an indication that the state has increased its reliance on borrowings to fund operations. The government will supplement the income from borrowings by printing money. The domestic debt surged to Z$21 trillion on November 21, from Z$7.9 trillion on October 21 — increasing by 165.8% inside one month.

The unprecedented rise in government debt levels which over the years was sparked by huge interest payments this time ballooned due to the central bank’s advances to the government. RBZ advances to the government accounted for 88% of total debt or a hefty Z$18.7 trillion. Interest payments have for years remained over 70% of the total debt, a situation bank economists said was evident that the government was broke and had no other source of income other than the domestic market.

As from January 18, the Reserve Bank of Zimbabwe introduced a Z$10 million bearer cheque, the largest in the world, to be complemented by denominations of Z$5 million and Z$1 million. The new notes came two weeks after RBZ Governor, Gideon Gono, introduced three other higher denominated bearer cheques (Z$250,000, Z$500,000 and Z$750,000) under Operation Sunrise Two, in a bid to pacify a public reeling from a shortage of cash that has spanned over four months.

Economists are saying the higher denominations will fuel inflation to new heights. They also doubt cash shortages will stop because a lot of people are now in the informal sector and would be sceptical to deposit their hard earned cash because of previous experiences where they ended up failing to withdraw their monies from the banks.

Gideon Gono (actually Mugabe) should understand that this is a sure form of fuelling inflation and giving in to it is an admission of defeat to the inflation monster. Economic analysts likened the introduction of the higher denominations to “an attempt to apply lipstick to a frog”.

Bearer cheques are not money but promissory notes first introduced by RBZ at the height of cash shortages in 2003. They function the same as actual money. The government’s only response to the crisis has been to print more money — a futile exercise that only adds to the hyperinflation.

In June 2006, the regime decided to knock off three zeroes form the currency. Economic analysts have always maintained that the banknote crisis could only be resolved through sound economic policies, not piecemeal measures such as deleting three zeroes and printing more notes. These measures will always fall short of resolving the issue.

By midday on January 18 when the higher denominations were introduced, a survey showed that most retail shops and supermarkets had started adjusting prices upwards to match the higher denominations. For example, a 2kg packet of rice which was marked Z$3.5 million was raised to Z$5 million. Commuter omnibuses also started increasing fares on the same day with short distances going for up to Z$2 million whilst residents of Chitungwiza and Norton were being asked to pay up to Z$4 million. It was also established that foreign currency trading rates rose immediately after the new denominations had flooded the booming black market.

Just as Gono tried to assert control over the circulation of money, which he claims is being subverted by speculators in high places — the so-called “cash barons” — allegations emerged that his own institution had been complicit in shady foreign currency trading. The governor was fuelling inflation by printing money at will and failing to keep track of it properly. For example, one of the reasons that Gono gave for withdrawing the Z$200,000 notes was that, out of Z$67 trillion released onto the market, only Z$2 trillion could be accounted for in the banking system. The country at that time had Z$170 trillion in circulation and expected that total money in circulation would rise to Z$800 trillion by the 19th of January in an attempt to keep pace with surging inflation.

Agreed facts put before Magistrate Mishrod Guvamombe, in an economic crimes court, exposed how trillions of dollars secretly released by the RBZ ended up at the Roadport in Harare, where the black market barons’ “runners” operate. It was revealed that the Reserve Bank of Zimbabwe contracted a commodity broking company known as Flatwater Investments Private Limited to procure tractors from Michigan Tractors in South Africa for the government’s Agricultural Mechanisation Programme. There was virtually no documentation in a transaction involving the release of Z$2,120,650,000,000 in October 2007 from the RBZ to Joseph Manjoro who sourced the needed currency from individuals. Manjoro transferred some of the money to companies linked to fugitive ZANU (PF) MP David Butau.

Prosecutor Mr Tawanda Zvekare blamed the RBZ for fuelling illegal foreign currency dealings after they “blindly splashed” cash to the firm without verifying its claims of having US$9 million in an offshore account to sustain the purchase of the tractors.

“As far as this accused person is concerned, there are no special circumstances. What is feared is that, for reasons best known to the RBZ, they literally splashed cash to Flatwater without verifying if they were very good business partners. A mere letter by Flatwater to the RBZ confirmed the alleged US$9 million held in an offshore account, which has turned out to be false. Flawater had no foreign currency at all, but got the trillions from the central bank.

“The firm contracted Manjoro to source foreign currency on the black market on their behalf, who also subcontracted several runners like (fugitive MP David) Butau to assist him. The rest of the money given to Manjoro is not accounted for and the rest of the money he gave to his friends is also not accounted for. What we have now is a grand theft involving the RBZ itself.

“I find it incredulous that a whole central bank of a country would release trillions to a company on the strength of a mere letter, which was not verified. This marks of a conspiracy between the central bank and the company to steal all this money,” said Mr Zvekare.

The official government exchange rate is Z$30,000 to US$1. That same US dollar buys between Z$2.5 million and Z$4.5 million on the black market. Zimbabwean banks suffer from a chronic shortage of cash because most of the money is circulating in the black market. Illegal money changing has become a full-time job for many. While foreign currency might be hard to come by for persons buying at the government rate, it is available to those in powerful positions, who are then able to get far more for Zimbabwe dollars than they might otherwise.

Printing higher denomination bearer checks did not end long queues at banks, and Gono now accused banks of failing to collect bank notes from the central bank as they had tied up depositor funds in speculative illiquid assets.

“Notwithstanding the high levels of cash stocks sitting at the Reserve Bank ready for dispatch into the market, some banking institutions have been engaging in imprudent and unethical practices which are creating artificial queues for cash,” the governor said.

The state-owned Herald newspaper on 23 January reported that Gono and Finance Minister Samuel Mumbengegwi met bank executives to order them to resolve the crisis by the following week or face closure.

“Mumbengegwi said the central bank would not hesitate to close those banks that did not want to continue operating in the industry,” The Herald said. The finance minister also said the “unending queues had now assumed a political complexion as some mischievous individuals were now using the queues to advance their hidden political agendas,” the newspaper added.

It should be pointed out that another factor causing cash shortages may be the RBZ’s “statutory reserve ratio” which requires banks to deposit 50% of all money received, back to the central bank. This leaves Zimbabwe’s banks without enough cash. In other countries the ratio is only 12 — 15%.

In its weekly commentary Kingdom Stockbrokers (KSB) said while the introduction of higher denominated bearer cheques was welcome, the measures were by no means the panacea to the country’s problems. KSB said a long–term solution to the cash crisis is the stabilisation of the economy through reducing inflation and the re-establishment of positive real interest rates. Given that the amount of money held for transactions and precautionary purposes depends, among others, on the movements in prices, KSB said the current hyperinflation environment would soon render the new and higher denominations inadequate.

“The hyperinflationary environment coupled with low nominal investment rates has caused serious negative real investment rates…. These negative returns on investment have significantly reduced banking habit as the resultant reduction in the opportunity cost of holding cash has given rise to significant speculative activities, which have worsened the inflation situation through an increase in asset price inflation. Such financial disintermediation weakens monetary policy effectiveness as its transmission mechanism works through banks,” KSB said.

Rapid monetary expansion, declining investment and production levels, apparent indexation of prices to volatile parallel market exchange rates and adverse expectations have also contributed to the problem. In addition, the growth in the informal sector has meant that more currency now circulates outside the formal banking system. Given that most participants in the informal sector are either without bank accounts or they shun transacting via formal channels, cash in this sector is rarely deposited with banks.

Severe foreign exchange shortages in the economy have created a thriving parallel foreign currency market which has contributed to the worsening of the currency crisis. The economy is also experiencing a high degree of currency substitution as people now prefer holding foreign currencies in order to store value and hedge against inflation. The prevailing high inflation rate and policy uncertainties have resulted in a large proportion of transactions being conducted in foreign currencies.

Since the parallel foreign currency market is contributing to the continued circulation of cash outside the formal system, addressing foreign exchange shortages through a viable exchange rate regime is a necessary step in solving the cash crisis. It is prudent to allow free foreign currency transactions in the mainstream banking sector in order to limit the volume of currency circulating on the parallel market. Restoration of sanity in the foreign exchange market will eliminate arbitrage opportunities. To be effective, there should be a ditching of the country’s dual-currency system and readily acquire essential balance of payments support from the international community.

Moreover the shortage of basic commodities on the local markets has increased the demand for foreign exchange to purchase these in neighbouring countries like South Africa, Mozambique and Botswana. All these factors contribute to the continued circulation of currency on informal markets.

RBZ chief, Gideon Gono — who insisted the bank was “in full control of the currency situation in the country” — blames currency shortages on “cash barons” he says have siphoned off huge amounts of cash from banks to the lucrative black market to fund fuel deals and foreign currency trade. But analysts have dismissed this, finding fault with the government’s economic policies, which have created a fertile ground for corrupt and illegal business practices by a minority while the majority suffers.

Thus, it came as no surprise when media reports revealed that President Robert Mugabe had blocked the Parliamentary Committee on Finance and Economic Development from questioning Reserve Bank of Zimbabwe governor about the country’s serious cash shortages. Gono had offered to name individuals who were hoarding money and engaging in illegal activities on the black market, including senior government and ruling party officials that he called “cash barons”. But according to reports, Mugabe told the committee to wait until after the March 2008 elections to conduct the hearing.

It is believed the move was meant to prevent an embarrassing situation for the ruling party, ahead of the elections scheduled for March 29. Thus, it was always suspect that the Governor’s attempt to seek parliamentary cover to name and shame “cash barons” was not about banking regulations but smacked of a well-calculated political stunt. Subsequently, the much-anticipated hearing did not take place. As a consequence, the credibility of the RBZ, as the chief financial regulator, suffered a heavy knock because it could not exercise its statutory powers to follow laid down procedures that meet the requirements of Due Process.

The central bank should always adhere to principles of natural justice, and not adventure into a process that was bound to be interpreted as politically motivated, permitting in the process, suspected individuals to escape the net alleging political persecution.

It seems obvious to even the most obtuse elements in ZANU (PF) that Gono does not have a clue how to solve the country’s myriad problems caused by corruption in high places and mismanagement of the economy. He tried knocking off three zeroes from the currency in June 2006 but then a year later the zeroes had come back to haunt the Reserve Bank of Zimbabwe. He has now proceeded to print bearer cheques with higher denominations but again this cannot solve the country’s myriad problems nor chart a path to recovery and prosperity.

Gono and the Mugabe regime are constantly manufacturing new enemies to blame for things like the cash shortages and high inflation devastating the country. The cash crisis has seen people losing faith within the troubled country’s banking sector as they prefer keeping cash and not returning it back into the official system. Shop owners have resorted to buying foreign currency on the black market rather that deposit it.

Unofficial estimates say inflation is 150,000%. At that rate it is impossible to print enough money to keep up. It is now urgent that the broader political crisis is resolved, before the economy can even begin to stabilise.

Today, even those trying to give the dead decent burials have been affected. Funeral homes are stuck with dead bodies for days because relatives have to battle to withdraw cash from banks to transport corpses and meet burial costs.