On Monday the country woke up to a tweet by the former finance minister Hon. Tendai Biti that the Central Bank is to introduce a new currency. Despondency is the word that can describe the feeling that tweet brought on the microblogging site. In all this is, one question asked by one reader that got my attention was “what really makes a currency strong or weak and who determines the exchange rate of a country’s currency?”
By Tapiwanashe W Mangwiro
In finance an exchange rate is the rate at which one currency is exchanged for another. It is also regarded as the value of one countrys currency in relation to another currency. For example the parallel market rates between the US dollar and the Bond Note of $1/3.65, which means that it costs one $3.65Bond Notes to acquire US$1.
Those figures are not just picked out of a hat and or a spinning wheel like a lottery winning ticket. Various factors come into play in order to come to such a figure, and ultimately the concept of Demand and Supply plays the greater role. The long awaited for Monetary Policy Statement is one of the factors that affects exchange rates of many currencies the world over simultaneously with the fiscal policy, although their impact on the exchange rate are indirect they are also important. An expansionary fiscal and monetary policy can cause a widening gap between fiscal revenue and expenditure deficit will devalue a currency due to inflation as a country might cover that gap by printing more money. In contrast tightening of the fiscal and monetary policies will reduce fiscal expenditures, stabilize the currency and increase the value of the domestic currency.
When a country has a large international balance of payments deficit or trade deficit, it means that its foreign exchange earnings are less than foreign expenditures and its demand for foreign exchange exceeds its supply, so its foreign exchange rate rises and its currency depreciates. In the case of Zimbabwe our deficit we have been in the red and deep in the red, current figures have us at a trade deficit of $2.5 billion with our trading partners.
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With such a trade deficit we have broken a trend of reducing the trade deficit. On another perspective let us not forget that we have had the biggest value of exports in the last decade of $4.4billion in export receipts, this is due to gold and tobacco sales records in a while now. Such a figure in receipts is big for our economy but the income is pressured by the need for companies to import food, medicine and fuel. This is a testament to the fact that our companies are producing close to zero as we import things like building materials, food and medicines we used to produce a decade ago. If we are to manage to reduce 30% of that import bill holding exports constant then I think we would have made a huge stride to a better economy and until then the introduction of a local currency would be of importance in order to further boost our exports, like the current finance minister Mthuli Ncube has always said “PRODUCTION, PRODUCTION, PRODUCTION is key to achieving greater growth”. With such a big import bill the currency might not last two months with the same value especially in a country with no import cover whatsoever in its reserves. We will be chasing too much foreign currency and hence flood the market with the new currency.
The major reason that brought us in this situation seems to have found a way to come back in the picture, and might need to be handled well and swiftly. The general population might blame the 2% tax for the increase on the rise in inflation but it has many dynamics that come into play.
Coincidence might be the word I can use to describe what happened in October 2018, the inflation rate was on a steady rise since June 2018 due to the realization by the public that new bond notes had been released on the market and also the value of the RTGS transactions powered by the treasury bills issued by the previous administration became a public secret. The rumor of a floated exchange rate between the Bond note and the USD also came into play as businesses and large RTGS value holders stormed the parallel market and caused mayhem that resulted in the sharp rise of prices in the month of October and a sharp rise in inflation.
With a persistent rise in inflation comes a reduced purchasing power of the money, the paper currency starts to depreciate internally before it starts to depreciate externally against foreign currency. Such a phenomenon has been in our sights for the past four months as we saw our bond value depreciate not only on the parallel market but also in the number of items we could afford to buy. For example $10 bond was able to buy 2 Mazoe Orange Crush but four months down the line it can now only buy one item. In essence the currencies of countries with high inflation will depreciate against those with low inflation.
Interest rates are also a tool used to strengthen a currency and a luxury that Zimbabwe cannot afford. With such a high debt figure of $18 Billion both domestic and foreign debt in which we are failing to pay, interest rates can be as high as we want but will not work. They are the cost and profit of borrowing capital and when a country raises its interest rates higher than that of foreign countries, it will cause capital inflow and thus increasing demand for domestic currency and allowing it to appreciate in value against foreign currency.
In conclusion all the fundamental indicators are pointing against a stable currency to come in the immediate future. If anything is to come this year I would expect it in the fourth quarter after at least some debt repayment and containing inflation as well as reducing “twin deficits” of the BOP. My gut tells me it is just a rumor arising from the delay in announcing the Monetary Policy Statement by the Reserve Bank Governor because as it stands we clearly are not ready for a new currency.
Tapiwanashe W Mangwiro is a researcher and an economist writing in his own capacity, for feedback you can contact him on email@example.com