Paradox of inflation from below in liquidity crisis

BondDr Tinashe Nyamunda
In this article, I argue that the main problem in the Zimbabwean economy is not necessarily monetary, but the country needs to revitalise its economic fundamentals.

Ever since the demonetisation of the Zimbabwe dollar and the short-lived stability of the foreign exchange denominated financial system, the country has gone through a liquidity crunch that prompted the Reserve Bank of Zimbabwe (RBZ) to introduce bond notes as an interim solution under an export incentive scheme. Many have cited many reasons for the liquidity crunch, including externalisation, hoarding of currency and outright sabotage.

Although this is not untrue to some extent, the major cause for me is the fact that Zimbabwe has been consuming more than it has been producing, particularly importing more than it has been exporting. Moreover, there has been sustained loss of foreign direct investment as many companies’ closed shop and left the country.

The country mainly exports minerals but mining has not been regulated enough to contribute significantly to the fiscus and earnings checked to ensure that they are locally retained to increase local financial capacity. Consequently, whatever foreign exchange that has been available for circulation in the market and the little that was realised through remittances has haemorrhaged out of the economy. Therefore, Currency is merely an indicator of profound economic misalignment.

That is not to say that the government has not attempted to resolve the issues. By way of Statutory Instrument (SI) 64 of 2016, the state attempted to deal with the symptoms of a larger problem.

It tried to limit the volume of imports in order to try and stimulate local industrial production into targeted commodities. But the advantages to be derived from such a move are limited for a number of reasons. Firstly, with a huge loss of foreign direct investment, the pace of recovery will be minimal given major capital constraints, especially as banks struggle under the current financial conditions. Secondly, even aspiring local industrialists would face similar capital constraints. And even if they could somehow build the necessary financial capacity, there is very little foreign currency to allow them to import capital goods and machinery to stimulate their activities.

Thirdly, given the toxic environment of corruption from the borders to the cities, smuggling networks will still thrive even as SI 64 is being enforced. Smuggled products will still remain cheaper in spite of the high costs of landing them to final trader, as the cost of production is made high by limited capacity in those industries that the state wants to stimulate.

So the above identifies some of the main problems facing the Zimbabwean economy.

These problems have been responsible for the gradual depletion of foreign exchange in the market, forcing the State to turn to bond notes. Whether or not the RBZ has adequate exchange controls in place or regulations sufficient is another issue, but its forex reserves are inadequate to sustain continuous local economic activity or fund imports. So the printing of bond notes is an inevitable response to this situation.

The hyperinflation that resulted in the demonetisation of the Zim $ in 2009 was stimulated from above as the state ran the printing press into overdrive. Numerous quasi-fiscal interventions by former Governor Dr Gideon Gono such as farm mechanisation, Baccosi among others, failed to resuscitate the ailing currency. With horrors of hyperinflation in Zimbabwe’s recent history still haunting people’s memories and influencing the caution of the RBZ in injecting bond notes on drip-feed; hyperinflation is unlikely to come from above at the same intensity as before. Instead, this time it is likely that inflation will creep in from below. And I will explain why.

Even though the bond notes were printed on par with the US $, the increasing scarcity of the foreign currency will inevitably raise demand for it from importers.

Recent information suggests that the banking system is currently endowed with at least 65 percent of currency denominated as bond, and 30 percent as US $. The implication of this bond to US $ equation is anyone’s guess. Less than three months after the introduction of the bond notes, foreign exchange has been rapidly mopped off market.

As Zimbabwe is largely dependent on imports, whether via legitimate routes or clandestinely, demand for foreign exchange is likely force up exchange rates.

But instead of too much money chasing too few goods as was the case in 2008, even if the drip-feed system of currency supply is maintained, inflation is likely to creep in. This will shift money mostly into the hands of importers, whether informal/irregular cross-border traders or big corporations as they seek to replenish supplies.

Ultimately, the poorer in society will face more severe liquidity problems, even of bond notes whose value will be compromised by exchange rate pressures, forcing the RBZ to loosen its control on how much is injected into the economy.

There is a silver lining however. The good rains have provided an opportunity for hopefully better harvests than previous years. Whatever the legacy of the government’s farm input scheme, there is some confidence that improved yields can help provide some relief. The government and its RBZ should take advantage of these conditions to plan better.

What this article identifies are just some of the major challenges facing the economy, and the shortcomings of current strategies to overcome them. They try to provide pointers to where the government should try and address issues. I argue that instead of putting too much emphasis on monetary/financial measures, the problem is more to do with reconfiguring the productive economy.

The RBZ only managed a deepening liquidity problem by injecting bond notes, but are there adequate exchange controls to manage the foreign exchange available. It must by now be clear that bond notes are serving their purpose more as a pseudo currency rather than an export incentive scheme, but with this reality, I leave you with the following concerns/question: what strategies are being worked out to insure that the inflation, which has started creeping in, is contained?

Already, US$100 is being exchanged for Bond 110 in certain areas, a depreciation of about 10 per cent in the value of the pseudo-currency.

Clearly, the monetary solutions have their limitations as they need to be accompanied by other initiatives from other sectors of the economy. My suggestion is that there is an urgent need to revisit the economic fundamentals of the country, otherwise any relief from good harvests or strategies to manage liquidity problem will be short-lived.


Dr Tinashe Nyamunda is a postdoctoral fellow at the International Studies Group, University of the Free State working on Zimbabwe’s financial history.

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