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This article participates on the following special index pages:
Sunrise of currency reform - Index of articles and reports on Zimbabwe's new currency reforms
Rebasing
dollar seen stoking inflation
Phoebe Goremusandu
August
04, 2006
http://www.theindependent.co.zw/viewinfo.cfm?linkid=12&id=5050
Reserve Bank
of Zimbabwe (RBZ) governor Gideon Gono’s monetary policy statement
issued this week rebased the Zimbabwe dollar, reviewed the exchange
rate and interest rates and introduced more pronouncements for the
real sectors of the economy.
Our view is that
the monetary policy measures introduced will need a long time before
real improvements are evident in the economy.
Slashing zeros
In addition
to bringing convenience to the transacting public, the experience
of other countries has been that rebasing the currency can have
the effect of fuelling more inflation, especially in the absence
of other initiatives to tame inflation.
A rebased currency
can create an illusion of lower prices hence a tendency to increase
prices even higher. This could see inflation increasing to levels
beyond current expectations.
Therefore it is
important that there be initiatives to address inflation at the
fundamental level. While there is a risk that some monetary values
may be lost especially for bearer cheques that had been exported
to other countries, the amount that will be forfeited in our view
will not significantly affect the amount of notes and coins in circulation.
The planned introduction
of a new currency under phase two is welcome but the macroeconomic
fundamentals in our view have to be corrected if the introduction
is to be a permanent solution.
The currency conversion
is expected to generate uncertainty in that the transacting public
has been given little time to adjust to the new system. It is also
not certain at what point a new currency will be introduced as the
market may also be caught unaware.
The strategy of
the governor seems to be to to ensure that notes and coins in circulation
are kept within the formal banking sector and we acknowledge that
this is the correct way to steer the economy.
Exchange rate
On the
exchange rate front, on this basis, we believe that the governor
moved the exchange rate in the correct direction, although this
is clearly not far enough. Importantly, however, we are looking
with keen interest at the announcement of the formation of the currency
board.
The experience
in other economies is that an independent currency board can be
an effective and key entity in determining a "clean fair value"
for the currency.
It is however
not sufficient for the central bank to adjust the currency at six-month
intervals as it makes it difficult to plan ahead, therefore the
sector needs a clear and transparent exchange rate adjustment system.
The scrapping
of the gold support price is also positive, as gold miners will
get the international gold price translated at the ruling exchange
rate. Apart from boosting earnings in the gold sector, this also
reduces the central bank’s support to the productive sectors through
quasi-fiscal activities.
The extension
of the foreign currency retention period for exporters is positive
as it makes it possible for exporters who may need to utilise their
foreign currency beyond the 30 days that had been set previously.
This mechanism
enables exporters to maintain the real value of their exports and
has the potential to stimulate output in the export sector. While
the tobacco sector is still accessing support from the central bank,
the move should be towards a situation whereby the market price
adequately compensates the farmer so that we move away support frameworks,
which result in money creation.
The reduction
in accommodation rates is expected to see lending rates softening
and this should benefit the productive sectors of the economy. While
this is favourable for borrowers deposit rates are expected to ease
and in real terms returns on the money market are likely to become
negative in real terms.
On the productive
side it is also important to complement the reduction in interest
rates with increased foreign currency inflows in order to boost
production. Monetary policy was loosened significantly with the
reduction in statutory reserves and while the banking sector has
been encouraged to direct loans to the productive sectors, in our
view, with lending rates expected to ease, domestic credit to the
private sector is expected to expand significantly with most of
the loans directed towards non-productive borrowing. All this will
result in money supply accelerating and this ultimately feeds into
inflation.
Overall
Overall,
the illusion of lower prices created by the currency rebasing together
with the soft lending rates expected to result from the lower accommodation
rates will add to inflationary pressures. At the same time, money
market investors and depositors to banking institutions are likely
to experience reduced investment returns.
In the absence
of enough stimulation of the supply side of the economy, we are
of the view that sustained improvements in output and the economy
are still a long way away. The foreign currency management framework
remains unclear thus making it difficult for long-term planning.
Money market investors will be the hardest hit as returns are expected
to be significantly negative.
* Phoebe
Goremusandu, is a senior markets analyst with Old Mutual Asset Managers,
Zimbabwe.
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