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Comments on RBZ-s First Quarter 2008 monetary policy report
John Robertson
May 03, 2008

While the Reserve Bank Governor-s description of the difficulties affecting Zimbabwe-s economy is comprehensive and colorful, his sources of evidence and his concentration on trivia permit much of his discussion to expound on themes that lie a considerable distance away from the original causes of the problems.

Such as they are, the policy changes announced have been designed almost entirely to deal with the symptoms of the problems and, far from addressing the actual problems, he barely even mentions them. He uses lengthy accounts of the world food crisis to expound on the way governments of other countries are intervening in their markets and claims from these that the Zimbabwean authorities- various interventions are therefore appropriate.
Assistance to financial institutions from the central banks of many countries affected by the sub-prime mortgage-linked liquidity crisis is also extensively referred to in an effort to justify Reserve Bank of Zimbabwe-s quasi-fiscal expenditures. A critical IMF report pointing out that these expenditures were generating Zimbabwe-s rising inflation rate is attacked on these grounds, but with each of these attempts, the Governor carefully avoids any mention of the very distinct differences in scale or degree between these examples and the meld-down taking place in Zimbabwe.

Food shortages in large areas of the world resulted from severe weather problems and dramatic increases in demand for grain that could be processed into bio-diesel. Zimbabwe-s food shortages have resulted from the forced displacement of skilled, large-scale farmers who fed the nation, and their replacement by less skilled small-scale farmers who have had difficulty feeding themselves.

After an excellent growing season, Zimbabwe should be harvesting crop surpluses for export and benefiting from the much higher world prices, but this year the country-s food import needs will be higher than at any time in its history. In the Governor-s only references to this source of difficulties, the land reform programme, he describes it as visionary, audacious and irreversible.

To the extent that failures of any description have to be admitted, the Governor-s repeated claim is that these are all due to sanctions. Despite the fact that the sanctions that do exist apply only to targeted individuals and affect their ability to obtain visas to visit, or to operate bank accounts in certain countries, sanctions are blamed for Zimbabwe-s inability to borrow from abroad or attract capital inflows.

Sanctions are also blamed for the loss of balance of payments support, the difficulties in "bridging internal shortfalls", the populations- access to food, medicines, public transport and "many other basic necessities" that between them have frustrated government-s efforts to turn the economy around. In urging that sanctions be condemned, the Governor exhorts the international community to lift them and suggests that their root causes be addressed in a comprehensive fashion. But these are the very the root causes that he himself does not address.
Efforts to link causes to effects that do no exist must prove futile, but if open and honest debate exposed the fact that the country-s failure to meet the repayment terms agreed on previous loans had disqualified Zimbabwe from being considered a good credit risk, the efforts might lead to useful results. Zimbabwe-s inability to meet debt repayment commitments could then be linked to the fact that the country-s foreign earnings fell steeply after the Land Reform Programme caused sharp declines in agricultural exports.

Less directly, it could also be linked to falls in foreign exchange revenues from other sectors such as manufacturing and tourism, but equally seriously it caused falls in food production that have forced Zimbabwe to import food every year since this "visionary" process began. Having to pay in foreign exchange for most of this food directly eroded Zimbabwe-s ability to pay its debts. This should have prompted policy changes, but repeated declarations that the policy is "irreversible" have done nothing to assure possible lenders that the country-s debt service performance might one day improve.

Whatever definition is given to the word "sanctions", the fact that has to be acknowledged it that they have nothing to do with the poor performance of Zimbabwe-s agricultural sector. This stems from a much more basic policy choice, the very one upon which government is trying to prohibit debate.

This policy choice not only forced the closure of almost all companies that made up Zimbabwe-s largest business sector, thereby closing down the country-s largest employers, largest commercial and industrial suppliers, largest foreign exchange earners and largest direct and indirect sources of tax revenues, it also broke down the economic system that previously supported all of these separate activities.

By declaring agricultural land to be the property of the state, government erased the land-s collateral value and immediately had to accept the need to provide all the funding required all the way through the production chain.
In a supplement to his latest presentation, entitled Role of Central Bank Interventions Under Extraordinary Circumstances, the Governor demonstrates in a graph the collapse of commercial bank lending to agriculture after Land Reform. However, in reporting on the Agricultural Sector Productivity Enhancement Facility (ASPEF) being needed to make up for the banks- unwillingness to lend, the Governor makes no mention of the destruction of the land-s collateral value, the event that very effectively broke the link between the banks and the farms. He also fails to mention that without very cheap loans, most of the new farmers would not even try to produce a crop.

After coming to the decision that Reserve Bank intervention is the best possible way to restore flows of funds to productive sectors, the authorities persuaded themselves that the argument could be comfortably applied to all sectors in which government wished to see improving levels of success.

Before ASPEF loans were offered, farmers and others were able to borrow from a Productive Sector Finance Facility (PSF) that was funded by stepping up the Statutory Reserve Ratio imposed on the banks. This reserve ratio had to be further increased to accommodate ASPEF financing and the loans were at such low rates of interest that they were effectively paid off by the rapidly rising inflation rate.

Further loans were extended to parastatals and city councils and then the new farmers, whose regular demands for handouts of seed, fertiliser and fuel had been generously met, were offered even more support in the form of heavily subsidised or free agricultural machinery.

From these beginnings, the conviction that state intervention could solve all problems began to spawn yet more state funding schemes and despite their highly inflationary effects, they soon dominated every facet of government thinking.

State-managed farms were created and funded under Operation Maguta and commercial activity in the smaller settlements was supported by funds from a Rural Business Facility. When price controls were imposed at levels below production costs, a low interest rate Basic Commodities Supply-Side Intervention Facility (BACOSSI) was offered to producers and traders to permit them to continue operating at a loss - without going bankrupt.

Hidden from view and carefully excluded from any government explanation of the process was the fact that it was consuming the bulk of the corporate reserves and the bank deposits of every company and individual and was absorbing the formal savings held by pension funds and insurance companies on behalf of current and future pensioners and policy-holders.

Previously, these were the funds that could be used on a revolving basis to fund public sector as well as private sector investment plans and they were also the savings from which the recurring central government and local government budget deficits were funded. However, by imposing deeply negative real rates of interest on all lenders, government caused the rapid dissipation of the nation-s savings.

As a result of not being able to raise enough tax revenue from Zimbabwe-s crippled economy to fund its ballooning expenditures, but not being able to borrow the money needed to close the gap, government is now being forced to figuratively "print" the money that used to be generated by taxes on value-adding economic activity.

One of the few monetary statistics disclosed in the Monetary Policy Statement is that government-s domestic debt reached $6 480 trillion on April 17 2008. As this table shows, the debt stood at $60,8 trillion on February 1 2008, so it can be seen that the total has risen more than 100-fold during the eleven-week period shown.

This surge of money to fund unsupportable public sector expenditures, salary increases, parastatal losses, unproductive subsidies and the ruling party-s electioneering expenses is already causing a further acceleration in the inflation rate. This is certain to gather momentum as it translates into buying power that will increasingly overwhelm the quantities of goods for sale. A mention of this in the Monetary Policy statement would have been helpful.

As economics involves the study of human reactions to problems, the basic question on how people might try to lock in the value of newly acquired bricks of Zimbabwe dollars, whether earned or borrowed, needs to be repeatedly asked. For now, converting them into foreign exchange is one option and buying shares is another.

Both depend upon certain market distortions remaining in place, one of which is low interest rates. With the Reserve Bank having reaffirmed its belief in maintaining these, the quick returns that seem set to remain on offer are making longer-term investment in productive capacity a non-starter. That, in turn, will sustain that part of the rising inflation rate that is caused by the scarcity of consumer goods.

The Reserve Bank-s hopes that a degree of exchange rate stability will be generated by drawing all foreign exchange transactions into a formal foreign currency market appears set to falter on that one issue - scarcity.

Proposals to overcome the scarcity by "incentivising" exporters cannot possibly work quickly enough and may not work at all while Zimbabwe supports legislation that can dispossess business owners of controlling interests in their companies. Inflows of loan capital would help to overcome the foreign exchange scarcity much more quickly, but Zimbabwe has no prospect of receiving any international financial support while the conduct of its authorities continues to generate opprobrium from all countries other than those that have no money to lend.

The extreme shallowness of the Governor-s claim that inflows can be stepped up sufficiently by offering incentives to exporters beggars belief. Most companies cannot draw foreign exchange from their own Foreign Currency Accounts to meet the immediate challenge of staying in business, but very nearly every company would first require investment capital inflows to restore lost capacity, to reach the quality requirements and to win back customers. Inflows of foreign capital items will be needed for some time before the country can hope to achieve larger inflows of foreign earnings.

The Governor-s sequenced recovery plan leap-frogs all of these issues and goes directly from the announced incentives to the rewards for compliance. Lower percentage off-takes from exporters- receipts will come with rising export volume growth rates, and by promoting accountability and discipline as well as production, better relationships with trading partners will result and will overcome price distortions.

Carefully joining these dots, the Governor arrives at the conclusion that this is going to overcome the inflation problem. This, he hopes will encourage a return to the Social Contract. The Social Contract, it will be recalled, suffered a miscarriage as a result of the June 2007 blitz on prices.

Before making some critical comments on the imposition of price controls, the Governor describes the Social Contract as the "only viable solution to getting our economy back on its rails" and claims that if its requirements had been met, Zimbabwe would by now be recording single-digit inflation.

New measures
The package of measures, that comes into immediate effect incorporates a new pricing and allocative framework that the Reserve Bank claims will guarantee the viability of all foreign exchange-earning companies, while also ensuring availability and affordability of funds for importers, particularly those that do not have export revenues of their own.

To ensure the success of the plan, the Reserve Bank has introduced what it calls a willing-buyer, willing-seller priority-focused twinning arrangement. "Under this framework, authorized dealers will match sellers and buyers of foreign exchange, guided by a predetermined priority list as set from time to time by the Reserve Bank, in consultation with stakeholders across the country-s sectors."

In practice, this will require authorised dealers to submit fortnightly reports to the Reserve Bank, detailing the willing buyer-willing seller transactions they handled over the preceding two weeks in the hope that they will receive certification of compliance with the priority specifications.

Authorised dealers who fail to comply will face severe penalties that might include the suspension of their licences to trade foreign exchange.

If the interaction between willing buyers and willing sellers is allowed to result in a single US dollar exchange rate that will apply to all transactions, the changes announced will amount to a significant achievement - the full restoration of a single exchange rate against the US dollar.

Whether this will be allowed to become the important breakthrough that, among other things, brings an end to the parallel market, will depend upon whether government interference in the transactions is also brought to an end. Unfortunately, the requirement that foreign currency dealers have to work to a priority list while trying to match foreign exchange sellers and buyers under the threat of severe penalties for any mismatch somewhat clouds the issue.

The probability looms large that buyers whose activities do not feature on the priorities list will make known their demands as well as their eagerness to pay a premium, and that the parallel market will therefore surface again. Government-s demand that funds held in FCAs must be relinquished after 21 days is already a potentially disruptive requirement.

If government intervenes in other ways, such as to deny the sellers their right to withdraw their funds if they are not satisfied with the rate, or if it sets limits as to quantity and price as well as who is allowed to buy, the arrangements will no longer display the attributes of a genuine market and the more functional parallel market will take over once again.

An earlier attempt to achieve the same objective was made in 2004, but when demand for foreign exchange settled at four to six times the supply and the rates did not move, the evidence soon proved that a functional market was not being allowed to develop. Officials were clearly setting the exchange rate and it was soon obvious that the claimed prioritised disbursement process - in the guise of a currency auction - had become no better than a managed lottery. Sellers and buyers became deeply dissatisfied with the system and the arrangement was virtually abandoned when the parallel market again proved to be the more reliable marketplace.

Whether this new policy will develop into a repeat performance of the events in 2004 has yet to be seen, but we might do well to recall the Reserve Bank-s main complaint at the time: the expected massive supply-response from exporters after the sharp devaluation and the exchange control changes never happened. So, they said, it was all the fault of the business sector.

It bears repeating that while this Monetary Policy Statement once again accurately records the long list of Zimbabwe-s handicaps, it again studiously avoids correctly identifying the policies that caused the problems in the first place. This approach permits it to exclude discussion on the measures that would be needed to restore investor confidence - and that elusive supply-side response.

As a Monetary Policy Statement, it is remarkably short of information about the monetary situation. The Governor did not talk about money supply growth, the size of the government-s overdraft or how it found buyers for Treasury Bills when the bulk of the country-s savings have been siphoned away.

Neither did the governor admit that the banks might experience some difficulty paying "real interest rates" to depositors, mentioned in his speech, while the Reserve Bank continues demanding that 50% of deposits should be lodged with the Reserve Bank for nothing.

Such as they were, the monetary policy changes announced might prove close to irrelevant because of one major failing that is still affecting the entire economy - the loss of production from each and every sector. The Governor-s frequent references to incentives to spur producers to export more will fall a long way short of making it happen. It is the disincentives that need attention.

Producers need not only to have their FCA money restored to them, they also need confidence, which is presently being undermined by political uncertainty and the threat overhanging all company owners that control over their enterprises might soon be lost to boards of directors appointed by the yet to be identified new owners of 51% of their shares.

Setting percentage limits for priority groups and threatening banks with penalties for overstepping boundaries will do no more than revive memories of similar ideas that didn-t work before. Unattractive exchange rates will do nothing to restore the depleted foreign earnings and if grossly overvalued exchange rates are kept in place for privileged officials, these will continue to undermine efforts to eradicate corruption.

Production increases will also depend upon access to capital, much of it in foreign exchange, and the inflows of these sums will also depend upon confidence, this time among potential investors and lenders. They too have yet to be persuaded that acceptable policies are on the way, and this Monetary Policy Statement will do nothing to persuade them that the authorities in Zimbabwe have any intention of changing direction.

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