Political Risk Alert (22 March 2019)
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Political Risk Alert (22 March 2019) Zimbabwe: New currency will struggle to gain acceptance Event: Reserve Bank of Zimbabwe (RBZ) Governor John Mangudya denied on March 7 that the bank had “fixed” the exchange rate of its new de facto local currency. Significance: The authorities' latest attempt to stabilise the parallel foreign exchange market is the real-time gross settlement (RTGS) dollar, which will trade on a new interbank foreign exchange market on a ‘willing-buyer, willing seller’ basis. In February, Mangudya effectively acknowledged Zimbabwean bond notes and electronic RTGS bank balances as part of a new currency scheme, although recent public protests are likely to have delayed the introduction of a brand-new national currency for now. The government will struggle to improve its international reputation despite a heightened public relations drive. Analysis: Zimbabwe scrapped its own currency in 2009 and has since operated a multi-currency basket. Quasi-official bond notes ('bollars'), first introduced in 2016, and RTGS bank balances have been officially considered 1:1 with the US dollar. Annualised inflation officially spiked to 56.9% in January and the authorities hope that the formalisation of the parallel market will lead to a stronger exchange rate and lower prices. However, opposition leaders have condemned the move as premature, raising concern over a lack of capital reserves as well as a lack of market trust. Following the announcement of a 2% money transfer tax by Finance Minister Mthuli Ncube in October 2018, the parallel market rate for RTGS against the US dollar depreciated rapidly, hitting an all-time low of 5:1. The rate eventually stabilised at around 3.5 to the dollar. Consumers have been heavily affected by the depreciation amid the spiralling inflation. The government has sought to limit the impact by lifting its ban on the import of basic commodities, and by maintaining the official price of fuel at its pre-October value. At the official 1:1 peg between the local bond notes and the US dollar, Zimbabwe's fuel price was regionally competitive. However, for most of 2018, the retail price of fuel was discounted by almost 25% in real terms relative to regional pricing. By November, the real price of fuel in Zimbabwe had dropped to less than a quarter of the South African fuel price. Prior to October, Zimbabwe had already been grappling with periodic fuel shortages. While the shortages were generally attributed to a lack of foreign currency, official statistics show that fuel imports had been steadily increasing for months and it seems clear that the fuel shortages were being driven by demand. However, there was no evidence that the rising demand for fuel was prompted by an improving economy. It seems more likely that fuel was being used as a store of value, as was done during the hyperinflation era of the mid-2000s. With the government keeping the fuel price artificially low by regional standards in order to limit the impact of October's soaring parallel market premiums, the fuel market was one of the few places where ordinary Zimbabweans could spend their RTGS bank balances and effectively receive full 1:1 value for their money in return. Because of its strategic importance, fuel was at the top of the priority list in the RBZ foreign currency allocation process. The RBZ received its foreign currency from exporters. It would take their foreign earnings and transfer RTGS money into the exporters' bank accounts at the official 1:1 rate, then redirect the foreign currency toward priority imports. By passing this saving on to fuel consumers through the low fuel price, the RBZ created an arbitrage opportunity that was exploited. Fuel was diverted from commercial petrol stations and then re-sold on the black market. By January, black market fuel prices were reportedly as high as 6 RTGS per litre. The cycle had an inbuilt feedback loop: by diverting the fuel, black market traders were creating the shortages in the formal market that forced motorists to buy fuel from them. When the government intervened by raising fuel prices in mid-January, which should theoretically have returned the market demand to a more sustainable level, it is unlikely that it expected the scale of the mass demonstrations not only in the main cities of Harare and Bulawayo, but also in smaller towns and villages nationwide. Against a backdrop of high inflation driven by the depreciating parallel market exchange rate, widespread shortages and a collapsing healthcare system, calls for a national shutdown or 'stay away' quickly spread. In response, the authorities soon implemented a full internet blackout and a heavy crackdown followed. A dozen civilians were reportedly killed and hundreds were injured, and almost a thousand civil society and opposition activists detained. By the time the High Court overturned the internet ban on January 21, the stayaway had ended and the fuel shortages had eased. But in response to the crackdown, the United Kingdom withdrew its support for Zimbabwe rejoining the Commonwealth, while the EU voted to extend sanctions against the country. On February 20, the RBZ’s Monetary Policy Statement that had been due in January was finally delivered. It abandoned the US dollar currency peg and the RTGS dollar was included in the multi-currency basket. Access to foreign currency on the interbank market is now being restricted to authorised payments to foreign suppliers. This means that the parallel market continues to operate, demanding higher premiums for less restricted access to foreign currency. In the first few weeks of trading, the RTGS dollar has traded at 2.5 to the US dollar at the interbank rate. The parallel market rate has strengthened back to around 3.5 to the dollar, having weakened during the January protests. If the official exchange market begins to function more effectively, the gap between the official rate and the parallel rate should narrow further. This would be a major achievement for Ncube's reform programme, if only because official government debt will be substantially discounted in real terms. However, if the rate disparity does not narrow, there is a concern that entrenched interests will not resist using their political position to exploit the rate differential. The latest reform was perhaps the only practical response to the worsening economic crisis, but it may be derailed by the same political processes and entrenched interests that caused the crisis the first place. Looking ahead: The banking sector has been slow to implement the new interbank foreign exchange market, and the official RTGS-US dollar exchange rate has remained within a very tight band in its first weeks of trading. If the official market becomes more liquid, it is possible that the RTGS dollar will achieve a widespread, albeit begrudging, acceptance. However, if the market rate continues to be manipulated, exporters will suffer as they have before and the economy will continue to re-dollarise. Willis Towers Watson (NASDAQ: WLTW ) is a leading global advisory, broking and solutions company that helps clients around the world turn risk into a path for growth. With roots dating to 1828, Willis Towers Watson has over 45,000 employees serving more than 140 countries and markets. We design and deliver solutions that manage risk, optimize benefits, cultivate talent, and expand the power of capital to protect and strengthen institutions and individuals. 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