On May 7, President Emmerson Mnangagwa announced a cocktail of measures which he said were aimed at stabilizing the rapidly depreciating local currency. The measures included an indefinite suspension of lending by banks. One of the local banks, BenchABCsent the following analysis of the president’s speech to its clients:

Restoration of lost value on bank deposits

The government will compensate people who had funds of less than USD 1,000 in their bank accounts at the end of January 2019.

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In February 2019, Zimbabwe abandoned a 1:1 peg of the Z$ to US$ exchange rate, causing the exchange rate to depreciate from Z$1 per US$ to Z$2.5 per US $.

The depreciation of the Z dollar means that depositors lost the value of their deposits which, at the time, were considered at par in US dollar terms. At the time of conversion of the deposits, the total deposits which were supposed to be 1:1 for the US dollar was 8.965 million Zimbabwean dollars.

This is not the first time the government has compensated depositors for loss of value. In 2015, depositors were also compensated following the demonetization of Z$ during the multi-currency period.

These systems could be a waste of resources because depositors need a stable and predictable economic environment, rather than being continually compensated for loss of value.

Clearance of foreign currency arrears

The government is committed to clearing the foreign currency auction allocation backlog by the end of May 2022; the currency allocation must be settled within 14 days and the auction to allocate only available foreign currencies.

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Lack of political will to implement agreed policy measures is eroding confidence in the economy. This pronounced exchange rate management framework was agreed upon long ago, yet the authorities have not embraced it.

The current economic collapse could have been avoided if the authorities had implemented an agreed roadmap on exchange rate management.

As previously highlighted, the currently overvalued ZW$ at auction creates fertile ground for arbitrage and generates inflated demand for forex.

Continuation of a multi-currency system

The current multi-currency monetary system will remain in place and the dedollarization process will be driven by economic fundamentals.

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The market is not yet ready for the adoption of the single currency system, as the economic fundamentals are still below the required benchmarks. Any premature introduction of the single currency will lead to greater economic instability and rejection of the local currency by the market.

Consent-Buyer-Consent-Seller (WBWS) exchange system

The amount that can be traded under this system has increased from $1,000 per day to $5,000 or $10,000 per week per individual.

Retailers/wholesalers are allowed to compare their prices to the WBWS average exchange rate.

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So far, the WBWS market has been biased towards buying currencies, which is not ideal.

The WBWS exchange rate is also still low compared to the unofficial market exchange rate, which makes it difficult to attract large sellers.

Base money growth

Quarterly reserve currency growth was further reduced from 5% to 0%.

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In the past, the growth of reserve requirements despite a 5% reserve currency growth target was a sign that monetary policy was not restrictive enough as deposits continued to grow.

Differential tax on intermediate fund transfers (IMTT)

A 2% fee will continue to apply to local currency transfers. Domestic transfers in foreign currencies to attract 4% IMTT.

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The IMTT has been a controversial tax since its introduction with the aim of capturing the informal sector to contribute to the tax net, as well as to mobilize resources for infrastructure.

Since then, the IMTT is now used as a broad-based tax for the informal and formal sectors, to help the government raise revenue.

The high IMTT effectively means that the market will avoid depositing the US dollar in the banking system. This will increase the informalization of the economy as transactions will take place in cash and outside of formal channels.

Levy on cash withdrawals in foreign currencies

Cash withdrawals over $1,000 will incur a 2% tax.

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These measures prevent customers from using banking channels and this goes against financial inclusion efforts.

This is an opportunity for banks to develop digital platforms to support US dollar transactions. Customers will feel discouraged from using the banking system because of the high costs involved.

Settlement of Forex tax obligations locally Cash

Settlement of local currency tax obligations will be at the WBWS exchange rate.

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Following the introduction of the WBWS, the government should immediately unify the auction exchange rate system and the WBWS. The existence of multiple exchange rate systems will encourage arbitrage and corruption.

Liquidation of the redemption part of Export earnings

The settlement of the remitted part of the export earnings will be done at the WBWS exchange rate.

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This is commendable as it will improve the viability of forex generators. The main risks are related to the manipulation of the WBWS system, which will result in a widening of the premium.

Ideally, the auction system no longer serves its purpose because it is an arbitrage vehicle. Crucially, continuing the auction involves the government paying a subsidy (which is the difference between the auction and the WBWS exchange rates) which is not budgeted for. The existence of a multiple exchange rate system only benefits the elite and is a major source of corruption and arbitrage.

Suspension of payment by a third country on foreign payments

Foreign payments from third countries have been suspended.

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This is to stem the likely illicit financial flows.

Suspension of loans by banks

Bank loans have been suspended.

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The growth of the local currency, which in turn is accused of fueling the parallel market, cannot be attributed to bank lending alone, as the government is well known for injecting huge amounts of cash as it makes payments to local contractors.

The decision to suspend bank lending is unprecedented as it goes against the norm of economic recovery and contrary to the logic of supporting economic recovery.

The government is adopting unconventional practices in an attempt to avoid dealing with monetary reforms.

The government is using a heavy-handed approach to try to solve a long-standing monetary conundrum.

Bank credit is the central function of the financial intermediation of banks

process. Banning lending activities will threaten the survival of banks as it will wipe out 20-50% of their income.

Consequently, this could push banks to engage in risky and/or unauthorized activities to compensate for the loss of revenue. It could also push bank fees higher as banks devise survival strategies.

On the other hand, businesses cannot survive without working capital. This will lead to reduced operations, commodity shortages, further price increases, viability issues and possible business closures and job losses.

No economy can survive without access to working capital.

Promote discipline on the ZSE

The transfer of funds between accounts by brokers is now prohibited and investments in ZSE for less than 270 days will incur 40% capital gains tax (CGT).

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Markets, by their nature, are intertwined and reflect inherent distortions in the economy.

The runaway performance of the ZSE was a sign of upheavals in the foreign exchange and money markets and in the economy in general. The ZSE also reflects the behavior of investors who hide during difficult economic times, as well as the lack of confidence in the direction the local currency is heading.

A plethora of regulations impose operational bottlenecks, make the ZSE inefficient and unattractive to foreign and domestic investors. This has the potential to hurt retirees and new registrants.

Summary

The government believes that the growth of local currency deposits has caused volatility in the foreign exchange market. Although bank lending has partly contributed to some level of money creation, this is only a fraction of the drivers of forex volatility.

The growth of local currency deposits is largely attributed to huge state payments to local contractors and quasi-fiscal operations.

Rising… Chart showing local currency deposits between December 2020 and February 2022
Spike… Chart showing monthly increase in local currency deposits

Clearly, the huge growth in local currency deposits is concentrated in specific months which could be associated with the huge government payments which in turn triggered exchange rate volatility.

Interest-Based… A Chart Showing the Revenue Composition of Zimbabwean Banks

Banks derive 20-50% of their income from interest income from lending activities. The loan ban will therefore endanger their viability.

Likewise, businesses need working capital to replenish, increase capacity utilization and smooth cash flow.

Prohibiting access to finance will jeopardize operations, stunt growth, cause shortages of goods and escalate prices.

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