If anything, the May 2019 official inflation figures indeed confirm our deepest fears. Touching the shores of 100% in May (actual inflation may be significantly higher), there is no sign of price escalations relenting anytime soon – indeed, they cannot relent for as long as the parallel market prevails. Inflation is truly heading northwards and the incipient buildup of inflation pressures in the economy is entrenching. If unchecked, not long hereafter, entrenched inflation expectations will soon create an expanding torrent of further upward price spiral. If only this was just undue pessimism, but unfortunately it is not.
The reality on the ground is far too severe. The dislocative effects of inflation and price escalations are everywhere. Hold your breath for pensions being decimated for a second time in a decade. Give some thoughts to those among us with chronic conditions, who require constant medication. The economy is re-dollarising furiously. We are witnessing an upward drift in prices on a daily basis. Quotations, even for on-going business transactions are now valid for 24 hours – or in US dollars, at the parallel market rates. The only thing truly matching the surging inflation is the growing tide of the impoverished, chronic poverty, the swelling ranks of the indigent, and hungry. We have survived on penury before and, ominously, indications are that we are headed in that direction, unless immediate and comprehensive remedial measures are implemented to arrest the inflationary spiral.
The most significant aspect of price formation is that beyond a certain threshold, inflation generates a life of its own, it gains a long memory, or in macroeconomic parlance, a non-stationary drift trend. For us non-economists (and those former economists who have abandoned the Ceteris Paribus road, to pursue fisheries, animal husbandry or plate tectonics), what this means to all of us is that, each day or month that passes by – inflation becomes increasingly harder to control.
This is our present reality and daily costs for basics are rising beyond sustainability thresholds. We did not need to be this far because we have been this route before. This path is well beaten. We can cast aspersions to eternity but increasingly, it is inescapable that we must introspect as a nation, on several myths and misconceptions which, we have collectively accepted, but particularly more so those entrusted with critical policy formulation and implementation for broader macroeconomic stability, recovery and growth. Among them:
#1: Money or Money Growth can engineer output growth
We have been here before. Despite the overflow of monetary policy research and the fact that this is an area overflowing with abundance of on-going research, somehow, ourselves and in particular our policy makers hold on irredeemably to a strange belief that money actually can engineer production and output growth. We are not alone here – our brothers/sisters across the Limpopo also face the same high level (acrimonious) debate, with many highly placed officials and even technocratic experts holding the view that more production and productivity as well as employment can be engineered through monetary incentives, regardless of the money supply growth implications on the wider economy.
Years ago, during my decades’ long sojourn at the Central Bank, but particularly from 2004 to 2008, any differential view to the appropriateness of such a monetary policy thrust was immediately met with a slew of hastily assembled statistics showing that companies were indeed increasing production and employment because of the special interventions. And with Nabatean refrain, we conditioned ourselves to believe that progress is only represented by discrete variable counting – yet another myth. So many tonnes and kgs produced; so many new people employed, so much exports! Well and good.
But as sure as the sun rises from the east and sets in the west, monetary policy has no capacity to engineer long run growth in the economy, with its role limited only to the short run or near term effects on the economy. Even then, the short run effects of monetary policy are still conditioned by so many factors as to be completely neutral for economies plagued by adverse inflation expectations. Among them, for a small open economy, foreign currency availability, international prices determining the terms of trade and factor mobility.
The biggest challenge however, has to do with the presence of endemic inflation expectations. Where these are mild, the demand for money approaches normality and some short run benefits may be realised from monetary stimuli. But in our case, where adverse inflation expectations are latent, yet alive, then even in the short run, the benefits of monetary policy stimuli are non-existent. Does that mean that monetary policy is of no value? Of course No. The greatest contribution of monetary policy to the economy is its capacity to control inflation and achieve low and stable inflation, allowing economic agents to make investment decisions based on stable prices and a stable price signaling process.
The economy’s capacity to produce goods and services beyond the near term can only be influenced by our investment in Labor, education and health, capital infrastructure development, ICT and technology. These accompanied by wider structural reforms, including ease of doing business, investment laws harmonization, zero tolerance for corruption, red tape, labor market flexibility, among others – they influence the economy’s production potential and crucially cannot be influenced by monetary interventions.
Added to the large recurrent fiscal deficits, all the monetary incentivisation only serves to deck the economy with a whirlpool of money supply growth that steadily builds up pressure on foreign exchange demand, parallel markets and eventually a build-up of incipient inflation pressures in the economy. At that point whatever has been gained from the initial interventions is washed to sea by the permanently high and runaway inflation.
For sure money is required for production, but this must come from commercial banks through the normal financial intermediation process and not from the only institution that has limitless capacity to create money in the whole country. We must reverence money and eschew too much money in the economy as the basic principles for sound money.
#2: Severe Inflation Expectations of 2007/08 have been banished
The economy was characterized by severe inflation expectations leading to the hyperinflation of 2007/08. The migration to Multicurrency only assuaged the escalation in prices, bringing as it were borrowed price stability, conditioned on Multicurrency pricing. So the Multicurrency succeeded in bringing price and macro stability, but this is not synonymous with banishing inflation expectations. These were dormant but very much alive; only latently buried beneath the surface – like an active volcano lying dormant only to erupt, causing a trail of destruction.
Countries that have experienced hyperinflation rarely banish adverse inflation expectations within a few decades. It usually takes several decades of consistently sound and effective macroeconomic policies to address the public residual fears and psychology of expectations.
It was therefore quite audacious for Monetary Authorities to introduce anything that mimics local currency or quasi currency within a decade of the loss of the local currency. This directly re-flamed and re-energized latent inflation expectations, fueling the parallel markets, particularly for foreign currency.
#3: Introducing a local Currency necessarily confers Monetary Policy Control
All over the world, a country’s currency is a symbol of so many things, including sovereignty, independence, culture, hopes and aspirations, among so many other things. For macro policy makers, the local currency has a very significant added dimension – control of monetary policy and inflation – and with that, the internal and external value of money. This is true for nearly all countries. However, this is uniquely untrue for Zimbabwe. On account of the history of the past decade and half, in our present circumstances, Zimbabwe is the only country where introducing a local currency may not confer any monetary policy advantage. This is because of the already highlighted issue of de-anchored inflation expectations.
Monetary policy affects the economy overtime – time varying distributed lag effects, usually spread over 6 to 8 quarters. The key assumption however, is that prices adjust slowly to changes in aggregate demand following monetary policy stimuli, hence creating a positive real demand in the short run, increasing aggregate demand in the economy and stimulating real GDP growth and employment. The presence of de-anchored inflation expectations, changes all that by front loading prices as happened during the 2007/08 era of burning. In this regard, although Monetary Authorities made many pronouncements in 2007/08, and in some way the local currency was still functioning, until its demise in 2008, in essence monetary policy was already lost, as early as 2006. Authorities could no longer influence the economy, in any way. The loss of currency in 2008 only sealed the loss of Monetary policy, which had already occurred two years earlier.
#4: Production can be sustained under a Strong currency
The assumption of monetary policy engineered production is married to a yet an abiding trust that production can yet be sustained on an on-going basis, even under a strong currency. That production can be incentivized to counter the effects of a strong currency. Perhaps so.
Critically though, it is not that simple linear relationship. An overvalued real exchange rate or strong currency has complex non-linear relationships with so many variables, exports, imports, services, asset bubbles, among others, creating tides or ebbs in the production process. An overvalued exchange rate is a de facto incentive for imports, often creating an asset bubble with imports that are not necessarily for production – witness the surge in passenger vehicle imports every year. A country with a small population of 16 million has an unusually high density of passenger vehicles – as of 2018, the 4th largest category of imports. It is an asset bubble, a direct result of an overvalued and strong currency.
It is difficult for an economy based on primary production to sustain an overvalued and strong currency and the sooner Zimbabwe exits a US dollar dominated multicurrency, the better for the economy. But this has to be an orderly exit and cannot be a direct shift from Multicurrency to local currency, as that too has disastrous consequences. A hurried and injudicious introduction of local currency can be far more damaging than the attritional effects of an overvalued exchange rate.
#5: What we do not see in the economy will not hurt
The economy is truly an amazing living organism – a complex web of multilayered and interwoven relationships, whose beauty can only be compared to the surpassing elegance of the universe. A tapestry and a multiverse, with layers above and beneath the labyrinth.
So in the economy, there are things we all see such as nominal prices of goods and services, there are things we see imperfectly, such as relative prices, particularly when everything is in motion and there are things we completely do not see, such as real values – the real exchange rate, the real wage, real interest rates, real demand for money and so forth. We do not see an equilibrium but we know that where there is demand and supply of anything, there is some tendency towards equilibrium, whether optimal or not. Among the most important things to establish is the recognition that what we do not see, especially the real variables have far reaching damaging effects on the economy and great care is required.
Policy Proposals to Anchor Inflation Expectations and Contain Inflation
In light of the above and the pervasive effects of re- dollarization, has the battle for inflation been lost already? No. Not yet but every week and month that passes by, is deterministic. It is more akin to the British Army landing on the Normandy beaches on D-day in 1944. In the morning of the same day, a company could have taken the city of Caen; by midday this required a battalion and by evening of the same day; a Division could not take it. Our biggest enemy is adverse inflation expectations and unfortunately, he is gaining ground.
We must urgently arrest and reverse the current re-dollarization and the corresponding pegging of prices at hugely depreciated parallel market rates. This therefore means that achieving exchange rate convergence is a pre-requisite for stabilizing the currency, anchoring inflation expectations and therefore containing inflation.
What can be done? Several mutually reinforcing policies must be urgently and decisively implemented as necessary to burst the anvil of inflation expectations. Among the gamut of measures should include:
- A truly market determined exchange rate
- Removal of All Pricing distortions.
- Re–configure the currency basket (narrow to three currencies)
- Sustain Fiscal Consolidation and Fiscal Budget surpluses
- Review Government Overdraft at RBZ to 4% of last year’s revenue.
- Clear Money supply growth targets (targeting 8 -10% annual Broad money growth).
- Moderated but Upward Review of interest rates.
- Effective Safety Nets, and
- Social Contract
It is imperative that a truly market determined exchange rate be allowed to prevail in the economy. Not that I believe in perfect markets. Markets are imperfect, both at home and abroad, markets have shown recurrent aberrations and often the resulting volatility is completely unrelated to macro fundamentals. But in our case, we had continued for far too long with macro imbalances, which have a created a salient of bottled up pressures in the economy. This pressure often manifests in quantity or price adjustments, but not overnight.
All pricing distortions must be removed and it is important that Monetary Authorities follow up on a very tight monetary policy program with no leakages as per Staff Monitored Program (SMP), perhaps targeting annual broad money growth of 8 – 10% per annum. This must be, complete with weekly, monthly and quarterly targets. The level of money supply growth must be consistent with private sector credit growth, implying significantly curtailed money growth. The Government Overdraft at the Central Bank must be reduced from the current 20% of last year’s revenue to 4% of last year’s revenue and judiciously adhered to, with no waiver.
The Government must not only sustain cash budgeting and fiscal budget surpluses but also immediately adjust all wages and allowances for civil servants now living on penury. The same is true for the private sector. More than ever before, a clear program of safety nets is critical and the private sector must join hands with Government and create Food banks at designated points and feeding centers to cater for the indigent, the poor and vulnerable. Hunger is stalking – there are isolated pockets of plenty/abundance, but this is the exception.
The Multicurrency basket must be reconfigured. It has served its purpose which was to bring price stability. Our mistake was to relax in the warmth of the Multicurrency and think that what was enough to bring stability will be sufficient to sustain economic growth. It has its limitations, particularly now as dominated by the US dollar, a global reserve currency demanded by all countries from Andorra to the Andaman and Nicobar Islands.
We must immediately change the Multicurrency basket and revert to a narrowly defined basket of three currencies only – Rtgs, Rand and Pula. Thereafter float the interbank exchange rate. The US dollar and all other currencies must be treated as foreign currency. This means that pricing in Zimbabwe will automatically be in RTGS and Rands or Pula. No need to join the Rand Monetary Union. The rand currency will flow into Zimbabwe, similar to what happened in 2009. There was neither, US dollar nor Rand facility then. Combined with a temporary opening of the border for imports of basics, this will have the effect of collapsing local prices to levels close to those prevailing in South Africa.
Further, it is critical that there be seamless and clear communication on currency, particularly the critical arms of Government – the Central Bank and Treasury/Ministry of Finance. Firstly, harmony and then clarity on the currency issue. In particular to expressly acknowledge that we already have our local currency as in RTGS, but notes and coins will be introduced to facilitate payments and for public convenience. At present, there is no chance of replacing the entire stock of RTGS.
We have begun to take corrective measures, the Transitional Stabilisation Plan is under implementation and Authorities have now agreed on an IMF Staff Monitored Program (SMP).
As well, fiscal surpluses are being realised (though on the back of significantly high and elevated taxes). This is commendable progress, but a swallow does not make for summer, especially after Government issued $5.5 billion TBs in 2 years and the RBZ Overdraft went through the roof. Accordingly, we must not be surprised if our initial reforms yield more pain with seemingly limited or no gains. We must continue and press on.
Macroeconomic policies affect the ordinary man in pernicious ways. Reminds me of an incident, years gone by in 2008. I was driving to Chipinge and passing the Ngaone turn off, I immediately stopped to offer a lift to a woman and her kids – on their heads, including the little boy of early primary school age – heavy baskets of bananas. She lumbered into the car with her boys and sat behind my seat, an impenetrable gaze upon her scraggy face, as though half dazed, staring into empty space. They had had been walking for hours, with no food. In those days communities and families across much of Zimbabwe could go for days and weeks with no proper meal. Their hope was to get to Chipinge and sell their bananas. They are a microcosm of the larger populace. I pray that our policy makers think of macroeconomic policy in terms of the millions of such voiceless in our country.
We can propagate the “good news” of early inflation deceleration to levels near single digit levels, if we wish but there is no such early redemption at hand. This journey is long. Even as Jeremiah prophesied to the Babylonian captives in 586 BC just before the fall of Jerusalem…..….”Thus saith the Lord of hosts, the God of Israel, unto all the captives……build ye houses and dwell in them, plant gardens and eat the fruit thereof, take ye wives and beget sons and daughters……..seek the peace of the city and pray unto the Lord for it. For thus says the Lord, after 70 years be accomplished at Babylon, I will visit you and fulfil my gracious promise.” (Jer. 29vs 4 -10). Of course, in our case, this will not require 70 years. With perseverance and determination, as well as consistent implementation of corrective measures, inflation stability can eventually be secured. But this will not take less two years of consistent, mutually reinforcing and well sequenced anti-inflation policies. Anchoring inflation expectations, must precede price and inflation stabilization.
Joseph Mverecha is an Economist with a local Bank and he writes in his personal capacity.