Zimbabwe Central Bank delicate balancing

Reserve Bank of Zimbabwe

Monetary authorities face a delicate decision of adjusting interest rates.

The interest rate (or the amount of interest due per period, as a proportion of the amount lent, deposited or borrowed) is a critical economic component insofar as it has an impact — either positive or negative — on the cost of borrowing and return on savings.

It is also significant with regards to the total return on numerous investments.

So far, the Reserve Bank of Zimbabwe (RBZ) has maintained a contractionary monetary policy, choosing to keep the overnight accommodation rate at 35 percent last month.

The apex bank held the medium-term lending rate for the productive sector at 25 percent.

The overnight accommodation rate is the interest rate at which banks lend or borrow funds with another depository institution in the overnight market.

With the fiscal and monetary authorities having moved to entrench economic stability through the introduction of the foreign currency auction system earlier in the year, there are growing expectations that the interest rate could be reviewed downwards.

Analysts at research firm and stockbrokers Morgan & Co say the prevailing economic stability and projected economic contraction as a result of the pandemic necessitate a lower interest rate.

“There remains some level of uncertainty as to the direction of the rates in the forthcoming monetary policy statements, but independent analysis strongly suggests that a lower rate might be announced by the RBZ sooner than expected.

“Firstly, the central bank and Ministry of Finance and Economic Development have enacted policies that contain inflationary pressures driven by the parallel market, such as the more liquid auction system and stringent limits on mobile money and ZIPIT.

“The success of these measures has seen stability in prices and open up an opportunity for the RBZ to lower rates and further support businesses without worrying about inflationary pressure from the parallel market,” said Morgan & Co.

“Further, the empirically positive relationship between interest rates and economic growth warrant a further decrease in the policy rate given the estimated 10,4 percent GDP contraction by the International Monetary Fund (IMF) largely due to Covid-19.

“The lower growth prospects of the global economy since the declaration of Covid-19 as a pandemic in March 2020 were met by lower interest rates globally.”

One of the reasons why the central bank implemented a relatively high interest rate of 35 percent in June was to discourage speculative borrowing.

But the move has impelled the cost of borrowing for businesses, in particular.

Business has already rung the country’s monetary authorities to revise the interest rate from the current 35 percent to 20 percent to help cope with the effects of the pandemic.

“Interest rates must be lowered to 20 percent from 35 percent and loans must be restructured so as to allow businesses to recover,” said business representatives, the Zimbabwe National Chamber of Commerce (ZNCC) recently.

However, monetary authorities argue that the present interest rates will contribute to the sustenance of stability that has already been

achieved in the economy since the establishment of the foreign currency auction system.

“This decision on interest rates takes into account of the current tight liquidity conditions in the market and the need to continue controlling speculative borrowing,” said the RBZ Governor Dr John Mangudya last month.

It’s been a topsy-turvy ride with Zimbabwe’ interest rate, not least in 2020.

This year alone, the interest rate was reduced from 35 percent to 15 percent earlier in April after businesses made representations to the apex bank to reduce the bank rate to circa 20 percent following the outbreak of the coronavirus (Covid-19) pandemic.

But a rise in speculative borrowing has forced the central bank to backtrack on the earlier policy shift, increasing the rate to 35 percent in June.

Last year, the monetary authorities hiked the overnight accommodation rate from 15 percent to 50 percent in June, and then to 70 percent in September in a move to discourage speculative borrowing and protect the value of the Zimbabwe dollar following its floating on the interbank market for the first time since 2009.

Then in November 2019, the central bank reduced the bank rate from 70 percent to 35 percent as part of its efforts to promote lending to productive sectors, before reducing it to 15 percent due to the Covid-19 pandemic.

Although intimating that Zimbabwe’s interest should go lower, the analysts at Morgan & Co say the rate is around its effective range given the country’s economic circumstances.

“An additional, but loose, proxy for gauging the appropriate level of the policy is the Yardeni model. This model is an extension of the Federal Reserve model, which is a market timing tool for determining whether the US stock market is fairly-valued.

“The model is based on an equation that compares the earnings yield of the S&P 500 with the yield on 10-year US Treasury bonds. The Yardeni model incorporates the earnings growth forecast in addition to the earnings yield of the S&P 500. If we take this closer to home and reverse-engineer it to find the theoretical representative 10-year government bond yield in Zimbabwe, we get a yield of roughly 40 percent,” they explained.

“Given that the longer-dated Treasury Bond yields are conventionally higher than the policy rate, the current policy rate of 35 percent set by the RBZ seems plausible. There are also some factors that we believe the central bank also considered in its decision to maintain the 35 percent rate, specifically the need to balance between affordable financing for productive sectors and preventing parallel market speculation with ‘cheap’ money. – Sunday Mail