Zimbabwe Central Bank hikes forex reserve requirement, raising growth concerns

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The Reserve Bank of Zimbabwe has raised the statutory reserve requirement for foreign currency demand deposits from 15 percent to 20 percent, in a move aimed at curbing inflation. Analysts warn the increase could stunt economic growth.

In its 2024 Monetary Policy Statement presented last week, the central bank raised the statutory reserve requirement by 500 basis points, but economic analysts said this move carries significant implications for the financial landscape, affecting lending, economic growth prospects, and overall monetary stability.

Analyst Namatai Maeresera believes one of the primary repercussions of the increased statutory reserve requirement is its impact on the availability of free funds for lending. “By raising the reserve requirement, financial institutions are compelled to set aside a larger portion of their foreign currency demand deposits, thereby reducing the pool of funds available for lending purposes.”

This is said to decrease lending capacity which can potentially tighten credit conditions, leading to higher borrowing costs and dampened investment activity.

As a result, businesses may find it more challenging to access financing for expansion or innovation initiatives, which could impede overall economic growth.

Asset management firm Zimnat said, “The increase in statutory reserve requirements for foreign currency deposits continues to signal that the RBZ does not favour bank lending in US dollars, due to challenges with domestic nostro accounts.

“As a result, domestic nostro liquidity is expected to remain tight, with further increases in statutory reserve requirements for foreign currency deposits expected, if the USD liquidity situation does not improve.”

According to economist Shawn Sakala, the heightened reserve requirement poses potential risks to economic growth, particularly in economies reliant on robust credit provision for investment and consumption.

“With reduced availability of funds for lending, businesses may scale back their investment plans, leading to a slowdown in capital formation and job creation. Similarly, consumers may face constraints in accessing credit for major purchases, such as homes or automobiles, affecting consumption patterns,” Sakala said.

Consequently, the overall pace of economic expansion could decelerate, posing challenges for policymakers tasked with fostering sustainable growth trajectories.

However, FBC Securities are of the opinion that increasing reserve requirements for foreign currency deposits can be a prudential measure aimed at enhancing the stability of the financial system despite potential downside risks.

“The downside of increasing reserve requirements for foreign currency deposits is a reduction in the money supply available for lending and investment which may slow down aggregate demand and economic growth.

“The increase in reserve requirements may also lead to higher interest rates as banks may have to price the increased statutory reserves into pricing models. This can make borrowing more expensive for businesses and individuals,” the Securities firm said.

Some analysts believe the adjustment in the statutory reserve requirement serves as a vital tool for central banks to regulate the quantity of money circulating within the economy.

“By mandating financial institutions to hold a higher proportion of their foreign currency demand deposits as reserves, authorities aim to mitigate the risk of excessive liquidity in the financial system,” opined banker Raymond Madziva.

“This measure helps in controlling inflationary pressures by curbing the potential for an overheating economy fuelled by an abundance of available credit. Moreover, it enhances the central bank’s ability to manage exchange rate stability by influencing the supply of foreign currency in the market.”

Despite the potential challenges it poses, an increase in the statutory reserve requirement offers several benefits from a macroeconomic standpoint.

Maeresera believes it strengthens financial stability by bolstering the liquidity buffers of banks, thereby enhancing their resilience to external shocks or liquidity crises.

“This safeguards depositor confidence and maintains the overall stability of the banking sector. It provides policymakers with an effective tool for managing monetary policy and macroeconomic stability,” he added.

Through adjusting reserve requirements, central banks can fine-tune liquidity conditions to align with their policy objectives, whether it be controlling inflation, stabilising exchange rates, or promoting sustainable economic growth.

While it may constrain lending activity and pose risks to economic growth in the short term, it also serves as a crucial instrument for central banks to manage liquidity, control inflation, and ensure financial stability according to the experts.

The effectiveness of this policy adjustment hinges on the delicate balance between restraining excessive money circulation and supporting the credit needs of businesses and consumers. “Going forward, policymakers must closely monitor its impact on various economic indicators and remain agile in adjusting policy parameters to navigate evolving macroeconomic dynamics,” said Maeresera. – Business Weekly