Auction system threatening stability





HARARE – The foreign currency auction system that is being used by the Reserve Bank of Zimbabwe to allot foreign currency to importers — in its current form — is now seriously distorted and has become a huge threat to exchange rate and price stability, Business Weekly has observed.

While the auction system has managed to allot as much as US$1,7 billion to the productive sectors of the economy, its rigidness in price discovery, has come at a huge cost and has fostered exchange rate imbalance and by extension, price instability.

Just like most central banks across the globe, the Reserve Bank of Zimbabwe’s mandate is to foster price and financial system stability.

In that regard, the central bank, following lobbying from industry, via representatives such as the Confederation of Zimbabwe Industries (CZI), introduced the auction system to assist in price discovery of an appropriate and stable market-based exchange rate for the country.

Although there have been some modicum of improvements, with the premium between the official and parallel market exchange rate coming down to approximately 20 percent at some point, and inflation coming down from as high as 837 percent, the positive trend has always been fragile amid reports that the auction system is not a true Dutch auction system as proposed by industry.

By design, a Dutch auction is a price discovery process in which the auctioneer has to start with the highest asking price and lowers it until it reaches a price level where all the bids received will exhaust the entire quantity on offer.

However, the current auction is also not inclusive with some economic players excluded from accessing foreign currency, while others receive it on a prorated basis. This has left the auction system ineffective and fragile and this fragility has since worsened.

After starting well, the Dutch foreign auction in Zimbabwe has now been distorted by a lagging supply stretching over 15 weeks in some instances and this has become a driver of the widening parallel market premium.

Instead of assisting in the discovery of an appropriate and stable market-based exchange rate for the country, the auction system has resulted in distortions in pricing with economic players resorting to speculative pricing and parallel market exchange rate indexation of prices.

The gap between the official exchange rate, and that of the parallel market has since widened to more than 100 percent that observers say is not sustainable.

The rate of price increases has also accelerated, with annual inflation for September coming out at 51,55 percent from 50,24 percent the previous month.

Month-on-month inflation for September reflected a similar trend coming out at 4,73 percent up from 4, percent in August.

The pass-through effects of the depreciation of the currency are quite severe on inflation and lead to the erosion of value of wages, salaries, savings and pensions.

This has raised questions on whether the auction system is still serving its purpose amid suggestions it is creating rent-seeking opportunities and fuelling the parallel market over adjustment.

There is also belief the country has enough foreign currency to meet requirements, but because of the current pricing mechanism, which is the auction system, the exchange rate is determined by other factors such as speculation and lack of confidence.

High levels of money supply growth is also a factor and this phenomenon has been made worse by corporates with huge local currency balances or those receiving huge payments in local currency, as some of these funds are being used to destabilise the foreign exchange market.

However, with US$1,7 billion in nostro accounts, and nearly US$1 billion in SDR funds, plus what is circulating outside the banking sector, the economy has approximately US$4 billion, which is more than enough the required six months cover of US$2,5 billion.

In a private conversation, a senior Government official revealed, if the country had a serious foreign currency shortage, this would have reflected in the shortage of critical goods and services.

But the fact that the country is not experiencing any shortages of goods and services, and yet has a runaway parallel market exchange rate, means the current pricing mechanism, in this case, the auction system, is flawed as it has failed to assist in price discovery and fostering widespread price stability.

“We introduced the auction system because we wanted to ration a scarce commodity (foreign currency), but given what is obtaining, with more than 10 months import cover (technically) is the commodity still scarce.

“What we thus have to question is the methodology of still allocating a commodity which is no longer scarce in this current manner (auction system),” the official said.

“Our problem is our methodology of allocation and price discovery which is inefficient. The auction as a vehicle for allocation and price discovery of foreign currency is inefficient and requires some form of review or adjustment.”

The failings of the auction system as a price discovery mechanism is exposed by the widespread resort to speculative pricing and parallel market exchange rate indexation of prices by economic players across the economy.

In its economic intelligence report for the second quarter, the CZI said there is fear that moral hazard and adverse selection risks are beginning to creep in due to perceptions about the foreign currency auction.

“Due to the perception that there is now cheap foreign currency at the auction, even those businesses which would otherwise have not participated in preference for strengthening local value chains can end up participating to enjoy access to foreign currency.”

According to the business membership organisation (BMO), adverse selection risk can easily reverse the import substitution benefits that are central to NDS1 and Vision 2030.

“Thus, the huge parallel market premium is dampening the motivation for exporting business as it eats into the viability of exports,” reads part of CZI’s briefing to members.

The business lobby group added that the allotments at the auction system have not been accompanied by real time disbursements with the lag between allocation and disbursement increasing over time.

“The foreign currency settlement backlog that is being experienced at the forex auction system is regarded as a threat to business operations as companies’ cashflow gets tied up, affecting smooth flow of operations.

“The delay is also a cost to business, as it significantly reduces the number of times that stock is normally sold in a year (stockturn), thereby reducing returns.”

As a solution, CZI said the auction market needs to be improved to a real auction platform (not an allocative one).

“The rate should be floated and quick settlement of bids should be undertaken,” said CZI. – Business Weekly