Fiscal discipline key to exchange rate stability

Prof. Mthuli Ncube

ZIMBABWE may soon discontinue the partial dollarisation of the economy as foreign currency revenues improve following the introduction of tax heads now paid in hard currency.

STAFF WRITER

The outbreak of the Covid-19 pandemic resulted in the easing of the country’s exchange controls as the authorities allowed the use of free funds for the purchase of goods and services.

The government also introduced US dollar-based presumptive tax and the extension of intermediate money transfer tax (IMTT) to US dollar transactions as Treasury seeks to boost foreign currency inflows.

In his 2021 budget presentation, Finance minister Mthuli Ncube (pictured)  reviewed presumptive   in US dollars, extending them to the informal sector while also extending the IMTT to US dollar incomes.

While the country had previously banned the use of the multi-currency basket  declaring Zimbabwean dollars as the sole legal tender, the country has self-redollarised with the government also introducing dollarisation through the back-door use of  free funds.

In June last year, the  government introduced a  foreign  currency auction system which has brought a measure of stability  to the exchange rate.

FBC  Securities in its  2021 outlook and  investments  research note said while the central bank had been keeping a hawk’s eye  on   liquidity, should the fiscal discipline improve, a reprieve emanating from the stabilising currency was expected.

“The US$ revenue space is set to widen given the introduction of US$-based presumptive tax and the extension of IMTT to US$ transactions; this will help contain the funding gap in 2021.

The central bank has been keeping a hawk’s eye on liquidity, as it maintains a stranglehold on money supply growth, which can upset the macro-economic stability brought about by exchange rate stability.

Should fiscal discipline improve, we expect reprieve emanating from a stabilising local currency. The economy is less likely to continue its dollarisation trend if the local currency is stable,” FBC Securities said in its research note.

The exchange rate depreciated from ZW$17.35: US$1 in January 2020 to ZW$57: US$1 at the first foreign exchange auction in June, and further to ZW$81.82:US$1 by the end of November 2020.

Consequently, foreign currency deposits increased from ZW$12.45 billion in January to ZW$102.18 billion in November 2020, thus significantly accounting for the expansion in money supply.

Foreign currency deposits accounted for 55.4% of money stock, while local currency deposits constituted the remainder.

FBC Securities added that the pace at which money supply grows should be linked to the development of a healthy economy.

Broad money supply as of November 2020 stood at ZW$190 billion, an annual growth rate of 750% with the government recording   a “surplus” of ZWL$3.8 billion for the year to September 2020.

As at end of December 2020, reserve money was ZW$18.76 billion, compared to a year-end target of ZW$25.20 billion.

Money supply increased over the year, rising from ZW$36 billion in January 2020 to ZW$184 billion in December 2020.

The growth in money supply was largely attributable to the impact of exchange rate movements on the 60% foreign currency component of the deposits.

“Empirical studies have indicated that measures of the money supply through time have exhibited close relationships with important economic variables (GDP, price levels).

Money supply provides important information about the near-term course for the economy and determines the level of prices and inflation in the long run.

Level of money supply in the economy is critical and should be well monitored and controlled through the monetary policy.

It is the duty of the central bank to have money supply maintained at sustainable levels.
“The pace at which money supply grows should be well linked to the economic development of a healthy economy,” FBC Securities said.  – Source: News Hawks