Reserve money targeting key for rate stability: CZI


Reserve money targeting remains a critical tool for managing exchange rate stability, as such, monetary authorities should keep a tight leash on money supply growth, findings from a recent study commissioned by industry reveal.

The study was commissioned by Confederation of Zimbabwe Industries (CZI) and presented last Friday by leading econometrician, Dr Carren Pindiriri.

CZI said exchange rate stability was a key element of industrialisation.

The findings dovetail into the central bank’s current policy thrust under a monetary targeting framework and inflation control efforts, which entail measures to restrict money supply growth.

And this comes after Zimbabwe experienced rapid inflation increases since late 2018, on the back of parallel market exchange rate volatility, amid rampant speculative illegal currency trading.

Such a scenario resulted in the Zimbabwe dollar’s parallel market rate, after the domestic unit was floated on the interbank market in February last year at $2,5/US$1, depreciating to lows of around $120 against the greenback by June 2020 at the unofficial market.

In the same stride, inflation took off from a low of 5,39 percent in September 2018 to a post dollarisation high of 837 percent by June 2020, as markets struggled for direction without a systematic yardstick for rate determination.

Without a formal way of determining the rate, markets relied on their whims to beat the volatility, forward pricing products in a manner that fuelled price hikes, in order to stay ahead of the rampaging inflation curve.

But sanity and stability has returned to the market after the launch on June 23, 2020 of the highly successful forex currency auction market, which has improved formal access to hard currency for key imports.

The exchange rate, on the RBZ’s Tuesday weekly auction, which has allotted over US$400 million to importers since June 23, has stabilised around $81,6 to the US dollar.

Amid the prevailing stonewall exchange rate stability, inflation too has started trending south with expectations that prices, largely unchanged since September this year, will also eventually follow suite as the year ends.

According to CZI, the study titled “Modelling Exchange Rate Determinants and Volatility in Zimbabwe” focussed on the range of variables causing exchange rate depreciation in the domestic economy.

One of the main causes was found to be reserve money or large amounts of liquidity held by banks and readily available to them for on-lending to customers.

“The second policy implication is that memory or expectation under low confidence levels can sustain extensive exchange rate volatility, even if money supply is controlled. In this regard, the study recommends rebuilding confidence.”

To buttress the confidence, Dr Pindiriri study recommended consistent and persistent good macroeconomic management, prudent fiscal and monetary policies as well as central bank autonomy.

Further, the study found out that macro and exchange stability call for fiscal support through strict management of Government expenditure (Fiscal Discipline).

The fourth implication of the research findings was that there is need to take a closer look at the period of the instability, which provides critical information needed to guide future economic policy decisions.

“The findings support the Dornbusch overshooting hypothesis, that is, a monetary shock is associated with disproportionately large variations in the exchange rate. Exchange rate is money supply (M0, M1, M2, M3) elastic,” Dr Pindiriri said.

He said expectations and unpleasant memories of historical negative monetary experiences were key drivers of exchange rate volatility in Zimbabwe together with disproportionate monetary aggregates.

“A monetary shock instantly increases volatility of the exchange rate. Aftermath of a monetary shock, exchange rate volatility is intensified by expectation/memory and fiscal instability,” Dr Pindiriri said in his research findings.

But an official with the RBZ told delegates who attended a zoom presentation of the research findings that exchange rate volatility was not exactly a result of too much money supply growth, but too much liquidity in the hands of a few, who abused it to trade in forex.