Zimbabwe economy in vicious inflation expectation cycle

HARARE – Businesses are largely complicit in further driving inflationary pressures in the country by pricing their goods and services according to expectations of worsening inflation, the Reserve Bank of Zimbabwe (RBZ) has said.

Zimbabwe’s apex bank has been “theoretical’ of late. Only a few weeks ago, RBZ governor Dr John Mangudya said the jump in parallel foreign exchange market rates lacked fundamentals and was merely a consequence of behavioural economics.

This time the central bank has claimed that some economic agents are further impelling inflation in the country by ‘forward pricing’ their goods and services.

And this time, the Zimbabwean banking sector regulator has strong backing.

“The United States dollar remains the most preferred currency of payment. For those that prefer to pay in RTGS or Zimbabwean dollar, the exchange rate used to quote prices is way above that of the parallel market, and traders locate it between the parallel market rate and the Old Mutual Implied Rate (OMIR),” Confederation of Zimbabwe Retailers (CZR) president Mr Denford Mutashu told our sister paper, Herald Finance & Business this week.

Forward pricing is typically used in international commodities trading.

And Investopedia.com describes the ‘forward price’ as the predetermined delivery price for an underlying commodity, currency, or financial asset as decided by the buyer and the seller of a forward contract, to be paid at a predetermined date in the future.

The RBZ says this form of pricing is worsening the economic climate in the country.

“Price determination in the economy by businesses is being established on the basis of expectations about the depreciation of the exchange rate and prices that will exist in the future,” said the RBZ on Monday in an update on reserve money supply.

“This forward pricing system or practice of front-loading anticipated exchange rates in the current prices based on fear factor, is detrimental to the economy, as it leads to self-fulfilling depreciation in the exchange rate, with negative knock-on effects on prices.”

Zimbabwe’s annual rate of inflation has maintained an upward trend, albeit at a slower rate for last month.

According to Zimstat, the year-on-year inflation rate (annual percentage change) for the month of May as measured by all items stood at 785, 55 percent.

This was a 19,98 percentage increase from the previous month’s rate of 765,57 percent.

Zimbabwe’s inflation rate jumped to 676, 39 percent year-on-year in March 2020 from 540, 16 percent the previous month.

And by April, the annual rate of inflation had jumped to 765, 57 percent.

During this period (March/April), the parallel market rate spiked from around 30 to the United States dollar to levels of around 70, as activities on the black market went uncontrolled.

The Zimbabwe dollar was only re-introduced exactly a year ago, following the ending of a long-standing multi-currency system, in which the US dollar emerged as the preferred currency.

Experts say inflationary psychology is premised on the basic concept that if prices are rising and have risen in the past, then the various economic agents will expect prices to continue to rise in the future, and thus behave accordingly.

Although there are several models to describe inflationary psychology, the model indicated by the RBZ and detailed by the CZR boss has some justifications on the ground.

For example, although prices of imported goods in the country are priced in Zimbabwe dollars, a translation of the same price into US dollars and comparison to the US dollar price on the source market(s) show that local prices are overpriced even in US dollar terms.

In its Monday update, the central bank also maintained its conviction that speculation is the real driver behind the significant deterioration of the Zimbabwe dollar.

The Zimbabwe dollar is trading at a premium of circa 80 to the US dollar on the parallel market, as opposed to the 25 to the US dollar peg on the official interbank market.  The monetary authorities have however hinted that the peg could soon be removed.

“Depreciation in the exchange rate, observed over the past few weeks, was largely a result of behavioural and other non-monetary factors such as negative perceptions, adverse expectations, speculative tendencies of economic agents and tracking of the Old Mutual Implied exchange rate

(OMIR), which was quoted at around $140/US dollar over that period,” said the RBZ.

“The depreciation was divorced from economic fundamentals, as it occurred immediately after the opening of the tobacco selling season, which is traditionally associated with stability and appreciation of the local currency.

“In addition, the introduction of the $10 and $20 notes did not represent increase in money supply but a substitution effect – from electronic dollars to physical notes.”

In cases where ‘inflation psychology’ grips an economy, experts say active policy responses to control against that market sentiment may be required.

It perhaps explains why the RBZ’s Financial Intelligence Unit (FIU) has been involved in a campaign to stop speculative activity around the Zimbabwe dollar, which may have resulted in a slowing of both the month-on-month and annual inflation rates during the month of May.

Over the past two months, the FIU has implemented a number of measures to curb speculation on the local currency, including freezing flagged mobile money agent lines, limiting Zipit and bank transactions and shutting down mobile lines of individuals and/or entities advertising illegal foreign currency dealings on social media platforms. – Business Weekly