Understanding liquidity in Zim

Persistence Gwanyanya
QUITE often economists are more inclined towards analyses-based approaches to economic issues, which is itself rooted on a “describe-before-prescribe” approach.
I find this approach powerful in that it recognises that the efficacy of an economic policy largely depends on an understanding of how that policy would work under ideal conditions before making an analysis of the unique constraints that may prevent the proposed policy from achieving desired results.
This approach also gives clarity to the nature and root cause of an economic problem; thus, safeguarding against the danger of prescribing wrong policies to remedy a problem.
In medicine it is understood that a wrong diagnosis could result in a wrong prescription, which could aggravate the ailment. As such, the need for economists and policymakers to fully acquaint themselves with an economic problem facing business and the economy before prescribing successful policies to deal with the same cannot be over emphasised.
With the advent of dollarisation in 2009, we thought the traumas of doing business in a hyperinflation environment had disappeared forever. But like they say, solutions to one crisis breed seeds for another crisis; it seems the cash crisis is now resurfacing, ostensibly because it is no longer possible to counteract the effects of low economic activity and unfavourable balance of payments position through monetary policy interventions such as open market operations and through printing of money (seigniorage).
When Zimbabwe dollarised in 2009, it lost its monetary policy autonomy and thus the ability to control liquidity. The country is, therefore, at the mercy of unfavourable global economic and financial conditions and any unfavourable policy shift may result in deeper and potentially explosive crises which could be difficult to address. This demonstrates the extent to which policy makers must be now more careful and thoughtful in their policy formulation and roll-out.
Hyperinflation and banking sector madness prior to dollarisation saw the erosion of the savings culture in Zimbabwe as confidence in the banking sector sank to historic lows. The general populace would now prefer to keep their money outside the banking system as the tragedy of losing their hard-earned cash at the height of the hyperinflationary era continue to take its toll on confidence levels.
This has affected the banks’ intermediation capacity and therefore their ability to create money.
Banks are fiduciary institutions which survive on the confidence levels of the banking public. They create money by lending out depositors funds to those in need.
The proportion of money left in bank vaults and that which is lent out is informed by the understanding that depositors may not demand their money at one go.
The problem will only arise when depositors lose confidence with the banks and demand their money en masse.
Faced with a bank run, banks may fail to meet the demand for cash as borrowers would need more time to unwind their investments or raise the required funds to pay back their loan balances.
The starting point in analysing the country’s liquidity constraints is to consider the sources of liquidity in Zimbabwe and how these have performed over time.
An ideal economy under dollarisation generates liquidity from exports, diaspora remittances, foreign investments (including portfolio investments) and external lines of credit (including grants), which are attributes of BOP.
The Reserve Bank of Zimbabwe reports that since the adoption of multiple currencies in 2009, export earnings accounted for over 59 percent of the country’s liquidity, followed by diaspora and international remittances at 29 percent, external loans, income receipts and FDI at 12 percent by December 2015.
The generated liquidity is mainly used to meet import bills, repayment of loan maturities and servicing interest, transfers to diaspora recipients and payments for external services, grants and allowances for foreigners.
Since dollarisation, the demand for liquidity has outstripped available liquidity, weighed down by an unfavourable current account position – itself an indication of an economy unbalanced towards high levels of consumption and imports vis-a-vis low savings, production and exports. It is estimated that Zimbabwe has accumulated current account deficit (net payments for foreign goods, services and other foreign remittances such as payments of grants, aid and allowances) of more than US$18 billion since dollarisation.
Being a capital scarce economy, there has been heavy dependence on foreign capital to fund the ballooning current account deficit.
Building adequate foreign exchange buffers and improving domestic money supply conditions has been a major challenge.
At this point, most of you may be trying to figure out the connection between the explanation on the drivers of liquidity and what is being experienced in the market today. It is crucial to point out that Zimbabwe is a commodity-dependent economy, with more than two-thirds of exports being tobacco, sugar, gold, platinum, ferrochrome and diamonds. Global commodity prices have been softening since reaching their peak in 2011, and in 2015 the prices of gold, copper, platinum and nickel extended their decline on the back of anaemic global economic growth and a slowdown in China.
This saw revenue flows from exports for the 11 months to November 30, 2015 plummet by 12,2 percent to US$2,5 billion on the previous year’s performance.
Capital flows continue to be constrained by tight global economic and financial conditions, differences over empowerment laws and unfavourable ease of doing business conditions.
An appreciation of the constraining factors to liquidity growth at national level has been laid out. But obviously you may be wondering what could be the major factors influencing distribution of scarce liquidity among banks.
There is need to understand why it has become increasingly difficult for some banks to push payments, both local and foreign.
It may be a good starting point to highlight that a bank can only do international payments using cash deposits into its foreign accounts.
All foreign earnings are received into a bank’s account(s) maintained with foreign banks. These accounts are called Nostro accounts, and if there are not adequately funded, a bank may find it difficult to push its foreign payments.
Thus, a bank’s ability to meet foreign payments depends on its ability to attract deposits in its foreign accounts from various sources such as exports, foreign loans, diaspora remittances and different other forms of foreign capital.
In the event of a bank’s foreign account being inadequately funded it may have to repatriate (export) cash from local deposits to fund this account, otherwise it may have to stagger payments until the account is adequately funded.
However, cash repatriation comes at a cost, which would mean increased charges on foreign payments. The cash situation could have been aggravated by the RBZ directive to reduce the maximum threshold on cash that can be held in Nostro accounts from 30 percent to five percent in 2014 to improve the local liquidity situation.
The directive came when the country’s export revenues were dwindling as the global economic and financial conditions got tougher, typified by softening commodity prices.
Subsequent to the implementation of this, a number of banks started struggling to make international payments and the RBZ reacted by increasing the maximum threshold to 10 percent. However, it seems several banks are still failing to generate enough cash into their foreign accounts to allow smooth flow of cross-border payments.
The RBZ pointed out in its recent Monetary Policy Statement that about US$2 billion was siphoned out of the economy in 2015 through illicit financial flows by both business and individuals. US$684 million was externalised by individuals in 2015 under the auspices of free funds.
In a dollarised economy it is difficult to demarcate between free and non-free funds, which made the RBZ abolish the concept of free funds. For all withdrawals of US$10 000 and above, a notice period of at least one day should be given to the bank to enable it to do the necessary Know Your Customer procedures and to mobilise the required liquidity.
The RBZ also emphasised the use of plastic money, citing the practice in other jurisdictions, including the US, which enforce the maximum reportable cash limits that can be carried on person and/or withdrawn from financial institutions to guard against money laundering and leakage of liquidity.
Following promulgation of these controls, we have seen sceptics withdrawing their money from banks and one must be forgiven for thinking that these controls could have been construed or misconstrued as indication that the liquidity situation is worse than the market thought. Those companies that generate huge sums of money started to speculate and others even started selling cash.
We understand that some companies have been selling cash at between one and 1,5 percent for an RTGS transfer.
Does that sound familiar? Those who were around during the hyperinflation era will tell that this is what we call “burning”.
We hope that with the opening of tobacco floors on April 4, 2016, the cash situation is going to improve.
However, we take cognisance of the fact that small-scale farmers, who are normally a significant contributor to liquidity have been hard-hit by drought and their sales would be low, with reduced impact on liquidity. Tobacco from contracted farmers has limited impact on liquidity because most of it is pre-funded from foreign sources and the bulk of sales go to loan repayments. Maybe successful implementation of the Lima Convention would proffer a lasting solution to this cash nonsense!
I have laid out the foundation for the “describe-before-prescribe” approach by forming an understanding of the ideal liquidity scenario in the dollarised Zimbabwe and an understanding of the constraining factors to liquidity today.
We would now what to take our analysis further by subjecting the policy measures such as controls on Nostro accounts and cash withdrawal limits under the identified constraining conditions before advising the best policies that the RBZ can adopt to address the country’s liquidity situation in Zimbabwe. This is a discussion for another time.
Persistence Gwanyanya is an economist, banker, and a member of the Zimbabwe Economics Society. He writes in his personal capacity. Feedback: [email protected] and WhatsApp +263 773 030 691.