It is too early to get rid of the 1:1 currency peg, as doing so in the current environment may bring “irreparable damage” to the economy, according to analysts at Zimnat Asset Management.
They however warn that Finance Minister Mthuli Ncube’s new taxes will cut consumer spending and slow down the economy in 2019.
Ncube is under pressure to float the rate, fixed at par with the US. Critics see this as an artificial rate that is bleeding the economy and hurting exporters.
In his 2019 budget statement, Ncube insisted that he would keep “preserving the value of money balances on the current rate of exchange of 1 to 1, in order to protect people’s savings and balance sheets”.
Economic commentator Eddie Cross last week described government’s insistence on currency parity as “ridiculous”.
But in a note to investors on Ncube’s budget, Zimnat Asset Management says Ncube is already slowly “deregulating” the foreign currency market and must stay the course on targeting the budget deficit and raising reserves, before considering any “devaluation”.
“Prematurely devaluing RTGS dollars, i.e. under the current unstable macroeconomic environment, may cause irreparable damage to confidence, national savings, the financial sector, and the overall economy. We therefore agree with the Finance Minister that currency reforms must be undertaken only after the economy and its markets have stabilised. We also hope that a properly constituted and learned Monetary Policy Committee will steer the currency reform process, through the crafting and implementation of sound and sensible monetary policies going forward,” Zimnat says.
Ncube, in his budget, also introduced duty in foreign currency on imported cars and a wide variety of goods. The move has been hugely unpopular, especially given that government has continued to insist on the parity of US dollars to RTGS deposits and bond notes. It will also make it harder for lower income earners to import cars and other goods, while senior officials are exempt from similar duty.
Zimnat analysts take a different view on the measure, saying: “Government’s new controversial policy of levying duties in foreign currency for luxury goods such as motor vehicles, may translate to either a decrease in demand for such goods, which contributes to lowering the trade deficit, because of the higher costs of importing them or may translate to an increase in foreign currency receipts for government, if the demand for the imported luxury goods remain unchanged. Either way, government wins.”
Ncube also ordered that companies selling goods in US dollars must also pay taxes in the same currency. Zimnat says this may boost forex earnings.
“Whilst the new multicurrency taxes are controversial, considering government’s stance in terms on the parity between RTGS dollars and US dollars, from our assessment, government is trying to recover what it has foregone in exporter foreign currency retentions via foreign currency taxes. In addition, government’s ability to generate foreign currency receipts through multicurrency taxes, may accelerate the deregulation of the foreign currency market which we believe is more beneficial for the economy in the long run.”
Zimnat however cautions that 2019 will see a slowdown in the economy, as Ncube’s austerity measures bite.
“We believe that the increases in taxation across the entire economy, coupled with a significant decline in government spending [contractionary fiscal policy], may translate into a slow-down in economic activity in 2019. In addition, if the 2019 Monetary Policy is also contractionary in nature i.e. focuses on tightening liquidity, which is what we expect, this may further accelerate the economic slowdown initiated by the fiscal policy.”
With consumers having less money to spend to buy goods, businesses will also suffer.
Zimnat says: “A slower economy means weaker consumer demand (lower disposable incomes), which may affect industry output and volumes growth. Coupled with foreign currency shortages which are expected to persist in 2019, industrial output is expected to remain subdued, as imported raw material supplies remain difficult to secure or are expensive.”
Ncube has refused to free up the exchange rate, preferring instead to go after the budget deficit, which he sees as the key cause of the currency crisis. He has curbed the issuance of Treasury Bills – the primary source of government’s local debt – and limited use of the central bank overdraft. However, he has been criticised for not going far enough in cutting rampant government spending.
If Ncube’s reforms are implemented fully, Zimnat expects economic stability by the end of 2019. However, the risk of “political pushback” from politicians and the public remains high.
“We strongly believe that controlling the money supply growth and mopping up the excess RTGS liquidity, is critical for the stabilisation of the currency markets, inflation and the overall economy. The deregulation of the foreign currency market must continue, as this will strengthen the country’s exporter base, increase US dollar liquidity within the banking/private sector and stabilise prices,” the Zimnat report says.