Zimbabwe's Government Continues To Mismanage Economy

The Zimbabwe government has continued its horrendous monetary policy with its recent attempt to drive Zimbabwe's interest rates down in order to aid its country's exporters and to reduce its own payments on its national debt. While the motivation for its recent initiative may be good the results of the new policies will undermine the African nation's economy, which is already on the brink of collapse.

Even though Zimbabwe's inflation rate hovers at 55% and is expected to reach 80% by year's end, the central bank, the Reserve Bank of Zimbabwe (RBZ) has established its intentions to dramatically lower interest rates in the money market. In just the last 60 days interest rates on Zimbabwe's 91-day Treasury Bills have dropped from 60% to 15%. In addition, the Zimbabwe government is making 11 billion Zimbabwe dollars in short-term financing available to Zimbabwe's productive sector and exporters at artificially low interest rates of 30% and 15% respectively.

The short-term rates have been driven down by the RBZ's refusal to mop up excess liquidity by replacing maturing Treasury bills. This month alone, 55 billion worth of Treasury Bills, in Zimbabwe dollars, are maturing and will not be replaced by a new issuance of short-term debt. The excess liquidity has gone to certain equities in the Zimbabwe stock market sending it to record highs but the gains will be short-lived as the chief enemy of the Zimbabwe economy - inflation - continues to erode real earnings and increase uncertainty in Zimbabwe's economy.

The drop in the government's Treasury bills has brought down commercial short-term rates with it but the lower 3-month rate has had no effect on longer-term rates or on commercial bank lending rates. This is because both of these rates are more sensitive to inflation.

The inconsistency of the new policy is revealed in the fact that while the RBZ is driving down short-term rates to 15% it is holding its lending rate to its best banking customers at 58%. This is due to the RBZ's policy of keeping its lending rate to banks at 2 to 3 percentage points higher than the rate of inflation. This has caused banks to keep their lending rates to their customers in the range of 55 to 63%. Lending rates at such exorbitant levels stifle economic growth.

The RBZ is hoping that it can roll its short-term debt into longer term debt at artificially low interest rates but the policy is already showing signs of failure as last week's efforts by the government to raise money with 1 and 5 year debt instruments fell short of its goals. The reason: investors wanted a higher rate of interest in return for their purchase of Zimbabwe debt.

The reason that interest rates are so high in Zimbabwe for bank loans and in the mid-term monetary market is because creditors and bidders want an interest rate that protects them from the ravages of inflation. And the only way that Zimbabwe will address its inflation problem in the long-term is by providing stability in its unit of account - its currency. Currently the Zimbabwe officially dollar trades at the rate of 55 Zimbabwe dollars to 1 US dollar.

In August of last year, on IMF advice, Zimbabwe devalued its currency from the rate of 38 Zimbabwe dollars to 1 US dollar. At the time we editorialized that the decision would prove to be a disaster and would result in only more inflation inside of the country, which did in fact occur.

Now, pressure is mounting inside of the country for another devaluation. In addition, the IMF, who inspired the initial devaluation, is now telling Zimbabwe that its currency is overvalued by as much as 50%.

But the Zimbabwe government is hesitant to devalue its currency as it seeks to manage its enormous debt. Currently the country's debt is 150% of its Gross Domestic Product (GDP), with its domestic debt as large as 50 % of GDP and interest payments accounting for half of the expenses in Zimbabwe budget. The IMF estimates that Zimbabwe's interest payments on its debt this year could balloon to as much as 119 billion Zimbabwe dollars. And with an external debt projected to rise to $900 Million US dollars a decision to devalue its currency would be counter-productive, as it would take more Zimbabwe dollars to pay off its external debt.

But it must do something to address its inflation and interest rate woes. The inflation problem has become so much of a nuisance to everyday citizens that the government is being forced to introduce $200 and $500 bills in Zimbabwe in order to make transactions convenient. Currently, the country has no note values higher than the $100 note. Inflation caused the introduction of the $50 and $100 notes in 1994 and 1995.

The best way for inflation and interest rates to fall would be for Zimbabwe to tie its currency to the US dollar or euro under a currency board arrangement with a gold price rule that enables it to determine whether the US dollar or euro were dramatically inflating or deflating in terms of gold. In addition, Zimbabwe should lower its marginal tax rates, which are some of the highest in the world, across the board. As inflation races upward it causes Zimbabwe's impoverished citizens to be forced into higher tax brackets (known as tax bracket creep) where they are forced to pay more taxes on dollars that are increasingly worth less.

A gold-price rule currency board and lower marginal tax rates will dramatically lower inflation, interest rates, and Zimbabwe's debt-service payments while allowing Zimbabwe citizens to maintain more of their earnings, setting the stage for capital formation and economic growth.

Cedric Muhammad

Wednesday, January 31, 2001

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