After a decade’s hiatus, the Zimbabwe Dollar has been officially declared back from the currency graveyard.

At the same time, the multicurrency basket was illegalized. Meaning that anyone who has made or received a USD cash payment since about 11am yesterday is a fresh monetary criminal.

Although most Zimbabweans ignored these same legal tender laws during the heights of hyperinflation in the 2000s. So this declaration of a new monocurrency regime is not, in itself, enough to bring the Zimbabwe Dollar back in practice. After all, Zimbabweans have forced dollarisation once before on an unwilling government.

But after the close of banking hours yesterday, the Reserve Bank of Zimbabwe announced its monetary support measures for the new Zimbabwe Dollar. They were technical measures, which made them quite difficult to understand. But the short summary is this: the RBZ does appear to be throwing every measure it can behind bringing the Zimbabwe Dollar back from the dead.

The next few weeks are going to be very telling.

But in the meantime, here’s a (not so short) analysis for you.

6 months, 3 official monetary regimes (and one unofficial one)

First, let’s talk about what has happened in the last six months.

Month 1, Regime 1: The 1:1 Official Parity, Fixed Exchange Rate, Multicurrency Regime

Zimbabwe began the year officially claiming that the US dollar, the Bond note and the RTGS units of currency in the banks were all one and the same thing.

Of course, they were not.

Zimbabwe’s commitment to the US dollar had been a worsening myth for some time. Almost all US dollar trade was happening on the parallel market, and export earners had spent three years being increasingly penalised for being law-abiding users of the formal banking system.

In 2016 and early 2017, the parallel market spread was small – around a 10% premium on the US dollar. By January 2019, exporters were losing almost 70% of their revenues through the 1:1 parity exchange.

A graph for you (of the parallel market rate – remembering that exporters were being forced to convert at 1:1):

There was only one legal way for exporters (and most Zimbabweans) to secure the value of their money: by buying up those assets that were being purchased at the 1:1 official parity exchange rate.

Or to put it slightly differently: through their priority allocation policy, the RBZ was effectively taxing foreign currency earners (and for a time, diaspora remittance recipients), and then using that ‘tax’ to subsidise priority imports (mostly fuel imports, but also food and medication). As the foreign currency crisis worsened, those subsidies grew – as did the tax on inward foreign currency transfers.

This was clearly a bad thing.

Firstly, if you heavily tax your export earners, you’ll get less foreign currency being earned. Which worsens the foreign currency crisis. Which then increased the ‘monetary tax’. So foreign currency inflows were being strangled.

Secondly, if you continually increase subsidies on an imported product (like fuel), you get increasing demand for it. Which means that you need to buy more of it. Which also worsens the foreign currency crisis (just from a different side of the equation). And if you leave the fuel price unchanged, then your subsidy increases and your fuel gets even cheaper in real terms.

This degree of market distortion also incentivises special interest groups to get involved in securing the arbitrage market for themselves. And once those interest groups are entrenched, they have a vested interest in worsening the crisis to increase their profits.

In Zimbabwe, this played out as two contradictory economic phenomena:

• massive increases in the volume of fuel being imported (between January 2017 and December 2018, the monthly fuel import bill doubled); and
• massive fuel shortages.

In mid-January, government intervened by hiking fuel prices to try and slow the arbitrage trade.

This was met with widespread protests, and government responded with an internet blackout, and a military crackdown.

The January Monetary Policy Announcement was delayed.

Then, in late February, Zimbabwe got a new currency regime.

Month 3, Regime 2: The supposedly-Free-Floating-but-actually-a-Managed-Fixed Exchange Rate, Multicurrency Regime

At the end of February 2019, the RTGS dollar was officially announced as a standalone currency. And instantly, the parallel market premium for the US dollar dropped dramatically. As it should. It was an overnight devaluation of the RTGS dollar by almost 60%. And the prospect of a formal foreign exchange market pulled the parallel market rate down as well.

Some keen-eyed readers will note that these numbers don’t quite agree to what they seen on sites like Marketwatch. That’s because, for a while there, Marketwatch was still quoting premiums with reference to the 1:1 rate. It still comes up that way on the page tag-lines, I think. Anyway. These are premium calculations relative to the interbank rate post-RTGSisation.

For most of March, the economy seemed to pause.

But as time rolled by, a few things began to become clear:

1. No one was really able to trade on the Interbank market. In order for a bank to process a trade that varied by more than 5% from the previous day’s closing rate, the bank’s Treasury department would need to clear it with the RBZ first. And the RBZ official on the other end of the line wouldn’t say no, exactly. But they wouldn’t say yes either. And bankers are not known for their courage on this front, so the trades just wouldn’t happen.
2. The priority allocation process remained in place. The RBZ was still handing 1:1 subsidies to priority imports. All the RTGS dollar devaluation had really accomplished was a short term reprieve in the pressure on exporters.

And as it became clear that the interbank rate was being restrained, and that priority imports were still being subsidised, the market rate began to break out again.

But you know who did really well out of this new monetary regime?

ZIMRA.

Sidebar: All the Budget Surplus

After the RTGS announcement, the Zimbabwe Revenue Authority went on a tax-collection spree. On the day that the RTGS dollar was announced, all import duties and VAT went from being calculated at 1:1 to being calculated at 2.5:1. Overnight, excise duties soared. This cost was passed along to consumers. And prices likewise soared. And as the interbank rate weakened, those duties continued to increase.

With all the price increases, the Money Transfer Tax collections also increased.

And let’s not forget that the fuel price structure from January 2019 was not changed. Fuel importers were still being allocated 1:1 import subsidies, which meant that the 70% excise duty on fuel remained.

All this inflation put upward pressure on salaries.

But the PAYE tax brackets also remained exactly as they had before. So PAYE collections began to climb.

In April, ZIMRA announced that it had exceeded its 2019 Q1 revenue collection target by 41% – in a depressed economy, with their targets already based on an austerity budget!

No word yet on the 2019 Q2 revenue collection targets (as we’re still in Q2).

But I’d expect them to overshoot it – by an even longer shot.

Month 5, The Unofficial Monetisation Regime: Dollarisation

Here’s what the interbank and parallel market rates were doing between mid-March and mid-May:

During May, fuel shortages re-emerged with a vengeance, and the parallel market began to spike.

In panic, the RBZ suspended their 1:1 subsidy on fuel, and insisted that fuel importers source their foreign currency on the interbank market. They also allowed the interbank rate to weaken overnight by almost 25%. The Ministry of Finance simultaneously stripped away the excise duty on fuel; and the energy regulator, ZERA, hiked fuel prices by just under 50%.

If you have a look at the market rates, you’ll see a brief recovery in the days after the announcement:

And then the parallel market began to climb again.

As the rate ran, many businesses just stopped even trying to make RTGS pricing happen. The bills would arrive in US dollars, with the option to settle at the parallel rate of the day.

And if you were an exporter, you’d just pay directly in US dollars from your Nostro FCA account.

In short, entire segments of the market had shifted from “dollarising” to “dollarised”.

What was driving the parallel market rate?

When a currency devalues with this level of speed, you usually expect there to be money printing going on. And given that the RBZ (still) has not released any monetary data since January 2019, some might say that there has been some money printing going on.

But here’s the weird thing: for the last few weeks, the Zimbabwean banking sector seems to have been experiencing a liquidity crisis. And we’re not talking about the shortage of foreign currency. We’re talking about a shortage of RTGS dollars.

It seems to be common knowledge that, of late, some banks have been struggling to honour their domestic banking transfers.

Which makes the last few weeks something of a mystery, because:

• There was a shortage of RTGS money in the market; but
• The rapid devaluation of the parallel market rate implies that the market was overflowing in it.

Some suggestions for what was going on:

1. Somewhere in the Ministry of Finance and the Reserve Bank, things were schizophrenic. As in: while one faction within the RBZ and Finance was busy pulling RTGS out of the system (through high taxes and an expensive overnight borrowing window for reserves #rememberthispart), another faction was busy buying foreign currency in the parallel market at any price (possibly with that budget surplus, and the RTGS that they were mopping up).
2. The main traders in the parallel market had syndicated. Or, to use the more ugly term, it had turned into a cartel. Perhaps, after years of parallel market trading, the traders had begun to work together to push the rate up.
3. The market was fully rejecting the RTGS dollar. That is: even though there was a shortage of RTGS dollars in the system, it didn’t matter – because people didn’t want it.
4. Some combination of the above.
5. Or perhaps something else? Because who knows. I’m just speculating.

Either way, all of those options are scary.

Scary enough, it seems, for the monetary and fiscal authorities to introduce a new currency ahead of their timeframe.

Month 6: Zollarisation

First, this announcement from the Ministry of Finance:

Second, this announcement from the RBZ:

What the Minister of Finance wants is clear: for Zimbabwe to have its own currency.

But for it to work, he needs the Reserve Bank to push for it. Which they certainly seem to be doing.

What do those RBZ measures mean?

To answer this question properly, I’m going to ignore some of the more prickly questions (like whether Zimbabweans are prepared to stomach the full restoration of the Zimbabwe dollar), and focus on the weird way that exchange rate markets work.

How exchange rates work

When we talk about the “Exchange Rate between USD and ZWL” (and by USD, I mean “foreign currency in whatever form”; and by ZWL, I mean “Zimbabwe dollars in whatever form – RTGS/Bond/the new dollar/etc”), we are actually talking about the interaction of two different markets. This is different to, say, a market for ice-cream (where there are only really two factors in play: how much ice-cream people want #demand, and how much ice-cream can be produced #supply).

But when we talk about the exchange rate between USD and ZWL, you actually have four factors in play:

1. The demand for USD (eg: how much foreign currency is needed by importers to bring in their products);
2. The supply of USD (eg. how much foreign currency is earned by exporters);
3. The demand for ZWL (eg. how many Zimbabwe dollars are needed by exporters to pay for their local costs); and
4. The supply of ZWL (eg. how many Zimbabwe dollars are available in the local banking sector, and are being held by people that might want to buy USD for imports).

During Zimbabwe’s hyperinflation, the normal interaction of these economic factors was disrupted by a massive oversupply of Zimbabwe dollars by the Reserve Bank. And almost all economic agents (ie. not just importers) joined the USD market. Some were looking for the preservation of value. But many were speculating on the devaluation (mainly by borrowing in Zimbabwe dollars, converting the loan into foreign currency, and then selling only a portion of the foreign currency back to settle their Zimbabwe dollar loan).

So it’s no wonder that the RTGS money printing between 2015 and 2018 got everyone so concerned.

How does a Reserve Bank fix a period of money-printing?

If a Reserve Bank actually wants to reverse the effects of money-printing, it should do a few things:

1. It should start by stopping the printing presses (this is step one, because it only suspends further additions to the money supply);
2. Step 2 is to reduce the supply of ZWL in the market. Usually, it’s described as “mopping up liquidity”.
3. Step 3 is to increase the demand for ZWL. And it would be helpful if the Reserve Bank had a price mechanism to influence here. Oh wait! It does. The interest rate (more on this shortly).
4. Step 4 (if possible) would be to increase the supply of foreign currency.
5. Step 5 (more difficult) would be to reduce the demand for foreign currency – but this tends to be something that can only be done by the fiscal authorities (for example, they could hike tariffs, making foreign goods more expensive, and therefore lowering the demand for foreign currency to pay for them).

So what is the RBZ doing?

Step 1: stop the presses

While we don’t have the published data, the RBZ and the Ministry of Finance are certainly saying that they’re not printing any more money. And the liquidity crisis suggests that they’re telling the truth.

So that would be step one.

Step 2: drain the ZWL supply from the system

According to the announcement, the RBZ is directing the commercial banks to send the RBZ about ZWL 1.2 billion of counterpart funds for foreign legacy debt. As I read it, this forces the commercial banks to transfer some of their physical reserves across to the RBZ.

Having less money in reserves means that banks have to slow down their lending.

Or even recall some of their loans. Which pulls ZWL from circulation.

But there is actually something else here.

Step 3: drive up the demand for ZWL

This reduction in physical reserves has another potential implication.

To explain it, we have to think about how a bank works.

A bank has assets on the one side of its books (which are the loans that it gives to borrowers), and it has liabilities on the other side (which are the deposits that it has received). Banks don’t have all that much actual money sloshing around in their books – mostly, it’s just a lot of IOUs. Which is only natural, because banks don’t make money by holding money: they make money by ‘borrowing’ money from depositors at low interest rates, and on-lending to borrowers at higher interest rates.

But even if banks make their profits through loans, one of their daily functions is to make payments: both between their customers’ own accounts, and to accounts at other banks.

In order to make those payments to other banks, they have to keep some reserve money aside to transfer out. And where is this money kept? Not in the vaults – it’s kept in the commercial bank’s account at the Reserve Bank.

But what happens if they don’t have enough money in their RBZ account to do their transfers? Especially if, say, they just had to transfer a chunk of those reserves out to the RBZ permanently.

Well they have to borrow it. From the RBZ. Using the overnight borrowing rate. Which just went from 15% to 50%.

And because banks don’t make their money by borrowing expensively and lending cheaply, the commercial banks are probably going to increase their interest rates. A lot.

Which is going to encourage any borrowers to pay back their ZWL loans. In ZWL #demand

Step 4: increase the supply for foreign currency

Well, that is literally part (e) of the announcement. And, I guess, the hope is that some of the other measures will bring more foreign currency back into the formal banking system as well.

Step 5: kill the demand for USD

Like I said earlier, usually this is not something that can be done by the monetary authorities.

However.

Where the demand for USD is speculative, you can certainly try to discourage the speculation.

By, for example, making it very expensive to borrow Zimbabwe dollars.

Or, by making a dual-listed shareholder wait 90 days (ie 3 months) to receive payment for the share that they thought they were buying cheaply, and selling expensively.

Anyone doing the Old Mutual arbitrage is basically gambling on the Zimbabwe dollar holding its value for the next three months.

And, of course, the fiscal authorities are doing their part here. Because criminalising the use of USD to settle payments will make it more difficult to use USD. Which may well dampen demand.

So all that is a lot of effort from the RBZ. At least, as far as the announcement goes.

Does this mean the end of parallel market?

Frankly, the answer is an easy “no”.

Even if all those measures work out, there is a fundamental issue here: the RBZ is still trying to control the country’s foreign currency supplies. This means that the use of any foreign currency in the system is still heavily restricted by attempts to prioritise allocations, and to cushion fluctuations in the exchange rate.

On the parallel market, however, you can do whatever you want with the money.

People will pay for that freedom.

And (worse!) the parallel and interbank markets will be locked in a feedback loop with each other. The official rate will push toward the parallel rate (because no-one selling foreign currency will want to miss out on the premium) – but as that happens, the parallel market rate will shift above the official rate to reflect the fact that the use of parallel market money is unrestricted.

So if the RBZ is really serious about eliminating the premium (and stabilising the rate!), it has to release its heavy grip on exchange control. Otherwise, it’ll be forced to depress the official rate artificially – and we’ve seen how that has worked out in the last few months.

Basically, if there isn’t some relaxation of Exchange Control restrictions, the RBZ is leaving all the incentives in place for the parallel market to reprice in all those new interest rate charges, and then push on from there.

But is the Zimbabwe dollar here to stay?

Well, like I said up top, these next few weeks will be very telling.

If those extraordinary RBZ measures pay off, then a few people (possibly more than a few) are going to be quite exposed, and we can expect to see the rate begin to pull back. And that may give enough momentum to push the Zimbabwe dollar back into full circulation.

However.

There is still the issue of heavy-handed Exchange Control. And I keep coming back to the earlier issue of no one really knowing why the parallel market rate was spiralling during a shortage of ZWL liquidity.

If it wasn’t market manipulation, or money printing, or indiscriminate purchasing of foreign currency by a large player (like government or the RBZ), then perhaps it was just outright rejection by the market.

As in: no one would take the RTGS dollar (now the Zimbabwe dollar) at almost any price.

A final speculation

Most people think that currencies are built on “trust” in a monetary authority. That might be existentially true, but only in the grander scheme of things.

What really underpins a currency is what people can use it for. And if a government will accept payment for tax obligations in a certain currency, and as long as that government is committed to tax collections (rather than printing their revenue), then a government tends to back its own currency.

So perhaps the real issue in the last month was not the supply of ZWL.

Perhaps the bigger problem was that the Zimbabwe Revenue Authority has spent the last month insisting (in workshops, newspaper announcements and emails to taxpayers) that portions of VAT, PAYE and Provisional Tax be paid in US dollars.

This seems like something of an own goal to me.

Because if a government refuses to accept payment in its own legal tender, that does undermine the usefulness of said legal tender.

We shall see.

Rolling Alpha posts opinions on finance, economics, and sometimes things that are only loosely related. Follow me on Twitter @RollingAlpha, and on Facebook at www.facebook.com/rollingalpha.