Zimbabwe’s liquidity crisis: the curse of China’s slowdown and a strong dollar

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Zimbabwe’s economy has lost momentum since 2012. The period 2009-12 was marked by an economic rebound following the introduction of the multiple currency system (or dollarization), with the annual economic growing averaging 11 percent annually.

However, GDP growth decelerated sharply from 10.6 percent in 2012 to 4.5 percent in 2013, 3.1 percent in 2014, and 1.5 percent in 2015. Consequently, Zimbabwe is de-industrializing, and economic activity is increasingly shifting to the informal sector. The trend is worrisome.

Zimbabwe is sliding into the depths of a recession but economic collapse is not inevitable. One of the main causes of the economic contraction is a liquidity crisis largely caused by a strong US dollar against regional currencies that are part of Zimbabwe’s trade basket and China’s economic slowdown.

Lack of control mechanisms

Because Zimbabwe does not have its own currency, its central bank does not have the policy tools needed to increase (or decrease) the amount of money in the banking system. More specifically, the central bank cannot print paper currency to purchase government securities (lend money to the government) in order to inject money into the economy. Therefore, Zimbabwe is only able to increase the money supply (and liquidity) through (1) exports, (2) diaspora remittances, (3) foreign investments and (4) external lines of credit. Importantly, liquidity affects both the availability of loans to productive sectors and the interest rates charged by banks.

During the period 2009-2015, exports were the dominant source of market liquidity — contributing 59 percent of foreign exchange inflows. International remittances, external loans and FDI contributed 29 percent, 8 percent, and 3 percent, respectively.

But recently these sources of liquidity have been lacking, reflected in the deterioration of the overall balance of payments from – $40,2 million in 2014 to – $385,8 million in 2015. Furthermore, Zimbabwe’s current account deficit has averaged 22 percent of GDP for the period 2012-2015, considerably higher than the Southern African Development Community (SADC) macro-economic convergence criteria threshold of less than 9 percent. Put simply, Zimbabwe is consuming much more than it is producing.

Worryingly, an appreciating U.S. dollar and China’s slowdown will further depress capital inflows, and exacerbated an already critical liquidity crisis.

When China sneezes…

Zimbabwe’s trade exposure to China is high. According to data from China’s National Bureau of Statistics (NBS), bilateral trade between Zimbabwe and China increased from a mere $52.2 million in 1996 to a peak of $1,24 billion in 2014. By comparison, in 2014, the value of U.S.-Zimbabwe trade was $113 million; and the value of EU-Zimbabwe trade was €732 million (about $817 million). Remarkably, the value of China-Zimbabwe trade is greater than Zimbabwe’s combined trade with both the EU and U.S.
Moreover, China is Zimbabwe’s largest foreign investor. During the period 2009-13, China invested $1.3 billion in Zimbabwe (FDI increased from $11.2 million in 2009 to $602 million in 2013). The increase in both China-Zimbabwe trade and investment was propelled by Zimbabwe’s strategic pivot to the East in 2013 under its “Look East policy” — a response to the US and EU imposed sanctions on individuals and state-owned entities reacting to allegations of gross human rights abuses and electoral fraud leveled against President Robert Mugabe’s administration.

Zimbabwe is heavily dependent on China for international capital inflows. However, in 2015 China-Zimbabwe trade decreased sharply from $1,24 billion in 2014 to $462 million, and Chinese investment decreased from $238 million in 2014 to $46,53 million, reflecting the likely new normal as China’s economy looks inwards. According to the NBS, China’s annual GDP growth slowed to 6.9 percent in 2015—its lowest annual GDP growth since 1990. China’s economic growth is projected at 6.5 percent in 2016.

Indeed, over the last decade, China’s growth has had positive spillovers for Zimbabwe. In particular, China’s investment led growth model generated large demand for metals, boosting Zimbabwe’s terms of trade and export volumes. However, China is transitioning away from export and investment-led growth to a model increasingly driven by domestic consumption, with negative implications for commodity prices.

More specifically, in 2015, there was a sharp decline in the prices of precious and base metals: Gold (9 percent), platinum (28 percent), nickel (43 percent), copper (18 percent), and iron ore (42 percent). Critically, weaker prices for precious and base metals—which account for over 50 percent of Zimbabwe’s exports—will result in lower export and fiscal revenues.

Accordingly, as China reorients itself, Zimbabwe must upgrade its portfolio of international economic relations and overcome its dependence on primary commodities. Specifically, Zimbabwe must achieve faster and better-quality economic growth by relying on more engines of growth such as value-added agriculture and manufacturing. Without determined action to diversify its export portfolio, revenues will continue to decline, and market liquidity will further deteriorate.

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A robust USD

Since its introduction in 2009, Zimbabwe’s multicurrency regime—largely anchored to the U.S. dollar—has helped the country restore growth and tame hyperinflation. However, Zimbabwe still faces growth and competitiveness challenges that stem partly from persistent currency overvaluation.

The currencies of Zimbabwe’s major trade partners depreciated greatly against the U.S. dollar in 2015. For example, the South African rand depreciated by 28.5 percent; the Botswana pula by 15 percent; the Zambian Kwacha by 42 percent; and the Mozambican metical by 31.25 percent.

Moreover, a study by the Reserve Bank of Zimbabwe (RBZ) concluded that the real exchange rate under the multicurrency regime is grossly overvalued by 45%. The real exchange rate tells how much the goods and services in the domestic country can be exchanged for the goods and services in a foreign country. When the real exchange rate is high—as is the case in Zimbabwe—the relative price of goods at home is higher than the relative price of goods abroad. Consequently imports are likely to increase because foreign goods are cheaper in real terms than domestically manufactured goods.

Accordingly, Zimbabwe’s exports are not competitive because the same goods can be purchased more cheaply in competitor economies, in large part, because Zimbabwe’s de facto currency is the strong U.S. dollar — all pricing and 90% of trade is in U.S. dollars. Generally, when a currency is overvalued the authorities will adjust the nominal exchange rate by depreciating its currency. However, because Zimbabwe uses a foreign currency it cannot depreciate its currency to restore competitiveness.

(Un) palatable solutions

Therefore, Zimbabwe must either reduce domestic production costs to enhance competitiveness, or reinstate the Zimbabwean dollar. The latter is not a viable option. The largest benefits claimed from dollarization derive from the credibility it carries precisely because it is nearly irreversible. Among other positive economic indicators, high economic growth and accumulations of large foreign reserves would likely enable Zimbabwe to reinstate the national currency. (Country perception and market confidence are also extremely important.) Neither of these indicators describes the current state of Zimbabwe’s economy. Thus, it would be imprudent to bring back the national currency.

The authorities must, therefore, introduce policies that reduce production costs. This includes lower tax rates and less government regulation. Moreover, the authorities must redress key infrastructure bottlenecks in electricity, water and transportation sectors. For example, Zimbabwe’s commercial and industrial tariffs for electricity are higher than the regional averages due to ageing equipment and inefficiencies in the running of thermal power stations. Additionally, about 60 percent of treated water is lost due to broken pipes and illegal connections. Indeed, remedying these cost drivers is the key to restoring competitiveness.

Finally, the U.S. dollar (and Zimbabwe’s real exchange rate) is expected to appreciate further when the U.S. Federal Reserve increases interest rates in 2016, as expected. If the authorities do not urgently address the high domestic cost structures, Zimbabwe’s high import bill will continue to drain foreign exchange resources, further tightening liquidity conditions with constraining effects on economic growth potential.

Source: The Zimbabwe Mail