The economy has been moribund in the aftermath of the 1st of October policy pronouncements which introduced the infamous two per cent money transfer tax coupled with the new requirement for banks to separate export proceeds (NOSTRO FCAs) from local Real Time Gross Settlement (RTGS) balances. Conscious of the disastrous consequences of that policy pronouncement the minister deliberately left contentious issues to speculation in an effort calm the markets and hope that market forces will decimate the destabilising surrogate currency leading to the desired microeconomic environment. Inconsistencies and contradictions on currency matters punctuated his budget statement leaving too many grey areas. Below is an analysis of the key issues arising from the 2019 budget presentation.
Currency reforms
It was widely expected that Ncube was going to introduce far-reaching currency reforms in particular exchange rate liberalisation as a way of dealing decisively with the currency distortions in the market which are largely responsible for the multi-tier pricing structure in the economy and general market indiscipline. Albeit this was not to be as the minister avoided the contentious issue by maintaining the official exchange parity between the RTGS balances and the United States Dollar (USD). The new requirement introduced two months ago for banks to ring-fence export proceeds by creating NOSTRO FCA accounts was the first public admission by the authorities that all balances currently held by the local banks as represented by RTGS balances are now officially bond notes, the surrogate currency introduced by the central bank in 2016 purportedly as an incentive for exporters while easing shortages of US dollar cash in the economy.
Government policy cannot change facts as the market has gradually started rejecting payments in bond notes preferring USD cash including airlines, real estate companies, car sales and pharmaceutical companies. Surprisingly government urgencies have also joined the chorus with Ncube announcing that customs duty and all other taxes on imported motor vehicles and several other goods will now be levied in foreign currency. This is certainly a case of the left hand not knowing what the right hand is doing as the distortions will continue to the detriment of economic stability. The government is applying the parity policy when it suits them most and exporters with low retention percentages will be the main losers because local cost structures are based on RTGS prices which are on average three times higher than USD prices. For the good of the economy, the bond note should be allowed to float and gradually phase out within a reasonable timeframe to allow for re-dollarization and restoration of price stability.
The economy is in a recession
Ncube projected a real gross domestic product (GDP) growth of 4% for 2018 based on a conservative end of the year inflation rate of 25.9 per cent and projected nominal GDP of $24.582 billion. While the official inflation figure quoted for October was 20.85 per cent, independent economic analysts have put the real figure at over 100 per cent based on the recent spike in the prices of goods and services. According to Steve Hanke, a renowned Professor of Applied Economics at the John Hopkins University, the cumulative inflation figure for Zimbabwe is 160 per cent based on his advanced computation methodology which takes into consideration the exchange rate and purchasing power parity (PPP). Contrary to the assertion by the Minister, the Zimbabwean economy is in a recession as a result of a marked decline in real GDP. The projected real GDP for 2018 based on a conservative year on a year inflation rate of 100 per cent is US$12.290 billion down from US$21.844 billion in 2017 implying a real growth rate of -43.7% which firmly reflects an economy deeply in recession.
Fiscal deficits
By the Minister’s own admission fiscal imbalances lie at the core of Zimbabwe’s ongoing financial and economic crisis. The government is spending beyond its means as evidenced by the astronomical growth in the budget deficit which stood at US$2.7 billion (10.9% of GDP up from 2.3% in 2015) as at end of September 2018 and projected reach US$2.9 billion (11.8% of GDP) by year-end after government made a decision to pay an annual bonus to its bloated civil service. The deficit is largely being financed from the domestic financial market as external arrears prevents the country from gaining access to international capital markets. Government borrowing is largely crowding out the productive sector in the credit markets resulting in depressed growth in industrial output. Equally, banks are beginning to feel the pain of excessive government borrowings because of negative returns from Treasury Bills (TBs) after the rate of inflation exceeded the effective yields on the government instruments. The policy pronouncement by Ncube regarding fiscal consolidation is laudable in particular the proposed cuts to vehicle entitlements and fuel allocations to senior government officials. It remains to be seen if there is the political will to enforce the fiscal consolidation measures and trim the civil service to levels consistent with the size of the private sector through staff rationalisation and weeding out of ghost workers.
Taxation regime
Zimbabweans are an overtaxed lot and it was widely expected that the controversial two per cent would be scrapped or at least revised downwards but the minister turned a blind eye to the public outcry while narrowly increasing the non-taxable portion of personal income. In an effort to increase aggregate demand for goods and services, the tax-free threshold on personal income was reviewed upwards from the current US$300 to US$350 while the tax bands from US$351 to US$20,000 were widened and will attract tax rates of up to 40%. Incomes beyond US$20,000 will be taxed at the highest marginal tax rate of 45%. These measures will be effective from the 1 January 2019. The benefits of the additional disposable income will be more than offset by inflation after the minister increased excise duty on diesel and petrol by 7 cents and 6.5 cents respectively with effect from December 1 2018. Consumers should also brace for a new round of price increments after the Minister directed ZIMRA to immediately start collecting duty on imported goods in foreign currency. This is again another tacit admission by the authorities that the bond notes and USD are not at par. Sudden policy changes such as the new duty requirement will unsettle all prospective investors as it leads to unpredictability in the operating environment. Planning is a nightmare in the local environment as businesses cannot accurately predict future cash flows and profitability.
Reserve Bank of Zimbabwe (RBZ) role in forex allocations
It seems the era of excessive government controls is not behind us as the Minister maintained the RBZ fixed exchange regime as well as the inefficient allocation system through a Foreign Currency Allocation Committee, with a broader representation as compared to the current scenario. The allocation system superintended by the Central Bank has created an inefficient mechanism as evidenced by serious shortages of currency to import critical medicines, fuel, chemicals, machinery and raw materials for industrial production. The shortcomings in the official exchange markets are also evidenced by a thriving parallel market which is primarily driving up prices of goods and services and resulting in unstable macroeconomic conditions. The fixed exchange rate regime has also created arbitrage opportunities as well as a breeding ground for corruption. The Central Bank’s function is maintaining a stable exchange rate and supervising foreign currency remittances by authorised dealers through their Exchange Control division. The exchange rate should be allowed to float to enhance generation capacity while ensuring the efficient allocation of scarce foreign currency to different sectors of the economy through the registered dealers. Clearly urgent reforms are required at the apex bank to restore public trust in that institution while licencing of forex Bureau de changes is also necessary to provide a legal platform to exchange currency and reduce rampant illicit currency trading.
Attracting foreign investment
One of the key policy thrusts in the budget statement was the creation of a stable and predictable business environment conducive for growth in domestic and foreign investment in order to promote inclusive and job-creating growth. The local environment is handicapped because of a high country risk profile as evidenced by failure to repatriate dividends by foreign investors while international airlines have resorted to suspending air ticket sales locally as a result of failure to remit over US$150 million in the ticket sales proceeds. The minister revealed that in 2018 FDI inflows into Zimbabwe are projected at only US$470 million while our regional counterparts Zambia and Mozambique attracted about US$1.1 billion and US$2.3 billion respectively during the same period. While the minister committed to improving the local investment climate to attract investment, the budget statement is bereft of guarantees for capital mobility in light of the current account deficit which increased to US$935.8 million for the first three-quarters of 2018 relative to US$246 million for the same period in 2017.
Capital expenditures
One of the commendable aspects of the 2019 budget statement was the allocation towards capital expenditure. Out of the total expenditure estimated at US$8.2 billion, Ncube proposed to allocate US$2.1 billion (25.6%) towards capital expenditure as the first step towards addressing the huge infrastructure deficit in the country. Our infrastructure is in a sorry state following almost two decades of neglect and this is compromising service delivery and increasing costs of doing business in Zimbabwe. The absence of a functional and efficient rail network has resulted in businesses resorting to the use of more expensive alternatives such as road transport.
Foreign Debt and Arrears clearance
Zimbabwe cannot access fresh funding as external arrears are preventing the country from gaining access to international capital markets. Out of a total external debt of US$7.7 billion owed to multilateral lenders and bilateral creditors at least, US$2.4 billion is in arrears. Besides admitting the level of indebtedness, Ncube didn’t provide a clear roadmap on how arrears are going to be cleared at a time when the country has a current account deficit in excess of US$900 million and a ballooning backlog of foreign exchange payments. It is not clear whether the creditors are amenable to debt restructuring suggested by the Minister. The Heavily Indebted Poor Country (HIPC) Initiative, as well as the Multilateral Debt Relief Initiative (MDRI) programs, have been suggested as possible routes for getting out of the debt quagmire.
Sovereign Wealth Fund
The minister proposed to allocate resources from the 2019 Budget towards operationalising the Sovereign Wealth Fund (SWF) for building reserves for the country. While the move is laudable a few points are worth noting. According to the SWF Institute, an SWF is a state-owned investment fund that is commonly established from the balance of payment surpluses, official foreign currency operations, the proceeds of privatisation, government transfer payment, a fiscal surplus and/receipts resulting from resource exports. While the sovereign wealth fund bill was approved by the cabinet on 6 November 2013, it has not yet been operationalised because the capacity is non-existent. Reserves cannot be built up when the government is in a deficit.
In exactly twelve months it will be time to present the 2020 budget and the success or failure of Ncube’ s aspirations as enunciated in the 2019 budget will largely depend on whether the government walks the talk.