Monday, 25 May 2020

ITS A BUBBLE : MANGUDYA ON BLACK MARKET RATES


The rapid rise in parallel market foreign currency exchange rates is symptomatic of a bubble as it lacks any fundamental basis and could lead to economic depression, says Reserve Bank of Zimbabwe governor Dr John Mangudya.

Since the establishment of the interbank foreign currency market last February, parallel market rates have remained ahead of the official rate.

While the interbank rate has remained stable at 25 to the United States dollar, parallel market rates are circling around 60-68 to the dollar.

Bubbles are characterised by a bid-up the price of an asset beyond any real, sustainable value. And when the bubble “bursts” prices crash, demand falls, and the outcome is often reduced business and household spending and a potential decline in the economy.

Dr Mangudya said there are no economic fundamentals to explain the rise in the parallel rates. He indicated that the parallel rate jump was simply excessive speculative behaviour.

“What we have in Zimbabwe is behavioural economics, it’s not about any economic fundamentals. We need to understand why people are behaving the way they are.

“And that behaviour is what we need to deal with as a country. If we don’t do what the Financial Intelligence Unit (FIU) are doing we are going to reach a bubble. What we are doing at FIU is to try and stop it, but mobile telecommunications players are just looking at their income, not the economic welfare of the country,” he told the Parliamentary Portfolio Committee on Budget and Finance last week.

The asset market theory of exchange rate determination implies that exchange rates are largely driven by the development of macroeconomic fundamentals, and that foreign exchange market players form rational expectations concerning future exchange rate developments and that exchange rates are determined in efficient markets.

The RBZ governor contends that this is not the case when it comes to the parallel market.

“It does not take much to move the parallel market rate. US$10 000 can just exchange a few hands at a different rate, and the rate will go up,” he said.

The apex bank is currently embroiled in a legal dispute with Econet Wireless Zimbabwe over a move by the former to freeze flagged mobile agents’ lines.

Behavioural economics studies the effects of psychological, cognitive, emotional, cultural and social factors on the decisions of individuals and institutions and how those decisions vary from those implied by classical economic theory.

Experts in the field of behavioural economics say people’s actual behaviour deviates from the ideal of economic rationality due to at least two reasons: first, decisions are usually based on an incomplete information basis and, second, the information processing of human beings is limited by their computational capacities.

And as a result of these ‘limitations’ people are forced to apply simplification mechanisms in information processing.

The RBZ governor explained that the move to impose a blanket freeze on suspicious accounts was essential to break the network of illegal foreign currency dealers.

Previously, the bank has been suspending isolated accounts or financial entities that would have been flagged for foreign currency manipulation.

“When FIU froze agents accounts in the past, after a few days they found another opening.

“Economic agents in Zimbabwe have a lot of indiscipline and they are putting Zimbabwe’s economy in danger.

“The rising rates are threatening the welfare of the majority,” he said.

Typical economic agents are consumers, producers, and/or influencers of capital markets and the economy at large.

The four major economic agents are households or individuals, firms, governments and central banks.

“We tried isolating the bad apples, such as Cash24, but the rates would go down for a while. But then another operator would come up and push up the rates.

“There is a strong inter-linkage between these rogue entities and isolating one at a time wasn’t working that is why we moved to suspend agent lines.

“We see a small firm opening today and trading $80 million in few days’ time and failing to prove sources of income.”

Some observers have said that the current inflexible official rate of 25 to the US dollar has given impetus to the parallel forex market.

Zimbabwe’s monetary authorities moved from a floating exchange rate to peg the official rate at 25 in March as a move to help contain inflationary pressures during the Covid-19 pandemic.

But business has said the fixed exchange rate is unsustainable.

“Fixing the exchange rate is counterproductive as it weighs on exporters and the interbank, while propping up smuggling of minerals and other export commodities,” said the Zimbabwe National Chamber of Commerce a few weeks ago.

“RBZ should move back to a managed float with regular review to prevent widening parallel market premiums. Regular reviews should at least take into account commercial banks input.” —  ebusinessweekly.

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