The Effects of Reserve Bank Reforms in 2004.

When the new Governor of the Reserve Bank was appointed in 2003 he promised wide-ranging reforms. These were to be in three main areas - exchange rate management, interest rates and tighter controls on the banking system.

To be fair to Mr. Gono, he inherited a mess from his predecessor - registrations of new banking institutions, driven by a political agenda, were spiraling out of control. Interest rates were at dramatically negative levels and the exchange rate was far out of alignment with the real value of the Zimbabwe dollar. At the same time he was faced with rapidly rising inflation, which peaked at over 600 per cent at the year-end - although it should be noted that average inflation for 2003 would be about 325 per cent.

Prior to the Gono era, the parallel market for foreign exchange had been allowed to operate more or less freely and this enabled exporters to seek higher rates of return from exports than would be the case if all their earnings had been converted at the official exchange rates. The low level of interest rates also allowed for very high borrowings by the State with limited impact on the overall budget deficit. They also allowed many financial institutions and businesses that were highly geared, to continue to operate and indeed, thrive. This was at the cost of the accumulated capital stock of the country, which dwindled away to virtually nothing under the combined impact of low interest rates and low returns on investment and high inflation.

Dr. Gono launched his campaign in a spectacular manner - interest rates soared to over 1000 per cent at one stage and the introduction of a heavily disguised devaluation restored some sense to foreign exchange markets. But at the same time he drove the parallel market underground and began a selective witch-hunt for operators that goes on today. At the time these initial reforms were introduced Zimbabwe had 17 commercial banks, over 30 merchant banks and over 70 asset management companies. The huge growth in this sector in the past 5 years had been driven both by black economic empowerment, political patronage and the emergence of new players who had returned to the country to establish their own financial institutions.

Looking back over the past year, the record of the new team at the Reserve Bank is very patchy. The interest rate reforms are in tatters, leaving behind at least 10 commercial banks in trouble and about half of all other financial institutions facing a variety of difficulties. The combined losses of the failed banks will almost certainly exceed the total domestic debt of the Zimbabwe government. How the Reserve Bank will handle this is difficult to know.

The attempt by the Bank to harness the flow of funds from Zimbabweans living abroad has also had a patchy and disappointing record. To date the Bank has seen less than US$50 million flow through its "Homelink" service - a small fraction of the US$70 million a month that is reputed to be flowing through all channels to Zimbabwe recipients. Revenues continue to fall as the gap between the official exchange rates and the unofficial ones actually prevailing in the market widens.

The parallel market is back with a vengeance - rates are now 50 per cent higher than the so-called "auction rate". The Reserve Bank has been forced to recognise that the total elimination of this system would in fact have severe consequences and prosecutions of those operating in the system have dropped off. Exporters who had declared they were withdrawing from export markets, simply because they could not operate on the lower revenues derived from foreign exchange markets, have slowly come back as the Reserve Bank has eased restrictions and allowed some trading on the parallel market.

One success, which serves to highlight the potential of sound policies in the economy, has been in the gold industry. Gold sales to the Reserve Bank had fallen to a third of what they had been in 2000. Gono raised the price of gold rapidly and eventually gave the industry a price that was slightly above the world market price. This has weakened recently with the rise in real prices for foreign exchange and a significant rise in the market price of gold. But the effect has been to double the volume of gold going through the Bank. We estimate that at least a third of all gold production is still finding its way into illegal channels - but the position has improved. However no expansion in gold mining is taking place even under these conditions because of continuing policy uncertainty.

So how do we rate the new team at the Reserve Bank? They deserve credit for trying but must know by now that no amount of juggling with the chips on the table can turn a losing hand. The financial services sector is in a shambles, average inflation in 2004 will be at least 375 per cent - higher than the average in 2004 and there are lots of signs that we may be in for another surge in inflation. Capital stocks continue to shrink and capital flight remains at unsustainable levels in all sectors of the economy. Exports will, at best, stagnate at last years levels of about 1,3 billion US dollars - or a third of what they were in 1997.

The outlook is no better - tourist arrivals are down on 2003 levels, tobacco production will also be down and we are looking at the worst agricultural season ever in 2004/05. Gold sales to the Bank will not hold if more sustainable and predictable policies are not put in place. The recent flurry of new legislation and threats against the mining industry also has the effect of simply freezing all new investment and there would seem to be little willingness to change this situation in the short term. Industry is punch drunk and will continue to shrink in the face of foreign exchange shortages, rapidly rising local costs and restrictions on returns from exports.

The collapse of many of the new players in the financial services industry has taken its toll on the sound players as well as the crooks and incompetent - restoring confidence will be nearly impossible and cleaning up this mess will take time and resources. How many of the new players will survive is anyone's guess - I suspect no more than a handful. It is a tragedy for their investors, customers and for the whole black economic empowerment sector. Far from putting Zimbabwe back on the road to recovery, Gono has been just another Zanu inspired disaster.

E G Cross Bulawayo
21st October 2004