Tuesday, February 19, 2008

Zimbabwe's hyper-inflation's path

ZIMBABWE’S INFLATIONARY ENVIRONMENT

Zimbabwe’s chart topping inflation reportedly at 24,000 % qualifies the nation as experiencing hyper inflation. Compare that to the next highest inflation of 40% in Burma. The main cause of hyperinflation is a massive and rapid increase in the amount of money( estimated at 17,000%), which is not supported by growth in the output of goods and services. This results in an imbalance between the supply and demand for the money (including currency and bank deposits), accompanied by a complete loss of confidence in the money, similar to a bank run. The enactment of legal tender laws and price controls to prevent discounting the value of paper money relative to gold, silver, hard currency, or commodities, fails to force acceptance of a paper money which lacks intrinsic value. When the entity responsible for printing a currency promotes excessive money printing, with other factors contributing a reinforcing effect, hyperinflation usually continues. The body responsible for printing the currency cannot physically print paper currency faster than the rate at which it is devaluing, thus neutralising their attempts to stimulate the economy. This clear like with the new $ 750,000 bearer ( or is it burial) cheque. The country’s highest note could not even buy a loaf of bread. Can you imagine walking into Tesco in the UK and one loaf costing more than £ 50,or being in Walmart in the USA and the loaf going for more than US$ 100? Imagine being in No Frills ,in Canada one loaf going for more than C$ 100 ?This is how Zimbabwe’s currency has been decimated by inflation.


vde
Zimbabwean inflation rates (official) since independence
Date
Rate
Date
Rate
Date
Rate
Date
Rate
Date
Rate
Date
Rate
1980
7%
1981
14%
1982
15%
1983
19%
1984
10%
1985
10%
1986
15%
1987
10%
1988
8%
1989
14%
1990
17%
1991
48%
1992
40%
1993
20%
1994
25%
1995
28%
1996
16%
1997
20%
1998
48%
1999
58%
2000
56%
2001
132%
2002
139%
2003
385%
2004
624%
2005
586%
2006
1,281%
2007
24,059%
2008
%
2009
%

Zimbabwe Inflation Since 1980


Zimbabwe’s hyper-Inflation is a result of the monetary authority irresponsibly borrowing money to pay all its expenses and funding quasi-fiscal activities(which are normally left to Central Government). In Neoliberalism, hyperinflation is considered to be the result of a crisis of confidence. The monetary base of the country flees, producing widespread fear that individuals will not be able to convert local currency to some more transportable form, such as gold or an internationally recognized hard currency.
In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base, that is the confidence that there is a store of value which the currency will be able to command later. The perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums. This is akin to trading cash with no apparent economic activity( read Cash Baron).



Rates of inflation of several hundred percent per month are often seen. Extreme examples include:

Germany in 1923 when the rate of inflation hit 3.25 × 106 percent per month (prices double every 49 hours)

Greece during its occupation by German troops (1941-1944) with 8.55 × 109 percent per month (prices double every 28 hours).

The most severe known incident of inflation was in Hungary after the end of World War II at 4.19 × 1016 percent per month (prices double every 15 hours).

More recently, Yugoslavia suffered 5 × 1015 percent inflation per month (prices double every 16 hours) between 1 October 1993 and 24 January 1994. Zimbabwe may be on its path to match if not break some of these records.

A great deal of economic literature concerns the question of what causes inflation and what effect it has. A small amount of inflation is generally viewed as having a positive effect on the economy .One reason for this is that it is difficult to renegotiate some prices, and particularly wages, downwards, so that with generally increasing prices it is easier for relative prices to adjust. Many prices are "sticky downward" and tend to creep upward, so that efforts to attain a zero inflation rate (a constant price level) punish other sectors with falling prices, profits, and employment. Efforts to attain complete price stability can also lead to deflation, which is generally viewed as a negative because of the downward adjustments in wages and output that are associated with it. More generally because modest inflation means that the price of any given good is likely to increase over time there is an inherent advantage to making purchases sooner than later. This effect tends to keep an economy active in the short term by encouraging spending and borrowing, and in the long term by encouraging investments. High inflation, though, tends to reduce long-term capital formation by hurting the incentive to save, and to effectively reduce long-term spending by making products less affordable. Limited investments will result in shortages of opportunities for corporate which will be forced into speculation.In addition corporate become less focused on core-business as they try to survive.This can lead to corporate cannibalisation whereby companies essentially trade each other’s shares without any meaningful investment in plant, equipment, stock or capacity.

Inflation is also viewed as a hidden risk pressure that provides an incentive for those with savings to invest them, rather than have the purchasing power of those savings erode through inflation. In investing, inflation risks often cause investors to take on more systematic risk, in order to gain returns that will stay ahead of expected inflation. Inflation is also used as an index for cost of living adjustments and as a peg for some bonds. In effect, inflation is the rate at which previous economic transactions are discounted economically.

However, in general, inflation rates above the nominal amounts required to give monetary freedom, and investing incentive, are regarded as negative, particularly because in current economic theory, inflation begets further inflationary expectations.

Increasing uncertainty may discourage investment and saving.
Redistribution It will redistribute income from those on fixed incomes, such as pensioners, and shifts it to those who draw a variable income, for example from wages and profits which may keep pace with inflation. An senior pensioner still receiving a couple of thousand Zimbabwe dollars being a clear example.
Similarly it will redistribute wealth from those who lend a fixed amount of money to those who borrow. For example, where the government is a net debtor, as is usually the case, it will reduce this debt redistributing money towards the government. Thus inflation is sometimes viewed as similar to a hidden tax. This discourages savings and investment, the actual tax regime becomes impossible to calculate.

International trade: If the rate of inflation is higher than that abroad, a fixed exchange rate will be undermined through a weakening balance of trade, and forex shortage will set in.
Shoe leather costs: Because the value of cash is eroded by inflation, people will tend to hold less cash during times of inflation. This imposes real costs, for example in more frequent trips to the bank. (The term is a humorous reference to the cost of replacing shoe leather worn out when walking to the bank or hours spend trying to access cash) .Firms must change their prices more frequently, which imposes costs, for example with restaurants having to reprint menus.

Some economists see moderate inflation as a benefit; some business executives see mild inflation as "greasing the wheels of commerce."

Demand-pull inflation: inflation caused by increases in aggregate demand due to increased private and government spending, etc.
Cost-push inflation: presently termed "supply shock inflation," caused by drops in aggregate supply due to increased prices of inputs, for example. Unavailability of forex being a key driver of cost push inflation in Zimbabwe.
Built-in inflation: induced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built-in inflation reflects events in the past, and so might be seen as hangover inflation. All these factors are now at play in Zimbabwe, its now impossible to separate what is causing what.

Rational expectations theory holds that economic actors look rationally into the future when trying to maximize their well-being, and do not respond solely to immediate opportunity costs and pressures.
A core assertion of rational expectations theory is that market participants will seek to “head off” central-bank decisions by acting in ways that fulfil predictions of higher inflation. This means that central banks must establish their credibility in fighting inflation, or have economic actors make bets that the economy will expand, believing that the central bank will expand the money supply rather than allow a recession. But when you promise to withdraw a high value note only to say “I was just joking” that wont do much to build a solid reputation.

There are a number of methods that have been suggested to control inflation. Central banks such the Reserve Bank of Zimbabwe can affect inflation to a significant extent through setting interest rates and through open market operations (that is, using monetary policy).In Zimbabwe however monetary policy has ceased to be useful management tool. The inflation is at 24000%,RBZ borrows through treasury bills at 340% then on-lends the money at 25% .This sequence of rates is a disaster. In monetary policy was to be an effective tool using the above numbers RBZ would have to borrow at slightly above 24000% ,then on-lend at even higher rate say 24050%. High interest rates and slow growth of the money supply are the traditional ways through which central banks fight or prevent inflation, though they have different approaches. For instance, some follow a symmetrical inflation target while others only control inflation when it rises above a target, whether express or implied. Facilities such as Baccossi are highly inflationary.Such facilities subsidises loans and eliminate commercial banking activity since corporate are driven to borrow from such facilities and get a false sense of efficiency.

Wage and price controls have been successful in wartime environments .In general wage and price controls are regarded as a drastic measure, and only effective when coupled with policies designed to reduce the underlying causes of inflation during the control regime, for example, winning the war being fought(in Zimbabwe’s case winning Chimurenga 4). The usual economic analysis is that which is under priced is overconsumed, and that the distortions that occur will force adjustments in supply. For example, if the official price of bread is too low, there will be too little bread at official prices. And your only source of bread becomes the black market. This trend undermines the formal sector as more activity goes underground and the governments ability to raise revenue is reduced.

The removal of zeros only work is accompanied by some influx of forex to support the local currency. This can be in form of foreign aid ,foreign direct investment or increased exports.

Temporary controls may complement a recession as a way to fight inflation: the controls make the recession more efficient as a way to fight inflation (reducing the need to increase unemployment), while the recession prevents the kinds of distortions that controls cause when demand is high. However, in general the advice of economists is not to impose price controls but to liberalize prices by assuming that the economy will adjust and abandon unprofitable economic activity. The lower activity will place fewer demands on whatever commodities were driving inflation, whether labor or resources, and inflation will fall with total economic output. This often produces a severe recession, as productive capacity is reallocated and is thus often very unpopular with the people whose livelihoods are destroyed.
Price controls such as “operation dzikisa mutengo” whilst initially very popular they can ruin a nation dramatically fast.

Gilbert Muponda is a Zimbabwean born Entrepreneur, living in exile. He can be contacted at gilbert@gilbertmuponda.com

Zimbabwe inflation linked to corruption

In my first article I gave a quick comparison of Zimbabwe’s high inflation at 24,000% compared to the next highest which was Burma/Myanmar at 40%. Zimbabwe and Burma are both under sanctions. The two countries are also very close allies of China. They both possess massive natural resources. And the Chinese have been keen to maintain the relationships so as to access Rubber, Oil, Steel, Gold, Copper, Nickel, Timber and other natural resources. So the question that comes to mind is if these two nations share such similarities how come Zimbabwe’s inflation is so high at 24,000% and Burma is only at 40%. Part of the answer lies in corruption, so in this article I seek to establish the link between inflation and corruption. Corruption in finance and economics is at times called rent seeking. Inflation is correlated with corruption.

Burma like Zimbabwe, a resource-rich country, suffers from pervasive government controls, inefficient economic policies, and rural poverty. Lacking monetary or fiscal stability, the economy suffers from serious macroeconomic imbalances - including rising inflation, fiscal deficits, multiple official exchange rates that overvalue the Burmese kyat, a distorted interest rate regime, unreliable statistics, and an inability to reconcile national accounts to determine a realistic GDP figure .Its clear that Zimbabwe and Burma have a lot in common and their high inflation is partly due to similar policies. Burma is rated the most corrupt country in the world. And its inflation is the second highest in the world after Zimbabwe.

Corruption is a general concept describing any organized, interdependent system in which part of the system is either not performing duties it was originally intended to, or performing them in an improper way, to the detriment of the system's original purpose. Political corruption, dysfunctions of a political system or institution in which politically elected officials seek illegitimate personal gain through actions such as bribery, extortion, cronyism, nepotism, patronage, graft, and embezzlement. "Rent seeking" is a closely related term in economics. In some nations corruption is so common that it is expected when ordinary businesses or citizens interact with government officials (for example someone selling a passport form). The end-point of political corruption is a kleptocracy, literally meaning the “rule by thieves”. It should be noted that a government is not and cannot be corrupt. It is only the individuals who may become corrupted.

Monetary policy rests on the relationship between the rates of interest in an economy, that is the price at which money can be borrowed, the total supply of money and inflation. Monetary policy uses a variety of tools to control one or both of these, to influence outcomes like economic growth, inflation, exchange rates with other currencies and unemployment. Once one of these components is corrupted through any manipulation such as the direct release of funds from the issuing authority to the public such as black market forex runners then the system becomes corrupt and feeds directly into inflation. This is so because of the general market’s lack of confidence in the currency, which loses value at any alarming rate.

In economics, rent seeking occurs when an individual, organization, or firm seeks to make money by manipulating the economic and/or legal environment rather than by making a profit through trade and production of wealth. The term comes from the notion of economic rent, but in modern use of the term, rent seeking is more often associated with government regulation and misuse of governmental authority than with land rents.

Rent seeking generally implies the extraction of uncompensated value from others without making any contribution to productivity, such as by gaining control of land and other pre-existing natural resources, or by imposing burdensome regulations or other government decisions that may affect consumers or businesses. While there may be few people in modern industrialized countries who do not gain something, directly or indirectly, through some form or another of rent seeking, rent seeking in the aggregate may impose substantial losses on society.

Most studies of rent seeking focus on efforts to capture special monopoly privileges, such as government regulation of free enterprise competition (like fixing exchange rates and price controls as in Zimbabwe). Other rent seeking is held to be associated with efforts to cause a redistribution of wealth by, for example, shifting the government tax burden or government spending allocation.

If the international markets regard a domestic government as conducting an irresponsible monetary policy (such as excessive growth in the money supply or unduly low interest rates (Bacossi) Then there will be capital flight from that market. Other Central banks will not help when called upon to. The reported release of $2.1 trillion to a private firm on the basis of a verbal agreement undermines the credibility of the RBZ. We all know the Herald doesn’t lie. Right? If the report by the Herald is correct then it proves that the nature of the relationship maybe corrupt, and must be investigated further as it undermines the RBZ‘s reputation. Once the RBZ becomes involved in such corrupt practices then there is need to provide more checks and balances to ensure the national purse does not becomes someone’s back pocket.

Zimbabwe’s fixed and unsound foreign exchange rate policy aid corruption and in turn feed the hyperinflation. A simple example will clarify the point. Assuming one approaches the RBZ and accesses $US 1000 at the official rate of 1; 30,000.It means you pay the RBZ Z$ 30 million. The you walk across the city to fourth street to take the US$ 1,000 to Road Port and you meet one of the RBZ’s runners who offers you 1; 4,000,000.So for each US$ you get 4 million Z$. So for your RBZ sourced US$ 1,000 you get a whooping Z$ 4 billion. Magic? So within one morning $ 30 million becomes $ 4 Billion. Since this is sweeter than honey at around 2 PM you rush back your suitcases of burial checks to the RBZ and buy more forex. This time around you are loaded with $ 4 billion so you can get a massive US$ 133,000.And by now from a mere millionaire in the morning by end of day you are now in the respectable neighbour hood with Z$ 533 billion (US$133, 000 times Z$ 4,000,000).

From the above analysis its clear the fixed exchange rate accompanied by corruption feeds the hyperinflation cycle. There has to be corruption for you to access the US$ 1000.And once you have this money even if you are a very serious business man you will be very foolish to try and buy equipment, stocks or whatever it is you said you were going to buy. You simply take this $ US to the RBZ runners at Road Port then sell it to them at $ 4,000,000 and go back to the RBZ and buy some more at $30,000.So for each US$ you make a profit of Z$ 3,970,000.

As a result you keep doing this and why would you bother to go and open a proper business which produces Bread, Soap, Candles when you clearly know once operation Dzikisa mutengo comes you can lose all your “hard earned” profits. This trend is highly inflationary which explains why its not advisable to fix the currency especially if there is no other major source of forex once you do this then you will become the King of all cash barons.
As can be seen above our enterprising friend turned $ 30,000,000 into Z$ 533 billion within a day. There was no production involved; yet he had a ready buyer for the forex (RBZ runner). This is how inflation gets out of hand. No matter what policing you do as long as such loopholes exist then you have to keep running to stay at the same place.

This vicious cycle is further enhanced by other not-so-properly-structured facilities such as Baccossi, which lends money at 25%. One wonders why 25%, why not 15% or 300%. These cheap funds are disastrously inflationary. Assuming Cde Cell-Phone Farmer gets a Baccossi facility of Z$ 1 billion, its clear there is a clear incentive to take it or some of it to Road Port. But if he is more daring then he could simply get your burial checks to the RBZ and buy say US$ 1000 at 1; $ 30,000.Once he disposes the US$ 1000 to an RBZ runner at Road port then you have instantly become a billionaire so with his new found wealth the next week you can go back to the RBZ and pay off the $ 1 billion loan and remain with $ 3 billion profit before you even start any production. But since the money is almost free at 25% when inflation is at 24,000%, you are better off holding on to the money and spin it more. Or just lend it to the RBZ by buying treasury bills, which yield more than 300% with your cost being only 25%.

I hope this clearly explains why we end up with a trillion dollar house, Billion-dollar car, Million-dollar bed and a thousand dollar freezit. So Cde Cell-Phone Farmer would be a trillionaire or is it a quadrillionaire without any production whatsoever at his farm, thanks to facilities like Baccossi and fixed exchange rates. Please note nobody really knows why we have an exchange rate of 1; 30,000 and Baccossi interest of 25% .Why not lower, and why not higher.? Hopefully someone didn’t consult the diesel n’anga to come up with the interest rate or fixed exchange rate. These rates can’t be so divorced from reality as in inflation and trade deficit. Should this happen the mazhero will be back with a vengeance.

From a theoretical standpoint, the moral hazard of rent seeking can be considerable. If "buying" a favourable regulatory environment is cheaper than building more efficient production, a firm will choose the former option, reaping incomes entirely unrelated to any contribution to total wealth or well-being. This results in a sub-optimal allocation of resources — money spent on lobbyists and counter-lobbyists rather than on research and development, improved business practices, employee training, or additional capital goods — which retards economic growth. Claims that a firm is rent seeking therefore often accompany allegations of government corruption, or the undue influence of special interests. This affects inflation since money will exchange hands without any production or value addition.
Rent seeking may be initiated by government agents, such agents soliciting bribes or other favours from the individuals or firms that stand to gain from having special economic privileges, which opens up the possibility of exploitation of the consumer. It has been shown that rent seeking by bureaucracy can push up the cost of production of public goods. It has also been shown that rent seeking by tax officials may cause loss in revenue to the national purse (Zimra).

Corruption also undermines economic development by generating distortions and inefficiency. In the private sector, corruption increases the cost of business through the price of illicit payments themselves, the management cost of negotiating with officials, and the risk of breached agreements or detection. Although some claim corruption reduces costs by cutting red tape, the availability of bribes can also induce officials to contrive new rules and delays. Openly removing costly and lengthy regulations are better than covertly allowing them to be bypassed by using bribes. Where corruption inflates the cost of business, it also distorts the playing field, shielding firms with connections from competition and thereby sustaining inefficient firms, which fail to produce to meet demand.The shortage of goods will result in inflation as all the money available chases after the little that’s available.

Besides pushing inflation, corruption also generates economic distortions in the public sector by diverting public investment into capital projects where bribes and kickbacks are more plentiful. Officials may increase the technical complexity of public sector projects to conceal or pave way for such dealings, thus further distorting investment. Corruption also lowers compliance with construction, environmental, or other regulations, reduces the quality of government services and infrastructure, and increases budgetary pressures on government.

University of Massachusetts researchers estimated that from 1970 to 1996, capital flight from 30 sub-Saharan countries totalled $187bn, exceeding those nations' external debts. In the case of Africa, one of the factors for this behaviour was political instability and corruption, and the fact that new governments often confiscated previous government's corruptly obtained assets. This encouraged officials to stash their wealth abroad, out of reach of any future expropriation. In contrast, corrupt administrations in Asia like Suharto’s have often taken a cut on everything (requiring bribes), but otherwise provided more of the conditions for development, through infrastructure investment, law and order.

Gilbert Muponda is a Zimbabwe-born entrepreneur, living in exile. He can be contacted at gilbert@gilbertmuponda.com

Artificially low interest rates fueling inflation

How low interest rates are feeding Zim inflation

Interest is a fee paid on borrowed capital. The most common form in which these assets are lent is money, but other assets may be lent to the borrower, such as shares, consumer goods through hire purchase, major assets such as aircraft, and even entire factories in finance lease arrangements. In all cases the interest is calculated upon the value of the assets in the same manner as upon money. According to this Interest can also be viewed as "rent on money".Generally speaking, a higher real interest rate reduces the broad money supply. The "real interest rate" is the nominal interest rate minus the inflation rate. Zimbabwe continues to have negative real interest rates. These rates discourage investment and production but aid undesirable levels of speculation and in turn aid and abet inflation.

According to the quantity theory of money, increases in the money supply lead to inflation as explained in my first article published by Newzimbabwe.com. This means that interest rates can affect inflation .

Interest is compensation to the lender for foregoing other useful investments that could have been made with the loaned money. Instead of the lender using the assets directly, they are advanced to the borrower. The borrower then enjoys the benefit of the use of the assets ahead of the effort required to obtain them, while the lender enjoys the benefit of the fee paid by the borrower for the privilege. The amount lent, or the value of the assets lent, is called the principal. This principal value is held by the borrower on credit. Interest is therefore the price of credit, not the price of money as it is commonly - and mistakenly - believed to be. The percentage of the principal that is paid as a fee (the interest), over a certain period of time, is called the interest rate.

Loans, bonds, and shares have some of the characteristics of money and are included in the broad money supply. And any increase on these assets which is not matched by production feeds into the inflation spiral. The returns on loans, bonds and shares whilst having different names they are equivalent to interest and these returns can be inflationary if not matched by an equivalent quantity on the supply side.



Zimbabwe’s interest rate outlook, as already noted, continues controlled and directed towards a low interest rates policy through subsidised credit facilities designed to support the productive sectors of the economy. These facilities whose rates are as low as 25%include the Agricultural Mechanisation Program (AMP), the Agricultural Sector Productivity Enhancement Facility (ASPEF) and the Basic Commodities Supply-Side Intervention Facility (BACOSSI). The Government, as the biggest borrower on the financial markets, will be negatively affected if the Treasury bill rate was to be increased. As a result, the one year Treasury bill rate has been held constant at 340% since January 2007.

These facilities mortgage the nation’s future due to their nature of being loss making without any mechanism to compensate for the direct loss arising out of their implementation. As noted earlier the lending body borrows money at the treasury bill rate of 340% ,then lends through facilities such as BACOSSI,ASPEF,AMP at a rate of 25%.This direct loss could be recovered through taxation assuming the borrower pays tax . Unsound interest rate policy leads to rapid money supply expansion.

There is need to make interest rates market determined and let private sector play a leading role. This could be done through commercial banks and other privately owned financial institutions. Artificially controlled interest rates work in the same ways as any other price control. They normally achieve the opposite effect(opposite the desired outcome).

These facilities while implemented with good intentions end up fueling inflation. This is mainly because of loop holes and other factors which encourage speculative behaviour at the expense of long term investment. Facilities such as these work if accompanied by a stable macro-economic environment which allows for long term planning. There is need for predictable policies and consistant application of the rule of law which builds investor confidence to invest with a longer term view.

The Zimbabwe economic environment, as it stands now is not of short-term speculative participants. The speculative behaviour is both understandable and rational given the current operating environment.


Speculation, in finance, involves the buying, holding, selling, and short-selling of stocks, bonds, commodities, currencies, collectibles, real estate, derivatives, or any valuable financial instrument to profit from fluctuations in its price as opposed to buying it for use or for income via methods such as dividends or interest. Speculation or agiotage represents one of four market roles in financial markets, distinct from hedging, long- or short-term investing, and arbitrage.
Overall, the participation of speculators in financial markets tends to be accompanied by significant increase in short-term market volatility. This is not necessarily a bad thing, as heightened level of volatility implies that the market will be able to correct perceived mispricings more rapidly and in a more drastic manner. Speculation aids a more efficient price discovery process. Speculative purchasing can also create inflationary pressure, causing particular prices to increase above their true value (real value - adjusted for inflation) simply because the speculative purchasing artificially increases the demand. Speculative selling can also have the opposite effect, causing prices to artificially decrease below their true value in a similar fashion

There are markets for investments which include the money market, bond market, as well as retail financial institutions like banks, which set interest rates. Each specific debt takes into account the following factors in determining its interest rate:
Opportunity cost: This encompasses any other use to which the money could be put, including lending to others, investing elsewhere, holding cash (for safety, for example), and simply spending the funds.
Inflation: Since the lender is deferring his consumption, he will at a bare minimum, want to recover enough to pay the increased cost of goods due to inflation. Many governments issue 'real-return' or 'inflation indexed' bonds. The principal amount and the interest payments are continually increased by the rate of inflations. In Zimbabwe’s case there is an imbalance mainly due to negative interest rates. Its understandable that the Government being the biggest borrower has tries to maintain low interest rates (negative real interest).The logic being to access cheaper credit, but this has allowed other borrowers to borrow at the same or similar rate and such funds have led to rapid money supply expansion reportedly at or 17,000%.

Default: There is always the risk the borrower will become bankrupt, abscond or otherwise default on the loan. The risk premium attempts to measure the integrity of the borrower, the risk of his enterprise succeeding and the security of any collateral pledged. For example, loans to developing countries have higher risk premiums than those to the US government due to the difference in creditworthiness. An operating line of credit to a business will have a higher rate than a mortgage.
Creditworthiness of businesses is measured by bond rating services and individual's credit scores by credit bureaus. The risks of an individual debt may have a large standard deviation of possibilities. The lender may want to cover his maximum risk. But lenders with portfolios of debt can lower the risk premium to cover just the most probable outcome.
Deferred consumption: Charging interest equal only to inflation will leave the lender with the same purchasing power, but he would prefer his own consumption NOW rather than later. There will be an interest premium of the delay. He may not want to consume, but instead would invest in another product. The possible return he could realize in competing investments will determine what interest he charges.
Length of time: Time has two effects shorter terms have less risk of default and inflation because the near future is easier to predict. Broadly speaking, if interest rates increase, then investment decreases due to the higher cost of borrowing under normal circumstances.
Interest rates are and should generally should be determined by the market, but government intervention - usually by a central bank- may strongly influence short-term interest rates, and is used as the main tool of monetary policy. The central bank offers to buy or sell money at the desired rate and, due to their control of certain tools (such as, in many countries, the ability to print money which is the case in Zimbabwe) they are able to influence overall market interest rates. And if they do not properly use such tools hyper-inflation can easily be the result.
Investment can change rapidly to changes in interest rates, affecting national income, and changes in output affect unemployment. Positive real interest rates encourage savings which would hopefully be invested to increase production. Increased production will help to meet demand and bring about demand and supply equilibrium. This will result in stable prices.

Gilbert Muponda is a Zimbabwe-born entrepreneur, living in exile .He can be contacted at gilbert@gilbertmuponda.com

Challenges faced by Zimbabwe banks

Zimbabwe’s banking sector is under siege. Banks are being labelled all sorts things as the scapegoat finding season hots up. Banks and other institutions have been accused of holding “non-core assets” and engaging in “non-core” activities. As pointed out last week this presents Big Brother with a good sample to select appropriate whipping boys to open the latest round of “scapegoat finding season”.

The relevant question is how did it come to this ? And why did all banks find it necessary to do it ?Where were “the authorities“? It has to be beyond personalities. It’s a national problem and has to be treated as such. Those familiar with the sub-prime mortgage problems in the US and those in the UK will be more familiar with the recent or should I say current Northern Rock crisis. In the Northern Rock crisis the Bank of England has been forced to provide approximately £ 50 billion ( in $Z it’s a 5 with 21 zeros) to one bank to avoid a collapse due to a run on the bank. In the USA the Fed Reserve has had to inject billions of dollars. In December all major central Banks including US Fed ,Bank of Canada ,Bank of England, Swiss central bank and European Central Bank used combined effort and resources to inject more than US$200 billion to stabilise the financial markets. The point here is Banks can not be allowed to fail. Banks and financial institutions can not be allowed to collapse. The failure of a Bank is symptomatic of a bigger underlying structural problem emanating from beyond the bank.


The banking system developed when, people deposited gold coins,precious metals and silver coins at goldsmiths for safe keeping, in return of a note for their deposit. Slowly the notes became a trusted medium of exchange an early form of paper money was born, in the form of gold certificates and silver certificates.
Over time the notes were used directly in trade, the goldsmiths observed that people would never redeem all their notes at the same time, and exploited the opportunity to issue new bank notes in the form of interest paying loans. These generated income—a process that enhanced their role from passive guardians of bullion charging fees for safe storage, to interest-paying and earning banks. When creditors (the owners of the notes) lost faith in the ability of the bank to exchange their notes back into coins, many would try to redeem their notes at the same time. This was called a bank run and many early banks either went into insolvency or refused to pay up.

Banks are required to keep on hand only a fraction of the funds deposited with them which allows the function of the banking business. Banks borrow funds from their depositors (those with savings) and in turn lend those funds to the banks’ borrowers (those in need of funds). Banks make money by charging borrowers more for a loan (a higher percentage interest rate) than is paid to depositors for use of their money. If banks did not lend out their available funds after meeting their reserve requirements, depositors might have to pay banks to provide safekeeping services for their money. For the economy and the banking system as a whole, the practice of keeping only a fraction of deposits on hand has an important cumulative effect. Banks make money from various products and services .These include interest on loans, fees and margins on forex trades. It must be noted banks have to make money regardless of the operating environment. And for this to happen banks have to develop various products and services that match their operating environment. This article is a brief look at how the Banks operating environment has been poisoned to make it almost impossible for them to stay afloat whilst focusing on traditional “core-activities” and holding “core -business-assets”

The foreign exchange (currency or forex or FX) market exists wherever one currency is traded for another. It is by far the largest financial market in the world, and includes trading between large banks, central banks, currency speculators, multinational corporations, governments, and other financial markets and institutions. The average daily trade in the global forex and related markets currently is over US$ 3 trillion.Retail traders (individuals) are a small fraction of this market and may only participate indirectly through brokers or banks, and are subject to forex scams and arrests in the case of Zimbabwe‘s black market. In many markets there is bureau de changes which help mobilise foreign currency. In Zimbabwe these were outlawed in one of the early “scape goat finding” seasons, when they were blamed for fuelling the black market.

The Zimbabwe forex market was further reduced by various regulations which essentially tried to centralise the market whilst simultaneously paying an unrealistic exchange rate .This action has deprived the banks of an important fee and income generating product and service. Banks would normally source forex,be its custodian and provide a ready and perhaps more transparent market for forex. Banks generally knew the exporters and the importers. As such Banks were better placed to match these participants requirements and earn a fee or some income in the process.

This cant be viewed in isolation. The other main area a is bank is supposed to make money is on loans through interest income. The RBZ has come up with various programmes providing subsidised funding .These facilities whose rates are as low as 25% include the Agricultural Mechanisation Program (AMP), the Agricultural Sector Productivity Enhancement Facility (ASPEF) and the Basic Commodities Supply-Side Intervention Facility (BACOSSI).This product directly competes with Banks who are supposed to lend to the same clients and earn sufficient interest income to keep the banks afloat. In reality a bank can not match this rate being offered by the RBZ, which has now been converted to a massive commercial bank. The only difference being it can lend money on a non-commercial basis with a net effect of taking the bread out of the commercial banks mouth.

Below is a general description how the forex market should work .The forex market has various transactions including spot, forward and swaps. A spot transaction is an immediate delivery transaction. This trade represents a “direct exchange” between two currencies, has the shortest time frame, involves cash rather than a contract; and interest is not included in the agreed-upon transaction. Spot has the largest share by volume in FX transactions among all instruments.

A forex forward contract is an agreement between two parties to buy or sell a currency at a pre-agreed future point in time. Therefore, the trade date and delivery date are separated. It is used to control and hedge risk, for example currency exposure risk (e.g. forward contracts on US$ or Z$).Its use broaden and deepen the forex market since participants will have more option to satisfy their forex needs.

One party agrees (obligated) to sell, the other to buy, for a forward price agreed in advance. In some forward transactions, no actual cash changes hands. If the transaction is collateralized, exchange of margin will take place according to a pre-agreed rule or schedule. Otherwise no forex of any kind actually changes hands, until the maturity of the contract.( but a commitment fee maybe payable upfront).This secures the forex. These contracts are legally enforceable. Its therefore important to have a strong and independent judiciary system which allows both parties to enforce their rights. The presence as in Zimbabwe’s case of a participant who appears above the law or who can unilaterally shift contract goal posts undermines these critical financial instruments.

The forward price of such a contract is commonly contrasted with the spot price, which is the price at which the forex changes hands (on the spot date, usually within two business days). The difference between the spot and the forward price is the forward premium or forward discount. In Zimbabwe’s case the premium would then reflect the scarcity of forex plus the forex rate uncertainty and market volatility.

Forward contracts are personalized between parties ( but can be sold or ceded). The forward market is a general term used to describe the informal market by which these contracts are entered into. In Zimbabwe this would involve a financial institution and an exporter or an importer. This would allow the bank or the exporter to plan with some certainty about a future cash flow. This stabilised the market. The premium which now is openly a black market rate would legally and correctly be incorporated as the premium for committing to rates upfront. Standardized forward contracts are called futures contracts and traded on a futures exchange.

In finance, a swap is a derivative in which two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. This allows parties to swap say Zim dollars today and exchange the amounts at an agreed date. This allowed participants to legally lend each other foreign currency. This involved most financial institutions including the Central Bank which was probably the biggest player and beneficiary.

Zimbabwe has always needed outside forex for it balance of payment support. This came from various sources including donors,aid,direct foreign investment, supra-national organisations such as world bank,IFC and exports. These started to dry up about 8 years ago .As forex became more scarce the black market developed. The Banking industry responded with various products that included forward contracts, swaps and other forex linked derivatives. This allowed industry to access the at market determined rates.This is so because derivatives allow a premium or discount to factor in the scarcity, the volatility and the uncertainty. Using such instruments the banking system was able to efficiently allocate the scarce resource without letting the exchange rate get out of control. This way the market remained more formalised as banks acted as agents of the RBZ and the RBZ didn’t have to directly release trillions directly to its runners.

Prior to December 2003 this was the norm. The market players would transact at the going market rates as determined by the forward, swap and other derivative market instruments. These instruments were critical in the price discovery process as they factored most of the known risk variables .This kept the market reasonably stable and allowed RBZ, government and industry to orderly access whatever forex available. Then suddenly in December 2003 the biggest player in the market decided to unilaterally change pre-agreed rates in all forward, swap and other derivative contracts it had obligations .

This spelt a disaster for the sector. This is so because even if an institution was not a direct participant in the forward or swap contracts if it had exposure to any player who had a contract that was unilaterally re-priced that spelt enough trouble to cause panic which would then trigger a bank run when coupled with other factors. The unilateral re-pricing of contracts ( i.e. changing exchange rates pre-agreed) was and is ruinous to who ever is holding the contract .In short this meant certain institutions were unable to pay for their obligations as their expected cash flow from forward, swap and other derivative contracts were dramatically reduced by the key participant in the forex market.

A currency swap (or cross currency swap) is a foreign exchange agreement between two parties to exchange a given amount of one currency for another and, after a specified period of time, to give back the original amounts swapped. Swaps can be used to hedge certain risks such as interest rate risk and exchange rate risk plus the future availability of forex.In the Zimbabwean case this would involve swapping forex for Zim dollars ,with the understanding that at maturity this would be reversed. Obviously should the other party choose to unilaterally change the swap currency or transaction terms then other market participants would be exposed to ruin.

Currency swaps can be negotiated for a variety of maturities up 25 years. Unlike a back-to-back loan, a currency swap is not considered to be a loan by many accounting laws and thus it is not reflected on a company's balance sheet. A swap is considered to be a foreign exchange transaction (short leg) plus an obligation to close the swap (far leg) being a forward contract. This allows market participants to lend each other and carry out their normal economic activity using such products . Currency swaps involve the exchange of the principal amount. Interest payments are not netted (as they are in interest rate swaps) because they are denominated in different currencies.

Currency swaps are often combined with interest rate swaps. For example, one company would seek to swap a cash flow for their fixed rate debt denominated in US dollars for a floating-rate debt denominated in Euro. This is especially common in Europe where companies "shop" for the cheapest debt regardless of its denomination and then seek to exchange it for the debt in desired currency. Zimbabwean companies have been excluded from such markets because of the country’s risk profile. The involvement of an interest and currency swap in one transaction allows the participants to accurately price the risk and reward who ever is providing the commodity being traded in this instance the exporter would be fairly rewarded whilst the importer can plan with certainty that they will be able to import their raw materials. This kept production systems on tracks and allowed the formal economy to function.

It is clear banks have been left with no option but to improvise to remain afloat. They deserve credit for that. They cant make loans out as the clients have a greater risk of default due to hostile environment. In addition the central bank has forex runners who by-pass the banks. They cant trade in forex as this has all been centralised and generally monopolised to such an extent its now a preserve of the central bank. This indicates the need to look beyond individual banks but rather the whole operating environment, regulations and various policy shifts which happen so constantly such that its almost impossible to assess their benefits. The central bank is now competing with the banks and as such banks have been crowded out of the traditional areas such as provision of market determined loans and forex transactions. Instead of being the lender of last resort the RBZ has become the lender of first choice. This is partially responsible for eroding the confidence in the banking system and undermining the sector. It may be time to amend the Banking Act to enable banks to ride the crisis .

Gilbert Muponda is a Zimbabwe-born entrepreneur, living in exile. He can be contacted at gilbert@gilbertmuponda.com

Zimbabwes Economic recovery

By Gilbert Muponda
http://www.gilbertmuponda.com/

Zimbabwe needs fresh leadership for the Zimbabwe Economy to recover. Zimbabwe can be likened to a very poorly performing Company. And its CEO is non other than President Mugabe, and if the company is to have any chance of recovery its imperative that the CEO who led the company to its ruin must be “retired”. I have already written extensively about Zimbabwe’s Economic problems. In this article I seek to suggest ways to resolve the Economic decay. Even if Zimbabwe was to get a Finance Minister from planet Jupiter and RBZ Governor from the Outer Space Zimbabwe’s Economy would never recover as long as President Mugabe remains the CEO of Zimbabwe Inc.

There is no need to act like false prophets who masquerade as turn around experts and avoiding giving the clear and honest advice that the nation’s economic problems can not be solved as long as President Mugabe remains in office .Zimbabwe needs a new CEO who can restore confidence to investors ( foreign and local).It is pointless to keep changing or criticising the governor when its clear he is only a messenger acting on behalf of his “principal”.I am sure President Mugabe would like to retire but is obviously asking himself what is in it for me?


Zimbabwe’s political risk is so high such that its almost impossible to attract any investment ( foreign or local).Political risk refers to the risk that revolution or other political conditions will result in a loss.
There several different types of political risk, including (among others):
Political violence, such as revolution, insurrection, civil unrest, terrorism or war;
Governmental expropriation or confiscation of assets;
Governmental frustration or repudiation of contracts;
Wrongful calling of letters of credit or similar on-demand guarantees; and
Inconvertibility of foreign currency or the inability to repatriate funds.
There is total lack of confidence in the economy such that capital flight and a run on the currency make it impossible to simply try to cover up the real issues affecting the Economy. The President is 84 years old and has been ruling for 28 years. Any reasonable analyst will ask what other strategy or plan can he implement which he hasn’t in the last 28 years. I have yet to hear of such a senior citizen who was able to successfully turn around an economy .Given his advanced age and a that turn around situation demands a younger leader who can with-stand the pressure and stress that comes with trying to save a sinking titanic. As a comparison Russia’s next leader is likely to be a 42 year old.


In a corporate set up Zimbabwe’s presidential candidates can be likened to investors trying to take over a company.The phrase mergers and acquisitions (abbreviated M&A) refers to the aspect of corporate strategy, corporate finance and management dealing with the buying, selling and combining of different companies that can aid, finance, or help a growing company in a given industry grow rapidly without having to create another business entity.Takeover is a business term that refers to one company (the acquirer, or bidder) purchasing another (the target). These candidates need a clear and sustainable strategy to achieve their mission of replacing the country’s current CEO. Just because it hasn’t been done in Zimbabwe doesn’t mean its impossible.


A likely and effective strategy is to form an alliance which in business we refer to as a Consortium. A consortium is an association of two or more individuals, companies, organizations or governments (or any combination of these entities) with the objective of participating in a common activity or pooling their resources for achieving a common goal. Each participant retains its separate legal status and the consortium's control over each participant is generally limited to activities involving the joint endeavor, particularly the division of profits.
Consortium is a Latin word, meaning 'partnership, association or society' and derives from consors 'partner', itself from con- 'together' and sors 'fate', meaning owner of means or comrade.

At this critical stage politicians can borrow various corporate and financial strategies to achieve their goal .In many situations a client may want to borrow more money than one bank can comfortably lend .A common strategy is to form a syndicate.
In finance, a group of banks lending, for a specific purpose and to one single borrower, a - mostly large - amount of money is referred to as a bank syndicate or often only as a syndicate . In investment banking, refers to a group of investment banks that share underwriting risk in respect to an issuer's securities. Referred to as the underwriting syndicate.This is what is currently confronting Zimbabwe.A hige task beyond capacity of one individual or one organisation.This limits individual risk but dramatically increases chances of success.

In the current set up its clear that all the other candidates lack the total resources required to unseat the current CEO. The answer is to form a syndicate of all the opposing forces. It must be noted the opposing forces dont actually need to like or love one another. All thats required is a common purpose. In business its not uncommon for competitors to collude or cooperate to achieve a common goal .A competitor should be ready to aid his opponent if the outcome serves to achieve a common objective. An immediate example is Google Inc currently offering to help its bitter rival Yahoo! Inc to fend of a hostile bid from Microsoft.

When a bidder makes an offer for another company, it will usually inform the board of the target beforehand. If the board feels that the offer is such that the shareholders will be best served by accepting, it will recommend the offer be accepted by the shareholders. A takeover would be considered "hostile" if (1) the board rejects the offer, but the bidder continues to pursue it, or (2) if the bidder makes the offer without informing the board beforehand.

The main consequence of a bid being considered hostile is practical rather than legal. If the board of the target cooperates, the bidder will be able to conduct extensive due diligence into the affairs of the target company. It will be able to find out exactly what it is taking on before it makes a commitment. A hostile bidder will know only the information on the company that is publicly available and will therefore be taking more of a risk. Banks are also less willing to back hostile bids with the loans that are usually needed to finance the takeover.In the Zimbabwe political scene this is what seems to be playing out.It is important for all the opposing participants to identify insiders and work across party lines to minimise risk and lend credibility to their proposed takeover of Zimbabwe Inc.

In a private company the shareholders and the board are likely to be either the same people or closely connected with one another. Therefore all private acquisitions are likely to be friendly, because if the shareholders have agreed to sell the company then the board, however comprised, will usually be of the same mind or be sufficiently under the orders of the shareholders to cooperate with the bidder.

In cases where management may not be acting in the best interest of the shareholders (or creditors or stakeholders), a hostile takeover allows a suitor to bypass intransigent management. This is very similar to politicians who are no longer faithfully serving those who elected them.In this case, this enables the shareholders to choose the option that may be best for them, rather than leaving approval solely with management. In this case, a hostile takeover may be beneficial to shareholders, which is contrary to the usual perception that a hostile takeover is "bad."

In publicly held companies, various methods to avoid takeover bids are called "poison pills".As a variation of the poison pill defense, the people pill is an anti-takeover defense under which the current management team of the target company threatens to quit en masse in the event of a successful hostile takeover.

The effectiveness of a people pill is dependent on the circumstances of the takeover. If the management team is efficient, the company will be left without experienced leadership following a takeover. On the other hand, a great number of takeovers are the result of inefficient leadership in which management will be fired anyway; the people pill will be ineffective in this situation.However in politics its slightly different because of the presence of career politicians those who eat,drink and sleep politics.They try to resist any takeover or change because they fear losing posts,jobs,perks and benefits.This section has to be handled with care as they are normally prepared to defend the status quo.

A golden parachute is a clause (or several) in an executive's employment contract specifying that they will receive certain significant benefits if their employment is terminated. Sometimes, but not always, these clauses apply only in the event that the company is acquired and the executive's employment is terminated as a result of that acquisition. These benefits may include severance pay, cash bonuses, stock options or a combination of the items. The benefits are designed to reduce perverse incentives.In Zimbabwe’s this is critical.It appears during the SADC initiated talks this particular clause was not tacticfully handled.It appears the opposition did not sufficiently address any incentives for the encumbent to participate in any proposed change.

A world wide trend to handle this is normally to offer a blanket immunity from prosecution for the current leadership from any crime or alleged crime.The amnesty and immunity normally covers the current leadership ,its family and close allies.This is critical to minimise resistance to change.This happened in Russia immediately when president Putin took power from President Boris Yelstin.This is critical as it allows a smooth and less volatile transition.It is most unlikely that any encumbent will ever cooperate unless and until offered such solid assurances that normally come as part of a new constitution or a presidential decree. For as long as their fate or allies’ fate remains unknown and subject to guess work then resistance will be at its maximum level.

In business a firm facing a hostile take over normally use what in corporate finance terms are called Killer bees.Killer bees are firms or individuals that are employed by a target company to fend off a takeover bid; these include investment bankers (primary), accountants, attorneys, tax specialists, etc. They aid by utilizing various anti-takeover strategies, thereby making the target company economically unattractive and acquisition more costly or impossible. They will defend the current management by almost any means necessary. The task of the bidder and his advisors is then to soften the killer bees and have as many of them defect to the other side. In a political set up in Zimbabwe’s case these comprise of elements within the security services,civil service and private sector who have embedded interest in the current set up. They need to be assured that they will not be disadvantaged by any proposed

Anybody who has ever bought a business will confirm that hard part is not to raise the money,but rather the part to convince management to cooperate and not resist new ownership .It is almost impossible to take over without reassuring the current managers that they will keep their jobs and perks.Should they be retired/fired they need to know that they are getting fair compensation for past service. Zimbabwe Inc’s current suitors need to address these concerns if the mission is to succeed.

Gilbert Muponda is a Zimbabwe-born entrepreneur, exiled in Canada. He can be contacted at gilbert@gilbertmuponda.com

See additional articles at http://www.gilbertmuponda.com/


Gilbert Muponda is a Zimbabwe-born entrepreneur, exiled in Canada. He can be contacted at gilbert@gilbertmuponda.com
See additional articles at http://www.gilbertmuponda.com/
Central banks and the conduct of monetary policy have often been viewed as impenetrable mysteries, understood only by the limited few who somewhere along the way gained access to an exclusive club.Even well-informed citizens will find it difficult to think clearly about many economic issues and debates without having at least an approximate understanding of what central banks do.As part of the 12 part inflation series I have had to cover Monetary and Fiscal Policies mainly due to Zimbabwe's now infamous Quasi-Fiscal Activities (QFA)being carried of by its central bank. These activities due to their nature as unbudgeted off-balance sheet expenditure have been inflationary since they have been funded through printing of money.

Monetary policy refers to any of a number of government measures undertaken to affect financial markets and credit conditions with the ultimate objective of influencing the overall behaviour of the economy. Monetary policy is the responsibility of the Central Bank that implements its policy decisions largely through its ability to alter the money supply.Any excess money growth will likely result in inflationary pressure.

Fiscal policy is the use of government taxing and spending powers to affect the behaviour of the Economy .Fiscal policy also refers to government action to change the total or composition of revenues and expenditures in order to manage the growth of demand in the economy .The economy's total output, income and employment levels are directly related to total private and public spending or aggregate demand.Fiscal policy is normally the responsibility of the minister of Finance.In most countries the minister of finance and the governor of the Central Bank consult regularly. Furthermore there has been an explicit agreement that if any irreconcilable conflict between the two arises, the governor must either follow the written (and publicly released) directive of the minister or resign office.


QFA are defined as operations and actions whose effect can and and should be in principle be carried out by budgetary measures in form of explicit tax,subsidy or direct expenditure .QFA are motivated most of the time by the desire to hide what are essentially budgetary activities for political or other reasons.Examples include subsidised credit facilities and lending to groups of borrowers with inadequate collateral or with unbankable business proposition.By shifting what are essentially taxes and subsidies from government account to central bank account QFA severely distort the measurement of revenue and expenditure they render attempts sto assess fiscal policy meaningless.QFA create contigent implicit liabilities which the government is expected to fullfil there by mortgaging the nations future without proper approval.Since QFA are normally meant to circumvent the normal budgetary process they end up being funded by printing money which leads to hyoer inflation is unchecked.

The use of off-Budget activities for public policy purposes that can be duplicated by specific fiscal measures, such as taxes, subsidies or other direct expenditures leads to policy instability. Public enterprises, for instance, are used to promote or subsidise certain groups through below-market pricing. These quasi-fiscal activities disguise the size of the government, cause over-consumption and waste, and contribute to macroeconomic imbalances.This leads normally to increase in monetary expansion which is unmatched by supply as a result inflation can set in.QFA are not encouraged as they by-pass normal check and balances as offered by the proven systems such as parliament and several parliamentary committees which keep expenditure in line with revenues as provided by budget.

Private spending consists of purchases of goods and services by consumers, by businesses for investment, and net exports (exports minus imports). Governments raise revenues from taxes such as the income tax, sales taxes and payroll taxes, and from other sources to spend on such things as health care, education, pensions, social assistance and defence.This process is guided by the national budget which is crafted by the ministry of finance after consulting with other government departments.This process is critical and if the foundation of public finance.Once the government ascertains its needs it then lookst at ways to fund it needs.The budget spells out all this.The point is to make sure government properly spends within its limits so as to maintain a sustainable budget policy.Any expenditure not provided for in the budget then exposes the nation to the risk of printinng money to cover for unbudgeted for expenses.This is why Quasi-Fiscal Activities are undesirable , as they hide government expenditure and revenues in the same way off-balance sheet transactions hide a Company's true financial position.

Central banks exist in most countries as government-owned institutions operating with considerable independence from the governing political structures. It is crucial, therefore, that the central bank be accountable to the people through their elected officials.For this reason most central banks are accountable to the Minister of Finance . Monetary policy may be sufficiently complex and technical that its implementation is left to experts who specialize in nothing else, but in a well-functioning and market economy, the people must ultimately be left to judge the performance of those experts. Such judgment requires a basic understanding of the main issues.

The monetary policy is aimed at harnessing the benefits of low inflation . Among other things, a credible commitment to keeping inflation low helps create a positive climate for low interest rates and productive long-term investment. This in turn strengthens the growth of the economy and its capacity to generate new jobs. An important benefit of low inflation is that it generates less uncertainty, interferes less with the operation of the price system, and thus imposes fewer costs on society .It is important that fiscal policy and monetary policy be separate even though they are complimentary.A hidden technique of combining the fiscal and monetary policy is generally refered ro as Quasi Fiscal Activity( QFA).It has to be avoided as it seeks to circumvent proven systems such as national budgets which make national institutions accountable to the people through Parliament.

Monetary policy is normally guided by an inflation-control target . This means adopting various measures and steps to keep inflation low and within a certain pre-set level.Low inflation would then bring about stability and translate into a better standard of living for the the nation.Essentially, successful monetary policy requires central banks to invest in the creation, monitoring, and projection of economic information-all devoted to achieving a better understanding of developments and relationships in the domestic and world economies.
Inflation erodes the value of money. When future prices are less predictable, sensible spending and saving plans are harder to make. People increasingly fear that their future purchasing power will decline and erode their standard of living.

Inflation encourages investments that are speculative and take advantage of inflation rather than productive investment. It can also create the illusion of temporary financial success while masking fundamental economic problems. Businesses and households must spend more time, and money, protecting themselves from the effects of rising costs and prices. Businesses, workers, and investors respond to signs of inflation by pushing up prices, wages, and interest rates to protect themselves. This can lead to a "vicious circle" of rising inflation. Inflation can mean particular hardship for those whose incomes don't keep pace with the rising level of prices, especially people on fixed incomes such as senior citizens who are receiving pensions.

Consumers and businesses are better able to make long-range plans because they know that their money is not losing its purchasing power year after year. Interest rates, both in nominal and real terms, are lower, encouraging investment to improve productivity and allowing businesses to prosper without raising prices. Sustained low inflation is self-reinforcing. Businesses and individuals do not react so quickly to short-term price pressures by seeking to raise prices and wages if they are confident that inflation is under long-term control. This contributes to keeping inflation low.

Finally, monetary policy is restricted by the impact of other government actions, especially Fiscal Policy ie, decisions about government expenditures and taxation. Fiscal policy also influences overall economic demand, and if fiscal and monetary policy are not co-ordinated, they can work at cross-purposes.

Central banks choose to focus on maintaining low and relatively stable inflation for two reasons. First, low inflation is beneficial for the operation of the economy. Second, both theory and evidence suggest that monetary policy cannot have a systematic and sustained effect on macroeconomic variables other than the inflation rate. Given this limited scope for monetary policy, it would make little sense for monetary policy to adopt other long-run targets, such as the unemployment rate or the growth rate of real output. It is natural for central banks to adopt a long-run target for the one thing that they can reasonably expect to influence over the long run-the rate of inflation.

When the Central Bank has clearly stated objectives and takes policy actions that affirm those objectives, the result is an increase in its credibility. This credibility, in turn, helps to keep expectations of future inflation close to the inflation target-what is sometimes called an anchoring of inflation expectations Through maintaining low and relatively stable inflation, central banks make their best contribution to the economic health of a nation. This objective is grounded in the propositions that (1) high inflation is damaging to the economy, and (2) monetary policy is unable to have a systematic and lasting effect on macroeconomic variables other than the rate of inflation.

The biggest cost of inflation is the uncertainty that it generates and the inefficiencies it creates by distorting the information conveyed by relative prices. Cross-country evidence suggests that countries with higher rates of inflation also tend to have more volatile rates of inflation.. Stable output growth is desirable. Genuine benefits come from having a more stable growth rate of real output and also from having a more stable output gap.

It is impossible to determine precisely that the greater stability in inflation and output growth has been the result of better monetary policy rather than just a less volatile economic environment. Monetary policy is forward-looking. The transmission mechanism of monetary policy is the complex chain of cause and effect that connects policy actions by the Central Bank to aggregate demand, output, and inflation. Monetary policy works with long and variable lags, and monetary policy must therefore be forward-looking, anticipating events that are likely to happen in the world and domestic economies. For this reason it is important that policy be clearly spelt out and then be given an condicive atmosphere to succeed.
Two types of uncertainty complicate the conduct of monetary policy: uncertainty about the precise workings of the transmission mechanism, and uncertainty about economic events in both the global and local economies. Both types of uncertainty require that the Central Bank invest considerable resources in research, current analysis, and projection in order to make the best-informed policy decisions.This means inflation figures be released on time and be accurate.

Currently there is hot debate whether inflation is 24,000% or 26,000% or 164,000%.This lack of accurate and trusted inflation statistics make the markets unstable.Currently there is a wide shortage of basket goods used to calculate inflation.Households have no choice but to use home-made statisitcs which tend to be closer to reality since they compare actual price movements albeit in the black market.Due to lack of accurate figures business and households generally expect inflation to be very high and in turn ask for higher prices and salaries which feeds the inflation circle.

The RBZ has come up with various programmes providing subsidised funding .These facilities whose rates are as low as 25% include the Agricultural Mechanisation Program (AMP), the Agricultural Sector Productivity Enhancement Facility (ASPEF) and the Basic Commodities Supply-Side Intervention Facility (BACOSSI).This product directly competes with Banks who are supposed to lend to the same clients and earn sufficient interest income to keep the banks afloat. In reality a bank can not match this rate being offered by the RBZ, which has now been converted to a massive commercial bank.These facilities represent a hidden tax since this money is not at market rates.It means someone (tax payer) is subsidising these facilities through an undeclared tax. As noted above these facilities lack an relation to reality.Current money market rates are around 700% -1600%, yet money can be borrowed at around 25% which creates loopholes and leads to market distortions and market inefficiencies.The only reason why this money is so cheap its because its printed money which mistakenly is being viewed as a benefit ignoring the more disasterous impact on money supply and inflation.

As a direct result of QFA the central bank has moved into areas which it doesnt have expertise or capacity.This has dangers especially in terms of giving out loans with no capacity to carry out a proper credit assessment and put in measures to recover the money.Once a lender like the RBZ gets involved borrowers are attracted to such a lender since this lender lacks proper capacity to monitor the loans dished out.The RBZ becomes lender of prefered choice as borrowers stampede for loans which in all likely hood they would never have to repay.Commercial Banks and other financial institutions a better plsced to be providing loans as they have long built check and balances to monitor loans and give other assistance to allow clients to repay the loans in full.

The recent threats to revamp entities such as Zimbabwe Development Company with a view to take over "unpatriotic" companies represents an extension of QFAs.The now much talked about People's shops cant be viewed differently from the controversial Operation Dzikisa Price.If all other Supermarkets cants provide cheap food how can the People's Shops do it without being subsidised?This is how QFA activities mislead the market and distort resource allocation.This trend discourges business to invest .As a result shortages will follow leading to increased black market activities and run away inflation..The formal sector will be further eroded as most economic activity goes under ground to escape unsound policies.

Gilbert Muponda is a Zimbabwe-born entrepreneur, exiled in Canada. He can be contacted at gilbert@gilbertmuponda.com
See additional articles at http://www.gilbertmuponda.com/