NOTHING BUT STOP-GAP MEASURES IN LATEST MONETARY POLICY

UNCLAS SECTION 01 OF 03 HARARE 000653 SENSITIVE SIPDIS AF/S FOR G. GARLAND ADDIS ABABA FOR USAU ADDIS ABABA FOR ACSS NSC FOR SENIOR AFRICA DIRECTOR B.PITTMAN TREASURY FOR D.PETERS AND T.RAND STATE PASS TO USAID FOR L.DOBBINS AND E.LOKEN COMMERCE FOR BECKY ERKUL E.O.12958: N/A TAGS: EFIN ECON PGOV PREL PHUM ZI SUBJECT: NOTHING BUT STOP-GAP MEASURES IN LATEST MONETARY POLICY STATEMENT REF: Harare 627 -------------- SUMMARY -------------- ¶1. (U) In his Monetary Policy Statement (MPS) delivered on July 30, 2008, Reserve Bank of Zimbabwe (RBZ) Governor Gono announced the removal of ten zeros from notes in circulation, and the introduction of a new currency. He failed, however, to introduce any new policies that would tame inflation and sustain the new currency. He continued to defend the disbursement of deeply concessionary funding that is driving money supply growth and fuelling inflation. Despite the dire need for growth in exports to generate foreign exchange, the RBZ increased its anti-export bias by reducing companies' retained export earnings, which will likely result in a further fall in exports and put more downward pressure on the local currency. In the face of a sharply contracting economy and out-of-control inflation, this MPS offered nothing more than stop-gap solutions to the symptoms of economic meltdown. END SUMMARY. -------------- Ten Zeros Lopped Off, And a New Currency -------------- ¶2. (U) The centerpiece of the MPS was a temporary fix to the problem of high-denominated bank notes, which arose out of hyperinflation and vexed IT systems. (NOTE: The highest denominated bank note of Zimbabwe's palette of over 40 different bills is the Z$100 billion "special agro-cheque" introduced on July 21 and now worth about U.S. 65 cents on the street. END NOTE.) Gono announced the re-denomination of monetary values by a factor of 1:10 billion (i.e. he removed ten zeros) with effect from today. ¶3. (U) To buttress the removal of zeros, Gono announced the introduction of a new currency. (COMMENT: The denomination of the new bank notes (Z$1, 5, 10, 20, 100 and 500) printed over a year ago appears to have determined the number of zeros dropped in this round of revaluation. End Comment.) The current bearer and special agro-cheques will continue to be legal tender and circulate concurrently with the new currency until the end of December 2008. Gono also reintroduced coins that had been demonetized during "Sunrise 1" as legal tender in the new values. -------------- Higher Daily Cash Withdrawal Limit -------------- ¶4. (U) Gono also announced a twenty-fold hike to Z$2 trillion (before revaluation) or Z$200 (revalued) in the daily cash withdrawal limit, which had been Z$100 billion. He appealed to "stakeholders to exercise restraint in their demand for cash and in how prices are set." -------------- Killing the Goose... -------------- ¶5. (U) The Governor admitted that the shortage of foreign exchange was a major constraint on production, yet he penalized exporters by increasing the amount of foreign exchange that they must surrender to the RBZ. He raised the proportion of earnings that exporters receive in local currency (at a grossly overvalued exchange rate) from 35 percent to 45 percent. -------------- Domestic Credit to Government - HARARE 00000653 002 OF 003 Driving Money Supply Growth -------------- ¶6. (U) Figures in the MPS show that the year-on-year rate of growth in broad money (M3) rose from 64,113 percent in December 2007 to 420,867 percent in April 2008, underpinned by a massive 734,014 percent increase in the rate of growth in credit to government. Consequently, the stock of domestic debt as of mid-July 2008 had risen by 7,417 percent from Z$10.5 quadrillion, recorded at the beginning of the second quarter of 2008, to Z$790.9 quadrillion. Furthermore, over 99 percent of the debt is short term, implying that interest and capital repayments fall due almost at once, thereby putting additional pressure on government expenditures. Of the total domestic debt outstanding, the banking sector accounted for 95 percent, which explains why government borrowing has been highly inflationary. (COMMENT: It comes as no surprise that money supply expanded at such high rates in light of the RBZ's quasi-fiscal spending on the ASPEF and BACOSSI lending programs to the agricultural and manufacturing sectors, plus massive pre-election spending. END COMMENT.) -------------- -------------- Capital Requirements Raised as Inflation Erodes Value -------------- -------------- ¶7. (U) Gono also announced an increase in the minimum capital requirements for all financial institutions with effect from August 31, 2008. The minimum capital requirement for commercial banks will be US$12.5 million; for merchant and building societies, US$10 million; for microfinance institutions, US$5,000, at the average inter-bank rate of exchange. (COMMENT: Several banks are likely to struggle to raise the capital; those listed on the Zimbabwe Stock Exchange will probably satisfy the new requirements through rights issues. END COMMENT.) -------------- -------------- FISCORP to Become a Development Financial Institution -------------- -------------- ¶8. (U) Gono said he intended to turn FISCORP, which he created in 2007 to ring fence the RBZ's quasi-fiscal activities, into a Development Finance Institution as a way of addressing "market failures." (COMMENT: The issues that the new institution is meant to address are by and large policy induced failures, not market failures. A classic example is the low level of lending to agriculture since 2003. Gono's figures show that while 80 percent of commercial bank loans were made to the agricultural sector in the late 1990s, by 2003 the proportion had fallen to 12 percent. However, the massive decline was not due to market failure. It was due to the chaotic land reform that transformed land into a deadweight asset bereft of commercial value and changed the risk assessment profile of land occupiers seeking credit. END COMMENT.) -------------- Contracting Economy -------------- ¶9. (U) Gono released several gloomy economic figures: a 21 percent drop in export proceeds from US$648.6 million in the January-June 2007 period to US$510.2 million in the corresponding period of 2008; mineral shipments declined 16 percent over the same period; agricultural sector exports declined 7.8 percent; tobacco sales as of July 10, 2008 were also off last year's comparable figures, although Gono did not provide the 2007 figures for comparison in his Statement. -------------- HARARE 00000653 003 OF 003 COMMENT -------------- ¶10. (SBU) In the face of a sharply contracting economy and out-of-control inflation, this MPS offered nothing more than stop-gap solutions to the symptoms of economic meltdown. Gono clearly had to take some measure against the problem of high bank note denominations, although lopping off zeros without addressing the fundamental problem of inflation may prove to be counterproductive in the medium to long term. But the focus of his MPS was entirely short-term. The release of notes printed and stored for a time when the economy had stabilized appears to have been his only option for warding off an impending cash shortage (reftel). Indeed, the decision to reuse coins that had been taken out of circulation in 2006 indicates the level of desperation at the RBZ. ¶11. (SBU) The increase in the daily cash withdrawal limit is a welcome development, although hyperinflation is likely to erode away the value swiftly. Without throttling the rate of growth in money supply, i.e. reducing public sector borrowing, inflation is untamable and will put further pressure on the value of the Zimbabwe dollar. ¶12. (SBU) The RBZ's decision to raise the percentage of export proceeds surrendered at the inter-bank rate is an implicit tax increase on exporters. They are likely to respond by reducing exports. Gono's introduction of the inter-bank market for foreign exchange in late April 2008 failed to increase the competitiveness of exporters, as the inter-bank rate has lagged sharply behind the parallel market exchange rate and created a further disincentive to exporters to remain in the formal market. MCGEE