Contrary implications of currency devaluation

By Respect Gwenzi

Export data released by the Zimbabwe Statistical Office shows increasing exports and the export figures show an increasing value of manufactured goods.

Internally, data such as capacity utilization in manufacturing data also shows an upward trend, indicating a rebound in domestic production. The rebound in production is supported by two factors: the recovery in aggregate demand with the slowdown in inflation and the slowdown in national production against the backdrop of a good agricultural season.

On the other hand (exogenously), goods produced in Zimbabwe have increased their price competitiveness in the region supported by currency devaluations. Currency devaluation refers to the loss of value of one currency against another.

The Zimdollar weakened by more than 80% in 2019 and 2020 respectively from the opening levels of the year, becoming one of the worst performing currencies in the world. It also allowed the currency to become cheaper compared to other regional currencies. Due to the strength of their currency, goods imported from Zimbabwe have become comparatively cheaper.

As a result, Zimbabwe presented this as an economic achievement and a validation of the reintroduction of the Zimdollar, the local currency. The government considers the recovery of the industry and its growing production, part of which is destined for the regional market, as a sign of a positive economic repositioning.

Economic theory points out that once a currency becomes too cheap, goods produced in the host country also become relatively cheaper. It is a simple economic principle.

However, as pointed out earlier, this phenomenon is not the result of positive fundamentals such as improved production efficiency and cost rationalization, but the result of currency devaluation. Currency devaluation alone has the power to make goods produced in the respective country cheaper compared to regional peers.

But the question goes further: is the devaluation of a currency a positive thing when viewed from an overall economic point of view? Before exports increase, the implication of currency devaluation is to dampen aggregate demand in an economy.

Producers re-price their products upwards to maintain value parity, thus marginalizing certain consumers whose disposable incomes do not adjust at an equivalent rate.

The reason why producers increase their local price is to maintain value parity with the foreign exchange equivalent earned previously. This is endemic in an economy which has a dual currency system like that of Zimbabwe.

It is also high for countries with higher raw material imports in the manufacturing sector, a factor which is also true for Zimbabwe. Once a devaluation occurs in real terms, the price of goods should therefore naturally follow the same path with prices revalued upwards, impacting local demand. At the same time, demand for the same products is expected to increase in export markets as prices become cheaper.

The Zimbabwean phenomenon (for the first scenario) was that although prices rose, the rise was not proportional to the depreciation of the currency, so demand remained relatively positive. This was further supported by an overall economic boost driven by a positive agricultural season.

By smoothing out the outcome of these extreme factors, which are unlikely to recur in the outlook, the trajectory of price spikes and demand declines would become evident.

In short, the devaluation of the Zimbabwe dollar between 2019 and 2020 was severe and severely undermined economic activity and demand. Its impact is reflected in the unfavorable economic growth recorded in the respective years, averaging around 10% per year.

The positive growth recorded by exports was therefore coupled with a decline in economic growth. This year, the trend will be changed.

Exports will show a positive performance while the economy will also show similar positive growth.

It should be noted that this positive economic growth comes from a very weak base, even though the net result of GDP for the year will be more than 30% lower than the record level reached in 2018. Growth is also supported by the previous one the agricultural outperformance mentioned.

More importantly, this growth is anchored on flawed monetary stability only induced by the hand of the national government in the market. The fall in the interbank rate helped stabilize the currency and inflation, subsequently supporting output growth. This, in our opinion, is not sustainable and therefore discredits the underlying policy.

On the outlook, a currency floating in the current economic situation will cause production to contract sharply as demand falters and forex availability decreases.

Our view of the government, in particular the RBZ, influencing the market is supported by the buyout clause which allows the bank to control the supply of currencies and thus influence the weighted average exchange rate. The larger gap between the interbank market and the parallel market highlights the cracks. Going forward, exporters across the board are discouraged from producing more in such an environment, as profits are undervalued by a low buyout rate. In conclusion, we believe that the devaluation of the currency does more harm than good to the economy.

  • Gwenzi is a financial analyst and managing director of Equity Axis, a financial media company providing business intelligence, economic analysis and equity research services. – [email protected]
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