Is it price discovery or putting a method to the madness?
THE foreign currency auction system has arguably brought price and exchange rate stability.
Is this a myth or reality?
This article seeks to discuss the dynamics of the auction system that was introduced by the central bank in June of 2020 to replace the interbank market exchange rate system.
From the onset, one has to ask the following questions:
Who was driving parallel market rates?
Why did the interbank market fail?
Is the auction system sustainable?
The major players now participating in the auction system are the same players who were yesterday allegedly sourcing forex from the black market to finance raw materials imports and other foreign payments.
This had transformed the parallel market into an untamed jungle with no rules leading to runaway parallel market rates, all because, there was not enough forex to allocate on the market through the forces of demand and supply.
Similarly, the interbank market collapsed because demand exceeded supply at the then prevailing rates.
Moreover, forex buyers used the arbitrage to offload some of the forex on the black market. This saw the emergence of high premiums between the official and parallel market rates.
With the introduction of the auction system, the official rate rose from 1:57 to 1:83 as at August 23.
In my view, it is just the official rate that has caught up with the parallel market rate. The premium still exists. For example as at August 23, the parallel market rate was 1:120 compared to the official rate of 1:83, which means that the auction rate is a moving target. It will never catch up or be at par with the parallel market for the following reasons:
Importers will supplement what they get at the auction from the parallel market in order to meet their full import requirements.
The diaspora remittances are around US$150 million per month. This is money getting directly into peoples’ pockets. This money is liquidated on the parallel market
Part payments to gold producers and tobacco farmers are liquidated on the black market.
Civil servants salaries and wages are offloaded at the parallel market.
Embassy and NGOs staff receive their salaries in USD and they are likely to offload on the parallel market.
The market has dollarised (and not de-dollarised as we are made to believe). Hence the use of the USD for transactions is now the order of the day.
It is because of the above reasons that the gap between the two rates will remain unabridged. The only way to kill the black market is to fully dollarise and decommission the RTGS/bond note, which is not going to happen because of the pressures from employment costs of civil servants.
That being the case, there is a real danger that the parallel market rate will pull up the auction rate until the price discovery mechanism begin to fuel inflationary pressures.
The auction system has temporarily managed to slow down the price level changes, but this does not mean the current prices are tenable at the current levels of incomes.
The auction system is fatally flawed because it is preoccupied with the demand side of forex and not its supply.
The elephant(s) in the living room are: lack of forex supply response and a mono-currency that is worthless.
Unless these two mischiefs are addressed, the auction system will remain a price discovery mirage. The mono-currency is a surrogate currency.
But government does not have many options. It just has to continue rationing the scarce resource through an auction system which yields a weekly fixed exchange rate.
Fixed exchange rates are by their nature not competitive whether arrived at by price discovery or other means. The auction system does not reflect the true market value of the USD because it’s a controlled system, an observed system managed by a visible hand as opposed to an invisible hand, which is the market
By December 2020, I hazard to forecast that the auction rate will breach the 1:100 mark. I hope I will be proved wrong.
Mashakada is a former minister of Economic Planning in the inclusive government. He is an economist and Member of Parliament.