·         RBZ reduces Bank policy rate to 140%

·         Exchange rate premium rises above 72%

·         Blended inflation reflects a biased value movement

Harare - In the recent adjustments to the current contractionary monetary policy, the Central Bank reduced the Bank policy rate from 150% to 140% per annum. The move is premised on the supposed slow-down in inflation, following the adoption of the blended inflation model in February. Meanwhile, exchange rate premium between the formal and the informal currency markets has gone above 72%.

The new model of inflation reporting in Zimbabwe, the blended inflation model, takes-into-account price movements in both the ZW$ and the US$, as opposed to the previous model which only accounted for ZW$ price movements. The new model, therefore, tends to heavily weigh on the US$ price movement due to different weights which are also a function of currency mix which currently stands at 70:30 as US$’s to ZWL. Since the heavy weight is on the US$ which is a hard currency and therefore not susceptible rapid price fluctuations, the blended inflation will likely show a downward trend going forward.

The Central Bank’s decision to reduce the borrowing costs was based on this slow-down in inflation, which is rather not reflective of real value loss in the economy. It is arguably more important for the RBZ to focus on exchange rate movement and less on inflation. Exchange rate control is more effective in controlling inflation than inflation control itself. When a country’s currency depreciates, imports become more expensive, which leads to an increase in the price of goods and services. This can lead to inflation. By controlling the exchange rate, a government can prevent this from happening.

While inflation is showing a slow-down, the parallel market exchange rate has gone up by more than 40% over the last 30-days. This has expanded the premium between the two distinctive exchange rates to more than 72%, thereby leaving room for arbitrage. By reducing borrowing costs from 150% to 140%, the RBZ is in essence promoting borrowing. This has the adverse effect of increasing money supply in circulation as borrowing increases, and this money will find its way on the black currency market as borrowers seek safe haven in a hard currency. The borrower can store the hard currency as it appreciates against the ZW$ and later repay the borrowed funds at a lower cost in real terms, and the cycle of value loss increases.

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