Deflation could help end liquidity crisis in Zimbabwe- IMF

The current deflation in Zimbabwe may not be bad for the country after all. The International Monetary Fund says in its country report released on Friday that falling prices boost real money supply and could alleviate the persistent liquidity shortages.

Temporary falling prices benefit consumers with job security. Deflation could also correct the existing overvaluation in the real exchange rate although that would require prices of non-tradable goods, notably labour, and final goods to fall faster than the prices of traded goods.

“On the downside, persistent deflation may increase the real burden of existing debt in a country that is already under financial stress. However, Zimbabwe’s financial underdevelopment (low stocks of loans and deposits, with short maturities) may mitigate this effect,’ the IMF says.

It also says that deflation hurts producers and might reduce Zimbabwe’s productive capacity, if it leads to widespread company downsizing and closures.

Some analysts have argued that Zimbabwe is not going through deflation but disinflation.

Full IMF excerpt:

Zimbabwe: Deflation Risks

Zimbabwe’s 12-month inflation rate decelerated from 2.9 percent at end-2012 to -0.3 percent in April 2014. The deceleration is partly driven by weak aggregate demand. A closer inspection of CPI components indicates that deflationary pressures have been stronger in traded sectors, suggesting that pass-through from a depreciating rand also plays an important role. There are benefits and costs from deflation for Zimbabwe.

On the upside, temporarily falling prices benefit consumers with job security. By delivering a boost to aggregate demand, falling prices may contribute to eroding the country’s negative output gap. Deflation could also correct the existing overvaluation in the real exchange rate, although that would require prices of non-traded inputs (notably labor) and final goods to fall faster than the prices of traded goods, which has not been the case so far.

Finally, falling prices boost the real money supply and could alleviate somewhat the persistent liquidity shortages. On the downside, persistent deflation may increase the real burden of existing debt in a country that is already under financial stress. However, Zimbabwe’s financial underdevelopment (low stocks of loans and deposits, with short maturities) may mitigate this effect. Deflation hurts producers and might reduce Zimbabwe’s productive capacity, if it leads to widespread company downsizing and closures, given downward wage rigidity.

In the medium term, structural reforms that improve the business environment and stimulate domestic and foreign investment could offset the deflationary impulse. In the near term, in the absence of monetary policy tools, the authorities must avoid exacerbating the distortions and imbalances, for example, by resisting the impulse to restrict imports and by avoiding further public sector wage increases, which put pressure on salary negotiations elsewhere in the economy.

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