Zimbabwe needs self-discipline to cushion itself from impact of recent US interest hike

Zimbabwe, which is now using the United States dollar as its main currency, needs self-discipline to cushion itself from the vulnerabilities associated with the recent hike in interest rates by the United States government.

The US central bank, the Federal Reserve Bank of America, raised interest rates by twenty-five basis points, in December.

According to Zimbabwe’s Central Bank governor John Mangudya, the rise in the interest rate in the USA is expected to have an impact on the global economy through its effects on both short term and long-term interest rates.

“In the Zimbabwean context, the US interest rate hike is likely to be transmitted to the domestic economy mostly through the trade and financial channels. The anticipated strengthening of US dollar emanating from the interest rate hike will potentially result in a further slowdown in prices of commodities that act as safe investment havens, notably gold and platinum,” Mangudya said.

“The decline in the price of these precious metals, will further dampen export receipts, a development that has an undermining effect on domestic liquidity conditions and economic growth prospects at large.

“On the other hand, a stronger US dollar relative to Zimbabwe’s trading partner currencies may result in increased imports of cheaper goods. This expenditure switching effect may further compound the country’s external sector position.

“The further strengthening of the US dollar, however, confers advantages to entities that can affordably acquire capital goods to retool their operations particularly from countries such as South Africa, China and Brazil, whose currencies have depreciated over the recent past.

“Zimbabwe, has limited options to cushion itself from the vulnerabilities associated with the recent US interest rate hike. The absence of an exchange rate policy to deal with the overvalued real effective exchange rate, implies that the country has to strengthen self-discipline to undertake fiscal and internal devaluation policies in order to enhance competitiveness in the domestic economy.”

Zimbabwe uses a basket of currencies which include the South African rand, the Botswana pula, the pound sterling, the euro, the Indian rupee, the Japanese yen, the Chinese yuan and the Australian dollar but the US dollar currently dominates the market.

Below is the section of Global economic developments extracted from Mangudya’s monetary police statement:

Global economic activity in 2015 continued to face elevated financial market volatility and a marked slowdown in developing and emerging market economies. In particular, lingering uncertainty that preceded the U.S. interest rate increase depressed global economic activity for the greater part of 2015. In the Eurozone, global economic activity remained uneven, as economies such as the United Kingdom (UK) somewhat recovered.

On the other hand, developing and emerging market economies, particularly China, Russia and Brazil faced significant challenges that dampened growth prospects in 2015. Constrained import absorptive capacity from China which is experiencing a managed economic slowdown, occasioned the accumulation of commodity inventories, a development that depressed metal prices.

Reflecting the effect of declining commodity prices, inflationary pressures in advanced, emerging markets and developing economies remained muted while real effective exchange rate fluctuations have been unusually high over the recent past.

In its October 2015 World Economic Outlook (WEO) report, the International Monetary Fund (IMF) projected global economic growth at 3.1% in 2015, compared to the July 2015 projection of 3.3%.

Despite subdued global economic activity, the world economy is expected to modestly recover by 3.6% in 2016. This primarily reflects the expected narrowing of attendant divergences in economic activity and growth patterns across major economies in 2016. Improvements in the global economic outlook is attributed to the projected acceleration of activity in the US economy, coupled with the consolidation of recent gains in the Eurozone and Japan.

Accommodative monetary policy, low oil prices and in some instances, real exchange rate depreciation are expected to spur economic performance in the Eurozone in 2016.

Economic growth in China is estimated to have declined to 6.8% in 2015 and projected to further decelerate to 6.3% in 2016, as the economy is expected to continue drifting from an investment towards consumption-led growth. Accordingly, the country’s fixed asset investment growth has been slowing down in recent years, although it remains the key driver of aggregate demand. Discernible progress has, however, been made towards promoting a more market-based financial system, improved government finances, gradual floating of the exchange rate and levelling of the playing field between state-owned enterprises and the private sector.

On the back of the negative repercussions of the slowdown in China on commodity demand, activity in Sub-Saharan African economies is estimated to have decelerated from 5% in 2014 to 3.8% in 2015. Additionally, the tightening of global financial conditions in the wake of an interest rate increase in the U.S. and other frontier market economies further dampened economic activity in the region.

In Southern Africa, economic growth prospects for South Africa, Angola, Botswana, Zambia and Zimbabwe remained vulnerable to the downturn in international commodity prices, the depreciation of domestic currencies (except for Zimbabwe) and deteriorating electricity supply conditions. Against this background, export earnings and fiscal revenues declined somewhat for these commodity exporting countries.

Following the decision by the US to end the quantitative easing policy, the Federal Reserve Bank of America (the Fed) raised interest rates by twenty-five basis points, in December, 2015. The rise in the interest rate in the USA is expected to have an impact on the global economy, through its effects on both short term and long-term interest rates. In turn, changes in long-term interest rates have a bearing on exchange rates, asset price developments as well as capital flows.

In the Zimbabwean context, the US interest rate hike is likely to be transmitted to the domestic economy mostly through the trade and financial channels. The anticipated strengthening of US dollar emanating from the interest rate hike will potentially result in a further slowdown in prices of commodities that act as safe investment havens, notably gold and platinum. The decline in the price of these precious metals, will further dampen export receipts, a development that has an undermining effect on domestic liquidity conditions and economic growth prospects at large.

On the other hand, a stronger US dollar relative to Zimbabwe’s trading partner currencies may result in increased imports of cheaper goods. This expenditure switching effect may further compound the country’s external sector position. The further strengthening of the US dollar, however, confers advantages to entities that can affordably acquire capital goods to retool their operations particularly from countries such as South Africa, China and Brazil, whose currencies have depreciated over the recent past.

Zimbabwe, has limited options to cushion itself from the vulnerabilities associated with the recent US interest rate hike. The absence of an exchange rate policy to deal with the overvalued real effective exchange rate, implies that the country has to strengthen self-discipline to undertake fiscal and internal devaluation policies in order to enhance competitiveness in the domestic economy.

The Chinese economy has been growing at a rapid pace for the past thirty years, over the recent past, the Chinese economy has, however, slowed down primarily on account of slower fixed asset investment growth especially in real estate and manufacturing sectors which face oversupply problems.

The decline in China’s stock markets, which began in June 2015, coupled with the 4.5% devaluation in the local unit, had adverse spill-over effects in other world economies. These contagion effects were largely transmitted through marked declines in equity markets, commodity markets, and increased exchange rate volatility around the globe. These negative developments are expected to fully manifest themselves through lower commodity prices. In particular, the fall in oil prices is likely to hurt oil exporting countries through lower revenues. On the other hand, a decline in commodity prices attributed to slackening demand from China will likely hurt commodity dependent economies such as Zimbabwe.

On the back of anemic global economic growth and the slowdown in China, gold, platinum, copper, and nickel prices declined in 2015. The strengthening of the US$ also eroded the demand for precious metals as alternative investment assets. Importantly, the improved supply of base metals resulted in the accumulation of inventories, a development that further dampened commodity prices. Food prices also registered declines, largely on account of favourable yields in major crops across the world.

Precious mineral prices declined in 2015, mainly underpinned by the sustained strengthening of the U.S. dollar coupled with prolonged speculation surrounding the U.S. interest rate hike and reduced financial risks associated with depressed crude oil prices. These developments undermined the appeal of precious minerals as safe investment assets. Against this backdrop, gold and platinum prices retreated by 14.6% and 30.9% respectively, in 2015.

In the medium term, precious metal prices are projected to continue on a downward spiral in response to the appreciation of the dollar as economic recovery in the US gains substantial traction.

Base metal prices remained depressed over the period of review as evidenced by the decline in nickel and copper prices. In this regard, nickel and copper prices declined significantly by 41.3% and 20.5%, respectively, on account of progressive inventory build-ups stemming from slackening demand from China. Similarly, crude oil prices retreated by 21.2% during the same period, largely underpinned by subdued demand and excess supply.

Energy prices have generally been on a declining trend largely as a result of the marked drop in international oil prices. According to the World Bank, the ongoing European Central Bank’s expanded quantitative easing program is anticipated to spur the demand for most industrial metals and in the process boost their prices in the medium term. Oil prices are expected to average US$61.2/barrel in 2016, as supply growth moderates.

International food prices, as measured by the United Nations’ Food and Agriculture Organization (FAO) Food Price Index, have declined since September 2014. The decline in food prices was occasioned by ample supply conditions, a slump in energy prices and concerns over China’s economic slowdown. International cereal prices have been under downward pressure since early 2015, amid large inventories and generally improved crop prospects.

During 2015, Food and Agriculture Organisation (FAO) Food Price index averaged 164.1 points, nearly 19% less than in 2014, marking the fourth consecutive annual decline. Abundant supplies in the face of depressed world demand and an appreciating US dollar are the key factors that weakened food prices in 2015. However, the Elnino effect which has caused floods in some parts of Europe, the US and Asia and drought in southern Africa is likely to result in low agricultural output and global food shortages and hence rise in food prices.

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