Zimbabwe: exchange rate targeting or inflation targeting?

Zimbabwe: exchange rate targeting or inflation targeting?

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By Gardner Rusike

IN EFFORTS to find appropriate economic reform programs in Zimbabwe, one issue that arises is the appropriate monetary policy framework.

A number of frameworks have been used internationally which range from eclectic approach, monetary targeting, exchange rate targeting and the newly favored inflation targeting framework.

In this article, I discuss two frameworks i.e. inflation targeting and exchange rate targeting. The aim is to show that while inflation targeting may be favoured, it might not be appropriate for Zimbabwe.

Inflation targeting is a monetary framework that spells out the intentions of a central bank by making known the target level of inflation in an economy. Inflation targeting makes monetary policy more transparent, reduces uncertainty and improves the coordination between monetary policy and other macroeconomic policies.

The inflation target can be set by the government and implemented by the central bank or alternatively agreed by both parties. As one of its critical elements, inflation targeting requires an independent central bank to implement monetary policy effectively.

Given such requirements, as policymakers craft new economic policies, inflation targeting may not be appropriate for a number of reasons. Firstly it could be too early in Zimbabwe’s growth process. Zimbabwe has been experiencing economic decline since the late 1990s and would require a framework which aims at stabilising the economy.

As apparent from the quasi-fiscal activities, the Reserve Bank of Zimbabwe is not as independent a central bank as would be required and may thus not be in a position to implement IT credibly. The influence of government activities may result in the inflation targets being missed. Such activities could include unbudgeted expenditures which result in the RBZ printing money to fund the activities of the government which in itself is inflationary.

Then we have the consumer price basket. The basket itself seems not to reflect the actual rise in prices of goods since some of the goods are not included in the basket. Another issue is the weights attached to the consumer goods included in the consumer price basket. Given such questions, it is inappropriate to make IT the prime objective of the central bank. Reconstructing another basket together with the Central Statistical Office and other stakeholders would take resources as well as time. We do not want such a process to be hurriedly done in an effort to implement IT in Zimbabwe.

A hypothesis that needs to be explored is on the relationship between IT and economic growth. I strongly believe IT can reduce the growth rate of an economy particularly in emerging or developing countries. For instance, South Africa has not experienced massive growth rates which other emerging markets such as China have experienced, yet they are not inflation targeting.

Another problem that Zimbabwe faces is an overvalued exchange rate. As the exchange depreciates in the official and parallel markets, it feeds on inflation which may result in inflation increasing beyond its targeted range.

As an alternative monetary policy framework, exchange rate targeting could be one of the possible options for the central bank. The objective of any central bank is to maintain the value of its currency i.e. internal and external value. In Zimbabwe’s case, there is need for an explicit focus on the external value of the Zimbabwe dollar.

In order for exchange rate targeting to be successful, it is critical that international financial support be availed. This could be in the form of an injection of foreign currency to increase the supply and perhaps match the demand for forex in the country.

At the same time, the central bank will be building its foreign reserves. When the RBZ has adequate reserves, then it can enter the forex market to influence the value of the dollar by buying or selling forex to affect liquidity conditions in the market. This is similar to its open market operations in the money market.

As investors gain confidence in the economy, foreign investment starts flowing into the country, increasing supply of forex. Also, as production increases due to a favourable market related exchange rate, exports will increase and so will be the inflow of forex. The main reason why the exchange rate continues to overshoot its real value is because, the central bank lacks the capacity to influence its value due to lack of adequate foreign reserves.

An appropriate monetary policy framework would be vital for Zimbabwe, if there is willingness to see the country growing again. Exchange rate targeting as opposed to inflation targeting could prove to be one of the useful policies that could be adopted.

Gardner Rusike writes from South Africa. He can be contacted on e-mail: gardyrusike@yahoo.com
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