Open Economy: on Monetary Policy: Better safe, but we’ll all be sorry

Last week, Reserve Bank of Zimbabwe Governor Dr John Mangudya gave his maiden Monetary Policy Statement.

In what I considered to be a safe statement, Dr Mangudya lacked in-depth inquiry into our core economic challenges. By playing it safe, the governor simply pointed out the widely assumed economic problems and offered agreeable solutions.

I would not dare insinuate that he meant to be devious or misleading, but if indeed he is a free market, demand-focused economist as described at the time he took up the governorship, then surely he cannot be fully convicted in his statement; specifically his diagnosis and contextualisation of our economic challenges.

In what he segments as two phases, Phase 1 credits our current economic circumstances to a “euphoria stage” where we experienced growth through unsustainable business expansion. Businesses used short-term funding to purchase long-term assets, thereby creating unsustainable funding mismatches.

Phase 2, “the self-adjustment phase”, is the eventual liquidity and credit shortage that left businesses today facing high debts and high costs of operation.

His diagnosis is not entirely wrong but lacks necessary depth to find the real problem. As a result, he offers ineffective remedies.

For an individual supposedly cognisant of aggregate demand, it is surprising that he focuses so much on the production side of the economy and barely considers consumption.

Perhaps we view economic growth differently, but my understanding of economic growth is not necessarily increasing business production but increasing consumer wealth.

After all, it is increased consumer wealth and the subsequent higher consumer demand that drives production.

So while he is right in saying credit was misplaced on business expansion, he could have been more precise and said this credit during the “euphoria stage” should have been focused on increasing consumer wealth. Businesses did acquire credit much more easily in 2009-2011, but the problem was not that they spent it on long term-assets.

The problem was their use of credit on these assets became unsustainable because there was no accompanying consumer demand. At no time during this period did consumers accumulate the necessary wealth to meet this business expansion.

Further, what the governor calls the “self-adjustment” stage is nothing more than the result of aggregate demand being absent to support invested expansion.

Likewise, our liquidity situation is dire because of declining consumer wealth over the years. Yes, cash is necessary, but an economy can have some continuity as long as there is credit. Credit, especially in lending facilities, is basically what assets an economic agent can put up as a guarantee for a transaction or loan.

Meaning that the more citizens create wealth to accumulate assets for themselves, the more credit that exists within the economy. What has happened in our economy,especially with the large share of our population entering informal activity, is that these same consumers who never accumulated assets are now the larger proportion of economic participants.

The majority of our economic participants lack creditworthiness.

That may explain why banks, and other economic participants, are hesitant to extend credit across the board. By focusing on production while negating the consumption side, the governor has identified the wrong problems.

When you make the wrong diagnosis, you prescribe the wrong treatment.

There are two policies in the governor’s statement that I think will be ineffective.

First, banking sector loans increased from US$3,7 billion to US$3,8 billion last year. But with many citizens lacking the assets to be creditworthy, we can assume that these banks increased loans to the same industrial sector which is guilty of the same unsustainable expansion mentioned by the governor; thereby recycling the same problem in the long run.

Second, Cabinet approved creation of the Zimbabwe Asset Management Corporation to acquire toxic non-performing loans (NPLs) from banks. NPLs had increased from 15,9 percent in December 2013 to 18,5 percent as at June 2014. Sure, this move will strengthen banks’ balance sheets and provide them with liquidity as intended.

However, how does it fix the root cause of non-performing loans? Dr Mangudya argues that NPLs are cutting lending by banks at a time when businesses require working capital for funds and retooling. Well, again let’s say businesses do get this funding and retool, which consumer market will sustain this expansion? Aren’t those the same characteristics of the “euphoria stage”? Mass expansion and increased production without sustainable long term-consumer demand?

I concede that businesses hire people, which, in turn, gives consumers money to spend, but I highly doubt that diligence into strategic allocation of loans was done before either of these two policies were implemented. Instead of allocating loans to industry and simply recapitalising banks, monetary policy should be focused on the informal market — the marginalised private sector. This is the only sector which stands a realistic chance of increasing consumer wealth.

The governor played it safe and told us the problems that we expect to hear. He missed to identify the real problem in our economy. Unfortunately it seems we shall be spending time healing the symptoms but never cure the ailment; the ailment being our failure to create monetary policy that focuses on increasing consumer wealth.

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