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RBZ to tighten money supply. What does that mean and how are they trying to achieve it?

Bond notes in vault

Every single Zimbabwean knows more about economics than the average person everywhere else. We might as well do away with the Economics degrees at our colleges. The school of life was our college and hyperinflation our teacher. However, there are still some concepts we need help breaking down. Today, we try to understand what tightening the money supply means.

The RBZ announced money supply tightening as a solution for the depreciation of the local currency. What does that mean?

Depreciation of the Zimbabwe Dollar and inflation

To note is that the problem the Reserve Bank of Zimbabwe and the Ministry of Finance are trying to fix is the loss in value of the Zim Dollar – its depreciation.

We usually measure the value of our currency against other currencies, most commonly the USD. That is why we talk about direct comparisons, called exchange rates.

We have seen the Zim Dollar fall from parity with the USD in 2017 to ZWD$87 being equal to US$1, a rate of 1:85, on the official market. The parallel market sees US$1 being equal to ZWL$170, a rate of 1. As the rate of decline has accelerated in the past few months, the RBZ has increased efforts to counter the forces driving this depreciation.

The reasons for the depreciation of the ZWD

We cannot go through all that has caused the depreciation. The bottom line is that our currency just doesn’t have value because:

  1. It is a fiat currency. This means that like most other currencies there is no gold backing the notes in circulation. The Zim Dollar note is just a piece of paper whose value comes from the trustworthiness of its issuer. Therein lies the problem, a lack of trust (justifiably so) in the RBZ and the Zimbabwe government’s monetary discipline.
  2. We are not buying more from other countries than we are selling. How it works is that if you want to buy something in South Africa for example, you need their legal tender – the Rand. Our cross-border traders will tell you this, you need to convert whatever currency you have into Rands before you go to S.A to shop. At a larger scale, the country scale, if there were many foreign companies buying from Zimbabwean companies, they would need the Zim Dollar thus driving up demand and therefore the value.
  3. Too much money chasing few goods. Every Zimbo who was alive in the hyperinflation-era of the noughties knows this. Today, we have a lot of Zim Dollars chasing few US Dollars. Everyone wants to convert their Zim Dollars into USD as soon as possible. Problem is there aren’t enough USD in the market for this. What happens is that those holding Zim Dollars are bidding more and more to get the USD which will hold value better than the Zim Dollar.

The excessive money in the market leads to high inflation because prices are based on the USD via the parallel market rates. As the Zim Dollar depreciates and the USD gains value, prices also increase, hence the high inflation.

Tightening the money supply

That last cause is the one that the RBZ wants to address. We have a lot of Zim Dollars chasing a few US Dollars. What the RBZ wants to do is reduce the amount of Zim Dollars in the market. This is what tightening the money supply means. You may hear them talk about mopping up excess liquidity. That’s essentially the same thing as tightening the money supply.

The money supply increased by over 3300% from January 2018 to April 2021. The broad money supply growing from about $7.5m to about $262m USD equivalent. That is a lot of Zim Dollars introduced into the market.  

This increase in money supply is chiefly caused by government borrowings from RBZ through the overdraft facility, issuance and repayments of Treasury Bills, which are short term debt obligations backed by the government and RTGS credits by the RBZ which are not backed by any foreign currency reserves.

Now the RBZ wants to mop up some of that money. The idea is that when there are fewer and fewer of us chasing the USD, the value of the USD will fall as compared to the Zim Dollar.

How are they tightening the money supply?

The RBZ is targeting individuals and corporates that have huge RTGS balances in their accounts. As we discussed, no one wants to hold that currency in Zim Dollars and so they are using these huge RTGS balances to seek USD on the black market. This is increasing the demand for forex and therefore weakening the local currency and increasing inflation.

On a side note, the huge RTGS balances are responsible for the increased activity on the stock exchanges. Corporations realise if they can’t convert their RTGS balances into USD, they might as well purchase stocks and preserve value that way.

The RBZ wants to make sure these huge RTGS balances do not make it onto the black market. Instead, corporations are being invited to purchase special government ‘bills’ called….

Exchange rate linked Open Market Operations

The RBZ has used such instruments before, also called Principal Exchange Rate Linked securities. Here is how they are supposed to be attractive to corporations.                               

To note is that for such instruments we talk about the principal and the interest. The principal is the original amount you pay and the interest is a percentage of the principal paid daily, weekly, monthly or annually. So, consider a corporation that purchased a $100,000 bond at 5% interest per annum that matures after one year. After one year, they receive their initial $100,000 and $5,000 interest.

Now in Zimbabwe where the currency will have lost a lot of value, such a bond would not be really attractive to an investor. That’s where the exchange rate linked OMOs come in.

The instrument is linked to the exchange rate. That means the principal will be determined by the exchange rate on the date of maturity. Let’s say the above $100,000 bond is bought today when the rate is about 1:87. Let’s say the rate is 1:97 after one year when it matures. The principal will then be worth 100,000/87*97 = $111,494. That’s before the interest.

In a way, this is similar to purchasing foreign currency. If the Zim Dollar loses value against the USD, the holder of this instrument sees their principal payment increase. So, this instrument should be more attractive to holders of huge RTGS balances than the other bonds and bills on the market.

If corporations take up the exchange-rate linked securities, this will reduce demand for foreign currency. This would help ease the inflationary pressure the high demand for forex has.

Why the OMOs might not work

You’re probably distracted by the elephant in the room. Which exchange rate will be used? I illustrated how the securities work using the official auction rate and that is the one that will most likely be used. The difference between the official rate and the parallel market is huge and widening and so the exchange rate policy on these instruments will be key to their adoption.

The other problem is the trust issue we discussed above. Can the corporations trust that the RBZ will not introduce some new measure before the maturity of the securities that negates all its benefits? No, they cannot fully trust the RBZ.

So that’s it. That is what all this money supply tightening business is all about.


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18 thoughts on “RBZ to tighten money supply. What does that mean and how are they trying to achieve it?

  1. You guys are just plain stupid you concreate on the negatives ..you are supposed to be talking about technology and how it will better our lives instead you do a lot of politricking if you are sposnsored by opposition parties….your website is crap considering the level you take yourself as tech gurus ..

    1. You are just plain stupid you ignore all the realities ..you are supposed to be reading what you want where you want instead you do a lot of politricking here on TZ as if you are sposnsored by ruling parties….your opinion is crap considering the genius level you take yourself as ..

    2. Ignore reality demands the Murakashi. You must write happy talk. LOL . Zvakaoma

      This article is great journalism and free speech at work. Thank U.

    3. Joko, you my guy are just a political troll. What does understanding OMOs have to do with opposition parties? Won’t waste time responding to you.

  2. “Problem is there aren’t enough USD in the market for this.” there may not be a lot of USD in the fairyland world of the RBZ “market” … but there is plenty of USD in the REAL market here, problem is not all sellers of USD want to part with it at 80 something fairy-tale rates…

    1. I disagree. I think that even in the parallel market there aren’t enough USD to meet the demand. The fact that the parallel market rate is shooting up means more individuals and businesses are flocking there and bidding for a limited resource. The simple economic concept of supply and demand is at play. Remember that for almost every single RTGS$ out there is an owner who wishes to convert it to the USD.

  3. This one of the comprehensive simplified article i have read, its now crystal clear what OMOs are all about.

  4. OMO simply won’t work as it’s linked to the artificially controlled forex auction rate. Which sane Zimbo would buy such bonds? You are guaranteed of getting a negative return!

    1. The trick is to remove all other options to preserve the value of the RTGS balances. For the company with billions and no easy way to convert them to USD, the OMOs might be the only option. Otherwise, I agree, no sane Zimbo would willingly buy those bonds.

  5. The real issue is that if you are holding Zimdollars what can you buy with it? In our situation you can not buy the following with Zimdollars:
    1. Land and buildings
    2.GOLD
    3.maize
    4. Wheat
    5.Diamonds
    6. Cars
    7. Fuel
    8. Soya beans
    9. Bricks and cement
    10. Foreign currency

    So why should the Zimdollar have stable value if you can’t buy valuable things with it. Food for thought.

    1. Food for thought indeed. The market is rejecting the Zimdollar as payment for anything of value, indicating they don’t think it has value.

  6. The excess Zim $ are created by the RBZ. Unfortunately its not real money. OMOs operate on principles underpinned by real money.

    1. The RBZ is trying to close every avenue for holders of RTGS$ to convert to USD. Leaving them with OMOs as the only option with a semblance of preserving value. That’s the only way these OMOs would work, no one with options would choose them.

  7. Start it from the top officials l think the problem is there but you address it to the wrong people with nothing but victims of the privileged leaders who dont have mess to the public, stop shouting on the streets go to the government official offices and ask who is selling stone in usd , gold in usd, dimonds in usd then tell them to bank their monies to rbz not on their pockets or nearby coutry banks. Leave us alone

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