The Outside View: What is the inflation outlook? - Part 1

Thu Sep 9 07:28:15 CAT 2021

By The Woodpecker

Both the fiscal and monetary authorities have repeatedly given assurances
that the economic band-aid is firmly intact and effective, as evidenced by
the twin surpluses - budget position and current account - exchange rate
stability on the official foreign currency market, decelerating annual
inflation - as shown in the graph -  and upward revision in the 2021 GDP
growth forecast to 7.8%, among others. 

The authorities, in justifying recent decisions to stay the course on
current policy interventions, further affirmed that the current positive
trajectory is expected to persist into the near future, with a remarkable
economic growth rate of 5.5% expected for the year 2022.  

However, despite all these assurances, market players have continued to
anxiously ask for independent opinions regarding the inflation, exchange
rate, interest rates and economic growth outlook. 

Such uneasiness is not surprising, though, given that results of the
authorities' policy interventions have mostly received backhanded
compliments such as fragile stability, superficial surplus, and growth from
a low base, among others, throughout the reform period.  

Adding to the markets bewilderment is the authorities' shifting targets, for
example the several revisions to the expected 2021 year-end inflation rate
from an initial projection of less than 10%, to a revised figure of less
than 25% and now the recently revised range of 25-35%. 

Furthermore, market jitters seem to have been worsened by the authorities'
seemingly heavy leaning on a foreign currency auction system, that, like its
predecessor - which was introduced in January 2004 and later metamorphosed
into a managed float system in April 2005 before being replaced by a
Tradable Foreign Currency Balances System in October 2005 as relentless
monetary expansion broke the camel's back - is noticeably limping behind the
alternative foreign currency market. Moreover, the auction market has
noticeably continued to be sapped by the seemingly loose tightening of
monetary policy and intermittent settlement backlogs.

Thus, given the importance of macroeconomic forecasts, especially as
companies enter the traditional strategic planning period, I will, in this
article, attempt to provide answers to some of the market concerns around
the inflation outlook. However, this is not an easy task given the simmering
radical uncertainty wherein the future is increasingly being determined by
unquantifiable events, whereas market participants' behaviours are mostly
shaped by past events and memories. Worse still, the lack of up-to-date data
on variables such as money supply growth - a key variable in forecasting
inflation - makes it nearly impossible to build reliable mathematical
models.

Thus, given that, under such circumstances, the use of traditional
mathematical equations usually leads to precisely wrong conclusions, I will
try to get it roughly correct by using a combination of past events, case
studies, rules of thump and an open mind in building possible scenarios. 

But, first, it is important to establish and understand the major drivers of
inflation, and the attendant shock absorbers, in Zimbabwe. In fact, since
the macroeconomic reforms that began in 2019 - with the aim of addressing
the then diagnosed Currency, Debt and Growth (CDG) crisis - the major drives
of inflation have been, among others;

1.       exchange rate depreciation - given that most domestic prices are
largely indexed to the United States Dollar,  

2.      adverse expectations - especially in the period up to the
introduction of the foreign currency auction system in June 2020, 

3.      adjustments to administered prices, including utility charges such
as water and electricity tariffs, as well as the monthly adjustments to fuel
prices,

4.      money supply growth, but with the bulk of the pass through or
transmission happening indirectly via the exchange rate depreciation, and 

5.      exogenous factors such as rise in oil prices on the international
commodities markets and higher producer prices and logistical costs in South
Africa, the country's major trade gateway (not trade partner!). 

These factors, together with the continued lack of balance of payments and
budgetary support - a critical component in the quest to pursue the twin
objectives of economic growth and stability - as well as observed
experiences from countries such as Bolivia, Argentina and Liberia that have
gone through similar reforms and transitions - will largely shape the
scenarios.  

In the interest of time and space, I will end here for now. The next article
will expand on the inflation scenarios for the rest of 2021 and the year
2022. 

Invest Wisely!

Bulls n Bears 

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