Cablegate: Nothing but Stop-Gap Measures in Latest Monetary Policy

VZCZCXRO1214
RR RUEHBZ RUEHDU RUEHJO RUEHMR RUEHRN
DE RUEHSB #0653/01 2141148
ZNR UUUUU ZZH
R 011148Z AUG 08
FM AMEMBASSY HARARE
TO RUEHC/SECSTATE WASHDC 3245
INFO RUCNSAD/SOUTHERN AF DEVELOPMENT COMMUNITY COLLECTIVE
RUEHUJA/AMEMBASSY ABUJA 2032
RUEHAR/AMEMBASSY ACCRA 2193
RUEHDS/AMEMBASSY ADDIS ABABA 2312
RUEHRL/AMEMBASSY BERLIN 0844
RUEHBY/AMEMBASSY CANBERRA 1589
RUEHDK/AMEMBASSY DAKAR 1947
RUEHKM/AMEMBASSY KAMPALA 2368
RUEHNR/AMEMBASSY NAIROBI 4799
RHEHAAA/NSC WASHDC
RHMFISS/EUCOM POLAD VAIHINGEN GE
RUEHGV/USMISSION GENEVA 1458
RUZEJAA/JAC MOLESWORTH RAF MOLESWORTH UK
RHEFDIA/DIA WASHDC
RUEAIIA/CIA WASHDC

UNCLAS SECTION 01 OF 03 HARARE 000653

SENSITIVE
SIPDIS

AF/S FOR G. GARLAND
ADDIS ABABA FOR USAU
ADDIS ABABA FOR ACSS
NSC FOR SENIOR AFRICA DIRECTOR B.PITTMAN
TREASURY FOR D.PETERS AND T.RAND
STATE PASS TO USAID FOR L.DOBBINS AND E.LOKEN
COMMERCE FOR BECKY ERKUL

E.O.12958: N/A
TAGS: EFIN ECON PGOV PREL PHUM ZI
SUBJECT: NOTHING BUT STOP-GAP MEASURES IN LATEST MONETARY POLICY
STATEMENT

REF: Harare 627

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SUMMARY
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1. (U) In his Monetary Policy Statement (MPS) delivered on July 30,
2008, Reserve Bank of Zimbabwe (RBZ) Governor Gono announced the
removal of ten zeros from notes in circulation, and the introduction
of a new currency. He failed, however, to introduce any new
policies that would tame inflation and sustain the new currency. He
continued to defend the disbursement of deeply concessionary funding
that is driving money supply growth and fuelling inflation. Despite
the dire need for growth in exports to generate foreign exchange,
the RBZ increased its anti-export bias by reducing companies'
retained export earnings, which will likely result in a further fall
in exports and put more downward pressure on the local currency. In
the face of a sharply contracting economy and out-of-control
inflation, this MPS offered nothing more than stop-gap solutions to
the symptoms of economic meltdown. END SUMMARY.

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Ten Zeros Lopped Off, And a New Currency
----------------------------------------

2. (U) The centerpiece of the MPS was a temporary fix to the problem
of high-denominated bank notes, which arose out of hyperinflation
and vexed IT systems. (NOTE: The highest denominated bank note of
Zimbabwe's palette of over 40 different bills is the Z$100 billion
"special agro-cheque" introduced on July 21 and now worth about U.S.
65 cents on the street. END NOTE.) Gono announced the
re-denomination of monetary values by a factor of 1:10 billion (i.e.
he removed ten zeros) with effect from today.

3. (U) To buttress the removal of zeros, Gono announced the
introduction of a new currency. (COMMENT: The denomination of the
new bank notes (Z$1, 5, 10, 20, 100 and 500) printed over a year ago
appears to have determined the number of zeros dropped in this round
of revaluation. End Comment.) The current bearer and special
agro-cheques will continue to be legal tender and circulate
concurrently with the new currency until the end of December 2008.
Gono also reintroduced coins that had been demonetized during
"Sunrise 1" as legal tender in the new values.

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Higher Daily Cash Withdrawal Limit
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4. (U) Gono also announced a twenty-fold hike to Z$2 trillion
(before revaluation) or Z$200 (revalued) in the daily cash
withdrawal limit, which had been Z$100 billion. He appealed to
"stakeholders to exercise restraint in their demand for cash and in
how prices are set."

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Killing the Goose...
--------------------

5. (U) The Governor admitted that the shortage of foreign exchange
was a major constraint on production, yet he penalized exporters by
increasing the amount of foreign exchange that they must surrender
to the RBZ. He raised the proportion of earnings that exporters
receive in local currency (at a grossly overvalued exchange rate)
from 35 percent to 45 percent.

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Domestic Credit to Government -

HARARE 00000653 002 OF 003

Driving Money Supply Growth
--------------------------------

6. (U) Figures in the MPS show that the year-on-year rate of growth
in broad money (M3) rose from 64,113 percent in December 2007 to
420,867 percent in April 2008, underpinned by a massive 734,014
percent increase in the rate of growth in credit to government.
Consequently, the stock of domestic debt as of mid-July 2008 had
risen by 7,417 percent from Z$10.5 quadrillion, recorded at the
beginning of the second quarter of 2008, to Z$790.9 quadrillion.
Furthermore, over 99 percent of the debt is short term, implying
that interest and capital repayments fall due almost at once,
thereby putting additional pressure on government expenditures. Of
the total domestic debt outstanding, the banking sector accounted
for 95 percent, which explains why government borrowing has been
highly inflationary. (COMMENT: It comes as no surprise that money
supply expanded at such high rates in light of the RBZ's
quasi-fiscal spending on the ASPEF and BACOSSI lending programs to
the agricultural and manufacturing sectors, plus massive
pre-election spending. END COMMENT.)

--------------------------------------------- --------
Capital Requirements Raised as Inflation Erodes Value
--------------------------------------------- --------

7. (U) Gono also announced an increase in the minimum capital
requirements for all financial institutions with effect from August
31, 2008. The minimum capital requirement for commercial banks will
be US$12.5 million; for merchant and building societies, US$10
million; for microfinance institutions, US$5,000, at the average
inter-bank rate of exchange. (COMMENT: Several banks are likely to
struggle to raise the capital; those listed on the Zimbabwe Stock
Exchange will probably satisfy the new requirements through rights
issues. END COMMENT.)

--------------------------------------------- --------
FISCORP to Become a Development Financial Institution
--------------------------------------------- --------

8. (U) Gono said he intended to turn FISCORP, which he created in
2007 to ring fence the RBZ's quasi-fiscal activities, into a
Development Finance Institution as a way of addressing "market
failures." (COMMENT: The issues that the new institution is meant
to address are by and large policy induced failures, not market
failures. A classic example is the low level of lending to
agriculture since 2003. Gono's figures show that while 80 percent
of commercial bank loans were made to the agricultural sector in the
late 1990s, by 2003 the proportion had fallen to 12 percent.
However, the massive decline was not due to market failure. It was
due to the chaotic land reform that transformed land into a
deadweight asset bereft of commercial value and changed the risk
assessment profile of land occupiers seeking credit. END COMMENT.)

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Contracting Economy
-------------------

9. (U) Gono released several gloomy economic figures: a 21 percent
drop in export proceeds from US$648.6 million in the January-June
2007 period to US$510.2 million in the corresponding period of 2008;
mineral shipments declined 16 percent over the same period;
agricultural sector exports declined 7.8 percent; tobacco sales as
of July 10, 2008 were also off last year's comparable figures,
although Gono did not provide the 2007 figures for comparison in his
Statement.

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HARARE 00000653 003 OF 003

COMMENT
-------

10. (SBU) In the face of a sharply contracting economy and
out-of-control inflation, this MPS offered nothing more than
stop-gap solutions to the symptoms of economic meltdown. Gono
clearly had to take some measure against the problem of high bank
note denominations, although lopping off zeros without addressing
the fundamental problem of inflation may prove to be
counterproductive in the medium to long term. But the focus of his
MPS was entirely short-term. The release of notes printed and
stored for a time when the economy had stabilized appears to have
been his only option for warding off an impending cash shortage
(reftel). Indeed, the decision to reuse coins that had been taken
out of circulation in 2006 indicates the level of desperation at the
RBZ.

11. (SBU) The increase in the daily cash withdrawal limit is a
welcome development, although hyperinflation is likely to erode away
the value swiftly. Without throttling the rate of growth in money
supply, i.e. reducing public sector borrowing, inflation is
untamable and will put further pressure on the value of the Zimbabwe
dollar.

12. (SBU) The RBZ's decision to raise the percentage of export
proceeds surrendered at the inter-bank rate is an implicit tax
increase on exporters. They are likely to respond by reducing
exports. Gono's introduction of the inter-bank market for foreign
exchange in late April 2008 failed to increase the competitiveness
of exporters, as the inter-bank rate has lagged sharply behind the
parallel market exchange rate and created a further disincentive to
exporters to remain in the formal market.

MCGEE

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