@ Chairman Brighton Musonza this happens to be my favourite financial topic as its at times called the Financial equivalent of the trinity where the 3 most important variables in Finance meet - Interest Rate, Inflation rate and Exchange Rate which is the basis of the Purchasing Power Parity Theory. I will try to keep it short and relevant to your thread. Interest rate paid by the borrower is made up of 3 things - Risk free Rate Plus Risk Premium plus Usage rate which is equivalent to the rent the borrower should pay me to use the money. The Risk free rate is the base rate which I would get if I invest in theoretically risk free Government Paper such a Treasury bills or bonds. The Risk premium is my reward for taking risk in lending money to an entity other than the Government. Note the loan to a Government should pay me at least the Risk free rate because I am assuming the Government can not default because of its taxing powers or because of its powers to print money or signor age. The risk free rate should also at least be higher than the Inflation rate so that it makes senses for me to invest and lend this money to Government by buying Government paper otherwise there is no incentive or me to save and invest I would be enticed to spend ,spend and spend because if I do not spend it now ,it will buy me less goods in the future due to inflation therefore my return should at least cover inflation rate plus some margin to reward me for financing the Government. Therefore the Nominal Interest rate should be equal to Risk Free Rate plus Market Margin Plus Default Premium. Please not the Risk free rate already should be above Inflation for this to make any sense to the investor otherwise it will encourage consumption opposed to investment. These are not financial mathematical formulas but rather a break down of those formulas and their simplification for the purpose of the discussion. When a currency is attracting high interest rates for example if the US Fed increases interest rates this will serve to strengthen that currency because people will dump other currency and buy that currency and earn higher interest rates in that currency this will have an effect of reducing interest rates in the long run because investors will flood that currency and there will be too much of that currency deposited in the banks such that an equilibrium will finally be reached and this will be reached via the Feds or the Central Bank in charge which will then adjust its Risk free rate or the Overnite accommodation rate in line with its targeted Interest rate which normally is linked or viewed at via the same lenses with the required inflation rate. The Central Bank plays the critical role of forecasting the inflation rates and then adjust its interest rate target according to anticipated or desired inflation. Deflation can happen once you have low demand and poor liquidity.In Zimbabwe its still debatable what is happening .Zimbabwe had adopted some wild prices which were inherited from the Hyper inflation days Mazuva eku burner.Many things are over priced in Zimbabwe by any standard.I had Lunch at Nandos with 3 friends and we spent about US$100 which is close to ZAR 1200. I am informed that that’s way too much in South Africa to spend at Nandos for 4 guys who didn’t eat that much.The same can be said about KFC prices in Zim . A look at the fuel prices also sums this up.Zim prices still need correction and adjustment so its still difficult to say its deflation just because prices are going down its perhaps a long over due correction .Right now even the Regulator is finding it difficult to tell Fuel retailers to stop ripping off people and stop profiteering. It goes without saying that Oil prices have nearly gone down 50% yet Zim prices remain stuck somewhere at US$ 1,50 per litre of fuel which prices was obtaining before oil price free fall. Zimbabwe has a problem because we cant influence Interest rates or Inflation directly because we do not have power to engage in Open Market Operations or Quantitative easing which can control the amount of currency in circulation and affect interest rates and affect inflation rate. To simplify this you then need to look at the basic definition of Inflation.Inflation is when you have too much money chasing after a few goods. It follows that for you to be able to adjust inflation somehow you need some power over the amount of money in circulation.Zimbabwe doesn’t have this power except now the addition of Bond coins which are a drop in the Ocean for this purpose. Normally 25% of a currency in circulation should be in coins ROUGHLY. We are no where near tht which supports the RBZ view that these coins are meant to support trade and commerce and not meant to re introduce Zim Dollars. However this makes sense since there are other coins already in circulation we have South African ,Pula and US Cents in circulation so the Bond Coin joins these coins. As captured elsewhere Zimbabwe right now does not have capacity to have its own currency mainly because of poor Economic fundamentals in terms of very low Production, high un employments, Low Exports, High Imports and generally low Capacity Utilisation and a general low confidence in the Financial System and sector. Zimbabwe needs to take crawl, then stand, take baby steps with regards to the Economy before own currency can be implemented. What is required now is to set out certain key mile stones and targets which have to be met before we can have own currency. Once you Dollarize its very difficult to get rid of the Dollarization, its more like getting married and then seeking a divorce. When you get married its funny and exciting but it aint easy to get rid of your spouse should you want out it’s the same with Dollarization we cant just abandon it. The only way out is to fix the Economy by have credible Policies which attract Investment and also reduce the Government Pay roll which swallows more than 82 % of the Budget .That means we need to leave something for Investment not spend everything on salaries leaving nothing for critical investment in Infrastructure such as dams, power, roads, railways, ICT, Irrigation and also we need a culture of savings rather than borrowing for consumption purposes.
Posted on: Sun, 14 Dec 2014 19:49:04 +0000
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