Zimbabwe`s double digit inflation: It`s déjà vu all over again

Harare Central Business District

The recent announcement of the country`s official inflation data carries quite some far reaching ramifications for the local economy. Zimstat announced the annual inflation figure for October at 20.85%, far above the SADC region`s benchmark of 7%. 

This is the highest inflation figure since the country dollarized in early 2009. In the 9 months to September 2018, inflation had averaged 3.58% according to Zimstat`s own data, with the RBZ forecasting that annual inflation for 2018 would end the year well below the 7% threshold.

However, October alone saw inflation gaining by 15.46 percentage points, significantly overshooting the central bank`s targets. There has been widespread discontent over the authenticity of the data from Zimstat itself. 

OK Zimbabwe recently reported an average internal rate of inflation of 12.2%, while the controversial Steve Hanke an economist at the Johns Hopkins University who tracks troubled global currencies, estimates the official inflation to be at least 160%. General price increases of between 200-300% on some products have been observed in the market lately.

Inflation itself is not inherently bad. In fact it is a vital catalyst for economic growth, and Japan`s central bank for instance, has been flooding its market with cash hoping to edge the Asian country`s economy nearer toward its inflation target of 2%, which has remained elusive.

The consequence has been sluggish economic growth lagging behind its other peers. From February 2014 to around February 2017, Zimbabwe faced deflationary economic conditions, which curtailed growth. 

Nonetheless, recent events have swiftly swung the pendulum to the other extreme; with fears abounding that hyperinflation may be rearing its head again. Whatever the measure of inflation one settles upon, it is clear; the effects will be quite dire going forward.

Hardship Allowance

Several companies have already started offering ‘hardship allowances’ to their employees, while some have even went a step further to pay a portion of their employees’ salaries in united states dollars, in an attempt to cushion staff against the rampant inflation.

Even more, various union leaders have been leading the call for salary increments for their unionised workers across the board. All this seems justified in the wake of the recent price increases, which have effectively frazzled out the consumer buying power in real terms. The same dollar in a consumer’s pocket cannot buy what it could, say three months ago, and this inevitably hits them where it hurts the most, the pocket.

Yet these increments in salaries, which in most cases are not backed by increased productivity, will inevitably lead to the wage-price spiral, where further salary rises beget even steeper increases in prices. 

Everything being equal, these ‘hardship allowances’ can only be sustained for so long. At some point, stops making sense for companies to bear the albatross of a burgeoning wage bill amid stagnant at best, and decelerating productivity at worst.

The unfortunate impact may be job losses, which would not bode well for economic growth in the near term, due to dampened demand in the market. 

With food price increases – which carry a 31.98% weight in the total CPI basket -  mainly driving the inflation,  consumers are headed for an even tougher 2019, especially as the rainfall season is being forecast to be below average. In addition to the proverbial belt tightening, not only will consumers generally have to rethink their lifestyles, it appears they will have to alter their diets too. 

Constrained bank lending

In response to generally higher lending interest rates characterising the period after dollarisation where rates averaged 20%, the RBZ has over the years progressively capped rates at 18%, 15% and later 12% in March 2017. 

While the super profits that are being reported by banks on account of higher fee income, may portray resilience of the sector, true to form, interest rate caps have yielded undesirable effects on the economy. 

The natural response for banks faced with interest rate caps is to tighten credit standards for loan approvals, which inevitably result in a decline in new loans, as not every borrower will access the loans. 

For instance, following the implementation of the 12% cap early in 2017, the loan to deposit ratio declined sharply from 56.64% in December 2016 to 44.81% in December 2017 and 42.8% as at June 2018, primarily because banks` loan portfolios have been growing at a slower pace than their deposit base.

 In fact, loan growth has been near static, with latest available data showing that between December 2017 and June 2018, bank loans rose marginally by $280,000.00 from $3.80 billion to $4.08 billion. 

More so, the average loan sizes for banks has been increasing, pointing to lower access by small borrowers and larger loans to more established firms. Altogether these developments run counter to the central bank`s thrust of promoting affordable credit to those market segments that are often underserved and need it the most.

Negative real interest rates

With inflation far exceeding the interest rate cap imposed by the central bank, leading to negative real interest rates, lenders will suffer. Experiences elsewhere show that lenders will predictably shift focus to shorter-term loans to big corporate firms and parastatals at the expense of smaller businesses.

Broadly, the economy suffers in an environment of negative real rates, as there is no major incentive to save, thereby impeding the growth of loanable funds, key to economic growth. It becomes a vicious cycle, which ultimately hinders the disintermediation efforts for banks. Going forward, the central bank will have to reconsider its cap on interest rates, especially as inflationary pressures show no signs of abating.

The effects of double-digit inflation are disastrous, and the memories of the heady days of Zimbabwe`s hyperinflation era are still fresh to most. Yet it seems like déjà vu all over again, pointing to the obvious need to act fast to rein in inflation.