US embassy cable - 05HARARE491

C O N F I D E N T I A L SECTION 01 OF 02 HARARE 000491 
 
SIPDIS 
 
AF/EX 
AF/S FOR BNEULING 
EB/IFD FOR FCHISHOLM 
NSC FOR SENIOR AFRICA DIRECTOR C. COURVELLE, D. TEITELBAUM 
TREASURY FOR OREN WYCHE-SHAW, STATE PASS USAID FOR MARJORIE 
COPSON 
ALL AFRICAN DIPLOMATIC POSTS 
 
E.O. 12958: DECL: 12/31/2009 
TAGS: ETRD, PGOV, ZI, ECON, EINV, Economic Policy 
SUBJECT: CURRENCY AUCTIONS BECOMING IRRELEVANT 
 
 
Classified By: Ambassador Christopher Dell for reasons 1.4 b/d 
 
 
1. (C) Summary: Foreign exchange demand at the Reserve Bank 
(RBZ),s 14-month-old currency auctions is now twelve-times 
greater than supply.  Traders are migrating in droves to the 
illegal parallel market.  After the March 31 parliamentary 
elections, the GOZ will either have to resolve the 
supply/demand discrepancy through a hefty devaluation, or 
accept that its much-ballyhooed auctions are giving way to a 
resurgent parallel market.  End Summary. 
 
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The Auction,s Achievements  - From the GOZ Standpoint 
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2. (C) Through the introduction of RBZ currency auctions in 
January 2004 and stricter enforcement against parallel 
trading, the GOZ has accomplished several goals.  First, the 
GOZ has made exchange rate management, rather than monetary 
supply growth, its primary tool to contain inflation. 
Through this approach, the GOZ has been able to contain 
inflation somewhat while increasing money supply (about 200 
percent annualized during the period) to finance government 
spending.  Since the auction,s inauguration, year-to-year 
inflation has fallen from 623 to 127 percent.  Although 
growth has remained negative, and the few productive sectors 
of the economy are wilting under the strain of financing the 
government,s interventionist policies, lower inflation has 
become for political purposes the GOZ,s prima facie evidence 
of a recovering economy. 
 
3. (C) Second, the auction system has allowed RBZ Governor 
Gideon Gono to concentrate economic power in his hands.  The 
GOZ has ensured that, until recently, foreign exchange 
inflows and outflows largely pass through official rather 
than private channels.  By becoming the country,s only legal 
currency broker, the RBZ increased the share of export 
revenue it handled from US$300 million in 2003 to US$1.7 
billion in 2004.  (N.B. In its official media, the GOZ has 
often mischaracterized this redirection of inflows as a 
five-fold increase in exports.)  Under the auction system, 
the RBZ governor has been able to select the importers that 
obtain discounted forex through the only legal channel, a 
near-guarantee of success.  Furthermore, he has turned 
private banks and international transfer agents into RBZ 
agents, since they can no longer trade currencies and move 
forex freely. 
 
4. (C) Third, GOZ insiders have gained an additional pretext 
to harass political adversaries for violating the Exchange 
Control Act, i.e., trading on the parallel market or 
transferring funds out of Zimbabwe.  Many arrests seem to 
arise out of factional battles within the ruling ZANU-PF. 
Since January 2004, the GOZ has detained hundreds of 
prominent Zimbabweans for exchange transgressions, and 
Finance Minister Chris Kuruneri has already spent a year in 
jail awaiting formal charges.  The GOZ has accused Kuruneri 
and others for offenses prior to January 2004, when affluent 
Zimbabweans traded openly in the parallel market.  (N.B., 
Official prohibitions such as the Exchange Control Act were 
already in place before January 2004, but the GOZ tolerated a 
ubiquitous parallel market.  It was the only forex source 
only for imports, foreign tuitions, travel and other 
purposes.) 
 
 
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The Auction,s Unraveling 
------------------------ 
 
5. (C) According to the RBZ, it has increased available funds 
at the biweekly auctions from US$ 8 to 11 million since 
January 2004.  However, demand has far outstripped supply. 
Of 5,804 importers who competed for forex at the March 21 
auction, only 102 succeeded.  Moreover, we know of no firm 
that has succeeded in weeks.  Reportedly, most of the 
country,s forex is being routed to the fuel sector to ensure 
adequate supplies in advance of the election.  At the same 
time, the Z$6,000:US$ auction rate has become more and more 
implausible.  Even according to official statistics (which 
are not always reliable), cumulative inflation from January 
12, 2004-March 6, 2005 has run about 160 percent while the 
zimdollar,s &official8 rate has actually appreciated by 8 
percent  (from Z$6500 to 6000:US$). 
 
6. (C) After the GOZ lightened its enforcement against 
parallel traders two months ago, the zimdollar began to slide 
rapidly toward its intrinsic, inflation-adjusted value. 
Since then, the parallel exchange rate has moved from 
approximately Z$9,000 to 15,000:US$, a devaluation of 67 
percent.  Parallel trading has become more commonplace, with 
most Zimbabwean businesses forced to look there for forex. 
One trader even confided to us last week that he has started 
handling exchanges for the South African embassy and several 
RBZ staffers.  With the exceptions of fuel and electricity, 
prices for local goods and services reflect parallel rates. 
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The GOZ,s Dilemma: Devaluation or Parallel Market 
--------------------------------------------- ---- 
7. (C) To make the auctions relevant again, the GOZ would 
have to stomach a major devaluation of the official exchange 
rate.  RBZ officials have been telling us for months that 
devaluation will follow the March 31 parliamentary elections, 
but we are not at all certain that the GOZ will move far 
enough, fast enough to draw inflows away from the parallel 
market.  A small devaluation, for instance to 9000, might 
simply cause further depreciation of the parallel rate 
especially since the GOZ is unlikely to alter its underlying 
state-centric economic policies. 
 
8. (C) A better but probably less likely scenario would be 
for the GOZ to leave the auctions intact for certain 
transactions, such as parastatal operations, but to tolerate 
parallel trading for the economy as a whole. This would prove 
an important step toward exchange liberalization, as a 
largely decriminalized parallel market would in effect 
represent a self-adjusting, floating rate.  It would make 
exporters more competitive and enable importers to acquire 
forex through an orderly, predictable process.  The continued 
existence of an official rate would, however, remain a source 
of official corruption. 
Dell