US embassy cable - 02HARARE1406

UNCLAS SECTION 01 OF 04 HARARE 001406 
 
SIPDIS 
 
SENSITIVE 
 
STATE FOR AF/S, AF/EX, HR/OE-MTRACY 
NSC FOR SENIOR AFRICA DIRECTOR JFRAZER 
USDOC FOR 2037 DIEMOND 
LONDON FOR CGURNEY 
PARIS FOR NEARY 
NAIROBI FOR PFLAUMER 
PASS USTR - ROSA WHITAKER 
RIO FOR WEISSMAN 
TREASURY FOR ED BARBER AND C WILKINSON 
 
E.O. 12958: DECL: N/A 
TAGS: ECON, EFIN, ETRD, ZI 
SUBJECT: THE ZIMDOLLAR PLUMMETS ON THE PARALLEL MARKET 
 
REFTEL:  HARARE 1188 
 
SENSITIVE BUT UNCLASSIFIED, PLEASE PROTECT ACCORDINGLY. 
NOT FOR INTERNET POSTING. 
 
1.  (SBU) Summary: After remaining fairly stable for 
six months from December 2001 at around Z $320=US $1, 
the Zimdollar has devalued sharply on the parallel 
market over the last few weeks, with reports of trades 
in recent days going off at anywhere between Z $520 and 
Z $580.  This is roughly a 70 percent depreciation in 
three weeks.  The cause is a mismatch between supply 
and demand.  Demand is higher due to: changed tobacco 
sales rules that require all purchases of the leaf, 
including local, to be settled in US dollars; emigrants 
converting local assets to hard currency; importers 
scrambling for a stash of forex; likely GOZ buying to 
pay for fuel and food imports; and increasing 
recognition that the Zim economy is going to suffer 
substantially this year.  Supply is lower due to: slow 
tobacco sales and a stricter payment regime that sees 
the GOZ capture all forex receipts; both gold exports 
and manufactured exports are dropping steadily; and 
hoarding and speculation are more commonplace.  The 
effects of the slide on the economy are consistently 
negative: more and higher inflation; increased 
shortages of imported goods and domestic goods 
requiring imported components; shrinking real incomes; 
declining GDP; increased government deficits; financial 
and human capital flight; and reduced standards of 
living.  End Summary. 
 
2.  (SBU) A 70 percent currency devaluation in three 
weeks is a major alarm bell.  As no one knows where or 
when this slide will end, there is a so-far weak but 
distinct odor of panic in the air.  Such panic tends to 
become self-fulfilling when a run on a currency is 
allowed to precede unchecked, as is the case here so 
far.  The Government has been silent on the matter, but 
in the Finance Ministry there is a growing sense of 
looming disaster at the prospect of further deep and 
swift damage to Zimbabwe's economy as a consequence of 
runaway devaluation and the negative follow-on effects. 
We predict that any GOZ response, when it comes, will 
be heavy-handed and perhaps ill-thought-out, and it 
will rely on greater control rather than greater 
reliance on open market forces.  This could be a recipe 
for further economic disaster. 
 
------------------------ 
Reasons Behind the Slide 
------------------------ 
 
3.  (SBU) We have sifted, to the best of our ability, 
through the plethora of facts, half-facts and 
allegations that are currently being bandied about to 
explain the rapid slide.  We provide those we find most 
valid here in no particular order, and caution that the 
list is likely incomplete.  As the parallel forex 
market is a "free market", it is supply and demand that 
determines the price of the commodity, and the 
fundamental reason for the slide is demand that exceeds 
supply. 
 
Increased Demand Factors 
------------------------ 
 
== The new tobacco payment rules, announced in late 
April by the Reserve Bank and aimed at halting any 
forex leakage (the GOZ wants to capture ALL export 
receipts), requires that purchases be done in US 
dollars and that all payments go directly to the 
central bank.  This has two effects: local buyers (who 
buy either for domestic cigarette production or to 
process tobacco and then export it) now need to source 
hard currency when in previous years they could pay in 
Zimdollars.  Although the Reserve Bank set up a complex 
scheme utilizing a memorandum of deposit facility and a 
guarantee facility so that local banks could access 
offshore lines of credit for local buyers, none of 
these arrangements have materialized so far.  As a 
consequence local buyers have been sourcing small 
amounts of hard currency in the parallel market, 
driving up the price. 
 
== A host of sources have told us that the GOZ has been 
in the market for US dollars the last two weeks to make 
good on their promise to pay the Libyans for fuel 
imports (after deducting for exports to Libya and 
investments).  Apparently promises to pay no longer 
satisfy the northern neighbor, and it is time to put up 
or be shut off.  The other half of this claim is that 
the printing presses are running on double shifts to 
print the Zimdollars that are chasing limited forex. 
We have not been able to come up with hard evidence 
that proves either contention, but have no reason not 
to believe them. 
 
== We have also been told that the GOZ is in the market 
for hard currency to fund food imports.  Given the 
necessity, this is also highly probable behavior. 
 
== The numbers of intending emigrants, swollen by 
evicted white commercial farmers, is rising rapidly, 
and they need hard currency when they cross the border 
for the last time.  In addition, many of them are 
selling assets and chattels before departure, and they 
are demanding payment in hard currency.  MDC President 
Morgan Tsvangirai told us June 10 that the local Indian 
community bought up much of the forex supply last month 
after a war veteran leader threatened to take over 
their businesses and/or seize property. 
 
== There is a growing perception on the street that the 
sanctions imposed by us and others are affecting the 
GOZ leadership.  The thinking is that the leadership 
will lash out in an anti-Western response, perhaps 
outlawing all forex trading or holdings (limiting such 
to the Reserve Bank).  Consequently there is a rush to 
get hard currency now, while one still can. 
 
== At a NEPAD/World Economic Forum conference in South 
Africa a few weeks ago, Zimbabwe's Finance Minister 
laid out some bleak facts on his country's economic 
performance, including that a third of jobs in the 
manufacturing sector had been lost in the last year and 
a half to two years, and that an official devaluation 
was long overdue.  These remarks added to the negative 
pressure on the local currency, and created an 
expectation of further weakening, thereby sowing the 
seeds of substantial devaluation. 
 
== And finally, the perception that the Zimdollar is 
now on a runaway slide means that all importers, be it 
retailers or manufacturers, want to salt away a stock 
of hard currency, thereby feeding the chase that builds 
on itself. 
 
Decreased Supply Factors 
------------------------ 
4.  (SBU) On the supply side of the pricing formula are 
a number of developments that cause the market to be 
very short, especially in light of the above demand 
factors. 
 
== Tobacco sales have been slow to date, with both 
commercial and small-scale indigenous growers saying 
that even with the recently announced subsidy, prices 
are too low to provide a real return on the crop so 
many are holding back.  Slow sales means reduced hard 
currency inflows to the Reserve Bank. 
 
== On any tobacco sold, the Reserve Bank pays out to 
the growers 80 percent of the proceeds in Zimdollars at 
the subsidy price (a special rate of USD 1 equals about 
Zim $100, see Reftel).  The remaining 20 percent is 
intended to be set aside to fund a forex-denominated 
loan facility that tobacco growers can access to 
purchase necessary imported components to continue 
production.  To date there has been no funding of this 
facility (i.e. the GOZ is hanging on to all proceeds) 
and therefore no drawdowns of hard currency by farmers. 
This is an additional forex supply constraint not seen 
in prior years, when 20 percent of receipts went 
directly into farmer's foreign currency accounts, and 
it is a contributing factor to the mismatch of supply 
and demand. 
 
== Once the run started, holders or sellers of hard 
currency have held on, hoping for higher prices and by 
acting thus are helping to ensure that the local dollar 
devalues. 
 
== Zimbabwe's GDP continues to shrink, resulting in 
reduced manufactured exports.  The gold industry is 
also on the ropes; in 2000 exports totaled 27,000 
ounces and last year this dropped to 18,000 ounces. 
The trend of declining gold production is continuing 
this year, and though the gold price has firmed 
somewhat, overall, gold export proceeds are down, 
another forex supply constraint (gold is Zimbabwe's 
second-largest hard currency earner). 
 
----------- 
The Effects 
----------- 
 
5.  (SBU) The effects of this currency slide on the 
Zimbabwean economy are strongly negative.  The rapid 
devaluation means that inflation will continue to climb 
(up from the most recent May figure of 122 percent) and 
could easily exceed 200 percent at year-end (as the 
higher costs of imported goods and components are 
passed through, exacerbated by the rapidly swelling 
money supply).  The higher inflation, coupled with 
price controls and shrinking disposable income, will 
further reduce GDP, resulting in more manufacturing 
slowdown or shutdown, and further job and income loss. 
High domestic inflation cancels out the export lift 
normally associated with a weak currency, and high 
inflation, coupled with the central bank's low interest 
rate strategy, will further strip the country's already 
very low savings base, which is now only 6 percent of 
GDP, down from 9 percent last year.  This means that 
any recovery will be that much more difficult to 
execute, as there is little or no savings base to fund 
capital expenditure. 
 
6.  (SBU) The devaluation also makes food imports and 
any government relief program more expensive (if 
currency is sourced at parallel rates), increasing the 
likely footprint of malnutrition or starvation.  Higher 
costs and the slowdown of the economy means that the 
government's deficit will increase as spending surges 
and receipts fall.  Predictions made by Finance Minster 
Makoni that the deficit would be slowly brought under 
control this year and next are clearly going to prove 
wrong.  The devaluation and higher cost-of-living will 
increase the brain drain of service professionals to 
either regional or overseas destinations.  Electricity 
costs will increase (the state power authority 
announced a 45 percent increase two weeks ago), as 30- 
40 percent of national power consumption is imported. 
With the parallel and official rate difference at a 
multiple of ten, the corruption opportunities for 
ruling party insiders who have access to hard currency 
at the official rate are breathtaking.  Unfortunately 
these negative consequences tend to be self- 
reinforcing, and cumulative in a geometric rather than 
additive mode.  This means that damage can snowball 
quickly, and because it is widespread, take longer to 
repair. 
7.  (SBU) Comment. Zimbabwe's economy, already against 
the ropes and bleeding badly, looks set to receive 
another series of body blows.  Coupled with the food 
shortage, the negative economic repercussions of an 
uncontrolled and steep devaluation make it certain that 
the next 12 months will bring very difficult and hard 
times to Zimbabwe, with levels of suffering not before 
seen.  Given the levels of ego and greed at the 
leadership level we doubt that this coming crisis will 
bring about a substantive change of heart or policy, 
meaning that more of Zimbabwe will simply disappear 
over the edge of the abyss in the near term.  End 
Comment. 
 
SULLIVAN