Central Banks Must Act

HARARE – Opinion has been divided over how former Reserve Bank of Zimbabwe (RBZ) governor, Gideon Gono reacted to stem a hyper inflationary crisis that rattled Zimbabwe from 2000 to 2008. Many blame Gono’s quasi fiscal interventions for fuelling the crisis. Others say he saved the economy. In this abridged version of a thought-provoking scholarly paper, former ICAZ CEO Matts Kunaka, a doctoral student at Christ University, India, scholars Dr Jain Mathew (Christ University) and Dr Silas Luthingo Rusvingo (Great Zimbabwe University), give their perspectives. Their paper is titled; ‘Effects of Central Bank Intervention on the Economy Through Quasi-Fiscal Policies; Evidence From the Reserve Bank of Zimbabwe’

As Zimbabwe’s economic condition went through a nose-dive, government found itself unable to respond to the numerous needs with no resources. The country was achieving negative gross domestic product (GDP) growth rate every year since 2000.

Zimbabwe could not borrow from lenders like the International Monetary Fund (IMF) because of the illegal sanctions imposed by the United States and the European Union following land reforms from 2000.

The Zimbabwe Democracy and Economic Recovery Act (ZIDERA) (2001) enacted in the USA prevented American companies from doing business with Zimbabwe.

The RBZ stepped in to assist.

Literature review shows that central banks all over the world do intervene from time to time in economic crises to save the economy.

The mode, nature, and magnitude of intervention may differ.

But practical intervention is at times necessary.

The global recession due to the credit crunch in Europe and America witnessed the intervention strategies by central banks in the respective countries as a way of saving their economies from total collapse.

Thus, the RBZ sought to put measures into place to mitigate the effects of sanctions and provide liquidity to various sectors of the economy and government ministries.

Our research seeks to determine whether there were any adverse effects to the economy following the RBZ’s intervention, what were the benefits, where quasi fiscal programmes inflationary? What factors affected the success of quasi-fiscal operations and what options can be adopted to enhance their effectiveness should they be conducted again?

Zimbabwe experienced an economic downturn from 2000, as a result of illegal sanctions, man-made challenges and natural disasters.

As such, the RBZ sought to put measures (Quasi Fiscal Activities -QFAs) to mitigate the effects of these challenges and provide liquidity to various sectors of the economy and line ministries and ensure continued service delivery to the citizens.

From 2003 to 2008, QFAs were targeted towards productive and service sectors, spanning from agriculture, industry, parastatals and local authorities.

An all-encompassing definition of QFAs is the one stated in the IMF in 2002.

It states that QFAs are activities of central banks, public financial institutions, and non-financial public enterprises that are fiscal in character. They can be duplicated by specific fiscal measures such as taxes, subsidies or other direct expenditures, even though precise qualification in some cases may be very difficult.

QFOs refer to government transactions that are not included in the main budget and consequently do not get the same level of scrutiny and accounting standards as the annual conventional budget.

These activities or operations became a subject of intense debate globally with two contrasting views emerging, one in support and the other being critical of the concept.

According to Zhou (2001), in industrialised countries, the experience of market failures in the 1930s and the apparent successes of Kynesian-based reconstruction policies of the 1940s and 1950s practically asserted the need to put the state in command.

These views, which also derived strong support from labour dominated political parties, produced the “social democratic consensus” (Brett, 1988:16), which was responsible for organising the transition from the war economy to the long boom of the 1960s.

The main objective is to interrogate the options for enhancing effectiveness of quasi-fiscal operations based on empirical evidence from the RBZ and other key stakeholders. Our topic is useful especially if the central bank is contemplating embarking on QFAs in the near future to ensure that the quasi-fiscal operations are successful.

The need for QFAs

Gono (2008) points out that monetary policy, as much as fiscal policy, plays a central role in economic development.

The ultimate role of monetary policy in the process of economic recovery and development is to create a stable macro-economic environment. Under a stable economic environment, central banking and monetary policy are founded on the doctrine of instrumental monetary policy to achieve price and financial stability.

However, during periods of economic instability, central banks are forced to adopt ‘extraordinary’ measures that are usually in the form of QFAs (Gono, 2008).

According to Kanill (2008), 85 percent of policy makers said extraordinary interventions by central banks are critical to stabilise economies in times of crisis.

Thus, the challenges facing the Zimbabwean economy could have triggered the central bank to undertake extraordinary policies to manage the crisis.

Guidotti (2010), indicated that extraordinary policies in the form of direct intervention in the banking system such as insurance provided guarantees on debt issues and injection of capital have been effective in saving financial crisis challenges.

Cooper (2010) indicated that the Federal Reserve, the European Central Bank, the Bank of Japan, the Bank of Canada, the Sveriges Risk Bank and the Swiss National Bank adopted unconventional measures in response to the economic crisis.

Cooper (2010) further said a number of extraordinary measures were adopted.

These included lowering of interest rates, liquidity provisions to financial institutions were increased, intervening directly in wider segments of the financial markets, and purchasing long-term government bonds.

These have helped to stabilise the financial markets and helped to set the stage for the subsequent economic recovery.

This could be one of the justifications for the extraordinary measures that were taken by the RBZ.

The Zimbabwean economy faced multi-layered challenges from 2000.

Against the backdrop of recurrent droughts and declared and undeclared sanctions, the economy has been in a continuous state of decline.

These negative factors plunged the country into an economic crisis characterised by a multiplicity of challenges that combined to result in persistent contraction and capacity under-utilisation.

There were high unemployment levels, inflationary pressures, high monetary growth driven by government expenditure overruns, parallel market pricing of goods, services and foreign exchange, periodic administered price adjustments and severe adverse inflation expectations as well as high budget deficits financed from inflationary money printing (RBZ, 2006).

In addition to domestic imbalances, the economy has been impacted by the adverse global economic conditions, which included high international oil prices, which were inflationary.

The QFAs were targeted towards productive sectors.

Examples were Productive Sector Facility (PSF), Agricultural Sector Productivity Enhancement Facility (ASPEF), National Herd Restocking Programme, Operation Maguta, Support to Ministry of Lands, Maize and Wheat Bonus Facilities, The Bio – Diesel (Jatropha) Project, SMEs Revolving Fund, Farm Mechanisation Programme, support to fertilizer companies, parastatals and local authorities, National Housing Facility, Basic Commodities Supply Side Intervention Facility (BACOSSI) and the Medical Sector Skills Retention Programme.

There has been controversy surrounding the decision by RBZ to directly intervene in the economic direction of the country through what orthodox economists would term “quasi-fiscal interventions”.

This may have been because the effects/impacts of this action were either unnoticeable or simply misunderstood.

In terms of interrogating the options for enhancing effectiveness of the quasi-fiscal operations of RBZ if they were to be implemented again in the future, three components (see table below) out of the 11 that we looked at accounted for 88,1 percent of the total variance after extraction and rotation.

The scree plot below illustrates the extracted components for enhancing the effectiveness of the RBZ quasi-fiscal operations.

As is the case with the Eigen values the scree plot supports the three-factor solution.

Out of the 11 possible factors only three factors had values above the Eigen value 1.

Thus, as highlighted in the above paragraphs three factors are likely to exert the greatest impact in enhancing the RBZ quasi-fiscal operations.

Principal Factor Analysis and compare means results suggest that all proposed factors can have a positive impact with regards to RBZ quasi fiscal policies if implemented.

Inferred results using the One Sample t-test (Table 11.4 above) revealed the statistical significance of: relevance of the RBZ Quasi fiscal activities at the given time t(743)=55.88, the non-accomplishment of the quasi fiscal activities results t(743)=-62.274, p<0.05), the unjustified costs t(743)=-27.619, p<0.05) associated with quasi fiscal activities and the insignificant impact in alleviating the plight of distressed companies, t(743)=-1.573, p>0.05 (Table 11.4).