Central bank profiteering in Zimbabwe

Stephen Matteo Miller and Thandinkosi Ndhlela of Monash University have this interesting paper on Zimbabwe Central Bank.

As institutions deteriorated during Zimbabwe’s hyperinflation, people accessed official reserves through bribery to complete round-tripping transactions called Bicicletas, which hedge against losses of purchasing power. We model Bicicletas as options that replicate simultaneously exchanging outperforming official foreign reserves for underperforming domestic currency while exchanging back the domestic currency for the foreign currency in the parallel market. Bicicletas are compared to the parallel market premium. Both profit measures rise along with deteriorating institutional quality measured by Clague, et al’s (1999) contract intensive money, but Bicicletas are more informative than the premium because they reflect parallel market and official exchange rate risk.

It points how the central bank officials would exchange the dollars for a much higher exchange rate off the market. This led to development of the parallel market in forex market in the country leading to widespread hyperinflation and institutional decline:

We rarely hear about corruption in central banking, but Muponda (2008)describes a round-tripping trade that evolved from profit opportunities that officials at theReserve Bank of Zimbabwe (RBZ) exploited prior to the hyperinflationary demise of the Zimbabwe dollar (Z$):

Assuming one approaches the RBZ and accesses US$1000 at the official rate ofUS$1:Z$30,000, it means you pay the RBZ Z$30 million. Then you walk acrossthe city to Fourth Street or take the US$1,000 to Road Port and you meet one ofthe RBZ‟s runners who offers you a rate of US$1:Z$4,000,000.

The emergence of the trade reflects the deteriorating institutional environment asKarimakwenda (2007) notes a senior official hired the runners, who competed with blackmarket traders.

It seems weakening institutions, exchange rate misalignment-related volatility andcentral bank profiteering opportunities went hand-in-hand in Zimbabwe. We relate theparallel market premium to the Bicicleta in the next section before comparing arbitrage opportunities for each measure and analyzing how they respond to policy changes in Zimbabwe, prior to the demise of the Z$ and concluding.

Findings are:

By analyzing how the RBZ was used by officials for personal gain, we offer details that illustrate Bates’s (1981) general observations and Acemoglu, et al.‟s (2003)empirical findings that real exchange rate overvaluations may be used to expropriate wealth. Within an environment of deteriorating property rights, the payoff to corruption by elites accessing the RBZ increased, until the Z$ was eventually priced out of existence. Since Bicicletas capture money flows in each direction, as well as official and parallel market rate volatility they shed light on several facets of the problem that cannot be addressed by relying solely on the parallel market premium.

For instance, we find that Bicicletas rise as the RBZ took measures to increase its reserves during periods of higher parallel market volatility; the parallel market premium does not show this. Our findings suggest that devaluations might be delayed if officials are hoping to source foreign currency to purchase imports. However, they have little effect on the payoff to round-trip transactions, because the lower incentives to access official reserves resulting from devaluations are virtually offset by the increased incentives to convert back to domestic currency. With Shleifer and Vishny’s (1993) insights in mind, the trade is one of many signs that President Mugabe’s regime has weakened, as officials profiteered for their own benefit from their access to public goods.

Superb stuff. ..Corruption in central banks can have deadly consequences…The paper could have been much better if it explained more on the linkages….But still quite an insight..

One Response to “Central bank profiteering in Zimbabwe”

  1. FTSE regains 6,000 as miners surge and ARM outperforms | Daily Forex and Stock Says:

    […] Central bank profiteering in Zimbabwe « Mostly Economics […]

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