EDITORIAL COMMENT: Floating exchange rate has massive benefits

03 Mar, 2019 - 00:03 0 Views
EDITORIAL COMMENT: Floating exchange rate has massive benefits Prof Mthuli Ncube

The Sunday News

A floating exchange rate is one in which the value of a currency fluctuates in response to supply and demand.

The interplay of the market forces of demand and supply determine the currency’s value. Rather than government intervention, the currency’s value reflects public confidence in that country’s economy. Put simply, the value of a currency in a floating exchange rate depends on market forces.

This is opposed to a fixed exchange rate, which is a system in which the government attempts to maintain the value of its currency. In a fixed exchange rate, the government may also try to shadow the price of gold or silver.

The governments and central banks of some advanced economies try to let their currencies float freely.

They only intervene if there is a crisis or the currency has fluctuated too wildly. Canada’s exchange rate resembles a pure floating exchange rate most closely. The Bank of Canada has not intervened to defend the Canadian dollar since 1998, according to marketbusinessnews.com.

There are various advantages that go with a floating exchange rate. Marketbusinessnews.com says it is auto-correcting, that is, self-correcting. Market forces determine the value of the currency. The system automatically adjusts to any changes in supply and demand. It has better protection from external events. The country’s currency will withstand economic movements in other countries more successfully.

When there is free movement of demand and supply, the domestic economy has protection from changes in the global economy.

In addition, the government has more freedom. Specifically, it has more freedom to determine what its domestic policies are. A floating exchange rate self-corrects any balance of payment imbalance that a domestic policy may cause.

The only noted blemish is that in some instances there can be more fluctuations or more volatility.

Nigeria has successfully used the floating exchange rate in recent years.

The illiquidity and the difficulty to service foreign debt prompted Nigeria to respond by floating the currency’s exchange rate. The aim was to discourage imports emanating from the parallel market and devaluing the naira (Mondi, 2016). This was meant to arrest a runaway situation. When oil prices plummeted the country’s economic weaknesses were exposed. As the Nigerian dollar receipts dropped due to lower oil prices, the naira also weakened, prompting government to fix the currency in February 2015.

However, dollar receipts from the sale of oil continued to fall, making it difficult for importers. It also led to a scarcity of dollars. That in turn led to the development of a parallel dollar market that worsened the shortage in the formal sector. The illiquidity and the difficulty to service foreign debt prompted the state to respond by floating the currency’s exchange rate. The aim was to discourage imports emanating from the parallel market and devaluing the naira.

As the Minister of Finance and Economic Development Prof Mthuli Ncube has said, the newly announced Monetary Policy Statement by Reserve Bank of Zimbabwe Governor Dr John Mangudya is meant to allow recovery of the economy and enable industry to strive. With the introduction of the free market exchange of forex, the parallel market premiums are expected to shrink significantly. In his weekly column in our sister paper The Herald, Prof Ncube emphasised; “What does this mean for the average Zimbabwean?

“First, stability in the economy. Second, this development is expected to translate into availability of foreign currency, and its efficient allocation to support productive sectors. And finally, with stability and clarity for businesses and industry, combined with responsible economic and fiscal discipline from Government; investors will return. And with investors, comes jobs and opportunities.”

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