21 June 2019

Zimbabwe: Introduction of Zimdollar a Disaster

Photo: Zimbabwe Independent
Bond notes.
analysis

A major economic highlight of the week was the confirmation by the President Emmerson Mnangagwa that Zimbabwe will re-introduce a local currency before year-end. It is our view that our country is not yet ready for the introduction of full-fledged local currency.

This is corroborated by the fact that certain benchmarks that need to be achieved before the local currency can be sustainably introduced in order to anchor the local currency have not yet been attained. These benchmarks include: attaining a sustainable GDP growth rate of at least 7%; low and stable inflation; reducing the high debt ratios to very low and sustainable levels; increasing the level of savings and investments to at least 25% of GDP; reducing the balance-of-payments deficit to less than 5% of GDP; increasing the export level to at least 25% of GDP; high levels of productive capacity; political stability; foreign-currency reserves will also need to be built up to sustainable levels to anchor the Zimbabwe dollar and to defend it in the event of a currency or speculative attack.

A study of countries that have dollarised in the past reveals that dollarisation is not easily reversed, even after the underlying causes have been removed. It takes a long time to build public confidence and trust in the local currency and it has been shown that economies remain "addicted to dollars" in spite of the disappearance of those factors that initially led to dollarisation.

Empirical evidence suggests that successful dedollarisation is usually the outcome of a persistent process of disinflation and stabilisation, rather than a main policy objective. The persistence of low and stable inflation, on the backdrop of fiscal consolidation, should give rise to an endogenous, and rather slow process of dedollarisation. That is, dedollarisation should be a by-product of stabilisation rather than an outcome of a policy programme with that explicit aim. While some countries such as Brazil, Colombia, Mexico and Venezuela have tried to avoid dollarisation by banning or highly restricting the possibility of issuing deposits in foreign currency residents responded through opening offshore accounts.

In 1982, Bolivian authorities attempted to de-dollarise the economy by converting dollar-denominated financial instruments to pesos bolivianos at an exchange rate below the prevailing one in the market. Capital controls, price controls and interest rate caps were also imposed at the time. Real negative interest rates prevailed in Bolivia during the high-inflation period of the early 1980s. In response to this high inflation and the prohibition of holding dollar-denominated deposits onshore, offshore deposits grew significantly and financial intermediation declined sharply.

In 1985, when the stabilisation package aimed at targeting the fiscal deficit and increasing monetary policy independence was adopted, the ban on foreign currency deposits was also lifted. Inflation and the fiscal deficit were successfully reduced and financial intermediation resumed as financial dollarisation grew.

In the mid-1980s, the Peruvian government decided to combat dollarisation by forced conversion of foreign currency deposits to the local currency. Dollar deposits were converted in 1985 into domestic currency deposits. This policy had negative implications resulting in massive financial disintermediation and capital flight. The inflation rate quadrupled in the 1990s and the Peruvian sol lost its key roles and functions. Government was then forced to adopt re-dollarisation and follow a market-based process of de-dollarisation. The market-based process focussed on achieving macro-economic stability by creating a fiscal surplus, significantly lowering public debt, and stabilising inflation by introducing an inflation targeting regime, which was followed by significant currency appreciation from 2003-2011.

The macro-stabilisation policy was complemented by micro prudential regulations to better manage foreign currency risks, and to develop a market for securities with a long maturity in domestic currency. Consequently, Peru managed to reduce dollarisation by approximately 30 percentage points.

Zimbabwe adopted a partial (unofficial) dollarisation regime in February 2009 following the introduction of the multiple currency regime, with the South African rand acting as the reference currency for accounting purposes, under which all transactions are now conducted in hard currencies. Government only made official a process that had already been initiated by economic agents (the market) who had started rejecting the local currency owing to hyperinflation that had debauched the local currency.

The adoption of de facto dollarisation in Zimbabwe had the immediate impact of eliminating hyperinflation, resulting in an improvement in the business climate and macro-economic stability. The new multicurrency regime implied that the Reserve Bank of Zimbabwe (RBZ) could no longer exercise an independent monetary stance. The RBZ's lender-of-last-resort function was also seriously compromised.

With the painful experience of the demise of the Zimbabwe dollar still fresh in people's minds, it may take even longer to restore public confidence and trust in the national currency. Its re-introduction might simply result in massive capital outflows; a further erosion of public confidence in the financial sector, precipitating disintermediation and a run on the banks as people take rational steps to protect their wealth, including shunning the banking system altogether.

In conclusion, introducing a full-fledged local currency requires that macro-economic fundamentals be in place; high doses of public confidence and trust; political stability; a strongly independent central bank as well as fiscal discipline for it to be sustainable. De-dollarisation must be a market-driven process and a government decreed process. Achievement of macro-economic stability is the key success factor in any successful de-dollarisation exercise.

Dr Chitambara is a locally-based scholar. These weekly New Perspectives articles are co-ordinated by Lovemore Kadenge, immediate past-president of the Zimbabwe Economics Society.

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