1 July 2019

Zimbabwe: Govt Currency Reforms Dicey

analysis

If you were to search President Emmerson Mnangagwa and Finance minister Mthuli Ncube, as well as their colleagues and advisers, among others in officialdom, you will almost certainly find wads of dollars - greenbacks, not bond notes, or some other dubious local quasi-currency - in their pockets.

While government, in a surprise move this week, abolished the multi-currency system, which saved the country from the inferno of hyperinflation and chaos from 2009, the use of the United States dollar as a unit of account, medium of exchange and store of value in Zimbabwe is unlikely to end. It might have been removed as legal tender, but it will remain the preferred currency.

Prices will also continue to be pegged to the dollar and follow the exchange rate, hence inflation will surge. The exchange rate is the barometer of the state of economic fundamentals. Even if it has temporarily fallen in the aftermath of the shock Zimdollar return, it will soon start rising again because of the disequilibrium in demand and supply of forex in the market. This is not rocket science or a doomsday scenario, but an elementary principle of economics.

Of all the people out there, Ncube, with his glittering credentials in economics and finance, should know better.

The point is, Mnangagwa and Ncube's de-dollarisation process is going nowhere on account of the environment and volatile macro-economic fundamentals. To begin with, they did not voluntarily choose to tackle re-dollarisation as an emergency, but were forced into it. They admitted this by themselves.

Both of them had before Monday been talking about re-introducing the local currency upon restoration of fundamentals and production. They sounded clear on issues, saying conditions have to be right first before that is done.

However, as they later confessed, they were stampeded into it by re-dollarisation. The market was re-dollarising itself at a terrific pace and they were losing control of the situation. So emergency breaks had to be applied to stop re-dollarisation.

After 2009, Zimbabwe informally dollarised up to 95%. An economy is considered to be highly dollarised if the ratio of foreign currency deposits to broad money supply exceeds 30%. Many countries in Africa -- including Zambia, Angola, Liberia and Mozambique -- have ratios in excess of 30%, but the difference was foreign currency transactions there were only limited to certain areas.

In Zimbabwe, the local currency had been decimated by hyperinflation and demonetised -- with the US holding sway over the economy -- before its mysterious return on Monday.

While some citizens and businesspeople are celebrating the return of the Zimdollar -- it's a good thing in principle, but not under these conditions -- the consequences could be dire. It could lead to shortages, stoke inflation and wipe out savings and value; memories of 2008.

Mnangagwa and Ncube's rationale that every country needs its own sovereign currency is sound. Indeed, monetary sovereignty and seigniorage are critical. They ensure regaining of monetary policy leverage and all the associated benefits. It's a meaningful argument, but sadly they are making it out of context.

For instance, Mnangagwa says all normal countries have their own currencies. But then again Zimbabwe is not normal by any stretch of the imagination. A country engulfed by 97,85% inflation, measly wages, company closures, de-industrialisation, over 90% unemployment and poverty can't be normal.

Macro-economic stability, which acts as a buffer against currency and interest volatility, supplemented with prudential measures, is key. Empirical evidence shows successful de-dollarisation is usually the outcome of a persistent process of disinflation and stabilisation, rather than a main policy objective.

According to the Maastricht criteria, stability is measured by five variables: low and stable inflation; low long-term interest rates; low national debt relative to GDP; exchange rate stability; and low deficits. Confidence is also central.

There are some countries which have de-dollarised and many which have failed. The bottom line, though, is macro-economic stability and opportune timing are sine qua non to the process.

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