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Liquidity crunch, adoption of SA rand

Professor Ashok Chakravati
SINCE 2009, I have been arguing for the adoption of the rand as the currency of circulation and transaction in Zimbabwe.

All prices of goods, services and utilities; wages and salaries; money from ATMs et cetera should be in rand.

After the collapse of the Zimbabwe dollar in 2008, Zimbabwe adopted a multi-currency monetary regime in 2009.

It is important to note that after hyper-inflation reduced the value of the Zim dollar to zero, market forces resulted in the multi-currency solution in late 2008. The concept was officially adopted by Government through the 2009 Budget.

Initially, the adoption of this system brought stability to the economy and inflation was reduced to almost zero amidst economic growth.

At first, most of the foreign currency in circulation was the rand. However, as the rand began to depreciate, the US dollar became the dominant currency in circulation in Zimbabwe.

People preferred the dollar because it was acceptable to all as a currency for transaction. It was also good to hold in one’s bank account as a store of value, unlike the depreciating rand.

Consequently, although in name we had a multi-currency regime, in effect we had become a dollarised economy. At that time the monetary system was flush with US dollars and there were practically no restrictions on the amount of US dollars one could legally take out of the country.

The Reserve Bank considered money in individual bank accounts as “free funds” and remittances could be legally made without stringent documentation.

Unfortunately, the Finance Ministry and monetary authorities did not properly review the experience of economies that had dollarised in the past.

The facts are that there is not a single case of a dollarised economy that has successfully managed to keep on this path for a long period.

The dollar is an international currency in great demand. It is therefore not possible for a developing country to maintain a dollarised economy while being surrounded by a non-dollarised region and world.

There will always be a continuous leakage or “externalisation” of the dollar out of the economy.

The only countries which have managed to maintain a dollarised economy successfully over a long period of time are those which have a special relationship with the United States banking system, such as Panama and Ecuador.

Zimbabwe is not in that situation.

Our sources of US dollars are limited to what we can earn from exports, Diaspora remittances and FDI. These are barely enough to cover the foreign exchange requirements of import demands.

The table gives the availability of foreign currency (mainly US dollars) in the banking system from 2009 to date.

As can be seen from the table, the amount of foreign currency in the system has decreased from around US$600 million in 2009 to about US$300 million today.

To stop this externalisation, the RBZ correctly abolished the system of “free funds” and easy remittance of US dollars in March 2016.

However, in the absence of new sources of US dollar supply, this amount has not increased since then.

For there to be adequate cash in the system, and no signs of a cash or liquidity crisis emerging, the ratio of total cash to the total deposits being held in the banking system has to be around 15 percent.

The table shows that this ratio has declined from 35 percent in 2009, to 14 percent in 2013, and five percent in 2015.

The ratio today is still at five percent, but is slightly higher at 6,5 percent if we include the bond notes in circulation. To end the liquidity crunch we need almost about US$1 billion in cash to circulate.

Therefore, while bond notes have added to liquidity to some extent, they are not a solution to the problem.

Even if the RBZ today released the total amount of US$200 million in bond notes, the liquidity problem would not be solved.

Bond notes in effect are only addressing the symptoms and not the root cause of the problem.

Of course, if we had the capability of increasing our export earnings substantially and quickly, the liquidity situation could be solved temporarily.

Thus a good tobacco season will ease the situation and provide temporary relief, but it is not a solution to the problem.

Many of the economic problems that we are facing today stem from the use of the US dollar.

As noted earlier, while the US dollar can bring stability when emerging from hyper-inflation, its use cannot be a basis for competitiveness and sustained growth. Irrespective of what administrative measures are taken, it will continue to be externalised out of the country over time.

What we need therefore is a non-externalisable currency.

Ideally, Zimbabwe, like all other developing countries, should have its own national currency in circulation. Unfortunately, there are stringent conditions for the re-introduction of a national currency, and since these conditions are not present in the economy today, the introduction of a national currency is not an option open to us today.

Based, on economic theory, therefore, the most obvious currency for us to adopt is therefore the South African rand.

As per optimum currency theory, since 50 percent to 60 percent of our total trade is with South Africa, the most advantageous foreign currency for us to adopt is the rand.

The advantages of adopting the rand over the US dollar are:

1. It is a non-convertible currency and therefore it will remain mainly in South Africa and in Zimbabwe. There is no incentive for economic agents to try and externalise the rand;

  1. An adequate supply of rand is available from our exports to South Africa, Diaspora remittances from South Africa, and access to the South African banking system (with which many of our banks and financial institutions are already connected);
  2. The use of the rand will encourage regional integration, which will increase the financial flows from South Africa;
  3. The informal sector will be able to trade easily with South Africa. Since the informal sector is the largest sector of our economy, this will lead to growth and poverty reduction in Zimbabwe;
  4. The main reason why our industrial sector has collapsed is because we have continued to use the US dollar, which is a strong currency, whereas South Africa exporters use the rand, which is a weak currency;
  5. As China, one of the biggest exporters in the world has shown, it is good policy to maintain a weak currency. Then one can dominate world export markets. Use of the rand will help prices, costs and wages in Zimbabwe to equilibrate with South Africa, and this will result in the increased competitiveness of our industries, and the economy as a whole; and
  6. Maintaining the US dollar enables the US government to monitor every single US dollar transaction that originates from Zimbabwe. This is because all US dollar transactions must go through a US bank. Adoption of the rand will prevent this from happening.

Finally, it should be noted that what is being recommended here is not to move away from the multi-currency system.

It is to strengthen it by removing the US dollar from being the primary currency of transaction and circulation. In the new system:

–  The rand will be the currency of transaction and circulation. All prices, wages, salaries, etc will be denominated in rand;

–  The US dollar will remain, but become a foreign currency which stays within the banking system; and

–  Consequently, no more externalisation will be possible. Current dollar deposits will be converted into US dollar FCA’s and they will continue to perform the function of being a store of value. The dollar will primarily be used for external transactions through the banking system.

For the new system to come into place, full discussions need to be held between the monetary authorities, the banking system, and other key stakeholders.

However, it is not something that can be expected to happen naturally.

A Statutory Instrument will have to be put in place for this purpose, and a specific date set for

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