By Victor Bhoroma
Zimbabwe suspended its local currency on April 9 2009 and adopted a basket of multi-currencies such as the South African rand, British pound, Botswana pula, Japanese yen, euro and the United States dollar.
The country’s own currency had been rendered worthless by record hyperinflation of 231 million in 2007. The hyperinflation era left a trail of de-industrialisation and market shortages of basic goods and services. The government had no option but to follow market demands in accepting the United States dollar as legal tender after three failed attempts to redenominate the local currency through removing zeros.
The adoption of the US dollar left the central bank’s money printing machinery redundant but it stabilised the economy and tamed the scourge of hyperinflation (largely caused by excessive money printing to fund quasi-fiscal activities and budget deficits).
Adopting multi-currencies allowed Zimbabwe to eliminate exchange rate risks, build real savings, manage interest rates, improve its investment climate, resume financial intermediation, reduce transaction costs in trade and retool production through accessing foreign lines of credit. Economic growth rate averaged 7% per annum with all economic sectors registering successive growth between 2009 and 2015.
Dollarisation had its fair share of problems for the country as the government lost control of growing the economy through government expenditure. Dollarising the economy also opened floodgates of foreign currency externalisation from Zimbabwe at all levels. Between 2015 and 2017, over US$3 billion was externalised from the Zimbabwean economy by corporates, politicians and business tycoons to Mauritius, South Africa and the Far East.
Some may argue that foreign currency externalisation only grew after the 2013 national elections due to a decline in investor confidence and fears of possible economic mismanagement. However, there is no doubt that foreign businesses found it lucrative to sell their merchandise in Zimbabwe due to the high prices charged locally. This is largely because of the US dollar-inflated cost of doing business prevalent in the local market.
To make matters worse, profits made by these foreign businesses were not retained in Zimbabwe as savings or re-investments; as such, they did not contribute to economic growth. Without sufficient protectionist policies, local manufacturers often found it difficult to compete with imports from South Africa due to the high cost of production locally. That still remains the case despite the change of currencies.
Cracks in the multi-currency regime surfaced in August 2015 when Treasury passed the RBZ Debt Assumption Bill, which involved the government assuming the RBZ legacy debt of over US$1,4 billion through issuing Treasury Bills (TBs).
The objective of this Debt Assumption Bill was to clean the RBZ’s balance sheet and allow it to resume the central bank’s clearing role through the Real-Time Gross Settlement (RTGS) electronic money printing. After the debt assumption, broad money supply grew by over US$1 billion in less than 12 months and nostro accounts declined due to foreign currency externalisation. Alert investors started offloading five-year TBs on the local market at a discount in favour of offshore credits after it became clear that the central bank had no capacity to repay the TBs in foreign currency without introducing a local currency in the near future. Cash shortages started to creep in by February 2016 and have lasted to this day.
The government re-introduced the Zimbabwean dollar with the banning of multi-currencies on June 24 2019, despite adverse warnings on implementing monetary reforms before addressing fundamental aspects that support currency value. The local currency started trading on the inter-bank market in February 2019, but has lost more than 85% of its value in the last eightmonths. Official Inflation has quickened to over 353% as of September 2019 and the economy is as volatile as the currency in use.
Zimbabwe was neither the first country to fully dollarise (currency substitution, popularised by the US dollar), nor was it the first to attempt to de-dollarise. Countries such as Cambodia, Bolivia, Vietnam, Peru, El Salvador, Chile, Israel, Poland and Georgia have dollarised before. De-dollarisation has never been successful as a policy but as a benefit to pragmatic economic reforms. Only a handful (notably Israel, Poland, Vietnam and Georgia) have managed to fully de-dollarise due to a combination of some factors listed below.
Free market policies
Georgia has a transition economy almost the size of Zimbabwe with a GDP of about US$18 billion, though its monetary policy is run through a constitutionally independent National Bank of Georgia. Under its Larization Plan (borrowed from its domestic currency, the Lari), the national bank offered incentives for voluntary conversion of foreign currency mortgage loans to the domestic currency. There was also mandatory issuance of small loans in the domestic currency only so as to reduce foreign currency obligations in future.
Georgia runs a free floating exchange rate and took reforms to stabilise inflation rate below 7% as the key condition for adopting the Lari. Free market forces played an important role in achieving fast and long-lasting de-dollarisation. The country achieved a lower level of dollarisation by stabilising the macro-economic environment, without resorting to restrictive regulations.
Domestic money supply and macro-economic stability
High inflation rates induced by growth in domestic money supply growth are toxic to any de-dollarisation efforts. In the mid-1980s, the Peruvian government decided to combat dollarisation induced by massive growth in money supply and inflation.
The government forced conversion of foreign currency deposits to the local currency (Peruvian sol). This policy turned out to be counter-productive, provoking financial disintermediation and capital flight. The inflation rate reached quadruple digits in the 1990s and the Peruvian sol lost its essential functions. After this painful experiment, government authorities radically changed their de-dollarisation strategy.
Their new plan 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 prudential regulations to better account for earned foreign currency, and to develop a market for securities with a long maturity in domestic currency. As a result, Peru managed to reduce dollarisation and is set to achieve its 2020 de-dollarisation targets.
Institutional stability and confidence
Trust and confidence in the government and monetary authorities are key determinants in de-dollarising the economy. It allows consumers and businesses to hold large sums of the local currency, save and accept future payments in the local currency. The Vietnamese example proves that de-dollarisation policies instituted by the central bank can work if there is pragmatism in policy implementation and confidence in the market despite the existence of a planned economy. The Vietnamese government operates a fixed foreign currency surrender scheme on exports similar to that of Zimbabwe and maintains tight controls on the parallel foreign exchange market.
The State Bank of Vietnam (SBV) aims to reduce the proportion of foreign currency in total outstanding debts to below 7,5% in 2020 and below 5% by 2030. Despite strict controls on the amount of foreign currency to be withdrawn by individuals or travellers, the limits set on provision of foreign currency for importing commodities that can be manufactured in Vietnam stands out as the best. This has allowed Vietnam to realise successive trade surpluses of over US$1,6 billion in 2017 and 2018 and reduce pressure on the foreign exchange market. The market retains confidence in the Vietnamese Dong despite government controls on the economy.
The Zimbabwean government has been leaning towards the South African rand in the past few weeks, with the local currency inter-bank rate being pegged at 1:1 to the rand. There is no doubt that achieving macro-economic stability is the main driver of a successful de-dollarisation as evidenced in Georgia, Vietnam and Peru. There are ways to facilitate the process of natural de-dollarisation, driven by genuine fiscal consolidation (including privatisation of state entities), macro-economic stability, improved institutional integrity, political stability and stable production. It is true that dollarisation undermines the country’s monetary policy framework and takes away its lender-of-last-resort function. However, it is critical to point out that if there is no discipline in growing broad money supply on the part of the central bank and confidence in the monetary policy as is the case in Zimbabwe, de-dollarisation will be mission impossible.
Bhoroma is an economic analyst. He is a marketer by profession and holds an MBA from the University of Zimbabwe. — on email@example.com or Twitter: @VictorBhoroma1.