Zimbabwe’s million-dollar question

tendai_biti_budget_paliamentWhereto after multi-currency?
In an attempt to restore credibility in the monetary system and also to arrest the hyperinflationary trend, the government of Zimbabwe introduced the use of multi-currency on 30th January 2009. (Pictured: Finance Minister Tendai Biti in Parliament

Following the introduction of this regime, month-on-month inflation trend sharply declined from the rates of above 49 billion percent to less than 1% since February 2009 until today, with even negative inflations rates experienced in some monthly rates.

The government further suspended the use of the local currency, the Zimbabwean dollar (Z$) on 13th April 2009 initially for a year, and then latter for further three years (starting from January 2010).

According to the countrys three year macroeconomic framework announced on 23rd December 2009, Government will, therefore, maintain the principle of use of multiple currencies over the Framework period 2010 2012. Thus, the use of multiple currencies and the suspension of the Zimbabwean dollar from the monetary system have resulted in immediate and tangible effects on the economy.

For instance, besides single digit month-on-month inflations rates, the country for the first time in more than a decade has registered a positive economic growth rate and average production activities have leapfrogged from less than 10% in January 2009 to above 35% by end of December 2009. In short, the introduction of the multi-currency regime has improved the countrys economic health.

Despite the positive developments brought by the multi-currency regime, a political, social and culture decision has to be taken in the near future the decision to adopt another single currency once the country say goodbye to multi-currency as it will have to do that sooner or later.

Whilst there is debate within Zimbabwe for instance within the intelligentsia/academia, civil society, government and private sector; and outside Zimbabwe about the possible currency to be adopted, the intention of article is to contribute to this debate.

Thus, the main objective of this article is to critically analyse the various possible currency options that Zimbabwe can consider adopting in the after math of the multi-currency regime. This investigation is paramount because of two reasons.

Multicurrency is temporary

Firstly, the use of multicurrency is temporary, and secondly, the country needs a permanent single currency in its monetary system. The three broad possible currency options presented in this article and which Zimbabwe can potentially adopt in the aftermath of multi-currency regime are (i) dollarisation, (ii) joining the CMA and, (iii) re-introduction of the Zimbabwe dollar (Z$).

Dollarisation occurs when a country makes a foreign currency (currencies) full legal tender and reducing its own currency, if any, to a subsidiary role and being issued only in coins having small value. Generally, under such arrangement, there will be no risk of domestic currency, no currency risk, and therefore, no risk of currency crisis.

The country can join (assuming the current members accepts it) the Common Monetary Area (CMA) which currently consists of South Africa, Lesotho, Namibia and Swaziland. In such a system, Zimbabwe will adopt the South African rand as the legal tender, operating alongside the local currency, the Zimbabwean dollar on a one-to-one exchange rate with the South African rand.

The third option will be the re-introduction of the Zimbabwe dollar (Z$) however under different management regime. The proposed management systems to underpin the reintroduction of the Zimbabwean dollar are currency board, free banking and Reserve Bank of Zimbabwe (RBZ).

Although any of the three options [(i) dollarization, (ii) joining the CMA and, (iii) re-introduction of the Zimbabwe dollar (Z$)] could be adopted and implemented, the article considers the options in the following descending order of priority: (i) dollarization, (ii) retaining the Z$ but under the management system of a currency board, (iii) Joining the CMA, (iv) retaining the Z$ under the management of RBZ, with the institution having new management, and lastly (v) free banking.

Option 1: Dollarisation

Generally, dollarisation is often used in a number of countries. Specifically, on an informal basis, the US dollar has circulated alongside national currencies in a number of countries, both developing and developed.

It is only the formal dollarisation, which seems to prop up much interest, especially in previously highly inflated countries such as Zimbabwe. Thus, to have a clear understanding of dollarisation, three types of dollarisation will be distinguished in this section.

Definitions of dollarisation

Official or full dollarisation occurs when a country makes a foreign currency (currencies) full legal tender and reducing its own currency, if any, to a subsidiary role and being issued only in coins having small value. Generally, under such arrangement, there will be no risk of domestic currency, no currency risk, and therefore, no risk of currency crisis (Bogetic, 2000).

With official dollarisation, the foreign currency (currencies) adopted will not only be a legal tender for use among private parties, but will also be used by the government. One of the main features of full dollarisation according to Borensztein and Berg (2000) is that, once adopted, it will be permanent, or nearly permanent. Compared to currency board, full dollarisation will be relatively more difficult to reverse than doing away with or modifying a currency board.

A variation of official or full dollarisation is one called semi-official dollarisation or bi-monetary system, which exists when a foreign currency (currencies) is adopted as legal tender dominating bank deposits, but playing second role to the local currency in

payment of such costs as wages, taxes, and day to day transaction such as transport, groceries, etc.

Under this arrangement, the semi-official dollarising countries will have their own central banks or monetary authorities with vested authorities to champion their own monetary policies.

An example of this arrangement is the Common Monetary Area (CMA) in which Lesotho, Namibia and Swaziland have allowed the South African rand to circulate in their territories as legal tender alongside their respective local currencies at one-to-one exchange rate with the South African rand (ZAR).

Unofficial dollarisation occurs when residents of a given country hold a large proportion of their financial wealth in foreign currency dominated assets even though foreign currency is not a legal tender according to that countrys financial or monetary laws.

In this set-up, the dollar (or euro, or rand or any other foreign currency) will be widely used in private transactions as a medium of exchange, unit of account, store of value and standard of deferred payments.

According to Bogetic (2000), unofficial dollarisation may constitute holding of foreign currency in a variety of forms such as holding (i) of foreign currency bonds or other non- cash assets; (ii) foreign currency cash, whether possessing it is legal or illegal; (iii)

foreign currency deposits in domestic banks; and (iv) foreign currency deposits in foreign banks.

In the case of Zimbabwe and during the hyperinflation period, majority citizens have managed to unofficially hold their foreign currency in a variety form of cash. This has been necessitated by a number of factors.

Firstly, the fact that most goods and services since 2006 have been priced in foreign currency, so having foreign currency (USD or ZAR) has been a daily prerequisite for any transaction.

Secondly, the fact that up to end of January 2009 laws pertaining to opening and operating of foreign currency accounts (FCAs) have been tightened up, making it very difficult even to withdraw foreign currency in any local bank once deposited, made it prudent for people to opt for holding the foreign currency in cash, and not deposit into local banks.

Lastly, given the severe and acute shortages of foreign currencies in the country, for one to decide to part away with his or her hard earned foreign currency through deposits into the local bank was inconceivable, as withdrawing it was a fruitless exercise as in 99 percent cases there was no foreign currency cash in the bank.

Advantages of dollarisation

(i.) Low inflation

Dollarisation especially constituted at the right conversion rate has the ability to ensure low inflation to the dollarising country and this has been evidenced in Zimbabwe since beginning of February 2009 after the adoption of the multi-currency regime.

This comes from the fact that the dollarising countrys inflation will be closely related to the anchor countrys inflation rate since these two countries will be using the same currency and applying relatively similar monetary policies (devised by the anchor country).

For Zimbabwe this will be one of the most important advantage should the country officially dollarise given that hyperinflation has had unbearable social ramifications as majority of citizens have been pushed below the poverty datum line.

(ii). Reduced administrative expenses

With dollarisation there will be reduced administrative expenses. The reasoning here is that, the government of the dollarising country will not incur the cost of maintaining an infrastructure dedicated solely to production and management of a separate national currency.

For a country like Zimbabwe, these savings especially at such a time as this (where the country is coming out of severe hyperinflation) will be significant given that the country has been using a lot of resources over the years (e.g., money printed to

purchase foreign currency on the parallel market) in chasing the little foreign currency in the hands of exporters, banks, and individuals.

(iii). Establishment of a sound financial sector

Dollarisation can also provide the firm basis for the recreation of a sounder financial sector. In this case dollarisation will go beyond the mere adoption of a foreign currency, but will also mean financial integration with the anchor country and this will force

domestic financial institutions to improve their efficiency and the quality of their services.

Also dollarisation implicitly implies a supposedly irreversible institutional change, which can act as a signal for permanent commitment to low inflation, fiscal responsibility, and transparency. Such a scenario would be an asset to a country such as

Zimbabwe given that it has not enjoyed a consistent good reputation for price or fiscal stability.

(iv). Lower interest rates

With dollarisation there could be substantial reduction of interest rates for local borrowers. Dollarisation establishes a stable relationship with a currency whose reputation is already well established and secure, thus lowering the level and volatility of

domestic interest rates (real and nominal interest rates) by eliminating the risk of devaluation, thereby eliminating the devaluation-risk premium in local currency interest rates.

Through dollarisation, instead of investing heavily in efforts to build market confidence in its own monetary policy, a government can achieve instant credibility by hiring the respected anchor countrys central bank policy (Meyer, 2000). Given that Zimbabwes interest rates have been by far higher than the average rates applied in other neighbouring Southern African countries, any policy that reduces them is likely to be viewed as positive for the future prosperity of the country.

(v). Stimulate domestic long-term capital markets

Dollarisation spurs the development of domestic long-term capital markets by eliminating the risk of high inflation and currency devaluation. This comes from that fact that in a dollarisation system, the dollarising country cannot devalue the anchor currency

it has adopted.

The confidence brought about by a stable adopted currency (among other factors) will motivate investors, both domestic and foreign, to participate in the countrys long-term capital market. Zimbabwes long-term capital markets have not been attractive to most investor for a long time (2000 2008), and thus any confidence restoration in this market through dollarisation will be a benefit to the country.

(vi) Lower transaction costs

Since the country will be using an anchor currency, which in most cases will be highly traded, and convertible, for instance the US dollar or the South African rand, when compared to the local currency, transaction costs in international trade and investments

will be lowered, as there will be reduced need for currency conversions.

During the countrys hyperinflation period, because of the non-convertibility of the Zimbabwean dollar, transaction costs of doing international business were very high when using the Zimbabwean dollar. For instance, if a buyer from Zimbabwe wanted to import from Japan, the buyer had to first convert the Zimbabwean dollars to US dollars, and then convent US dollars into Japanese yen.

Because of hyperinflation and shortage of US dollar in Zimbabwes banks, the buyer had to purchase the US dollars from the expensive foreign currency black market and this meant exorbitant transactions costs. On the other hand, in the case of dollarisation with US dollar as the anchor currency, the Zimbabwean buyer will simply do one conversion from US dollar to yen, thus reducing transaction costs (of importing in this example).

Editors Note: This is an abridged version of a paper by trade policy analyst Albert Makochekanwa on the various possible currency options that Zimbabwe can consider adopting in the after math of the multi-currency regime. Next week he tackles the disadvantages of dollarisation.

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