Fragility of economy under the multi-currency system

Investigating the causes of the wealth and poverty of nations is perhaps one of the most important tasks in economics.
While Zimbabwe’s economy is in plateau mode, this cannot be attributed to dollarisation.

Kipson Gundani

Exports have stagnated since commodity prices plunged to record low levels in the first quarter of 2015, output is increasingly constrained by infrastructural bottlenecks, most notably electricity, but also water and transport. Investment averaging 15% of Gross Domestic Product (GDP), well below the 25% to 30% necessary to meet the Zim-Asset growth target of 6,1% annually, is held back by slow growth and excess capacity in some sectors, as well as by policy and political discord, especially over property rights and indigenisation.

There is growing debate in the country on what have been the pros and cons of this dollarised environment. Are we winning or losing? In real essence, the economic upsides of dollarisation — price stability, resumed GDP growth, revival of the financial sector — must be set against the downsides, most notably fiscal restraint, monetary policy inflexibility if not impotence, the loss of formal sector jobs and the acute balance-of-payments and external debt crises.

Dollarisation constrains fiscal space because it forces government to resort to cash budgeting, as has been the case in Zimbabwe since 2009. In any event, Zimbabwe’s fiscal space problem is essentially on the expenditure side since revenue – excluding grants is 29,6% of GDP against a Sub-Saharan average of only 24%. Spending however averages 35% of GDP (2010-2015) well above the regional average of 29%.

Zimbabwe needs structural fiscal reforms to reduce the ratio of recurrent expenditure to total spending and in particular to lower employment costs as a percentage of GDP while increasing the amounts devoted to investment and management. And people would ask, if this is the challenge, there is a very real risk that the return of the national currency would worsen the expenditure-revenue imbalance while reducing the pressure on the authorities to curb public spending in line with normal sources of revenue. The return of the Zimbabwe dollar would make matters worse rather than better.

If we take employment as a more intimate measure of the economic progress under the US dollar era, we will discover that, non-farm formal employment has declined since dollarisation from 805 000 in 2010 (the 2009 numbers are not meaningful) to an estimated 760 000 in 2013.

This 2013 figure is virtually identical to the 762 000 recorded 32 years ago in 1984.

It is simply impossible to calculate the extent to which recent employment experience is attributable to the adverse effects of dollarisation but there can be little doubt that tight money market liquidity conditions, export stagnation and the inability of government to use fiscal and monetary policy to stimulate economic activity, are responsible to some degree.

Furthermore, in a dollarised economy, employers are far less likely to concede above-productivity wage awards than in the previous system where currency depreciation and rampant inflation enabled them to pass on cost increases to final consumers.

Looking at the balance of payments, since dollarisation, Zimbabwe has a cumulative balance-of-payments deficit on current account exceeding US$18 billion. This is being partially financed by net capital inflows though, leaving a significant payments gap normally shown in the external accounts as errors and omissions (unrecorded transactions and financial flows).

Despite this very large gap in the accounts, the International Monetary Fund (IMF) believes that Zimbabwe’s external debt increased by only US$1,1 billion during the period, which seems highly improbable, especially given long term offshore borrowing of over US$900 million and short-term loans averaging more than US$500 million in 2012/13. The probability is that the foreign debt, including arrears of US$4,7 billion, is somewhat greater than the IMF’s US$9 billion estimate. Indeed this US$9 billion estimate made in 2013 is substantially lower than a previous estimate of over US$11 billion made in mid-2011.

Regardless of the accuracy of the IMF estimates, Fund and World Bank Debt Sustainability analyses have concluded that Zimbabwe is in debt distress and needs to negotiate a debt-rescheduling or debt-forgiveness package with its main creditors.

Unless and until this is done, the country will continue to be starved of development funding. As the debt burden grows, foreign capital will become both less accessible and more expensive.

Although bank deposits (money supply) have grown more than ten-fold since dollarisation, liquidity conditions have become increasingly tight. Bank deposits grew rapidly between 2009 and early 2012.

Since then money supply growth has slowed dramatically. In the latter half of 2012, deposits (effectively money supply) grew less than 10%, slowing to 7% in 2013 and 2% in the first quarter of 2014. Similarly, after expanding rapidly albeit from a tiny base, growth in bank lending has slowed to average 15% in 2012/13, turning marginally negative in the first quarter of 2014.

In sum, since dollarisation Zimbabwe policymakers have had very little room for manouvre, especially as fiscal policy is structurally constrained by the very high proportion of employment expenses in total revenues and the burgeoning informal sector, whose contribution to the fiscus is minimal. Against the background of a slowing economy, mounting unemployment and growing poverty, there are calls for currency reforms that would widen the scope for domestic policymaking, increase market liquidity, create additional fiscal space and enhance competitiveness via greater exchange rate flexibility.

In any event, as a small, open, resource-driven economy dependent on foreign capital, the future trajectory of the Zimbabwe economy and of living standards in the country will be influenced substantially by global and regional economic developments beyond the control of any domestic policymaker.

This profound reality highlights the relevance of much of the debate surrounding economic renewal in Zimbabwe. It is widely believed that if only government would change some of its policies — on indigenisation, land reform, taxation, etc – and improve policy implementation, foreign investment would take off and drive economic recovery. But the payoff from good or better policies will be diluted by weak, politicised, extractive institutions.

Moreover, without institutional reform and renewal, policy improvements are unlikely to be formulated, let alone implemented.
Normally, two main paths to economic adjustment are available for countries experiencing either internal imbalance (high unemployment, stagnant or failling output, rampant inflation and large fiscal deficits) or external imbalance in the form of a large current account balance-of-payments deficit or, as in Zimbabwe’s case, a combination of the two.

Zimbabwe, experiencing both imbalances, must eventually adjust. One possible adjustment path is exchange rate realignment (devaluation) to curb imports and boost exports, output and employment. But under a fixed exchange rate system — such as dollarisation — such external rebalancing via currency devaluation is not possible.

Accordingly, countries that seek to operate with a fixed exchange rate are forced to resort to internal devaluation whereby adjustment is achieved through changes in real variables — output, employment, wages and living standards. Such an austerity strategy which was also followed by peripheral Euro Zone economies — Cyprus, Greece, Ireland, Portugual and Spain proves to be an immensely painful process socially and politically because of the impact on employment and living standards.

In Zimbabwe where, according to World Bank data, per capital incomes are lower today than in the early 1960s and where there has been no increase in formal, non farm employment for 30 years, internal devaluation and internal rebalancing is socially and politically sub-optimal.

This explains why — despite the severe problems inherent in de-dollarisation – policymakers will seek over time to de-dollarise the economy. But even those dollarised states which retained their domestic currencies — Peru is a striking example — have struggled for over a decade to reduce dollarisation. The process will be far more difficult in Zimbabwe where as part of the process it will be necessary to re-introduce a local currency that, at present, no one wants to hold.

Gundani is the chief economist of the Buy Zimbabwe Trust. The views expressed in this article solely belong to the writer. The New Perspectives articles are co-ordinated by Lovemore Kadenge, president of the Zimbabwe Economics Society (ZES). E-mail: kadenge.zes@gmail.com, Cell: +263 772 382 852.

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