It’s better to dollarise

By Nhlanhla Nyathi

WHO would have ever imagined a well-endowed country with huge mineral and natural resources failing to feed its people?

y>President Robert Mugabe, at a recent state function while commissioning a bio-diesel plant, said that there was no excuse for the current bad state of the economy given the abundance of mineral, natural and human recourses.

Since the expulsion of Zimbabwe from critical International Monetary Fund (IMF) balance-of-payments support programmes in 1999, the government has employed a cocktail of economic recovery programmes most of which have been unsuccessful.

Seasoned economic analysts and the IMF have suggested that the continued deterioration of the economy is largely a product of policy inconsistencies and incoherencies within government decision-making structures.

Many point to swelling government expenditure and the just-presented 2008 expansive national budget of $7,8 quadrillion combined with quasi-fiscal operations spearheaded by the RBZ as major contributors to the unrelenting inflationary pressures.

Others point to the distorting effects of the overvalued official exchange rate as having a hand in reducing productivity in all sectors of the economy and encouraging contagion in parallel market trading.

Some have gone further to blame the over-valued official exchange rate as the main motivating force behind smuggling and under-invoicing of Zimbabwean minerals and products exported out of the country to the detriment of its people.

Other analysts have gone further to suggest that the Zimbabwean economic situation would have not reached such alarming levels of deterioration had monetary and fiscal authorities handled policy issues differently.

Many ask whether the exercise of slashing zeros and the subsequent introduction of a new currency should be an annual activity of masking the effects of inflation.

During the slashing of the first three zeros and subsequent introduction of a new family of bearer cheques in August 2006 excessive financial resources were consumed to educate the public and to print the new notes.

This year, with inflation already at 14 840% and still rising, the prospect of the so-called Sunrise Two is imminent as part of the psychological management tactics of inflation. Surely the RBZ cannot continue to undertake this daunting task yearly at such a massive cost to the nation. There should be some other way that addresses the underlying problem first.

A study conducted by the United States Joint Economic Committee on official dollarisation in emerging markets in 1999 indicates that economically unstable developing countries with high inflation and unstable currencies are good candidates for dollarisation.

The report suggests official use of the US dollar or other foreign currencies is rare today except in small economies mainly because of the perceived economic advantages of an independent monetary policy.

An independent monetary policy implies that a country has a distinct domestic currency, typically issued by a domestic central bank. According to some economic theories, an independent monetary policy enables a country to manage the money supply, interest rates, and exchange rates so as to facilitate economic growth or at least to manage it within reasonable limits.

In practice, though, developing countries with central banks have had worse economies and lower economic growth than those without central banks.

Despite this poor record, central banking in developing countries persists because many people are adamant that it should work well in theory and because it has the political advantage of allowing a government to print money when it cannot or does not wish to cover its budget deficits by other means.

Finally, many governments see a domestically issued currency as a symbol of national identity and political pride, even if their citizens would prefer to use US dollars or some other currency exclusively.

Dollarisation happens when the US dollar to some extent displaces domestic currency as the preferred currency for holding savings, making payments, and pricing goods. Often “dollarisation” is used in a generic sense to refer to any foreign currency, not just the US dollar, which displaces domestic currency.

This description mirrors the current modus operandi in Zimbabwe albeit largely in an unofficial manner. Mainly due to high levels of inflation that have rendered the local currency useless as a store of value, more people transact in US dollars, South African rands and British pounds and hold the same hard currencies as “mattress” money to preserve value.

People have lost faith in the domestic currency and only remains as legal tender because of statutory restrictions. The problem with the piecemeal dollarisation so far undertaken by the government and the RBZ is that it adds to distortions in the economy in the sense that other sections of the economy which are not dollarized will strive to dollarise illegally fueling the parallel market.

The desired course of action would be to officially dollarise the whole economy and automatically eliminate the management of interest rates, exchange rates, and money supply of which our failure to manage these factors has been the primary precipitator of the economic recession. The very fact that a stable foreign currency will be used in the local monetary system implies a more orderly and predictable progression of economic indicators.

The existence of a parallel market which thrives on the vast difference between the official and the black market rate will cease to exist and facilitate a re-birth of all the productive sectors of the economy through more internationally aligned market-determined pricing structures devoid of distortions.

The RBZ under the new system would be relieved of the task of structuring monetary policy and the government would have no recourse to the RBZ to print money in the event of a budget deficit.

Consequently, the government would have to live within its tax revenue collection limits as the luxury to print US dollars will not be at Zimbabwe’s disposal.

The RBZ would also cease to exist as a lender of last resort to commercial banks and as a result force banking institutions to develop international lines of credit as an alternative.

The intricacies of the logistics involved in introducing dollarisation would obviously require government or the RBZ to institute further research into the subject, which was not the basis of this article.

The current system of having an expansionary budget and expanded quasi-fiscal operations spearheaded by the RBZ in the hope of reviving the economy have proved rather ineffective because of the existence of distortions in the market that encourage recipients of concessionary funding to engage in black market activities.

There have been several reports made of farmers abusing subsidised fuel facilities, fertiliser allocations and concessionary loans because of the temptations of a black market that stands ready to transact in anything.

It would be hard to imagine that the so-called people’s 2008 budget would increase production and reduce inflation because it is empty in every respect. It is silent on how the growth will be achieved and how the targeted inflation will be reached. In terms of real fundamental solutions the budget has nothing.

It would be better to rid the market of distortion first and then inject massive concessionary funding to get the desired result.

In principle, dollarisation would rid the market of such distortions and does seem to offer a viable alternative.

Zimbabwe would not be alone in the dollarisation quest and should not be perceived as a failure option by authorities but a valiant effort towards finding lasting solutions. Just to show the level of confidence other countries have placed in the US dollar, a study conducted by the US Federal Reserve estimates that 55%-70% of US dollars in circulation are held outside the United States, most of which are in US$100 bills.

* Nhlanhla Nyathi is an independent financial analyst. He can be contacted on 0912 250 092.