PATRICK Conway, in his paper entitled The Economics of Cash Shortage concluded that cash shortages were a manifestation of shallow financial markets. His conclusions were based on analysis of cash shortages which occurred in countries in the former Soviet Union
during the 90’s as perestroika and glasnost took hold there.
In most cases, the preferred policy responses to cash crises were printing more money (currency emission) and/ or cash rationing. However, these policies failed to achieve the intended goal of eliminating the cash shortages without causing instabilities in the macro economy. Currency emission led to accelerating inflation while restrictions worsened the situation.
In Zimbabwe the major cause of the current cash crisis seems to be the hyperinflation which has vastly increased the transactional demand for money. Rapid monetary expansion, declining investment and production levels, apparent indexation of prices to volatile parallel market exchange rates and adverse expectations have also contributed to the problem.
In addition the informalisation of the Zimbabwean economy has meant that more currency now circulates outside the formal banking system. Given that most participants in the informal sector are either unbanked or they shun transacting via formal channels, cash in this sector is rarely deposited with banks.
Severe foreign exchange shortages in the economy have created a thriving parallel foreign currency market which has contributed to the worsening of the currency crisis.
The economy is also experiencing a high degree of currency substitution as people now prefer holding foreign currencies in order to store value and hedge against inflation. The prevailing high inflation rate and policy uncertainties have resulted in a large proportion of transactions being conducted in foreign currencies.
Moreover the shortage of basic commodities on the local markets has increased the demand for foreign exchange to purchase these in neighboring countries like South Africa, Mozambique and Botswana. All these factors contribute to the continued circulation of currency on informal markets.
The banking sector has been unable to attract meaningful deposits largely as a result of negative real returns on savings. Real interest rates have been negative since 2003 and this has removed the economic incentives for individuals and corporates to hold wealth as savings within the banking system.
Confidence in the banking system has also been severely affected by sub economic withdrawal limits which require frequent visits to banks. As a result saving levels have dropped dramatically due to financial disintermediation.
Furthermore, the current withdrawal limits make consumption smoothing difficult given the level of prices in the economy and uncertainties in the macroeconomic environment resulting in the bulk of income being consumed rather than saved.
Some of programmes which have been instituted in a bid enhance the supply side of basic commodities have resulted in the emission of trillions of dollars onto the market without a corresponding injection of currency into circulation.
Given the level of financial disintermediation and informalisation of the Zimbabwe economy, when the beneficiaries pay their own suppliers, the propensity to convert such funds into cash is very high and consequently such programmes end up contributing to the cash crisis, as the original funds were not underpinned by currency emission.
Although printing money to solve the cash shortage problem may help in the short run, this will lead to accelerating inflation in the medium to long term. More appropriate solutions should involve reversing the economic incentives to financial disintermediation as these both reduce the cash shortage and help in tempering inflationary pressures.
In particular, there is need to restore economic actors’ confidence in the financial sector’s ability to effectively and efficiently handle the banking needs of the economy.
Given that the parallel foreign currency market is contributing to the continued circulation of cash outside the formal system, addressing foreign exchange shortages through a viable exchange rate regime is a necessary step in solving the cash crisis.
It is prudent to allow free foreign currency transactions in the mainstream banking sector in order to limit the volume of currency circulating on the parallel market. Restoration of sanity in the foreign exchange market will eliminate arbitrage opportunities.
Although raising nominal interest rates is usually the preferred policy solution in removing the disincentive to save, applicability in the Zimbabwean context is limited because of high levels of inflation. Achieving attractive positive real interest rates therefore requires inflation reduction in the first place.
In the medium term the solution to cash shortages may lie in the areas of pursuit where countries facing similar double jeopardises of cash shortages and inflation have had to consider and among them is the dreaded dolarisation of the currency. Before that is practical examination of the results of measures applied in Latin American and Eastern Europe often under the advice of Rudiger Dornbusch need to be studied.
A holistic solution to the cash shortage centers on inflation reduction and stabilisation of the macroeconomic environment. This will increase the economic incentive to save/deposit money in the formal financial sector.
It is important to note that, proper diagnosis of the causes of cash shortages has important policy implications. As the three propositions state, excess demands for cash are reflections of conditions throughout the financial markets.
Efforts to remedy imbalances in one market without considering that the roots of the imbalance are found in another financial market will founder on the integration of financial markets. — Own Correspondent.