Dollarisation and the Zim Economy

THOSE who punt dollarisation as a quick-fix solution to Zimbabwe’s economic crisis are doing us a disservice. Ten months ago when a group of Zimbabwe economists was putting together the UNDP’s Comprehensive Economic Recovery Programme for Zimbabwe, we discussed dollarisation as a partial solution — not a comprehensive one — but discarded it.

We did so on political as well as economic grounds. We felt that Zimbabweans were unlikely to abandon their monetary autonomy, including a central bank dispensing largesse to all and sundry – a stance since validated by statements from ministers Tendai Biti and Patrick Chinamasa and RBZ Governor Gono.

However, now that dollarisation is an accomplished fact, it’s a different ball game.

The Zimbabwe dollar is effectively dead, though not apparently in the eyes of the eccentric Professor Hanke of the Cato Institute who continues to disseminate Zimbabwe dollar inflation numbers based on spurious stock market data.

Just how these measure changes in the level of prices in Zimbabwe now quoted in rands or US dollars is a mystery known only to aficionados of Hankonomics.

A decade of chronically high inflation and hyperinflation has bequeathed an uncompetitive economy. Prices in dollars or rands are far higher than in South Africa.

Accordingly, wage demands by industrial workers and teachers, along with utility tariffs set by state monopolies and private sector mobile phone and Internet companies, as well as private sector pricing models are detached from global as well as regional market realities.  

No one disputes that dollarisation will bring down inflation, but Zimbabwe will still be left with a hugely uncompetitive price level and business cost structure.

Normally, this would be tackled by devaluing the currency to bring price structures into line with those in competitor and trading partner countries. But once the dollar or rand is the national currency, monetary and exchange rate autonomy is lost.

 Money supply is determined through the balance-of-payments — exports, financial inflows, including Diaspora remittances and foreign aid handouts, foreign investment and offshore borrowing. The RBZ is an ineffectual bystander, for which we are all truly thankful.

Similarly, the exchange rate is determined by balance-of-payments fundamentals and interest rates — the latter set by Tito Mboweni in Pretoria or Ben Bernanke in the US.

Gideon Gono’s input is limited to setting a maximum premium over LIBOR, though just how this is arrived at is unclear.

In sum, we cannot determine our exchange rate — other than by choosing between the dollar and the rand, and regardless of what the RBZ says we cannot set interest rates, which will be determined by local rand or dollar liquidity along with risk premia as assessed by lending banks.

Money supply will be driven by dollar liquidity and the willingness of banks to lend.

This in turn will be constrained because there is no longer a lender of last resort — or in the RBZ’s case, first resort.

Since Independence, Zimbabwe’s money supply has averaged around 45% of GDP. Assuming a GDP of approximately US$4 billion — no-one knows the actual figure — the country needs a money stock of (say) $1,8 billion. Exports of $1,37 billion will fall sharply in 2009 reflecting the collapse of commodity prices (excluding gold).

Accordingly, the size of the money supply beyond export revenues will depend on aid inflows, offshore credit lines and the Diaspora, whose remittances will also decline in line with tougher economic conditions in the UK and SA.

Furthermore, financial intermediation by Zimbabwe banks stopped some time ago.  It will not restart until banks have deposits of greater maturity than the short-term transaction balances of recent years.

For the foreseeable future depositors are unlikely to maintain foreign currency balances for any length of time, meaning that dollar/rand liquidity will be very limited.

One possible solution is full dollarisation whereby the RBZ buys out the monetary issue paying holders in rands or dollars at some pre-determined exchange rate.

Depending on the exchange rate chosen, the result could be a money supply ranging from US$500 million to $3 billion.

No prizes for guessing that if it happens at all, which very unlikely, $500 million will be top of the range, thereby furthermore impoverishing savers, especially those with pension funds or stock market investments
To this mix add the need for most businesses to recapitalize.

How do they do so in an economy where savings have been destroyed by a decade of chronic inflation and hyperinflation?

The simple answer is through de-indigenisation — selling equity to foreigners, assuming that they are willing to buy.

If foreigners will not invest, then it will be a matter of borrowing offshore, which with an overvalued price and wage structure would be a high-risk strategy.

This means that dollarisation is not the neat silver bullet solution, it is claimed to be.

Right at the outset there will be a difficult choice between the rand and dollar as the currency of choice.

If we believe the Economist’s Macburger index, the US dollar is hugely overvalued and the rand undervalued which means Zimbabwe would be better off with the rand, certainly in the near-term. But such purchasing power parity-type indexes are fraught with danger, because while they may be a good long-run indicator they mislead in the medium-term.

Given the expected progress of regional economic integration, the rand is the more logical choice, especially as contrary to the Macburger index, the rand is more likely to slide than strengthen.

One thing is certain Zimbabwe needs to be pegged to a weak currency, not a strong one.
Then there is the unpleasant matter of adjustment.

How does a dollarised country adjust its overvalued price and cost structure? No quick fixes are available but the painful squeezing of living standards, wages and profits – especially profit margins – usually implies a period of deflation of recession which will be very difficult in a country emerging from a 10-year recession amid promises from politicians and donors that the utopia of milk and honey is at hand.  

*Tony Hawkins is a Professor at The Graduate School of Management, University of Zimbabwe.