Financial matters: Does currency regime matter?

ZIMBABWE faces growth and external competitiveness challenges, as indicated by its low trend growth and investment, declining share in the world exports, high current account deficits, and external debt.

The stock-flow approach to the equilibrium exchange rate reveals that the real exchange rate experienced periods of sizeable overvaluation, both prior to the 2008 economic collapse and under the current multicurrency regime.

While overvaluation hampers GDP growth, as well as growth and employment in export sectors, we have not found that undervaluation would raise growth. Replacing the multi-currency regime anchored in the US dollar by the South African rand as the sole transaction currency would help reduce overvaluation and stimulate exports and growth.

Under any currency regime, Zimbabwe needs to adhere to sound macro-economic policies, avoid overspending on public wages, and create environment conducive for investment.

After its economy collapsed in 2008, Zimbabwe opted for a multi-currency regime anchored in the US dollar. The objective was to stabilise the economy and establish a credible nominal anchor. The replacement of the Zimbabwean dollar by the multi-currency system brought the hyperinflation and the currency devaluation to a halt, laying foundations for economic recovery.

The average annual inflation during 2009–2013 was 3,3%, while the real GDP grew on average more than 8% a year. While it may be tempting to consider these outcomes a success, a closer look at the overall economic performance reveals a number of challenges and open issues.

One of them is external competitiveness and the extent to which an overvalued currency has contributed to the sluggish growth. Concerns about the limited external competitiveness have prevailed for some time given the country’s declining global export shares, widening trade deficits and high concentration of exports to South Africa.

The role of the real exchange misalignment in the 2008 currency crisis was also underscored.

This research paper aims to find out whether (i) currency overvaluation prevailed under the multi-currency regime introduced in 2009 and (ii) the overvaluation may have contributed to the Zimbabwe’s long-term weak external and growth performance.

Further, some recent literature posit that undervalued real exchange rates can stimulate growth and we examine if this is the case in Zimbabwe. The stock-flow approach to the real equilibrium exchange rate reveals that Zimbabwe experienced large currency overvaluation relative to the South African rand both in the run-up to the 2008 collapse and in recent years, with negative impact on GDP growth, exports and productive employment. We do not find robust evidence that currency undervaluation would boost growth.

With South Africa as the largest trading partner, Zimbabwe would benefit from implementing internal devaluation (and in particular contain wage cost) and accelerating structural reforms to correct the current overvaluation of bilateral real exchange rate (RER) with South Africa. Policymakers should also consider replacing the multi-currency regime with the South African rand. Such reform would help prevent major future RER overvaluations, reduce transaction costs, improve price transparency and stimulate growth and the agricultural sector.

Ncube and Brixiová work for the African Development Bank. This is an introduction to a paper done by the two titled The Real Exchange Rate and Growth in Zimbabwe: Does Currency Regime Matter?