Challenges posed by the surging US dollar

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ZIMBABWE adopted a multi-currency system in 2009 in response to hyper-inflation which had decimated the local dollar.

Jonas Mashamba

The US dollar, South African rand, British pound, Botswana pula and euro made up the multi-currency system. The government decided that the dollar would be the primary and official currency. This meant government and public sector accounts were denominated in dollar terms.

The private sector followed suit, resulting in goods and services being priced in dollars. In 2014, the Reserve Bank of Zimbabwe (RBZ) expanded the multi-currency basket by adding the Chinese yuan, Indian rupee, Japanese yen and Australian dollar. The objective was to encourage foreign currency inflows through reduction of transaction costs.

The move was also intended to boost trade, investment and tourism from these countries.

Demise of multi-currency system

The addition of the four major currencies to the basket did not alter dollar preferences. In fact, by 2015 the US dollar was so dominant that it accounted for 98% of the transactions in the multi-currency basket compared to 50% in 2011. The dollar momentum continued in 2016 and it elbowed out the rand and the other currencies from the basket.

For practical purposes, the multi-currency system introduced in 2009 became defunct and was replaced by de facto dollarisation.

Dollarisation

Dollarisation raises debate as dollarised countries give up their power to formulate monetary policy as this is independently done by the American Federal Reserve in the best interests of the US economy.

For example, Zimbabwe’s economic objectives would be better served by low interest rates and a weak dollar, which restricts imports while promoting exports. The weak dollar would also boost remittances and tourism receipts. For the Federal Reserve, low interest rates would be untenable in the face of the looming expansionary fiscal policy. A low interest rate policy stance would be inflationary for America. The same argument could be made against using the rand but there are some crucial differences. The rand is a softer currency which has progressively depreciated against the dollar. South Africa is Zimbabwe’s major trading partner and also a key source market for its diaspora remittances.

Above all, being Sadc members these two countries share common problems and economic objectives. The election of Donald Trump in 2016 has already impacted global capital markets and unsettled currencies. In the aftermath of the US presidential election, the dollar rose sharply against global currencies. Compared to other hard currencies the dollar is now on average about 40% above its lows in 2011. For instance, the dollar strengthened against the Chinese yuan which fell to its lowest level against the dollar since 2008. The Indian rupee and other Asian currencies were also battered by the surging dollar. In response to the dollar surge, Turkey‘s central bank raised interest rates on November 24 2016 after the lira fell to an all time low against the dollar.

The strength of the dollar is driven by policy pronouncements by the US President-elect who is committed to higher economic growth, tax cuts and huge infrastructure spending. The markets believe that the Trump administration’s expansionary fiscal policy will force the Federal Reserve to raise interest rates aggressively as a way of containing inflationary pressures.

Consistent with such market expectations the 10 year bond yield, which is a magnet for capital flows, has risen. Many developing countries, which borrowed heavily when interest rates were low are now seriously concerned with the prospect of sustained high interest rates. There is already a precedent when the value of the dollar increased by 50% between 1980 and 1985. The dollar’s relentless surge was then brought to a halt by the Plaza Accord of 1985 when the developed countries agreed to weaken the dollar through coordinated interventions in foreign exchange markets.

This time there is little optimism as the incoming American President’s anti-globalisation stance and his allegations about currency manipulation by China do not augur well for an early agreement to halt the surging dollar.

Impact on Africa

Many African countries would agree with the commentary of the Economist (December 3 2016) that a strengthening dollar is bad for the world economy. For Africa, a sustained appreciation of the dollar is likely to create conditions akin to the Asian financial crisis of 1997-1998. Earlier the Economist (April 16 2016) stated that “Only a few years ago people were queuing up to invest in Africa. As recently as 2012 Zambia paid less than Spain to borrow dollars. Private equity funds dedicated to Africa raised record sums to invest in shopping malls and firms, making everything from nappies to fruit juice. To stem capital outflows most of these countries face unpalatable options, namely high interest rates, currency devaluations, trade and exchange controls and/ or depletion of international reserves.

Impact on Zimbabwe

Zimbabwe is largely shielded from the currency turmoil. However, performance of significant sectors is being adversely affected by the surging dollar.

Exports

Exports account for 60% of the country’s foreign currency earnings. A sustained appreciation of the dollar makes Zimbabwe’s exports uncompetitive. Many African countries may resort to import controls in 2017 thus denting Zimbabwe‘s export drive.

While the RBZ’s export incentive scheme brings much-needed relief to exporters, it will not correct currency over-valuation. Calls by the Confederation of Zimbabwe Industries to use a softer currency such as the rand will grow louder in 2017.

Gold earnings

Gold is one of the largest foreign currency earners for the country. With investors regarding the dollar as a commodity, which stores value, any appreciation in the value of the dollar depresses gold prices and this impacts negatively on foreign currency earnings.

Zimbabwe Stock Exchange

In line with global trends, the appreciating dollar will trigger portfolio outflows.

Foreign investors will disinvest from the stock exchange while foreign inflows will be negligible in 2017.

Diaspora remittances

Diaspora remittances, mainly from South Africa and Britain, currently constitute about 30% of the country’s foreign currency inflows. The rand and British pound are vulnerable to a strong dollar as both countries have open economies with huge capital flows. A surging dollar will significantly reduce diaspora remittances to Zimbabwe.

Tourism

This is a sector, which will be hard hit by the surging dollar as Zimbabwe is already a high cost destination for tourists compared to South Africa and other SADC countries. The industry will therefore struggle to maintain current levels of tourist arrivals in the face of a surging dollar. The Minister of Tourism has advocated the adoption of the rand as a way of growing the industry. Tourism has lots of potential to generate the much-needed foreign currency in a relatively short time. Going forward, Sadc countries should harmonise trade and investment regimes and boost intra-regional trade. This way Zimbabwe and other Sadc countries would be better positioned to mitigate sudden exogenous shocks to their economies.

In the aftermath of the 1997-98 Asian financial crisis, Larry Summers, deputy secretary of the Treasury during the Clinton administration, had a favourite analogy: “Global capital markets pose the same kinds of problems that jet planes do. They are faster, more comfortable, and they get you where you are going better. But the crashes are much more spectacular”.

Mashamba is an independent economist and has worked at the Reserve Bank of Zimbabwe for 20 years, as well as the Zimbabwe Investment Authority and Deposit Protection Corporation on secondment. The New Perspectives articles are coordinated by Lovemore Kadenge, president of the Zimbabwe Economics Society (ZES) Email: kadenge.zes@gmail.com and cell no +263 772 382 852.

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