As the Zimbabwean economy regresses back to widespread use of multiple currencies that anchored economic stability from 2009 to 2018, it is worthy assessing why de-dollarisation is a tall order for most countries that once dollarised.
Harare officially dollarised on April 9, 2009, and adopted a basket of multiple currencies led by the United States dollar and South African rand. The local market rejected the Zimbabwean dollar and started using foreign currencies after record hyperinflation figures eclipsed 250 million (officially) in July 2008.
However, the local currency was re-introduced in February 2019 under the Real-Time Gross Settlement (RTGS) banner with the exchange rate pegged at US$1:ZW$2,5. Statutory Instrument 142 of 2019 soon followed in June to ban the use of multiple currencies and enforce the use of a monocurrency in the economy.
What followed afterwards was a rapid decline of production as a result of a combination of factors coalesced around high inflation, exchange rate volatility and foreign currency shortages. Economic output declined from 4% realised in 2018 to -6,5% recorded in 2019 according to official figures from Treasury.
Annual inflation raced from 57% in January to 521% recorded in December 2019. Real tax revenues plummeted from US$5,237 billion collected in 2018 to US$2,691 billion collected in 2019. Inflation consumed household incomes, pension funds and corporate incomes with the latter partially resorting to retrenchments to stay afloat.
The World Bank estimates that extreme poverty cases in Zimbabwe increased from 4.7 million in 2018 to 6.6 million people in 2019. The bank projects that the number of those in extreme poverty will increase to 7,6 million in 2020 as household incomes continue to decline and economic hardships persist in view of Covid-19 risks.
Zimbabwe’s dollarisation path follows a host of other case studies in the world. Over the last 40 years, particularly between 1980 and 1998, there was a surge in dollarisation that swept many developing economies in South America, Asia and Europe. Many countries resorted to using the US dollar to either revive or stabilise their economies. The significant inflow of dollars from exports, international remittances and growth in tourism made it easy for countries in South America to dollarise their economies between the 1980s and 1990s. These included Mexico, Ecuador, Peru, Brazil, Uruguay, Argentina, Chile and Bolivia.
There were also many European and Asian countries that went down the same route of dollarizing as a vehicle to stabilise their economies after macro-economic shocks and political instability. Israel, Vietnam, Poland, Cambodia, Lebanon, Georgia, Turkey and Lithuania are some of the few examples of countries that dollarised their economies or accepted the US dollar as legal tender. Most of these countries that dollarised have found it difficult to de-dollarise even to this day with a number of them partially dollarised.
To understand the reasons why, it is critical to underline the initial causes of dollarisation.
All the countries that dollarised have three notable push factors that are common. These are high levels of inflation (a result of either excessive money printing, quantitative easing or monetisation of fiscal deficits), macro-economic instability and low levels of public confidence in monetary institutions.
Other reasons from selected countries include exchange market inefficiencies, political instability/civil unrest and sharp fall in commodity prices. With resemblance to Zimbabwe, empirical evidence from over 30 failed attempts to de-dollarise points that local currencies issued without years of sustained economic stability, fiscal reforms, improved confidence in monetary authorities, inflation targeting measures, foreign reserves and a flexible exchange rate mechanism have all failed. A few countries quickly changed tact after notable failures and registered currency stability afterwards.
The Peruvian experience
In the mid-1980s, the Peruvian government decided to combat dollarisation induced by massive growth in money supply and inflation. The government forced conversion of foreign currency deposits into the local currency (Peruvian sol). The policy turned out to be counter-productive as it provoked financial disintermediation and capital flight by risk averse investors. The inflation rate reached quadruple digits in the 1990s and the Peruvian sol lost its essential functions.
After this painful experiment, government authorities radically changed their de-dollarisation strategy. Their new plan focused on achieving macro-economic stability by creating a fiscal surplus, significantly lowering public debt and stabilising inflation through the introduction of an inflation targeting regime. This was followed by significant currency appreciation from 2003 to 2011.
The macro-economic stabilisation policy was complemented by prudential regulations to better account for earned foreign currency, and to develop a market for securities with a long maturity in domestic currency. As a result, Peru managed to reduce transaction dollarisation levels to below 50% and is set to achieve its 2020 de-dollarisation targets.
Bolivia and Mexico experiences
In 1982, the central Bank of Bolivia attempted to de-dollarise the economy by converting all US dollar financial instruments to Bolivianos at an exchange rate below the market rate. To achieve this, the bank instituted interest rate caps to control capital creation, price controls to curb inflation and exchange control regulations to restrict movement of capital as witnessed in neighboring countries. This backfired spectacularly as inflation skyrocketed.
During a 12-month period (August 1984 to August 1985), prices rose by 20 000%. After the new government came into power, a comprehensive economic stabilisation program was announced that included reforms in government spending, trade liberalisation, privatisation of state entities and institution of a managed float exchange rate.
In Mexico, the government forced a conversion of foreign currency deposits into Pesos. The result was a massive externalisation of foreign currency and capital flight by investors, diminished remittances and limited financial intermediation. Central bank governance reforms were instituted with the country undergoing inflation targeting and economic stabilisation policies that lasted over 10 years.
Mexico succeeded in keeping its level of dollarisation low at below 5,2% as at December 2007.
In all the three case studies above, it can be pointed out that market-driven policies are more effective in achieving sustained de-dollarisation than forced measures that include regulations and government ultimatums.
Notable success stories
Countries that have successfully de-dollarised have yielded positive results of fiscal consolidation, free market policies and persistent economic stability that cultivates trust in the financial system. In Chile, Israel, Georgia and Poland, the process began with a successful disinflation program, leading to a more flexible market driven exchange rates and a monetary policy aimed at lower inflation.
The success stories in the four countries show that the first step toward de-dollarisation is macro-economic stabilisation. Fiscal consolidation then lessens the need for government borrowing from the central bank and a tighter monetary policy reduces credit growth. Both fiscal and monetary policies restrain aggregate demand and lead to the appreciation of the real exchange rates.
It can also be observed that de-dollarisation success stories followed a change in governance or policy shift to more pragmatic or market driven approaches that encompassed deregulation and privatisation of state entities.
Overall, macro-economic theory and the analysis of case studies of successful de-dollarisation processes suggest that the key contributor to successful de-dollarisation is a stable macro-economic environment. Prudential measures in the banking sector can only be considered as supplementary tools.
Above all, the most sustainable way in de-dollarisation is to achieve and maintain macro-economic stability by keeping inflation low and stable, keeping the exchange rate flexible to crowd in private capital, improving the country’s current account balance, reversing fiscal deficits and conducting institutional reforms that attract investment.
The Zimdollar was prematurely introduced and the government tried to use excessive regulations to force de-dollarisation with limited political will in addressing key factors that led to economic instability. These include low agricultural and industrial productivity, high levels of money printing by the central bank to fund subsidies and quasi-fiscal activities, low levels of public trust, high levels of corruption that feeds on public funds, high debt levels and institutional flaws on property rights and respect for rule of law. Without pragmatic efforts to address these economic fundamentals above, de-dollarisation is always a tall order.
Bhoroma is a marketer by profession, freelance economic analyst and holds an MBA from the University of Zimbabwe. — firstname.lastname@example.org or Twitter: @VictorBhoroma1.