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Myths, truths about dollarisation

Victor Bhoroma Analyst
AFTER three years of trying to enforce a monocurrency while avoiding critical economic reform, Zimbabwe’s de-dollarisation plan has all but failed.
The economy has vaulted back to the multi-currency regime that prevailed between 2009 and 2018 with the US dollar transactions now dominating formal and informal trade.
Even though the ratio of Zimdollar transactions to US dollar transactions is 55% to 45% officially, the official figures do not factor in the informal sector which contributes over 70% to Gross Domestic Product (GDP) or household savings done in foreign currency.
It is estimated that between US$1,5 billion to US$2 billion is circulating in the informal sector while local Foreign Currency Accounts (FCA) deposits are US$1,8 billion.
The 55% in local currency transactions is a direct result of high velocity being experienced in local currency because economic agents do not want to hold on to the local currency any period longer than necessary.
Zimbabwe is now unofficially dollarised.
Unofficial dollarisation arises when individuals lose confidence in a domestic currency and hold foreign currency bank deposits or hard currency to protect against high inflation in the domestic currency as is always the case with Zimbabwe. Inflation remains high at over 61% annually.
History  of  dollarisation  in  Zim
The market first dollarised in 2008 when economic agents rejected the local currency and started using the dollar to trade and store value without government legislation.
The government then followed the market and suspended the Zimdollar on April 9, 2009. A basket of currencies was adopted with the US dollar predominantly taking over alongside the South African rand.
The country’s own currency had been rendered worthless by record hyperinflation,which reached 231 million in 2007 before the government stopped announcing inflation figures.
Cracks in the multicurrency regime started in August 2015 when government passed the Reserve Bank of Zimbabwe (RBZ) Debt Assumption Bill, which involved the taxpayers assuming the RBZ legacy debt of over US$1,4 Billion through issuing Treasury Bills (TBs).
The objective was to clean the central bank balance sheet, allow it to resume its clearing role through the RTGS system and above all print money.
With a clean balance sheet, RBZ grew broad money supply by over US$1 billion in less than 12 months and depositors started to empty their nostro account balancesand externalising money.
Alert investors had started offloading five-year TBs on the local market at a discount in favour of offshore credits after it became clear that the central bank had no capacity to repay the TBs in foreign currency without introducing a local currency sooner.
That way, foreign currency started to wash away from the formal sector gradually.
Cash shortages started to creep in by February 2016 and the government introduced bond notes on November 26, 2015 using a choreographed export incentive and forex backed line.
The local currency started trading on the interbank market in February 2019 at US$1: ZW$2.50.
The multicurrency regime was banned on the 24th of June 2019 despite adverse warnings on implementing monetary changes before implementing fundamental reforms that support currency stability.
Positive impact of dollarisation
The adoption of the US dollar in 2009 left the central bank’s money printing machinery redundant but it stabilised the economy and tamed the scourge of hyperinflation (largely caused by excessive money printing to fund quasi-fiscal activities and monetisation  of budget deficits).
Dollarisation allowed Zimbabwe to eliminate exchange rate risks, thus improve its investment climate.
Additionally, it allowed the economy to build real savings after years of losses, enforce fiscal discipline on the government, manage interest rates, resume financial intermediation, reduce transaction costs in trade and retool production through accessing foreign or local lines of credit in a stable currency.
Economic growth rate averaged 8% per annum between 2009 and 2015 with all economic sectors registering successive growth.
Negative impact of dollarisation
Dollarisation has its fair share of problems for  the  country  if  there is  lack of confidence in economic policies and loopholes on economic governance caused by a burdensome taxation model, porous borders, high levels of corruption, restrictions on repatriation of dividends and movement of capital.
Thus, dollarisation opens flood gates of foreign currency externalisation at all levels.
Between 2015 and 2017, over US$3 billion was externalised from the Zimbabwean economy by corporates, politicians and business tycoons to Mauritius, South Africa, and the Far East.
However, some still argue that foreign currency externalisation worsened after the 2013 harmonised elections on investor fears of possible economic mismanagement.
A dollarised banking sector can also be characterised by higher insolvency risk and higher deposit volatility.
Without sufficient protectionist policies, local manufacturers often find it difficult to compete with competitively priced imports from South Africa and the Far East due to the high cost of production locally.
That remains the case regardless of the name of the currency used as it points to structural weaknesses in the local industry.
Dollarisation exposes competitiveness weaknesses that already exist, otherwise European Union countries or the United States of America would never export anything if the value of the domestic currency is what ONLY determines export competitiveness.
Countries that devalue their currencies to boost exports are largely biased towards manufactured exports or have sustainable export incentives.
Does   dollarisation  affect  exports?
Zimbabwe’s exports are largely raw, and semi processed minerals and tobacco.
These raw commodities account for 95% of the country’s exports while manufactured exports have declined below 3% for 2021, thus manufactured exports have a low base.
Prices for major commodities traded on the world market are indexed in US dollar and are not controlled from Zimbabwe.
However, a dual currency economy benefits all exporters (including manufacturers) as they can exchange stronger foreign currency earnings to meet domestic expenditure in a weaker currency. A huge component of this expenditure is labour cost and tax overheads.

Does Zim have enough forex?
It is incorrect to say Zimbabwe does not have enough foreign currency to dollarise because dollarisation was not initiated using state resources (the government gets its revenues from taxes).

Similarly, the level of foreign exchange receipts in 2021 is more than five times that of 2008 or 2009. Zimbabwe received just under US$9,7 billion in foreign currency earnings in 2021, up 54% from the 2020 figure of US$6,3 billion.
Foreign exchange earnings in 2008 were estimated to be US$1,75 billion.
Doomed  from  start
The country’s de-dollarisation plan was doomed from the onset as the country did not meet the basic fundamentalsfor a stable mono currency.
The country never had a truly managed floating foreign exchange market since independence and there was no market confidence in a local currency especially after the hyperinflation era on 2007-2009.
Further, the country hadinsignificant foreign currency or gold reserves to support a local currency, a sovereign debt repayment plan or the governance discipline required to curb rampant money supply growth in local currency.
It is true that every country needs a domestic currency to push its export policy and induce economic growth through quantitative easing.
However, that currency borrows its stability from a stable economy, business friendly economicpolicy and a stable political climate.
Experiences from elsewhere
Forced de-dollarisation has had limited success. Countries that tried to force de-dollarisation experienced financial disintermediation and capital flight.
Some chose to reverse their policies a few years later to counter the adverse economic consequences.
Zimbabwe was neither the first country to fully dollarise, nor was it the first to attempt to de-dollarise.
Countries such as Cambodia, Bolivia, Vietnam, Peru, El Salvador and Chile (among several others) have dollarised and tried to de-dollarise before. De-dollarisation has never been successful as a policy but as a benefit to pragmatic economic reforms.
Only a handful (notably Israel, Poland, Vietnam, and Georgia) have managed to fully de-dollarise due to a combination of factors such as free market policies, domestic money supply and macro-economic stability, and strong institutions.
Success was underwritten by political will to reform and grant the central bank monetary policy independency.
De-dollarisation will never be a success if the government constantly interferes with monetary policy, dictates foreign exchange prices to the market and maintains a local currency as a tool to print whenever need arises.
The government tried to use excessive regulations to force de-dollarisation withoutany political will to address key factors that lead to economic stability.
Agricultural and industrial productivity are still hampered by legacy issues while quasi fiscal activities by the central bank to subsidise gold production, fuel consumption or commodity imports remain.
Similarly, key constrains such low levels of public or investor confidence, high levels of public sector corruption, high levels of sovereign debt, institutional flaws on property rights and lack of respect for rule of law persist to this day.
It is true that dollarisation undermines the country’s monetary policy framework (rightly so if it is toxic to economic stability or growth) and takes away its lender of last resort function.
However, it is critical to point that if the government avoids critical economic reforms, if there is no discipline in money supply and confidence in the monetary policy as is the case in Zimbabwe, de-dollarisation will always be mission impossible.
The market will choose foreign currency over a local currency any day.
  • Bhoroma is an economic analyst and holds an MBA from the University of Zimbabwe. — vbhoroma@gmail.com or Twitter: @VictorBhoroma1.

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