Zimbabwe current currency crisis - what needs to be done!

Zimbabwe is in a currency crisis. Arguably, and to a larger extent, a contributing factor to this crisis is the government’s insatiable drive to printing the local currency in the form of bond notes without economic backing – a simple violation of the very basic economic principle. It goes without mentioning that failure to acknowledge, address and implement the necessary and fundamental economic principles will only keep on taking the economy down. As a follow-up to the budget presentation, and unfortunately, the introduction of a 10-year jail sentence is not going to help in any way in ameliorating the currency crisis. Well, you can arrest citizens, but you cannot arrest economic principles simply because you choose to go against them. Failure to address fundamentals in the economy is going to lead to high inflation in 2019, more severe cash shortages, high uncertainty, low economic growth (if not negative growth), wide current account deficit, further increases in unemployment and more social and economic unrest. The first thing that ought to be addressed as a matter of urgency is the currency crisis.

The current use of multi-foreign currency system is weighing down on the economy, besides high transaction costs, it creates a conducive environment for speculation in the currency market which, in turn, induces high volatility and uncertainty. High uncertainty leads to poor economic performance. In very recent times, fuel shortages, poor economic growth, high inflation, high unemployment, poor export performance, low production and productivity in the agricultural sector, manufacturing, poor road system can all be directly or indirectly linked to the current central bank currency stance.

Zimbabwe is currently not using its own currency after a collapse of the local currency a few years ago. The move to use foreign currency as legal tender in Zimbabwe, was driven by fiscal deficits through the actions of economic agents trying to evade from the inflation tax imposed by the financing of the deficit. Adopting a foreign currency as your own legal tender (dollarization) tend to come at a cost. Dollarization is associated with slower economic growth, primarily due to external disturbances, such as major terms of trade and capital flow shocks. In addition, it reduces the effectiveness of the interest channel since changes in interest rates have almost no influence on the rates of loans and deposits denominated in foreign currencies. It also increases the probability of foreign exchange liquidity deficit in the financial system in stress situations. However, after weighing the pros and cons, currently adopting a foreign currency as Zimbabwe’s legal tender makes a lot of sense as it stabilizes the economy and makes it less volatile. Research in economics shows that countries that have dollarized tend to have lower inflation rates.

To enhance credibility, reduce transaction cost, reduce inflation rate and address uncertainty, the central bank should completely abandon the bond notes – “bad money”, which has only contributed to increased speculative tendencies in the economy. The idea that bond notes are bad money is linked to Gresham's law, a well-known law in economics that simply states that "bad money drives out good”. This notion is supported by both theory and empirics.  If low quality and high quality currencies are used concurrently in a country, people will hoard the high quality currency for themselves and only use the low quality currency to conduct transactions.  This creates currency shortages and induces a lot of speculation in the currency market. Ever since the introduction of the bond notes the US$ has become more and more scarce. Anybody who is interested in seeing a better Zimbabwe should see the necessity to abandon the bond notes forthwith. This is supported by empirical evidence: To benefit from dollarization, dollarization should be implemented in full. For example, the experiences of Panama, Ecuador and El Salvador show that full dollarization can help countries achieve lower inflation, economic stability and growth. Full dollarization enhances policy credibility and encourages foreign investment. It promotes fiscal discipline, a competitive financial system and economic integration with international markets. However, countries implementing full dollarization must establish structural programs and institutional reforms to ensure that short-term stability develops into long-term economic growth. Sadly, the current monetary and fiscal authorities have been reluctant to do so since the initial dollarization in 2008.

Again, the use of multi-currency system, including the US$ should be dropped without delay, in favour of adopting the South African Rand as the sole currency. The Rand is preferred because of factors I mentioned in my previous article:

• Zimbabwe trade highly with South Africa (SA). This is fundamental when choosing which currency to use. For example, most of the Caribbean islands (Aruba, Bahamas, Barbados, and Bermuda, to name a few), peg to the U.S. dollar because their main source of income is derived from tourism paid in dollars. Does Zimbabwe highly trade highly with the US? NO!
• Countries ought to be geographically close to allow easy flow of goods, services and factor mobility. Countries whose official currency is the US$  which include Ecuador, El Salvador, Timor-Leste, Micronesia, Palau, the Marshall Islands, Puerto Rico and Guam, Turks and Caicos and the British Virgin Islands are all geographically close to the US. Is Zimbabwe geographically close to the US? NO!
• Both countries should share similar economic exogenous shocks (business cycles). Does Zimbabwe share similar business cycles with the US? NO!
•  The two countries should have high labour and capital flows between them. Does Zimbabwe have high factor mobility with the US? NO!

The SA Rand is without its demerits. First, high uncertainty around the SA Rand, driven mainly by the echoes of land redistribution without compensation will increase volatility and likely lead to low exchange rate value of the SA Rand against its major trading partners. This might trigger an increase in inflation in SA which will be imported to Zimbabwe which is not good for the economy. Second, there are costs associated with formally adopting the Rand. For Zimbabwe to adopt the Rand, Zimbabwe needs to negotiate with SA for it to join the currency union or some other terms for it to use the Rand. However, weighing the costs of using the SA Rand, multi-currency or the US$, the SA Rand has lower overall costs and should be the preferred currency.

Using a foreign currency instead of the domestic currency as legal tender should only be temporary in nature. It should be a very short-run measure a country is forced to adopt while the country takes  appropriate measures to increase its productive capacity, reduce unemployment, creates a sound and credible monetary system, fosters confidence, increases the overall economic growth and anchors inflation expectation to below 5%.  The most critical component of a de-dollarization strategy is bringing back confidence in the value of the domestic currency by implementing policies aimed at reducing inflation and making fiscal policy sustainable. This can be achieved with the help of fiscal policy,therefore, 5 years is a plenty a time for a government that is committed to economic development.

In conclusion, the Zimbabwean authorities should renounce and desert the use of the bond note immediately and adopt the SA fully. This is supposed to be done as a short-term measure and start crafting policies aimed at giving people confidence on the government’s ability to achieve low inflation and making fiscal policy sustainable  and reassure people that arbitrary printing of money will never take place. Failure to do so, there is going to be high inflation in 2019, severe cash shortages, high uncertain, low economic growth, wide current account deficit, further increase in unemployment and more social and economic unrest.