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Dr Gift Mugano
Zimbabwe in February 2009 adopted multiple currency regimes which technically transformed to a kind of full dollarisation as the United States Dollar later dominated the currency basket. Since 2009 there has been debates on the pros and cons of dollarisation. In recent weeks, there has been health debate on the introduction of bond notes alongside multiple currency regime. I must command the Governor of the Reserve Bank for not getting tired on this matter.He has been explaining and explaining. As we are carry on the debate on this matter, I thought it will be prudent to look at the cost benefit analysis of dollarisation and our way out.
This discussion will borrow experience from other countries which dollarised like Argentina, Panama and Ecuador although we will not go into the specifics of each country.
Benefits of Dollarisation
An immediate benefit from eliminating the risk of devaluation is reducing the country risk premium on foreign borrowing and obtaining lower interest rates for the Government and private investors. Lower interest rates and more stability in international capital movements cut the cost of servicing the public debt, and encourage higher investment and economic growth.
With dollarisation, the interest premium owing to devaluation risk would disappear, but the premium for sovereign risk would not. Since Government and the private sector can choose to borrow in foreign or domestic currency as in Argentina’s heavily dollarised economy, they eliminated the cost of devaluation risk by borrowing in dollars. The key question, then, is: would full dollarisation, by eliminating currency risk, substantially reduce the default risk premium on dollar-denominated debt?
Arguments exist on both sides of the question of how much of the sovereign, or default, risk to attribute to devaluation risk. Although sovereign risk and devaluation risk move closely together, this does not establish a causal link from one to the other. In fact, it is plausible that most of both dollar and peso spreads are explained by common factors.
For example, a global “flight to quality” would raise both the measured risk of default and risk of devaluation. In this case, dollarisation would not help reduce dollar spreads very much.
In fully dollarised Panama, for instance, the absence of currency risk did not insulate the country from swings in market sentiment toward emerging markets generally. Moreover, since movements in Panama’s spreads cannot reflect devaluation risk, the implication is that at least a part of Argentina’s spread also could not be explained by currency risk alone.
Stability,important as risk spreads and seigniorage are, dollarisation may offer gains that, although not immediately observable, may provide larger benefits over time. In addition to raising developing countries’ borrowing costs, currency crises wreak havoc on the domestic economy. Argentina suffered fierce speculative attacks that, although weathered successfully, dealt them serious economic setbacks.
Dollarisation will not eliminate the risk of external crises, since investors may flee because of problems of weakness in a country’s budget position or the soundness of the financial system. This sort of “debt crisis” can be as damaging as any other, and indeed, Panama has experienced several.
Nevertheless, dollarisation holds the promise of a steadier market sentiment as the elimination of exchange rate risk would tend to limit the incidence and magnitude of crisis and contagion episodes. Moreover, large swings in international capital flows cause sharp business cycle fluctuations in emerging economies even when they do not involve balance of payments crises.
Effect on Trade and Financial Links, a powerful but still longer-term argument for full, legal dollarisation is that it makes economic integration easier with the rest of the world, and insulation of the domestic financial system correspondingly more difficult. Dollarisation may establish a firm basis for a sound financial sector, and thus promote strong and steady economic growth.
The argument here is that dollarisation is perceived as an irreversible institutional change toward low inflation, fiscal responsibility, and transparency.
Furthermore, dollarisation may contribute to greater economic integration than otherwise would be possible with the United States, or any other country whose currency is adopted.
A number of studies have found evidence that Canadian provinces tend to be more integrated in trade volume and price level differences among themselves than with US states that are closer geographically, trading in the order of twenty times more among themselves than with nearby US states.
The use of a common currency may thus be a vital factor in market integration, given the fairly low transaction costs and restrictions to trade across the US — Canada border. This is our classical situation with South Africa. Hence, the reason why I would vouch for the rand in my proposal for our way out.
Dollarisation could also bring about a closer integration in financial markets. One of the most profound effects of Panama’s dollarisation is the close integration of its banking system with that of the United States and indeed with the rest of the world, particularly since a major liberalisation in 1969-70.
Costs of dollarisation
A Government adopting full dollarisation gives up the revenue from the loss of seigniorage. The ancient concept of seigniorage as a Government’s profit from issuing coinage that costs less to mint than its face value is essentially the same with paper currencies: abstracting from the minor cost of printing paper money, seigniorage is simply the increase in the volume of domestic currency. The immediate cost of this issuance can be significant, and it continues on an annual basis thereafter.
Dollarisation involves two kinds of seigniorage loss. The first is the immediate “stock” cost: as the dollar is introduced and the domestic currency withdrawn from circulation, the monetary authorities must buy back the stock of domestic currency held by the public and banks, effectively returning to them the seigniorage that had accrued over time. Second, the monetary authorities would give up future seigniorage earnings stemming from the flow of new currency printed every year to satisfy the increase in money demand.
In the case of Argentina, the first, or stock, cost of dollarisationwas the redemption of about $15 billion in domestic currency held outside the central bank, or about 4.0 percent of gross domestic product (GDP). In addition, the loss of seigniorage on account of the increase in currency demand amounted to about another $1.0 billion annually, or about 0.3 percent of GDP.
For countries that do not have enough foreign reserves to buy up their domestic currency and thereby dollarise, the acquisition of the initial stock could add indirect costs. If the country lacks the credit to borrow the reserves, it would be forced to accumulate them through current account surpluses. The cost of this could be substantial in forgone investment if, as is usual for developing countries, the better policy would otherwise be to run some sustainable level of current account deficit.
The United States would get more seigniorage from dollarisation in other countries. There is, therefore, a case for the U.S. authorities to share part or all of these additional seigniorage revenues with countries that adopt the U. S. dollar. A precedent exists in the arrangements between South Africa and three other states that use the rand (Lesotho, Namibia, and Swaziland). The United States has no sharing arrangement with Panama or any other legally dollarized economy, there have been some initiatives in the U.S. Senate to consider legislation providing for seigniorage reimbursement but nothing materialised.
Lender of Last Resort Function and Financial System Stability, while full dollarisation eliminates vulnerability of the banking system to the risk of devaluation, it does not eradicate all sources of banking crisis. And when they occur, full dollarisation may well impair the country’s lender-of-last-resort function and hence the central bank’s response to financial system emergencies. This is our current situation.
The central bank’s role in operating a discount window to provide short-term liquidity must here be distinguished from its role as the ultimate guarantor of the stability of the financial and payments systems in the event of a systemic bank run. Dollarisation should not greatly impede the ability of the authorities to provide short-term liquidity to the system or assistance to individual banks in distress. Such facilities are available if the central bank (or its replacement) saves the necessary funds in advance or perhaps secures lines of credit with international banks.
In contrast, the government loses some ability to respond to a sudden run on bank deposits throughout the entire system. In the case of a generalised loss of confidence, the authorities would be unable to guarantee the whole payments system or to fully back bank deposits. Ultimately, the ability to print money as needed is what allows a central bank to guarantee beyond any doubt that all claims (in domestic currency) will be fully met under any circumstances. Once the ability to print money ceases to exist, limits to the lender-of-last-resort function appear.A fully dollarised country that had already spent its foreign currency reserves to redeem its stock of domestic currency might well lack the resources to respond.
Our way out
First, we need to accept that it is hard to run out of the dollarised arrangement for a local currency if and only if the country has no sufficient reserves which provides import cover for several months.
For now, in order to restore the lender of the last resort ability, the Central Bank/Ministry of Finance need to urgently secure lines of credit from international financial institutions or who are amenable to our debt problem.
Second, we need to work very hard on reforms which addresses investor concerns so that Zimbabwe can attract foreign direct investments by virtue of maintaining the US dollar in circulation as Panama and Ecuador did. Naturally, Zimbabwe, with a well-educated workforce, good geography (that is, favourable weather, good location and enormous natural resources) and a fully dollarised economy should give Zimbabwe impetus to attract billions of dollars of FDIs ahead of Zambia, Mozambique, Angola and Nigeria. This should be a very serious consideration which may even require the Government to bite a bullet on indigenisation law.
Third, knowing that the US dollar is a vehicle currency for international settlements, it therefore follow that Zimbabwe has become a hunting ground from genuine business people like retailers and criminals like drug traffickers. Against this background, stringent regulations must be put in place (which should include Ministry of Home Affairs, Zimbabwe Revenue Authority, RBZ, e.t.c) beyond the terms of reference of the recently established foreign exchange committee which aims at regulating imports. The foreign exchange committee is a real pregnant mother who will give birth to twins of financial crisis and severe shortages and the associated grandchildren of job losses, company closures and inflation.
The central bank will not have capacity to regulate over 10 000 types of imports ranging from tooth pick to Twizer. Rather, Government Ministries (Industry and Commerce, Finance, Agriculture and one for Indigenisation & Empowerment) must work on enacting the local content law as a matter of urgency so that we can curb avoidable imports.
OR, knowing that the four cylinders that must help us raise liquidity, that is, FDIs, aid, remittances and exports, are not firing properly, we need to seriously consider adopting the Rand as an official currency. This will help us to raise the competitiveness of our exports since the rand has depreciated so much in recent years although there is risk of import induced inflation. Government will have the opportunity to get a share of seigniorage which will be quite useful in financing national budget. In addition, the rand is not prone to the threat of money laundering and other forms of capital flight as in the case of the USD. However, this requires a political process of joining the Southern African Customs Union and associated loss of sovereignty if there is any.
In our discussion towards improving liquidity, curb capital flight and enhancing export competitiveness, the bond notes is not an option!
· Dr Mugano is an Economic Advisor, Author and Expert in Trade and Competitiveness. He is a Research Associate of Nelson Mandela Metropolitan University. Feedback: +263 772 541 209 or [email protected]
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