adminCornelius Dube
One of the topical issues in Zimbabwe today is that of currency reform.
Various options are being debated with the main ones being full dollarisation, continuing with the multi-currency system or introducing a new currency.
Some economists have suggested that the challenges the economy faces are not a currency issue, but a productivity one.
However, currency and productivity are slowly becoming a chicken and egg scenario.
Government wants industry to produce and earn the country foreign currency while industry wants Government to allocate them foreign currency to produce.
Industry seems to have taken a model of importing to produce rather that finding innovative initiatives to produce raw materials locally.
While there is general consensus that currency reforms are inevitable, it is mainly the direction that the policies should take that is open for debate.
Dollarisation paradigm
There is a general interpretation that market signals are pointing to the preference to revert back to full dollarisation.
This reading of the market is based on recent developments where most shops are now charging products in United States dollars or its equivalent to bond notes and RTGs as prescribed by the black market rates.
Government policy seems to be suggesting that a new currency will only be introduced once certain fundamentals are in place.
However, when Government prescribed that motor vehicle duty and corporate tax be in foreign currency as well as an upward review in diesel and petrol prices, the message sent to the market is that we are headed towards dollarisation.
Thus, revelations by Finance and Economic Development Minister Prof Mthuli Ncube that the country will soon have its own currency caught the market by surprise.
But what are some of the challenges expected in the path towards either re-dollarisation or de-dollarisation?
Zimbabwe adopted a multiple currency regime in 2009 in which the US dollar was the main anchor.
From January 2016, the country began to experience cash shortages.
Low withdrawal limits were imposed on depositors triggering a panic.
The RBZ then introduced bond notes in November 2016.
The original reasoning behind the surrogate currency was that it was in response to the cash crisis before it was said to be just an incentive intended to boost exports.
But it can be argued that if Zimbabwe is to re-dollarise by de-monetising the bond notes and getting rid of RTGS balances without addressing the variables that caused the net outflow position when the economy was under dollarisation, then the same cash challenges that led to the introduction of bond notes might haunt us.
This can happen even if Government exercises fiscal discipline.
Thus, while re-dollarisation will eliminate inflation, there are no indications that the regime can become sustainable in the face a high marginal propensity to import.
Economists also call for the floating of the RTGS balances simultaneously with Government relinquishing the foreign currency allocation role so as to let the market decide its true value.
Currently the RTGS/bond note is one of the strongest ‘currencies’ in the region as the parallel market rate is trading against the US dollar at far below what the South African Rand and the Botswana pula are trading.
The rate has been relatively stable despite the current rise in prices.
While floating the RTGS will result in a new and probably stable rate, it is important to appreciate that the high value that the RTGS currently has against the US dollar is only a result of Government intervention in foreign currency allocation.
If Government allows fuel, cooking oil and pharmaceutical importers to trade their RTGS to get foreign currency, the rate can shoot even 10 fold as the supply of RTGS balances chasing the hard currency increase.
RTGS balances are currently in excess of $9 billion and probably still rising and unleashing most of them into the foreign currency market could be disastrous, including generating hyperinflation possibilities.
On the other hand there is fear that introduction of the local currency at the moment is not ideal as ‘fundamentals’ are not yet in place.
However, such fundamentals are rarely mentioned, leaving some to believe that they are just fictitious.
Possible meaning of fundamentals
One critical fundamental is fiscal discipline, where the central Government is able to streamline its expenditure in relation to revenue.
However, the excessive borrowing by Government to sustain recurrent expenditure, which resulted in net claims, from the banking sector, standing at over $9 billion in October 2018, will erode the value of the local currency.
This is because Government would be borrowing from the same sources which the private sector would be trying to unlock productive funding.
The value of the local currency can only be preserved if the productive capacity of the economy is expanding, such that there will be less demand for imports.
Banks and security providers would also be forced to introduce innovative products to attract business when their biggest cash-cow, Government, exits the market.
This includes offering higher interest rates, which would also make domestic securities more attractive to lure foreign investors. This strengthens the local currency.
Government has already identified the budget deficit as a priority area.
Given that Government was able to significantly increase its fiscal space through taxation in the form of the 2 percent tax on electronic payments and imposing excise duty on fuel, there is less pressure on further borrowing to balloon the deficit.
The capacity to honour maturing treasury bills instead of rolling them over constantly has also been enhanced.
Through fiscal discipline, Government is already making steps to make the environment conducive for a local currency.
The most important ‘fundamental’ is the extent to which the economy is open for business.
This includes removing all the key obstacles towards the smooth running of businesses, including high cost of doing business.
While reforms have been initiated in this area, the pace is not as fast as one would have expected given the urgency the matter deserves.
For example, the establishment of the Zimbabwe Investment and Development Agency (ZIDA) is still pending meaning investors are still subject to cumbersome approval processes.
Containing the growth of money supply is also another fundamental which needs to be demonstrated before a local currency is introduced.
An increase in money supply causes a country’s currency to depreciate.
The increase in money supply, which was observed over the years, can be attributed to fiscal indiscipline.
In October 2018, broad money supply was in excess of $10 billion, having increased by 31 percent compared to the stock of broad money as at October 2017.
Money supply needs to be contained for the new currency to become stable.
With fiscal consolidation being the main thrust of the current Government, the main driver of money supply growth is being contained.
Thus, the ground is being prepared for the introduction of the new currency.
A critical measure mostly used to assess whether conditions favour a local currency is the size of a country’s foreign reserves.
Reserves are important as a country can defend its exchange rate by running down reserves and increasing the availability of foreign currency in the market when the demand for foreign currency increases.
A rule of thumb usually used is that reserves should be sufficient to cover a quarter of the total annual imports.
This means that the ratio of reserves to imports should be at least equal to 0.25 or that the total reserves expressed in months of imports should at least be equal to three.
World bank indicators show that the closest that Zimbabwe has ever come to having three months of import cover was in 2009 when total reserves expressed in months of imports was 2.33.
The value has been on a free-fall between 2009 and 2016, closing at 0.72.
Based on the RBZ statistics for December 2017, the reserves in months of imports were at 0.64 or rather at 19 days of import cover.
It is not likely that Zimbabwe will ever reach the rule of thumb threshold.
If a local currency has to wait for such a fundamental, then we will wait for a very long time if not for ever, given that producers also want the reserves to be run down so that they are allocated foreign currency to produce.
However, many countries with their own currencies are also operating at very low reserves.
This also includes developed countries such as Germany, UK and the USA which all operate on less than two months of import cover.
There is also the fundamental of inflation.
Inflation determines the return on investment, as a high inflation country implies that the real interest rate is likely to be negative.
In other words, an inflation which is as high 42 percent recorded in December 2018 would imply that interest rates need to be more than that for investors to earn a return.
Introduction of a new currency can only work in an environment where inflation is contained, preferably to single digit levels.
While the authorities still believe that they would have contained inflation by December 2019, the ratchet effect of inflation needs not be underestimated.
Once prices have been increased, it is difficult for them to be brought down, even if they had risen because of speculation.
Thus, the manner in which inflation has been going up is not consistent with an environment where a local currency is imminent.
However, fiscal discipline will also help contain inflationary pressure such that if speculation is the major driver of inflation, it can easily stabilise.
But this would require Government to engage in a strong disinflation regime, with inflation targeting becoming central to monetary policy.
This implies that most of the fundamentals, except reserves, are generally attainable.
There appears to be some merits to quickly devise methods to work on these fundamentals rather than going back the route of the failed dollarisation.
Even if the $9 billion worth of RTGS are floated for US dollars as part of re-dollarisation, they are too high with respect to the few available hard currency balances in circulation, such that a high loss of value would be expected.
Any measure that punishes depositors who lost everything under the previous dollarisation phase would be suicidal.
Only a transition from RTGS to a stable local currency can offer some protection to depositors and help enhance confidence in the banking sector.
Cornelius Dube is an economist with more than 10 years research experience. He is a senior research fellow at one of the top economic think tanks in Zimbabwe. Views expressed are personal opinions and should not be associated with the institution currently affiliated with.
Online Reporter