Opinion / Columnist
Re-dollarisation of economy: Wrong turn for Zimbabwe
30 Dec 2018 at 05:06hrs | Views
There is an effervescence in the economy – an imperceptible but definite shift towards re- dollarisation of the economy.
Initially a trickle, this will soon turn into a mighty tide in one direction – a steady but irretrievable tendency towards re-dollarisation. Pharmacies and stockists of medical drugs and ancillaries commenced this process early in October, immediately following the separation of Nostro FCAs from Local RTGS FCAs, ostensibly because they source drugs in foreign currency and the Central Bank has been unable to supply the required foreign currency.
All industry, including the largest manufacturing firm in the country, Delta, has for many months bemoaned the acute foreign currency shortages, which have impacted negatively on capacity to produce.
As a result, this year's Christmas festivities were characterised by pronounced shortages of soft drinks, or where they are available, in the alleys and byways, the parallel market asking prices are prohibitive.
Now some retailers have followed suit, offering "discounted prices" for US dollar purchases and another RTGS price for the same commodity at a heavily "fortified" price pegged at some obsequious parallel market rate.
The customer is presented with this "choice".
I hazard to suggest that many retailers will unfortunately follow suit and this is defining, in as much as there is only one outcome – further sustained squeeze on consumers, who are already facing an unremitting escalation in school fees, uniforms and prices of nearly every basic commodity.
It is decidedly the wrong turn for Zimbabwe.
And I think this ranks very much the same as the timeless mistake by Churchill in 1925, when, as Chancellor of the Exchequer, he re- pegged the pound to gold at the pre-war value, triggering and fuelling the largest British industrial decline in the inter war years.
Why Re-dollarisation is the Wrong Turn
Below, I present a brief synopsis of why I think a return to dollarisation is the wrong turn for Zimbabwe. Suffice to mention that this will sustain disintermediation and dislocation in the economy, to the extent that foreign exchange access is non-existent for the vast majority of Zimbabweans who are non-exporters and constitute the largest segment of the population.
A large and growing segment of the Zimbabwean populace has for many years been left by the tide of an increasingly enclave formal economy. Industrious and intrepid, as always, they have, by and large, managed to create, beneath the labyrinth, a well-functioning informal economy, with about 60 percent of GDP now attributed to this sector, according to recent IMF estimates – the second largest in the world.
This economy intersects the formal system but only at specific junctions.
For example, supply of goods and services often flows into the formal system and the dependence on formal payments system is very high
The capacity to generate foreign currency through exports is still nascent and inadequate to meet demand. Evidence abounds among the SMEs and micro enterprises that constitute the vast informal sector.
Less than 10 percent access some form of foreign currency through official channels.
Re-dollarisation will make it harder for them, if not impossible, to access foreign currency.
The current atrophied foreign exchange management system, thus, leaves over 60 percent of the economy adrift.
Strong currency
Re-dollarisation means entrenching the US dollar at the epicentre of the so-called multicurrency system. Effectively, this means a US dollar payments system with marginal reference to other currencies.
The US dollar dominates the multicurrency to such an extent that it is in reality and in practice a US dollar payments system.
There are abiding dangers for the country to maintain as an internal currency payments an international reserve currency that is demanded for 65 percent of international payments.
It is not sustainable for a small open economy, whose GDP is less than that of a street in New Jersey, to sustain the US dollar as an internal payments system, especially where direct trade with the USA is less than 3 percent.
The ramifications for the economy are all too evident.
Further, the US dollar is a strong currency and will continue to strengthen for the next two to three years. The Fed is sustaining rate hikes, a clear indication that they view their economy is sufficiently recording strong growth over the near term.
Not only will the US dollar strengthen from growth of the economy, but also any jitters with emergency currencies – such as recently occurred with the Turkish Lira, Argentinian Peso and others – will immediately filter across the globe affecting all emerging market currencies, including the South African rand, our major trading partner.
There is less than minimum likelihood that Zimbabwe can sustain recovery and growth under a strong and strengthening US dollar currency.
No amount of internal incentives are sufficient to compensate for an overvalued real exchange rate.
As evidence, it would be important to just evaluate how many of the tobacco farmers who got paid incentives only four months ago can viably return to production this year, with nearly all prices of inputs, in particular chemicals and fertilisers having escalated 300 – 400 percent. The situation on the ground has been aggravated by multiple-tier pricing in the economy.
Foreign Exchange Management
The economy faces multiple intertwined and interconnected challenges.
As an example, authorities have maintained the 1:1 parity, the intention being to preserve value.
This is a genuine concern by Government to prevent a downward spiral in the value of RTGS balances and bond notes.
Although it can be shown that with prices now determined by the parallel market rates, the "preservation" of value at 1:1 is now only a theoretical construct.
Significant value has already been lost – infact, it is double loss – the parallel market rate and the escalation in prices.
Headline inflation will likely surge beyond 50 percent by May/June and deceleration in prices only possible from the fourth quarter of next year.
But the official parity of 1:1 guarantees that there is no formal foreign exchange trading, as no exporter will sell their receipts at 1:1 while facing escalating expenses pegged at depreciated parallel market exchange rates.
Indeed the current foreign exchange management, like a "black hole", cannot be satiated.
No amount of exports growth or huge lines of credit will correct this. Indeed exports grew over 20 percent in real terms last year and yet the foreign currency shortages are even more acute.
We must ask ourselves the searching question, why Zimbabwe, with foreign currency receipts in excess of $5,5 billion a year, faces perennial foreign currency shortages?
Yet Kenya, a larger economy in GDP terms, only generates about $4, 8 billion per year and there are no foreign currency shortages in Kenya.
In fact, Zimbabwe is the only Southern African country with acute and systematic foreign currency shortages in the region.
The answer is not necessarily in growing more exports, although that is important. The key priority must be a comprehensive revamp of the foreign currency management system to ensure a proper functioning interbank market with limited Central Bank direct interventions, with adequate off-site and on-site oversight arrangements to ensure adherence to regulatory requirements.
Proposed Way Forward
The on-going re-dollarisation is hurting the economy, undermining recovery and growth, not just from disinter-mediation, but escalation in prices and uncertainty, which undermines investment for long-term growth. There is a surge in "short termism" – an inclination for hustling, flourishing over-the-counter deals, asset price bubbles (e.g. stock exchange) aggravated by a build-up in incipient inflation pressures, heightening uncertainty.
Yes, Government has done well to contain the budget deficit and to send a strong message of austerity.
This is very important, but may not be enough. My estimation is that the way forward, is a policy tripod - a sequenced three-leg policy programme as below:
i. Fiscal Consolidation (Including SOEs Reforms/Privatisation)
ii. External Debt and Arrears Clearance
iii. Currency Reforms
The above must form an integral part of a first wave of the many reforms that must implemented for balanced recovery. They are not the only reforms required, but they form the core or bedrock of any macroeconomic reforms. Other policies are equally critical, including cost of doing business and removal of all distortions, pricing policies, among others, but the above form the core. The 2019 fiscal budget announced in November has set the pace for both Fiscal Consolidation and External Debt and Arrears clearance. There is significant and visible progress on both.
Authorities must address the third, inclusive of the tricky question of foreign exchange management, the interbank market for foreign currency and Treasury instruments. Naturally, this brings the question of financial market prices - for both foreign currency and Treasury instruments. It is not an easy undertaking, but it cannot be postponed any longer, otherwise the implications on the economy may be too grievous and the pain of austerity will have been for little gain.
Currency Reforms
As always, the abiding question relates to what can be done on currency reforms. There are few reality checks to consider in this regard. Firstly, in my view, we cannot continue with a strong US dollar currency without material damage to the economy, as I have already highlighted above. We have the worst of both worlds under a US dollar environment - an overvalued exchange rate, bleaching the economy and limited access to US dollar lines of credit (hence cash shortages).
Greece under the mighty Euro is a perfect example. Ten years of austerity in Greece have produced no tangible recovery and whatever little progress achieved has been Government-induced expenditure.
For their multiplied suffering – over 25 percent cuts in pensions and other payments under a heavy Troika-induced austerity - are the Greeks seeing light at the end of the tunnel?
I doubt. Secondly, although we already have burgeoning RTGS balances (in essence local currency), a hurried and injudicious formal adoption of local currency is untenable - the psychology of expectations weighs heavily against this route.
Fiat money, all over the world, depends on public trust and for Zimbabwe, this is something we have to build steadily, brick upon brick and line for line. It is not overnight.
Unfortunately for us, this may well take over a decade to repair. A local currency will simply descend inexorably beyond the precipice.
What can be done?
A Midway or Half-Way House Policy Proposal
Instead of mortgaging our gold for US dollar lines of credit, under which there is no chance of resolving the current foreign exchange shortages nor ameliorate the deepening crisis - rather, it is better to mortgage a percentage of our gold, say 5 percent of gold output every month to South Africa for a facility of 10 billion rand. This facility can be structured to run for three or four years to cover:
i. Medical drugs
ii. Fuel, Fertilizers and Chemicals; and
iii. Cash
Under this facility, Government can implement the following:
i. Pay all small-scale gold producers in rand
ii. Pay all Tobacco and Horticulture farmers in rand
iii. Pay Civil servants 50 percent in RTGS and 50 percent in Rand
iv. Retain the multi-currency basket (with Rand as transacting currency)
v. Require all fuel purchases in rand
The Midway proposal does not imply joining the Rand Monetary Area. Rather, it is very similar to the recent Sino- Japanese bilateral payments arrangements, in which the two largest economies in East Asia agreed to direct inter-country trade payments, bypassing the US dollar as an intermediary payment.
This would increase bilateral trade between Zimbabwe and South Africa, boost growth and address the challenge of a strong currency.
The US dollar is retained, but more as a reserve currency in the basket.
All exporters will be required to retain their export proceeds and trade in the interbank market at market rates. This enhances FX availability for importers and gives fresh growth impetus for the economy. All local payments are either in RTGS or rand. This way, Government has a chance to accumulate FX reserves for future introduction of the local currency, which would be introduced in a graduated and phased approach.
Joseph Mverecha is an economist with a local commercial bank. He writes in his personal capacity.
Initially a trickle, this will soon turn into a mighty tide in one direction – a steady but irretrievable tendency towards re-dollarisation. Pharmacies and stockists of medical drugs and ancillaries commenced this process early in October, immediately following the separation of Nostro FCAs from Local RTGS FCAs, ostensibly because they source drugs in foreign currency and the Central Bank has been unable to supply the required foreign currency.
All industry, including the largest manufacturing firm in the country, Delta, has for many months bemoaned the acute foreign currency shortages, which have impacted negatively on capacity to produce.
As a result, this year's Christmas festivities were characterised by pronounced shortages of soft drinks, or where they are available, in the alleys and byways, the parallel market asking prices are prohibitive.
Now some retailers have followed suit, offering "discounted prices" for US dollar purchases and another RTGS price for the same commodity at a heavily "fortified" price pegged at some obsequious parallel market rate.
The customer is presented with this "choice".
I hazard to suggest that many retailers will unfortunately follow suit and this is defining, in as much as there is only one outcome – further sustained squeeze on consumers, who are already facing an unremitting escalation in school fees, uniforms and prices of nearly every basic commodity.
It is decidedly the wrong turn for Zimbabwe.
And I think this ranks very much the same as the timeless mistake by Churchill in 1925, when, as Chancellor of the Exchequer, he re- pegged the pound to gold at the pre-war value, triggering and fuelling the largest British industrial decline in the inter war years.
Why Re-dollarisation is the Wrong Turn
Below, I present a brief synopsis of why I think a return to dollarisation is the wrong turn for Zimbabwe. Suffice to mention that this will sustain disintermediation and dislocation in the economy, to the extent that foreign exchange access is non-existent for the vast majority of Zimbabweans who are non-exporters and constitute the largest segment of the population.
A large and growing segment of the Zimbabwean populace has for many years been left by the tide of an increasingly enclave formal economy. Industrious and intrepid, as always, they have, by and large, managed to create, beneath the labyrinth, a well-functioning informal economy, with about 60 percent of GDP now attributed to this sector, according to recent IMF estimates – the second largest in the world.
This economy intersects the formal system but only at specific junctions.
For example, supply of goods and services often flows into the formal system and the dependence on formal payments system is very high
The capacity to generate foreign currency through exports is still nascent and inadequate to meet demand. Evidence abounds among the SMEs and micro enterprises that constitute the vast informal sector.
Less than 10 percent access some form of foreign currency through official channels.
Re-dollarisation will make it harder for them, if not impossible, to access foreign currency.
The current atrophied foreign exchange management system, thus, leaves over 60 percent of the economy adrift.
Strong currency
Re-dollarisation means entrenching the US dollar at the epicentre of the so-called multicurrency system. Effectively, this means a US dollar payments system with marginal reference to other currencies.
The US dollar dominates the multicurrency to such an extent that it is in reality and in practice a US dollar payments system.
There are abiding dangers for the country to maintain as an internal currency payments an international reserve currency that is demanded for 65 percent of international payments.
It is not sustainable for a small open economy, whose GDP is less than that of a street in New Jersey, to sustain the US dollar as an internal payments system, especially where direct trade with the USA is less than 3 percent.
The ramifications for the economy are all too evident.
Further, the US dollar is a strong currency and will continue to strengthen for the next two to three years. The Fed is sustaining rate hikes, a clear indication that they view their economy is sufficiently recording strong growth over the near term.
Not only will the US dollar strengthen from growth of the economy, but also any jitters with emergency currencies – such as recently occurred with the Turkish Lira, Argentinian Peso and others – will immediately filter across the globe affecting all emerging market currencies, including the South African rand, our major trading partner.
There is less than minimum likelihood that Zimbabwe can sustain recovery and growth under a strong and strengthening US dollar currency.
No amount of internal incentives are sufficient to compensate for an overvalued real exchange rate.
Foreign Exchange Management
The economy faces multiple intertwined and interconnected challenges.
As an example, authorities have maintained the 1:1 parity, the intention being to preserve value.
This is a genuine concern by Government to prevent a downward spiral in the value of RTGS balances and bond notes.
Although it can be shown that with prices now determined by the parallel market rates, the "preservation" of value at 1:1 is now only a theoretical construct.
Significant value has already been lost – infact, it is double loss – the parallel market rate and the escalation in prices.
Headline inflation will likely surge beyond 50 percent by May/June and deceleration in prices only possible from the fourth quarter of next year.
But the official parity of 1:1 guarantees that there is no formal foreign exchange trading, as no exporter will sell their receipts at 1:1 while facing escalating expenses pegged at depreciated parallel market exchange rates.
Indeed the current foreign exchange management, like a "black hole", cannot be satiated.
No amount of exports growth or huge lines of credit will correct this. Indeed exports grew over 20 percent in real terms last year and yet the foreign currency shortages are even more acute.
We must ask ourselves the searching question, why Zimbabwe, with foreign currency receipts in excess of $5,5 billion a year, faces perennial foreign currency shortages?
Yet Kenya, a larger economy in GDP terms, only generates about $4, 8 billion per year and there are no foreign currency shortages in Kenya.
In fact, Zimbabwe is the only Southern African country with acute and systematic foreign currency shortages in the region.
The answer is not necessarily in growing more exports, although that is important. The key priority must be a comprehensive revamp of the foreign currency management system to ensure a proper functioning interbank market with limited Central Bank direct interventions, with adequate off-site and on-site oversight arrangements to ensure adherence to regulatory requirements.
Proposed Way Forward
The on-going re-dollarisation is hurting the economy, undermining recovery and growth, not just from disinter-mediation, but escalation in prices and uncertainty, which undermines investment for long-term growth. There is a surge in "short termism" – an inclination for hustling, flourishing over-the-counter deals, asset price bubbles (e.g. stock exchange) aggravated by a build-up in incipient inflation pressures, heightening uncertainty.
Yes, Government has done well to contain the budget deficit and to send a strong message of austerity.
This is very important, but may not be enough. My estimation is that the way forward, is a policy tripod - a sequenced three-leg policy programme as below:
i. Fiscal Consolidation (Including SOEs Reforms/Privatisation)
ii. External Debt and Arrears Clearance
iii. Currency Reforms
The above must form an integral part of a first wave of the many reforms that must implemented for balanced recovery. They are not the only reforms required, but they form the core or bedrock of any macroeconomic reforms. Other policies are equally critical, including cost of doing business and removal of all distortions, pricing policies, among others, but the above form the core. The 2019 fiscal budget announced in November has set the pace for both Fiscal Consolidation and External Debt and Arrears clearance. There is significant and visible progress on both.
Authorities must address the third, inclusive of the tricky question of foreign exchange management, the interbank market for foreign currency and Treasury instruments. Naturally, this brings the question of financial market prices - for both foreign currency and Treasury instruments. It is not an easy undertaking, but it cannot be postponed any longer, otherwise the implications on the economy may be too grievous and the pain of austerity will have been for little gain.
Currency Reforms
As always, the abiding question relates to what can be done on currency reforms. There are few reality checks to consider in this regard. Firstly, in my view, we cannot continue with a strong US dollar currency without material damage to the economy, as I have already highlighted above. We have the worst of both worlds under a US dollar environment - an overvalued exchange rate, bleaching the economy and limited access to US dollar lines of credit (hence cash shortages).
Greece under the mighty Euro is a perfect example. Ten years of austerity in Greece have produced no tangible recovery and whatever little progress achieved has been Government-induced expenditure.
For their multiplied suffering – over 25 percent cuts in pensions and other payments under a heavy Troika-induced austerity - are the Greeks seeing light at the end of the tunnel?
I doubt. Secondly, although we already have burgeoning RTGS balances (in essence local currency), a hurried and injudicious formal adoption of local currency is untenable - the psychology of expectations weighs heavily against this route.
Fiat money, all over the world, depends on public trust and for Zimbabwe, this is something we have to build steadily, brick upon brick and line for line. It is not overnight.
Unfortunately for us, this may well take over a decade to repair. A local currency will simply descend inexorably beyond the precipice.
What can be done?
A Midway or Half-Way House Policy Proposal
Instead of mortgaging our gold for US dollar lines of credit, under which there is no chance of resolving the current foreign exchange shortages nor ameliorate the deepening crisis - rather, it is better to mortgage a percentage of our gold, say 5 percent of gold output every month to South Africa for a facility of 10 billion rand. This facility can be structured to run for three or four years to cover:
i. Medical drugs
ii. Fuel, Fertilizers and Chemicals; and
iii. Cash
Under this facility, Government can implement the following:
i. Pay all small-scale gold producers in rand
ii. Pay all Tobacco and Horticulture farmers in rand
iii. Pay Civil servants 50 percent in RTGS and 50 percent in Rand
iv. Retain the multi-currency basket (with Rand as transacting currency)
v. Require all fuel purchases in rand
The Midway proposal does not imply joining the Rand Monetary Area. Rather, it is very similar to the recent Sino- Japanese bilateral payments arrangements, in which the two largest economies in East Asia agreed to direct inter-country trade payments, bypassing the US dollar as an intermediary payment.
This would increase bilateral trade between Zimbabwe and South Africa, boost growth and address the challenge of a strong currency.
The US dollar is retained, but more as a reserve currency in the basket.
All exporters will be required to retain their export proceeds and trade in the interbank market at market rates. This enhances FX availability for importers and gives fresh growth impetus for the economy. All local payments are either in RTGS or rand. This way, Government has a chance to accumulate FX reserves for future introduction of the local currency, which would be introduced in a graduated and phased approach.
Joseph Mverecha is an economist with a local commercial bank. He writes in his personal capacity.
Source - zimpapers
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