Opinion / Columnist
Navigating multi-currency challenges
21 Feb 2016 at 07:16hrs | Views
Preamble
THIS week's economic focus is a continuation of last week's instalment which was titled "Lack of monetary policy sovereignty — the dark side of multi-currency regime". Due credit has been given to the decision by the Government to adopt multi-currency regime in this country from 2009.
The immediate results were quashing of hyperinflation, restoration of economic stability, increased fiscal discipline, and re-establishment of monetary credibility in the financial sector.
The implications of adopting the multi-currency regime were that Zimbabwe's national currency had, thus, become moribund, quoting from the then Finance Minister Tendai Biti's national budget statement.
On 12 April 2009, the Zimbabwe dollar was officially suspended as legal tender, in preference of the US dollar.
This happened despite the proximity of South Africa, as a source of the rand and the US dollar was adopted as the currency in which the Government would conduct all its transactions.
Other currencies, in the multi-currency basket were also allowed to circulate but mainly for transaction purposes by citizens and businesses.
Initially, when multi-currencies were adopted the US dollar and the rand competed equally across the country as the primary currencies in circulation. Practically, the consequence was that the Reserve Bank could no longer exercise an independent and full monetary stance-monetary policy sovereignty, and that, effectively, but theoretically the monetary policy sovereignty of the main-currency country, the USA, would become the monetary policy of Zimbabwe, with the monetary policies of the other currency countries acting to iron out any negative outcomes from US monetary policy.
May I reiterate that, this is theoretical, bearing in mind the insignificant size of the Zimbabwean economy in relation to the US economy — the reason why the Americans did not have any problem with Zimbabwe using or adopting the dollar.
The immediate gains
As alluded above, monthly inflation turned negative between January and May 2009: -2,3 percent for January, -3,1 percent for February, -3,0 percent for March, -1,1 percent for April, and -1,0 percent for May. (Zimstat).
GDP real growth rate, which in 2006 had been -4.6 percent and in 2008 -14,4 percent, rose to 3,7 percent in 2009, and even the agricultural sector posted gains of 24,3 percent in productivity.
During this time, bank failures, which had plagued the economy, most perceptibly in 2003 when several financial institutions failed, resulting in losses of about $350 million, did not bedevil the economy.
Elimination of the Zimbabwe dollar (sovereign currency) forced the banks to adopt more prudent competitive and transparent practices and policies, among other benefits, resulted in the stabilisation of the banking sector and system. Sanity was restored in the financial sector.
Challenges or costs of multi-currency regime and their mitigation
Multi-currency or dollarisation, though it benefited the general public in the country, did have an adverse effect on most businesses in general, and also rendered Zimbabwe a high cost country compared to other countries in the region.
The tumbling of the rand in South Africa is further attesting to this fact. Low confidence in the financial institutions of the country caused the public to keep their foreign currency transactions outside the financial system. Loss of monetary policy sovereignty also meant that the Reserve Bank of Zimbabwe ceases to exist as a lender of last resort and deposits were highly transactional in nature, loans-to-deposit ratios fell in the first six months of 2009 to 30 percent compared to 41 percent in 2008, and an average of 36 percent between 2003 and 2008. There were no money market instruments and interbank trading was limited to cash settlements only.
The major cost was that, the multi-currency regime or the dollarisation was effectively not backed up by significant foreign reserves — a critical ingredient in the management of multi-currency regime. This is still the biggest challenge up to today. When I said last week it is very true that there are very little liquidity inflows into our economy, in variance with the recently announced monetary policy statement, I was precisely expressing the need to back the multi-currency regime with significant foreign reserves, in the form of the very currencies in circulation in the multi-currency system as part of management of the supply side of the currencies.
The absence of the functions of a central bank in a multi-currency economy like ours implies that there is no lender of last resort in the economy. This induces banks to seek for alternative contingent credits, particularly foreign funds (off show), to replace partially the lender of last resort role. The necessity to seek for foreign funds gives a competitive edge to international banks (such as Standard Chartered Bank) over domestic banks, notwithstanding the cost of those off show funds to the international banks. This has been a contributing factor to the collapse of some of the domestic indigenous banks, over and above the challenge on unsustainable non-performing loans.
Bank off show funds cannot sustain multi-currency regime or dollarisation in an economy like Zimbabwe, bearing in mind the cost at which banks obtain those funds.
Unfortunately, the same way the multi-currency regime helped to stabilise the economy from the hyperinflation experience, when the economy suffers a "sudden stop" in the flow of foreign capital inflows — foreign direct investment and significant export earnings, financial dollarisation or multi-currency regime increases the risk of financial crisis (liquidity crunch). This happens because financial dollarisation normally facilitates the emergence of currency mismatches and balance sheet problems, particularly when income streams and debt services accrued in different currencies, especially when one of the multi-currencies within the basket significantly depreciate in value-what is happening with the South African rand at the moment.
Additionally, as the local monetary authority has very little room for acting as lender of last resort, notwithstanding the effort to address that limitation through the African Export Import Bank Trade Backed Facility (AFTRADES), when the banks become illiquid as a consequence of a run on foreign currency deposits, liquidity problems may rapidly transform into insolvency problems (exacerbated by non performing loans), aggravating the crisis.
The solution lies with importation of liquidity (foreign reserves) through increased export earnings, increased direct foreign investment, increased domestic investment, increased domestic production and capacity utilisation, reduction of the import bill, etc. Necessary reforms to attract foreign direct investment inflows through easing of doing business and lowering the costs of doing business in Zimbabwe will go a long way towards addressing the current economic ills, and facilitate real economic growth.
In conclusion it is our hope that the recently lunched 100 days' promotion plan or programme for ease doing of business in Zimbabwe will mark the beginning of the requisite will for creating an attractive investment environment for FDI.
Dr Bongani Ngwenya is a Bulawayo-based economist and senior lecturer at Solusi University's Post Graduate School of Business ngwenyab@solusi.ac.zw/ nbongani@gmail.com
THIS week's economic focus is a continuation of last week's instalment which was titled "Lack of monetary policy sovereignty — the dark side of multi-currency regime". Due credit has been given to the decision by the Government to adopt multi-currency regime in this country from 2009.
The immediate results were quashing of hyperinflation, restoration of economic stability, increased fiscal discipline, and re-establishment of monetary credibility in the financial sector.
The implications of adopting the multi-currency regime were that Zimbabwe's national currency had, thus, become moribund, quoting from the then Finance Minister Tendai Biti's national budget statement.
On 12 April 2009, the Zimbabwe dollar was officially suspended as legal tender, in preference of the US dollar.
This happened despite the proximity of South Africa, as a source of the rand and the US dollar was adopted as the currency in which the Government would conduct all its transactions.
Other currencies, in the multi-currency basket were also allowed to circulate but mainly for transaction purposes by citizens and businesses.
Initially, when multi-currencies were adopted the US dollar and the rand competed equally across the country as the primary currencies in circulation. Practically, the consequence was that the Reserve Bank could no longer exercise an independent and full monetary stance-monetary policy sovereignty, and that, effectively, but theoretically the monetary policy sovereignty of the main-currency country, the USA, would become the monetary policy of Zimbabwe, with the monetary policies of the other currency countries acting to iron out any negative outcomes from US monetary policy.
May I reiterate that, this is theoretical, bearing in mind the insignificant size of the Zimbabwean economy in relation to the US economy — the reason why the Americans did not have any problem with Zimbabwe using or adopting the dollar.
The immediate gains
As alluded above, monthly inflation turned negative between January and May 2009: -2,3 percent for January, -3,1 percent for February, -3,0 percent for March, -1,1 percent for April, and -1,0 percent for May. (Zimstat).
GDP real growth rate, which in 2006 had been -4.6 percent and in 2008 -14,4 percent, rose to 3,7 percent in 2009, and even the agricultural sector posted gains of 24,3 percent in productivity.
During this time, bank failures, which had plagued the economy, most perceptibly in 2003 when several financial institutions failed, resulting in losses of about $350 million, did not bedevil the economy.
Challenges or costs of multi-currency regime and their mitigation
Multi-currency or dollarisation, though it benefited the general public in the country, did have an adverse effect on most businesses in general, and also rendered Zimbabwe a high cost country compared to other countries in the region.
The tumbling of the rand in South Africa is further attesting to this fact. Low confidence in the financial institutions of the country caused the public to keep their foreign currency transactions outside the financial system. Loss of monetary policy sovereignty also meant that the Reserve Bank of Zimbabwe ceases to exist as a lender of last resort and deposits were highly transactional in nature, loans-to-deposit ratios fell in the first six months of 2009 to 30 percent compared to 41 percent in 2008, and an average of 36 percent between 2003 and 2008. There were no money market instruments and interbank trading was limited to cash settlements only.
The major cost was that, the multi-currency regime or the dollarisation was effectively not backed up by significant foreign reserves — a critical ingredient in the management of multi-currency regime. This is still the biggest challenge up to today. When I said last week it is very true that there are very little liquidity inflows into our economy, in variance with the recently announced monetary policy statement, I was precisely expressing the need to back the multi-currency regime with significant foreign reserves, in the form of the very currencies in circulation in the multi-currency system as part of management of the supply side of the currencies.
The absence of the functions of a central bank in a multi-currency economy like ours implies that there is no lender of last resort in the economy. This induces banks to seek for alternative contingent credits, particularly foreign funds (off show), to replace partially the lender of last resort role. The necessity to seek for foreign funds gives a competitive edge to international banks (such as Standard Chartered Bank) over domestic banks, notwithstanding the cost of those off show funds to the international banks. This has been a contributing factor to the collapse of some of the domestic indigenous banks, over and above the challenge on unsustainable non-performing loans.
Bank off show funds cannot sustain multi-currency regime or dollarisation in an economy like Zimbabwe, bearing in mind the cost at which banks obtain those funds.
Unfortunately, the same way the multi-currency regime helped to stabilise the economy from the hyperinflation experience, when the economy suffers a "sudden stop" in the flow of foreign capital inflows — foreign direct investment and significant export earnings, financial dollarisation or multi-currency regime increases the risk of financial crisis (liquidity crunch). This happens because financial dollarisation normally facilitates the emergence of currency mismatches and balance sheet problems, particularly when income streams and debt services accrued in different currencies, especially when one of the multi-currencies within the basket significantly depreciate in value-what is happening with the South African rand at the moment.
Additionally, as the local monetary authority has very little room for acting as lender of last resort, notwithstanding the effort to address that limitation through the African Export Import Bank Trade Backed Facility (AFTRADES), when the banks become illiquid as a consequence of a run on foreign currency deposits, liquidity problems may rapidly transform into insolvency problems (exacerbated by non performing loans), aggravating the crisis.
The solution lies with importation of liquidity (foreign reserves) through increased export earnings, increased direct foreign investment, increased domestic investment, increased domestic production and capacity utilisation, reduction of the import bill, etc. Necessary reforms to attract foreign direct investment inflows through easing of doing business and lowering the costs of doing business in Zimbabwe will go a long way towards addressing the current economic ills, and facilitate real economic growth.
In conclusion it is our hope that the recently lunched 100 days' promotion plan or programme for ease doing of business in Zimbabwe will mark the beginning of the requisite will for creating an attractive investment environment for FDI.
Dr Bongani Ngwenya is a Bulawayo-based economist and senior lecturer at Solusi University's Post Graduate School of Business ngwenyab@solusi.ac.zw/ nbongani@gmail.com
Source - sundaynews
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