Opinion / Columnist
Zimbabwe's multicurrency system: a critical appraisal
23 Nov 2011 at 17:29hrs | Views
Dollarisation entails the de jure abandonment of a country's own currency and ipso facto the adoption of a more stable currency of another country, generally the U.S. dollar as its legal tender. However, in Zimbabwe, dollarisation has taken a further turn, i.e. the adoption of a multicurrency system wherein a multiplicity of currencies are officially accepted as legal tenders in transactions.
The joint and several use of numerous currencies inclusive of the US$, the GBP, the Rand and the Pula is a phenomenon that is bespoke to Zimbabwe in the global financial history. Hitherto, other countries (eg. Argentina) have generally dollarised but the extent of their dollarisation had been limited to the adoption of the US$ per se while the local currency was either pegged to the dollar or generally ignored by the markets due to the extent of its depreciation.
Zimbabwe is the only country that has unequivocally adopted the multicurrency system under free market conditions, notwithstanding the government's propensity to stifle freedom of economic activity. This presents good grounds for a critical appraisal of the multicurrency monetary regime as practised in Zimbabwe.
The use of the multicurrency system tends to eliminate the risk of exposure to sudden, sharp devaluation of currencies since consumers are free to switch from one currency to the other with relative ease. This results in competitiveness on the part of the country and hence may reduce the risk premium attached to its international borrowing. A country using multicurrencies enjoys a higher level of confidence among international investors. Interest rate spreads on borrowing tends to be much lower compared to what a country's peers pay for similar borrowing. Competitiveness means reduced fiscal costs, and more foreign direct investment and economic growth. Certainly the ongoing infatuation with Zimbabwe by foreign investors is a case in point.
Some analysts have previously stated that multicurrency systems were not suitable for developing economies, arguing that free floating currencies risk excessive exchange rate volatility. However, Zimbabwe's utilisation of the multiplicity of currencies has worked without any major disruption except some alleged shortage of liquidity at certain times. But liquidity must be earned, in other words, money does not just fall like manna from the sky. The level of liquidity that is found in Zimbabwe is commensurate with the level of economic activity in the country.
For dollarization to work it must be permanent in fact and in appearance. It must be seen to be so, de facto, and also de jure. Money by its very nature is susceptible to volatility. By being a medium of exchange and a store of value, money is invariably a subject of endless scrutiny and speculation. Lenin once remarked that "the best way to destroy the capitalist system is to debauch the currency."
It is worth emphasising that Zimbabwe has previously tried to peg its own currency against major currencies but such a misguided policy failed miserably. The success of any currency regime whether dollarised or not is ultimately dependent on sound fundamentals underlying such an economy. This must be read to include the rule of law which is the bedrock of any free market economy which thrives on the integrity of the validity of contracts and legal certainty in case of contractual disputes.
Dollarization on its own is not a source of stability if underlying policies are unsound. Dollarisation (multicurrency) fully adhered to, can eliminate the possibility of excessive printing of money and restricts budget deficits to an economy's ability to borrow in dollars or the currencies that are operational within the borders of that sovereign.
It must be pointed out however that dollarisation is not without risks. Former US Federal Reserve chairman, Alan Greenspan has asserted that while the US$ currency circulating in a country like Zimbabwe is indeed credibly backed by the full might and credit of the U.S. government, any US dollar deposits or other claims are subject to the whims and caprices of the domestic government that could, "…with the stroke of a pen abolish their legal status." This assertion is very significant because it explains why deposits placed with domestic banks are a source of vulnerability for investors since they could lose their money should authorities decide (on political expediency ) to outlaw dollarisation or the multiplicity of currencies.
Consequently, US dollars deposited in banks within such political environments generally tend to sell at a discount to dollar currencies that are in circulation. US$ denominated interest rates in such a country like Zimbabwe tends to rise dramatically if persistent fears of the possibility of dedollarization keep lurking within investors' perceptions. Therefore Zimbabwe needs to manage such fears by assuring investors that the multicurrency system is here to stay. As stated above, Zimbabwe must do so in fact and in appearance. In street lingo, it must walk the talk.
In summary, dollarization or the use of multicurrencies stabilises a country's financial system. Denationalisation and de-monitisation of the local currency eliminates the possibility of a sharp depreciation of the national currency. The risk of currency volatility triggered by the vagaries of uncertainty and fears of currency depreciation and capital flight are mitigated.
Because dollarisation tends to be accompanied by lower inflation, a dollarised country might also strengthen its financial institutions and create positive sentiment towards investment, both domestic and international.
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Colls Ndlovu is an independent financial analyst and can be contacted on wabayi@hotmail.com
The joint and several use of numerous currencies inclusive of the US$, the GBP, the Rand and the Pula is a phenomenon that is bespoke to Zimbabwe in the global financial history. Hitherto, other countries (eg. Argentina) have generally dollarised but the extent of their dollarisation had been limited to the adoption of the US$ per se while the local currency was either pegged to the dollar or generally ignored by the markets due to the extent of its depreciation.
Zimbabwe is the only country that has unequivocally adopted the multicurrency system under free market conditions, notwithstanding the government's propensity to stifle freedom of economic activity. This presents good grounds for a critical appraisal of the multicurrency monetary regime as practised in Zimbabwe.
The use of the multicurrency system tends to eliminate the risk of exposure to sudden, sharp devaluation of currencies since consumers are free to switch from one currency to the other with relative ease. This results in competitiveness on the part of the country and hence may reduce the risk premium attached to its international borrowing. A country using multicurrencies enjoys a higher level of confidence among international investors. Interest rate spreads on borrowing tends to be much lower compared to what a country's peers pay for similar borrowing. Competitiveness means reduced fiscal costs, and more foreign direct investment and economic growth. Certainly the ongoing infatuation with Zimbabwe by foreign investors is a case in point.
Some analysts have previously stated that multicurrency systems were not suitable for developing economies, arguing that free floating currencies risk excessive exchange rate volatility. However, Zimbabwe's utilisation of the multiplicity of currencies has worked without any major disruption except some alleged shortage of liquidity at certain times. But liquidity must be earned, in other words, money does not just fall like manna from the sky. The level of liquidity that is found in Zimbabwe is commensurate with the level of economic activity in the country.
For dollarization to work it must be permanent in fact and in appearance. It must be seen to be so, de facto, and also de jure. Money by its very nature is susceptible to volatility. By being a medium of exchange and a store of value, money is invariably a subject of endless scrutiny and speculation. Lenin once remarked that "the best way to destroy the capitalist system is to debauch the currency."
It is worth emphasising that Zimbabwe has previously tried to peg its own currency against major currencies but such a misguided policy failed miserably. The success of any currency regime whether dollarised or not is ultimately dependent on sound fundamentals underlying such an economy. This must be read to include the rule of law which is the bedrock of any free market economy which thrives on the integrity of the validity of contracts and legal certainty in case of contractual disputes.
Dollarization on its own is not a source of stability if underlying policies are unsound. Dollarisation (multicurrency) fully adhered to, can eliminate the possibility of excessive printing of money and restricts budget deficits to an economy's ability to borrow in dollars or the currencies that are operational within the borders of that sovereign.
It must be pointed out however that dollarisation is not without risks. Former US Federal Reserve chairman, Alan Greenspan has asserted that while the US$ currency circulating in a country like Zimbabwe is indeed credibly backed by the full might and credit of the U.S. government, any US dollar deposits or other claims are subject to the whims and caprices of the domestic government that could, "…with the stroke of a pen abolish their legal status." This assertion is very significant because it explains why deposits placed with domestic banks are a source of vulnerability for investors since they could lose their money should authorities decide (on political expediency ) to outlaw dollarisation or the multiplicity of currencies.
Consequently, US dollars deposited in banks within such political environments generally tend to sell at a discount to dollar currencies that are in circulation. US$ denominated interest rates in such a country like Zimbabwe tends to rise dramatically if persistent fears of the possibility of dedollarization keep lurking within investors' perceptions. Therefore Zimbabwe needs to manage such fears by assuring investors that the multicurrency system is here to stay. As stated above, Zimbabwe must do so in fact and in appearance. In street lingo, it must walk the talk.
In summary, dollarization or the use of multicurrencies stabilises a country's financial system. Denationalisation and de-monitisation of the local currency eliminates the possibility of a sharp depreciation of the national currency. The risk of currency volatility triggered by the vagaries of uncertainty and fears of currency depreciation and capital flight are mitigated.
Because dollarisation tends to be accompanied by lower inflation, a dollarised country might also strengthen its financial institutions and create positive sentiment towards investment, both domestic and international.
------------
Colls Ndlovu is an independent financial analyst and can be contacted on wabayi@hotmail.com
Source - Byo24News
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