Editorial Note: From time to time, we accept guest contributions on specialist subjects. This week, we have an interesting contribution in the field of economics from Maxwell Gomera. Here, he shares his thoughts on the issue of currency substitution in Zimbabwe. How sustainable is the current multi-currency regime? Are the arguments against a return to local currency justified? These are some of the questions that Maxwell tackles in this article. In the interests of furthering robust debate, any learned responses to this will be considered for publication.
Maxwell Gomera
A few days ago, Alex Magaisa challenged economists to give a nuanced perspective on the implications of the decision taken in 2009 by the Government of Zimbabwe to abolish its domestic currency, the Zimbabwean dollar (ZWD), in favour of a basket of other currencies including the United States dollar (USD) and the South African Rand (ZAR) – a process known as currency substitution. Having abandoned its own currency, Zimbabwe has been using the multi-currency system.
He further challenged economists to debate robustly on the long-term prospects and sustainability of the present currency strategy and whether concerns over a return to local currency are justifiable. Is the continued use of the US Dollar wise given the low currencies in countries surrounding Zimbabwe, its major trading partners? Right now, the news is that Zimbabweans have abandoned the ZAR coins, in favour of the local Bond Coins, which the Government introduced much earlier amid great user resistance. This is an important subject, which requires interrogation by policy-makers, business and citizens.
Zimbabwe’s currency substitution process was not prepense government planning. The Government was ‘forced’ into this position after it became apparent that private transactions were no longer being conducted in ZWD and that the bulk of transactions were taking place on the ‘parallel market,’ with the ZWD only accepted in government institutions. Even the government institutions themselves were participating in the parallel market, albeit in most cases, under cover of agents. The move by individuals and private businesses (and government itself) to shun the ZWD as a medium of exchange of value was, of course, forced by hyperinflation, which peaked at a staggering 76 billion percent in 2008.
In 2009, recognising the futility of continuing with a currency that was no longer legitimate, the Government took a unilateral decision to adopt a multi-currency system. This is the system that operates today.
Six years on, opinion is divided between those who believe Zimbabwe should maintain a multi-currency system and those who prefer return to a local currency, by whatever name it might be called. The ZWD carries the burden of a soiled brand, the mere mention of it causing serious revulsion among many who have bad memories of its last years. Those who wish to sustain currency substitution base their belief in lessons from the past: Zimbabwe abolished its currency as a measure to deal with risks of rapid devaluation, exchange rate uncertainty for Zimbabwean businesses and exchange rate transaction costs for both businesses and tourists.
In many ways therefore, they argue, currency substitution has delivered stable and well-aligned exchange rates, macroeconomic stability and an increase in economic welfare for the ordinary Zimbabwean. As such, ditching the multi-currency system now would be a mistake, particularly in the absence of meaningful reversal of what triggered the hyperinflation in the first place.
In contrast, those who believe in a return to domestic currency accept that while Zimbabwe has now gained significant macroeconomic stability as a result of currency substitution, however, growing the economy and building on that gain is proving difficult largely because the lack of exchange rate removes a very effective mechanism for stimulating the economy and increasing exports through currency devaluation. The country’s central bank, the Reserve Bank of Zimbabwe, cannot exercise its function of setting monetary policy in any meaningful way in the absence of a local currency. In the absence of such a mechanism, they claim, Zimbabwe will likely be increasingly uncompetitive and unable to cope with differential shocks affecting Zimbabwe and its trading partners. Zimbabwe has no control over the USD or the ZAR, and as such cannot devalue these currencies to promote its competitiveness on the export markets.
As such, they conclude, a return to local currency could alleviate the economic costs and risks arising from losing the option to devalue the domestic currency in order to restore international competitiveness.
Do these arguments have a credible basis?
Giving up a national currency is not a uniquely Zimbabwean phenomenon. Several countries have adopted the strategy with mostly positive outcomes. Panama in South America currently uses the USD and countries in the Sterling currency area (United Kingdom of Great Britain and Northern Ireland) use the British pound. Similarly, the Euro-zone represents a single currency arrangement that came into effective operation on January 1st 2002, when 12 EU members got rid of their own currencies and introduced the Euro as their sole currency.
The assertion that currency substitution has been largely positive is correct. Sustained low-inflation has helped dramatically reduce long-term interest rates and stimulate some economic growth and competitiveness. Zimbabwe’s annual percentage growth rate of GDP surged from minus 17% in 2008, to 6% (2009); 11.4% (2010); 11.9% (2011); 10.6% (2012); 4.5% (2013) through to 3.2% in 2014. No doubt, the move created opportunity for some Zimbabweans, increased business confidence and enabled more effective and predictable planning.
So high is the confidence in this strategy that the Minister of Finance recently declared that a return to local currency is not imminent.
For others, the transition to a dollarized economy has caused discomfort – particularly to those whose stocks were denominated in ZWD.  However, as most transactions were already denominated in US dollars, the demise of ZWD did not produce totally unfamiliar circumstances. In fact it created conditions for price transparency and brought some credibility to financial planning processes – with investment and growth being obvious beneficial consequences.
The country is facing a myriad of challenges. From 2012 to date, the economy has been shrinking: Productivity is low; overall exports, save for those from the mining industry, are low; credit is almost non-existent (and where available, the interest rates are at near-extortionate levels!); and prices of goods and services are rising relative to those in the region. The high costs of operating have forced some business to close down, unable to compete with competitors in neighbouring countries. The promise of multi-currency system is waning. Attempts by the Zimbabwean government to introduce an economic policy to fight back against unemployment, such as ZIMASSET, are bearing no fruit.
Effectively, the option of re-booting the economy out of difficulties through well-chosen devaluation is no longer available to Zimbabwe. And that has strengthened the arguments for stepping away from the multi-currency system.
So who is right?
Zimbabwe finds itself on the horns of a dilemma on this issue. The Zimbabwe experience certainly suggests that currency substitution can offer economic benefits – but only under fortunate circumstances. And Zimbabwe’s circumstances are far from fortunate.
- First, the economy is still plagued by broader political trouble, including weak property rights and waning trust in regulatory institutions. There is no evidence that devaluation can resuscitate an economy facing such challenges.
- Second, there is no apparent policy coordination between Zimbabwe and the countries whose currencies it has adopted. The functions of the RBZ appear to have just been outsourced to a foreign entity, lessening the scope for monetary policy management, including money supply growth.
- Finally, the Zimbabwean economy is stagnating. Perhaps the biggest winner from adopting the multi-currency system has been South African, which has made Zimbabwe a prime target for South African exports and a cheaper source of the ‘Greenback.’ South African exporters are simply outcompeting Zimbabwe’s manufacturers.
So what to do?
To return to Alex Magaisa’s question, while concerns over a return to local currency or the adoption of a multi-currency system are often portrayed as an economic governance problem, their roots are in our politics and democratic practice. At the core of the problem is a massive loss of credibility in Zimbabwe’s monetary (and political?) institutions as well as a growing trust gap between the public and regulatory institutions. It is our politics and practice, including many years of fiscal indiscipline, political interference and imprudent monetary choices that are undermining public trust. In some ways therefore, discussing the replacement of multi-currency system might be regarded as a distraction that may let off the Finance Minister and Government as a whole, too easily from the real issue of creating an environment conducive to good economic governance and performance.
Finally, as previously mentioned, the emergence of the ‘parallel market’ forced the Government’s hand towards adopting a multi-currency system. The implication here is that, in the absence of trust and confidence in governance institutions, even if the Government of Zimbabwe were to re-introduce a new local currency, it would find it difficult and impractical to force people to accept that currency in private transactions. The recent surge in the fortunes of the previously much-derided Bond Coin ahead of the beleaguered ZAR is probably more because the Bond Coin is pegged at the value of the USD. It is the better of two devils, between it and the ZAR, which has lost its flavour. Hence, to be sure, at least for now, the multi-currency system is the least harmful option. In the end, the currency conundrum is tied to the political conundrum that Zimbabwe continues to face.
Maxwell Gomera is an independent commentator and writes in his private capacity.
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