Calls have been made by various economic agents on how the country should resolve the prevailing local currency ($) instability epitomised by a depreciating exchange rate.
The official rate is pegged at $25:US$1, while the parallel rate has gone beyond $60:US$1. It is important to distinguish the peculiar challenges Zimbabwe faces when coming up with a plausible route for achieving currency stability.
This is also made extra difficult given a seemingly out of control money supply growth. The result has been the failure of the re-introduced local currency unit epitomised by the return to dollarisation of the economy as agents seek stability. The authorities have been at pains to find a suitable antidote.
The general view from various sectors have been the full liberalisation of the market preceded by a full adoption of the United States dollar (USD) as a twin unit of exchange with the ZW$. The call for adopting the USD is largely an emotional, if not nostalgic, recommendation based on the misnomer that the full dollarisation period of 2009 to 2013 was successful.
It is a misnomer because the facts on the ground actually point to the period as a significant source of the current challenges mainly arising from mismatches so created. An analytical review of Zimbabwe’s trading statistics reveal that the United States only accounts for 1 percent of the country’s exports and it ranked 14th as an export destination by 2019.
Imports from the United States on the other hand accounted for about 4 percent and it ranked highly at 5th as a source. Apart from showing a serious bilateral trade deficit for Zimbabwe, there are more reasons against the adoption of the USD and these can be elucidated in a different discussion.
In fact even the Netherlands ranks higher than the United States as a destination for the country’s exports and therefore the implied source of foreign currency inflows!
A further review shows that South Africa accounts for about 43 percent of Zimbabwe’s exports and 67 percent of its imports. It is Zimbabwe’s biggest trading partner and ranks first on both counts although the trade balance is in South Africa’s favour.
This calls for a deeper re-evaluation of the solution to eventually tame the $ volatility problem outside productivity growth stimulation measures. Currency stability itself is a stimulant for productivity therefore it is important to attempt to simultaneously achieve both.
Economic history shows that the issue of currency volatility and its management is not unique to Zimbabwe. Over the years, various methods have been used by countries in search of that elusive currency stability. The biggest challenge is that individual countries have unique macroeconomic conditions within their borders, which make currency unions a very difficult proposition.
Historically, nations have struggled to manage their monetary reserves. The Silver Standard and the Gold Standard were used in the 1800s up to about the 1930s when the Gold Standard was eventually abandoned.
In 1944 the Bretton Woods Agreement and System created a collective international currency exchange regime based on the USD and gold. This has held over the years although with increasing creation of fiat money.
The Smithsonian Agreement was a deal reached in 1971 among the G10 countries to adjust the system of fixed international currency exchange rates.
The Bretton Woods system persisted though and this is presumably the reason many agents in Zimbabwe still hold the view of the USD being the country’s solution. The statics alluded to above, however, do not justify the view. It is an utopian held view.
There are good grounds proving the efficacy of adopting the Rand as a partnering currency for the local unit through a Rand Currency Board. The misunderstanding at present is that some are regarding this as a recommendation for Zimbabwe to join the Rand Monetary Union. However, our call is far from it. The authorities are being urged to consider a currency board system for stabilising the $.
Examples of currency boards abound in the world as countries facing volatile local currencies seek stabilisation by riding on stable partner currencies. One typical example is that of the Hong Kong Dollar, which is based on a United States Dollar Currency Board.
Under a currency board, the monetary authority has to back all units of domestic currency in circulation with foreign currency. When all domestic currency is backed with foreign currency, it is called a 100 percent reserve requirement.
With a 100 percent reserve requirement, a currency board operates similarly to a strong version of the gold standard. The reserve requirement can be subject to negotiations in line with the underlying peculiar macro-economic conditions and the two authorities.
A currency board allows for an unlimited exchange of the domestic currency for foreign currency. While a conventional central bank can print money at will, a currency board forces it to back additional units of currency with foreign currency. A currency board earns interest from foreign reserves, so domestic interest rates usually mimic the prevailing rates in the foreign currency.
The notable advantages of a currency board include its relative stability and rule-based nature. A currency board offers a stable exchange rate, which promotes trade and investment and leads to productivity growth. It is disciplined and restricts authorities’ actions. Wasteful or irresponsible authorities cannot simply print money to pay down deficits. Generally, currency boards are known for keeping inflation under control.
It is acknowledged that some disadvantages also exist though since a currency board may be somewhat limited in its power. It would mostly just hold the required percentage of pegged currency as mandated. It also exchanges local currency for the pegged (or anchor) currency, in this case the Rand. Generally, currency boards may face resistance from political interests. These do not allow the local monetary authorities to set their interest rates. This may imply the Monetary Policy Committee and the Reserve Bank ceding some level of control.
For Zimbabwe, this may mean an implementation and monitoring role, much like the Currency Stabilisation Task Force. A currency board imports much of that foreign country’s monetary policy. It is, however, strategically important for the long term as this should only be regarded as a transitioning period.
Another disadvantage arises when two countries are at different points in the business cycle as is the case between South Africa and Zimbabwe. A currency board may create some serious bottlenecks. For instance, should the monetary authorities in South Africa raise interest rate to restrain inflation during an expansion in that country, the currency board transmits that rate hike to the domestic economy, regardless of local conditions and in this case Zimbabwe is cutting its interest rate.
Given Zimbabwe is already experiencing economic decline, any such induced rate hike could make matters worse. Fortunately, due to the Covid-19 pandemic, both countries are presently experiencing similar conditions and therefore it is an opportune moment to converge policies. The initiative lies with Zimbabwe to engage the counterpart.
In a crisis, a currency board cannot act as a lender of last resort. In the event of a banking panic, a currency board cannot lend money to banks in a meaningful way and therefore presents a standing risk. The banking industry in Zimbabwe has been confirmed as sound from the recent inspection reports by the Central Bank therefore this risk is manageable. Authorities are hence urged to seriously consider the Rand Currency Board route and the timing could not be more appropriate as of now due to the global economic decline. It is high time the country catches the train before it departs.
Misheck is a former expatriate banker once based in several SADC countries and currently works as a corporate advisory services consultant. He is the founder of Rucabel Investments Private Limited, an investment company based in Zimbabwe. He is a member and past Vice President of the Zimbabwe Economics Society. He can be contacted on firstname.lastname@example.org/Linkedin: https://www.linkedin.com/in/misheckugaro/Twitter: @twitcagan.com