Partial dollarization to induce economic stability

The Zimbabwean economy has vaulted back to the multi-currency regime that prevailed between 2009 and 2018 with the US Dollar transactions gradually growing in the formal market while dominating trade in the informal sector. The country’s hopes for a monocurrency were swiftly squashed by low levels of confidence in the Zimbabwean Dollar and record inflation (659.4% in September) caused by excessive money supply.

Harare had its first experience with the multi-currency regime after hyperinflation eclipsed a record of 250 million (Officially) in July 2008. The country fully dollarized on the 9th of April in 2009 and adopted a basket of multiple currencies led by the United States Dollar and the South African Rand. However, the local currency was re-introduced in February 2019 under the Real-Time Gross Settlement (RTGS) banner with the exchange rate pegged at US$1: ZW$2.5. Statutory Instrument 142 of 2019 was instituted in June to ban the use of multiple currencies and enforce the use of a monocurrency in the economy. However, the government made a U-turn 8 months later and allowed the market to use US Dollars.

The past four months have seen some stability in the exchange rate for the Zimbabwean Dollar with the rate settling at US$1: ZW$81.35 in the last few trades. The auction rate is morphing into the central bank’s desired crawling peg even though the sustainability of the financing model has been questioned. As of July 2020, the value of US dollar deposits in local Foreign Currency Accounts (FCA) was US$405 million (Up from US$352 million in January 2020), while the value of Zimbabwean Dollar in circulation in the economy has grown to ZW$14.988 billion in September 2020 as measured by reserve money figures.

After allowing the usage of foreign currencies in the economy, the government followed up by demanding taxes in foreign currency from producers and retailers who trade in foreign currency. In the process, the government retraced back to the Finance Act of 2009 which allows for collection of domestic taxes in US Dollar. The widespread use of foreign currency in a partially dollarized market has the following impact to the economy.

Cost of production & inflation

After years of currency distortions caused by growth in money supply, exchange rate disparities and currency confusion, the local economy is now undergoing readjustment through partial dollarization. The removal of various consumption subsidies such as wheat, cooking oil, fuel and electricity means that producers are now pricing their goods and services using open market prices of production inputs. The foreign currency adjustments on the cost of labour (partial remuneration in foreign currency), transport and taxation are also being factored in product pricing across the board. Therefore, the local cost of production is steadily increasing. The net result is that US Dollar prices for various goods and services will marginally increase in the short term before stabilizing by the second quarter of 2021. The appreciation or depreciation of the local currency on the auction market has limited impact to US Dollar prices in the market as Zimbabwean Dollar prices are deduced from US Dollar costing.

Impact on consumer spending

The local economy contracted in the last 2 years partly because of falling consumer demand. The impact of high inflation rates on consumer disposable incomes was immense.

The country’s largest supermarket chain, OK Zimbabwe experienced a 16% fall in trading volumes in the 12 months to March 31, 2020. TM Pic n Pay Sales volumes also retreated by 24% for the 9 months ending December 2019 as compared to the same period in 2018. Similarly Delta Corporation (Zimbabwe’s largest beverages producer), reported a massive decline in volumes across all its segments as consumers cut spending due to shrinking disposable income. Sorghum and Larger beer volumes declined by 25% and 42% respectively for the full year 2019 compared to 2018. Consumer traffic and the quality of the shopping basket were significantly reduced due to the impact of inflation. The decline in volumes and revenues in real money was experienced across the whole economy. However, partial dollarization if matched by upward adjustment of wages and salaries will result in growth of consumer spending and confidence. Foreign currency price stability will also positively impact household savings in the medium term.

Impact on supply

In the past 2 years, aggregate supply declined sharply due to inflationary pressure among other reasons such as foreign currency shortages and power cuts. Manufacturing capacity utilization for the local industry plummeted from 48% in 2018 to 36% in 2019. In the first Quarter of 2020 (Before COVID-19 national lockdown), capacity utilization had fallen below 28%. Ordinarily, the mining sector is insulated from local currency changes but power cuts and inefficient foreign exchange policies meant that output declined by 25% in 2019. Partial dollarization will likely have no impact on mineral exports value even though it will marginally affect the cost of production. The cost of production as informed by the cost of labour, raw materials and haulage of minerals are being readjusted. However, the previous exchange rate disparities and high levels of inflation ate into supplier margins across the whole economy and negatively impacted supply chains. Most producers and retailers will benefit from partial dollarization in terms of predictability in forward pricing, credit sales, sales margins stability and resurgence in effective demand from the local market. A number of manufacturers who were exporting at subsidized prices in order to get foreign currency can now shift to satisfying the local market. Growth in output will be gradual in line with improvements in consumer incomes and stability in inflation.

Impact on imports

Dollarization has an impact of increasing the country’s propensity to consume foreign merchandise and fast moving consumer goods. Similarly productive raw materials and equipment imports will also increase. However the current multi-currency setup will not result in an immediate jump in imports as the US Dollar circulation in the formal sector is still very low. Zimbabwe’s net foreign currency position (inclusive of remittances) will remain positive even though it will decline from the US$1.3 billion of the half year ending 30 June 2020.

Partial dollarization will also increase real investments in other sectors of the economy such as real estate, distribution and transport, mining, banking and insurance which were negatively impacted by exchange rate losses and high inflation.

The Zimbabwean government will be happy to sustain partial dollarization (multiple currency use) in the economy in the next few years as it offers benefits of collecting taxes in foreign currency through the Finance Act of 2009 while paying for supplies or labour in the local currency using a crawling peg. The government is also benefiting from getting cheap foreign currency from various exporters who surrender 30% of their export receipts to the central bank in exchange for the Zimbabwean Dollar. Critically, the central bank will maintain its most important arsenal of quantitative easing which allows it to print money (mostly electronic) to fund quasi fiscal activities and government subsidies which may be deemed politically strategic as the country readies for the 2023 elections. Printing money will also be handy in settling domestic debt as billions of Zimbabwean Dollar Treasury Bills (TBs) fall due. Small businesses and corporates will also be happy to trade openly in foreign currency as it maintains their incomes. The move to allow trading in the US Dollar has brought some stability in the supply of fuel and electricity in the country. Partial dollarization was certainly not the government objective but given the widespread rejection of the local currency and subsequent economic decline in 2019, it became a feasible compromise.

Victor Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). Feedback: Email or Twitter @VictorBhoroma1.

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