The Sunday Mail
Dr Ranganai Gwata
In 2009, Zimbabwe introduced a multi-currency regime to help curb the hyperinflation and extreme macroeconomic volatility that had tormented the economy for over a decade.
At the time, the multi-currency regime was widely viewed as a temporary measure.
While there are up to nine legal tenders in Zimbabwe, the most prevalent currencies used in trading for the last six years have been the United States dollar (USD) and the South African rand (rand).
Because of the prevalence of these two currencies and for the sake of clarity, my analysis and illustrations focus on the rand and USD.
Economists use the term dollarisation to describe the situation whereby a country adopts another country’s more stable currency, even if the adopted (or anchor) currency is not the USD.
Dollarisation may serve several purposes, one of which is signalling to investors that the adopting country is committed to maintaining a more stable economic environment.
Such a signal would be expected to instil investor confidence in the dollarising country and help kick-start the country’s recovery.
A major disadvantage of dollarisation is that the country gives up its currency and ability to stimulate or stabilise its economy using monetary policy (the setting of money supply by central bank policymakers to alter output and price level).
Consequently, this loss of monetary policy control puts additional pressure on the dollarising country’s fiscal policy (the setting of the level of Government purchases and taxation to alter output and price level) to be more robust.
In this article, I make two distinct but closely related arguments.
My first argument is that the multi-currency regime was a big mistake. The country should adopt a single currency.
Second, I argue that the currency of choice should be the rand, instead of the USD.
I also explain why the recent depreciation of the rand against the USD, combined with Zimbabwe’s prevalent use of the USD, is leading Zimbabwe’s economy deep into a deflation, worsening the plight of the average Zimbabwean instead of benefiting them.
My arguments are based on analysing the linkage between choice of currency and some important properties of the Zimbabwean economy.
These important properties include a huge informal sector and a large inflow of remittances.
I emphasize the point that a combination of dollarisation and a large informal sector means that standard monetary and fiscal policy tools for stimulating the Zimbabwean economy are extremely constrained.
The Government of Zimbabwe has no control over monetary policy as it does not have its own currency.
Stimulating the economy through fiscal policy is also constrained by an already shrinking small tax revenue base (tax paying sector) and a growing informal sector (non-tax paying).
With monetary and fiscal policy virtually out of the control of the Government, careful choice of a nominal anchor currency becomes critical.
I will conclude the article by proposing some economic policies, in addition to exclusive use of rand, that the Government can consider implementing to get the economy back on its feet.
A good starting point would be to emphasise more analysis-based macroeconomic policies that are rooted on a “describe-before-prescribe” approach.
The Government policy makers should always seek a deeper understanding of how the policy would work under ideal conditions and analyse the unique constraints that the Zimbabwean economy faces that may prevent the proposed policy from achieving ideal results. They should incorporate this knowledge to mitigate the effects of these constraints.
For instance, for every policy implemented, the policy makers should be asking: (i) how will investors and other economic participants perceive a particular policy and how can the Government quantify the market perception of the policy?
(ii) Does the policy inadvertently lead to moral hazard problems that may lead to inefficiencies? For example, do economic agents bear the full cost of their actions? If they can shift the bad consequences to others, they have less incentive to be more careful or take appropriate risks.
As an example of analysis-based policy making applied to the multi-currency regime, what did the policy makers conceptualise as the mechanics of the multi-currency regime?
Was each product’s price supposed to be listed in each of the nine currencies?
What were the criteria used for determining whether a particular currency qualified to be in the official multi-currency basket?
Why nine currencies, and not eight or ten? What was the end game for this policy?
What parameters will be used to measure effectiveness of the policy?
Why ban multi-currency regime
A big problem of using multiple currencies is the complexity and confusion that it brings.
The complexity is especially big in a cash economy like Zimbabwe where people often have to carry physical cash to buy goods and services.
As a concrete example of such complexity and confusion, in early 2015, commuter (“kombi”) fare was 1 USD for two or 5 rand per head from most Harare neighbourhoods to the city centre.
This fare implied a “Kombi Exchange Rate” of 1 USD to 10 rand. At that time, banks bought the USD at a rate of 1 USD to about 8 rand while selling at 1 USD to about 12 rand.
The street or black market exchange rate was 1 USD to 12 rand. Based on the above example, the seemingly simple question regarding the rand/USD exchange rate no longer has a simple answer.
The production of actual goods and services is given up as economic agents attempt to chase the arbitrage opportunities caused by this exchange rate confusion.
This loss in economic efficiency or dead-weight loss increases as the number of adopted currencies increase.
Consumers also have to familiarize themselves with the currencies that are in the official multi-currency basket, which takes time and effort and the risk of fraud and counterfeit currencies increase as the number of currencies in official use increases.
The most vulnerable people within society — elderly, rural folks, uneducated and disabled — are more likely to suffer from fraud and counterfeit as it may take this group more time to understand the currencies and their values.
The multi-currency regime thus imposes a burden on the Government to continually educate these vulnerable groups of people on the changing features of the various currencies in the basket.
Rand should be Zim’s only currency
To determine which single currency to use as nominal anchor, I use criteria borrowed from the theory of optimal currency areas.
The term “optimal currency area” refers to a geographical region for which economic efficiency can be maximized by using a single currency.
Having a nine currency parallel exchange rate regime is not optimal because there is no way all the nine currencies will simultaneously satisfy the criteria listed below as set by the theory.
The main considerations for which currency the Government should use as a nominal anchor are:
a) Trade with anchor country: The best choice for a nominal anchor would be the currency of a country that Zimbabwe trades with the most. This would help reduce transaction costs resulting from converting one currency to another.
According to the IMF, South Africa was Zimbabwe’s largest trading partner in 2008, around the time Zimbabwe was deciding which currency to adopt, accounting for 44 percent of Zimbabwean imports and 24 percent of exports. The rest of Africa accounted for 21 percent of imports and 17 percent of exports and the US and European Union had a combined 12 percent of imports and 24 percent of exports.
Today, South Africa remains Zimbabwean’s biggest trading partner accounting for around 44 percent of imports and 40 percent of exports.
b) Anchor country and Zimbabwe should have synchronized business cycles: If Zimbabwe and its anchor country have out-of-sync business cycles, optimal monetary policy in the anchor country may diverge, with Zimbabwe being made worse off when out-of-sync anchor country implements its monetary policy.
Empirical evidence from IMF shows that business cycles in Zimbabwe are more in sync with South African business cycles than with the United States business cycles.
c) Labour mobility between Zimbabwe and Anchor Country: If there is a recession in one part of a currency area, workers in the recession-hit part should be able to easily move to the booming part and find employment there.
This labour mobility mitigates the fact that once a country joins a currency union, it cannot use monetary policy to stimulate its economy. Labour mobility includes the physical ability to travel, for example, cost of transportation and visas. For the average Zimbabwean, it is much easier to obtain a work visa in South Africa than in the USA.
d) The Burden of Change: The optimal choice for an anchor currency is one where the supply of the whole range of bank notes and coins is not prohibitively expensive.
The notes and coins can be obtained through natural trade, remittances from Zimbabwe’s Diaspora community or direct purchase by the adopting Government. In a dollarised economy where the majority of transactions are done on a cash basis, the adequate supply of the foreign notes and coins is critical in maintaining low transaction costs and promoting local trade.
Zimbabwe’s population is still predominantly rural based with the last census showing that around two thirds of the population are in the rural areas. The majority of this population lives on less than a dollar a day. This means that US$0,10 (approx. R1,5) is still worth a lot to this population.
The physical distance of the USA from Zimbabwe makes the technicalities of supplying US coins prohibitively expensive, leaving Zimbabwe with a dangerously depleted supply of low-value denominated USD coins.
Such a situation has helped to devalue the USD in the country as business is forced to price most low value goods starting at US$0,50 or goods are priced in bulk (that is, two loaves of bread for a dollar) simply because of the burden of getting the change necessary to make such transactions feasible.
In instances where change of low value is required, businesses offer consumers small-value-goods such as sweets, matches, chewing gum; things that two thirds of the country do not have the luxury to buy on a daily basis.
This sort of “barter change” or the inconvenience of pricing of low value goods starting at US$0,50 essentially becomes the cost of transacting in USD because the consumer either overpays for the goods or ends up spending on goods that they do not need in order to facilitate the purchase of needed goods.
This cost clearly makes the USD the least optimal currency to use in Zimbabwe.
Using the rand would thus remove the “burden of change” due to (i) the proximity of South Africa, (ii) the relative ease with which Zimbabweans move to and from South Africa and (iii) the strong political ties between Zimbabwe and South Africa coupled with the large volume of trade, all of which, will facilitate a continuous supply of bank notes and coins at a relatively cheaper cost.
e) The case for stability and transparency
The choice of country for anchor currency should be one that has a stable and transparent economic and political environment, which eliminates elements of surprises for the adopting country. Given the size of the US economy and the age of its democracy, it is a clear favourite under this scenario.
However, South Africa also offers a relatively stable economic and political future in the 10-15 year time-frame.
The economy is by far the most sophisticated and advanced in Africa, supported by independent and functional institutions such as the South African Reserve Bank and the South African Supreme Court and Constitutional Court.
The ruling ANC enjoys a steady but declining majority (62,1 percent in 2014 vs. 69,7 percent in 2009) and has been in power since the end of apartheid in 1994 and successfully transferred power within its ranks three times over the same time frame, offering a relatively stable political environment.
Also to note is that the depreciation of the rand over the past 12 months was not entirely an idiosyncratic event as both Brazil and Russian (both members of BRICS with free market system) currencies lost value by 40 percent and 55 percent respectively over the same period of time.
Much of the rand’s drop has to do with overall health of the world economy and US monetary policy on rates than the performance of the South African economy.
Based on the above considerations, I conclude that the rand is the best currency for Zimbabwe to exclusively adopt as a nominal anchor.
Dr. Ranganai Gwati attained a B.A. in Mathematics & Economics from Reed College (Portland, OR), where he was awarded the Meier award for “distinction in the Reed undergraduate economics curriculum.” He went on to obtain a Master’s and PhD. degrees in Economics at the University of Washington (Seattle), specialising in International Finance. At UW, he also obtained a Graduate Certificate in Computational Finance. Dr. Gwati is currently an Assistant Professor of Economics at Benedict College (Columbia, South Carolina) and can be reached at [email protected] . Dr. Gwati acknowledges contributions from F.S. Nyangore (Rusape).
