As the Zimbabwean economy regresses back to widespread use of multiple currencies that anchored economic stability from 2009 to 2018, it is worthy assessing why de-dollarization is a tall order for most countries that once dollarized.
Harare officially dollarized on the 9th of April in 2009 and adopted a basket of multiple currencies led by the United States Dollar and South African Rand. The local market rejected the Zimbabwean Dollar and started using foreign currencies after record hyperinflation figures eclipsed 250 million (Officially) in July 2008.
However, the local currency was re-introduced in February 2019 under the Real-Time Gross Settlement (RTGS) banner with the exchange rate pegged at 1USD to 2.5ZWD. Statutory Instrument 142 of 2019 soon followed in June to ban the use of multiple currencies and enforce the use of a monocurrency in the economy.
What followed afterwards was a rapid decline of the production as a result of a combination of factors coalesced around high inflation, exchange rate volatility and foreign currency shortages. Economic output declined from 4% realized in 2018 to -6.5% recorded in 2019 according to official figures from treasury. Annual inflation raced from 57% in January to 521% recorded in December 2019.
Real tax revenues plummeted from US$5,237 billion collected in 2018 to US$2,691 billion collected in 2019. Inflation consumed household incomes, pension funds and corporate incomes with the latter partially resorting to retrenchments to stay afloat. The World Bank estimates that extreme poverty cases in Zimbabwe increased from 4.7 million in 2018 to 6.6 million people in 2019. The bank projects that the number of those in extreme poverty will increase to 7.6 million in 2020 as household incomes continue to decline and economic hardships persist in view of COVID-19 risks.
Dollarization rush
Zimbabwe’s dollarization path follows a host of other case studies in the world. Over the last 40 years, particularly between 1980 and 1998, there was a surge in dollarization that swept many developing economies in South America, Asia and Europe.
Many countries resorted to using the US dollar to either revive or stabilize their economies. The significant inflow of dollars from exports, international remittances and growth in tourism made it easy for countries in South America to dollarize their economies between the 1980s and 1990s. These included Mexico, Ecuador, Peru, Brazil, Uruguay, Argentina, Chile and Bolivia.
There were also many European and Asian countries that went down the same route of dollarizing as a vehicle to stabilize their economies after macroeconomic shocks and political instability. Israel, Vietnam, Poland, Cambodia, Lebanon, Georgia, Turkey and Lithuania are some of the few examples of countries that dollarized their economies or accepted the US dollar as legal tender. Most of these countries that dollarized have found it difficult to de-dollarize even to this day with a number of them partially dollarized. To understand the reasons why, it is critical to underline the initial causes of dollarization.
All the countries that dollarized have 3 notable push factors that are common. These are high levels of inflation (a result of either excessive money printing, quantitative easing or monetization of fiscal deficits), macroeconomic instability and low levels of public confidence in monetary institutions. Other reasons from selected countries include exchange market inefficiencies, political instability/civil unrest and sharp fall in commodity prices.
With resemblance to Zimbabwe, empirical evidence from over 30 failed attempts to de-dollarize points that local currencies issued without years of sustained economic stability, fiscal reforms, improved confidence in monetary authorities, inflation targeting measures, foreign reserves and a flexible exchange rate mechanism have all failed. A few countries quickly changed tact after notable failures and registered currency stability afterwards.
The Peruvian Experience
In the mid-1980s, the Peruvian government decided to combat dollarization induced by massive growth in money supply and inflation. The government forced conversion of foreign currency deposits into the local currency (Peruvian Sol). The policy turned out to be counter-productive as it provoked financial disintermediation and capital flight by risk averse investors.
The inflation rate reached quadruple digits in the 1990s and the Peruvian sol lost its essential functions. After this painful experiment, government authorities radically changed their de-dollarization strategy. Their new plan focused on achieving macroeconomic stability by creating a fiscal surplus, significantly lowering public debt and stabilizing inflation through the introduction of an inflation targeting regime.
This was followed by significant currency appreciation from 2003 to 2011. The macroeconomic stabilization policy was complemented by prudential regulations to better account for earned foreign currency, and to develop a market for securities with a long maturity in domestic currency. As a result, Peru managed to reduce transaction dollarization levels to below 50% and is set to achieve its 2020 de-dollarization targets.
Bolivia and Mexico Experiences
In 1982, the central Bank of Bolivia attempted to de-dollarize the economy by converting all US Dollar financial instruments to Bolivianos at an exchange rate below the market rate. To achieve this, the bank instituted interest rate caps to control capital creation, price controls to curb inflation and exchange control regulations to restrict movement of capital as witnessed in neighboring countries.
This backfired spectacularly as inflation skyrocketed. During a twelve month period (August 1984 to August 1985), prices rose by 20 000%. After the new government came into power, a comprehensive economic stabilization program was announced that included reforms in government spending, trade liberalization, privatization of state entities and institution of a managed float exchange rate.
In Mexico, the government forced a conversion of foreign currency deposits into Pesos. The result was a massive externalization of foreign currency and capital flight by investors, diminished remittances and limited financial intermediation. Central bank governance reforms were instituted with the country undergoing inflation targeting and economic stabilization policies that lasted over 10 years. Mexico succeeded in keeping its level of dollarization low at below 5.2% as at December 2007.
In all the three case studies above, it can be pointed out that market driven policies are more effective in achieving sustained de-dollarization than forced measures that include regulations and government ultimatums.
Notable success stories
Countries that have successfully de-dollarized have yielded positive results of fiscal consolidation, free market policies and persistent economic stability that cultivates trust in the financial system. In Chile, Israel, Georgia and Poland, the process began with a successful disinflation program, leading to a more flexible market driven exchange rates and a monetary policy aimed at lower inflation.
The success stories in the four countries show that the first step toward de-dollarization is macroeconomic stabilization. Fiscal consolidation then lessens the need for government borrowing from the central bank and a tighter monetary policy reduces credit growth. Both fiscal and monetary policies restrain aggregate demand and lead to the appreciation of the real exchange rates. It can also be observed that de-dollarization success stories followed a change in governance or policy shift to more pragmatic or market driven approaches that encompassed deregulation and privatization of state entities.
Overall, macroeconomic theory and the analysis of case studies of successful de-dollarization processes suggest that the key contributor to successful de-dollarization is a stable macroeconomic environment. Prudential measures in the banking sector can only be considered as supplementary tools. Above all, the most sustainable way in de-dollarization is to achieve and maintain macroeconomic stability by keeping inflation low and stable, keeping the exchange rate flexible to crowd in private capital, improving the country’s current account balance, reversing fiscal deficits and conducting institutional reforms that attract investment.
The Zimbabwean Dollar was prematurely introduced and the government tried to use excessive regulations to force de-dollarization with limited political will in addressing key factors that led to economic instability. These include low agricultural and industrial productivity, high levels of money printing by the central bank to fund subsidies and quasi fiscal activities, low levels of public trust, high levels of corruption that feeds on public funds, high debt levels and institutional flaws on property rights and respect for rule of law. Without pragmatic efforts to address these economic fundamentals above, de-dollarization is always a tall order.
Victor Bhoroma is an economic analyst. He holds an MBA from the University of Zimbabwe (UZ). Feedback: Email vbhoroma@gmail.com or Twitter @VictorBhoroma1.
