The recent BBC HARDtalk session between opposition MDC Alliance leader Nelson Chamisa and host Steven Sackur opened a lot of debate. The issue has been debated in the newspapers and radio shows on how Zimbabwe can solve the cash crisis, the causes and solutions.
By David Mhlanga
The interesting proposition by the opposition leader motivated this article just to define liquidity crisis (cash crisis) and to give the economic perspective on the cash crisis crippling Zimbabwe.
Definition of liquidity crisis
Liquidity crisis is defined as a sudden and prolonged evaporation of both market and funding liquidity, with potentially serious consequences for the stability of the financial system and the real economy.
Another definition: Liquidity crisis means that the two main sources of liquidity in the economy, banks and the commercial paper market, severely reduce the number of loans they make or stop making loans altogether.
Because so many companies rely on these loans to meet their short-term obligations, this lack of lending has a ripple effect throughout the economy, causing liquidity crises at a plethora of individual companies, which in turn affects individuals.
Is defined as the ability to trade an asset or financial instrument at short notice with little impact on its price.
Is defined as the ability to raise cash (or cash equivalents) either via the sale of an asset or by borrowing.
A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with bank panics, stock market crashes, bursting of other financial bubbles, currency crises, sovereign defaults and many others. Financial crisis directly results a loss of paper wealth.
A banking crisis is a financial crisis that affects banking activity. Banking crises include bank runs, which affect single banks; banking panics, which affect many banks; and systemic banking crises, in which a country experiences a large number of defaults and financial institutions and corporations face great difficulties repaying contracts.
A banking crisis is marked by bank runs that lead to the demise of financial institutions, or by the demise of a financial institution that starts a string of similar demises
List of bank crises in the world
Crisis of 1973 started in Amsterdam, begun by the collapse of Leendert Pieter de Neufville’s bank, spread to Germany and Scandinavia; panic of 1796-1797, Britain and United States; panic of 1847 in the United Kingdom; panic of 1857, a US recession with bank failures, 2002 Uruguay banking crisis, 2003 Myanmar banking crisis, 2008 United Kingdom bank rescue package, 2008-2012 Icelandic financial crisis.
The issue at stake is the situation obtaining in Zimbabwe.
The cash crisis some can call it liquidity crisis: Is it because of bank panics, stock market crashes, bursting of other financial bubbles, currency crises, sovereign defaults or otherwise. One can say, the cash crisis in Zimbabwe is the crisis of discipline and confidence. What is the meaning of this statement? One can ask.
The answer to this question follows: The government uses money on a daily basis to pay workers, financing elections, financing foreign travels, construction of roads, dams to mention a few. This is called government expenditure from the principles of economics.
This expenditure is divided into two classes. The first class is the capital expenditure and the second is the recurrent expenditure class. This expenditure is either financed by money from taxes (tax revenue), donations, borrowing and printing notes and minting of coins.
The most favourable and recommended source of money to finance government expenditure is tax revenue (eating what we kill as former Finance minister Tendai Biti put it across during the government of national unity).
The authorities must be disciplined on how they finance government expenditure because failure to do so will result in multiple problems. In the case of Zimbabwe, from 2009 up to 2013- 2014, government expenditure was financed through tax revenue, donations and minimal borrowing if it was there because the country during that time could not borrow because of poorly serviced debts with financial institutions like the International Monetary Fund and the World Bank.
This the reason why the economy was performing well and at one time the economy was the fastest growing economies in the world. This was attributed to discipline.
Banks in this period started to accumulate nostro balances (nostro account refers to an account that a bank holds in a foreign currency in another bank).
Nostros, a term derived from the Latin word for “ours”, are frequently used to facilitate foreign exchange and trade transactions. The accumulation of nostro balances by the local banks facilitated the procurement of raw materials needed for production from foreign nations.
This made production bottlenecks to be minimised. Goods started to increase in the market which automatically boosted confidence in the economy and among the financial institutions.
Firms and individuals started to build confidence with financial institutions because people could withdraw money when they need it, any shortages of foreign currency was solved as banks could just withdraw foreign currency from their nostro accounts when shortages arise.
This process made it possible for businesses to expand production and business was flowing up to a point when the Reserve Bank of Zimbabwe started to put strict controls on the movement of foreign currency.
During the same period, the government started to spend more that what is collected from tax revenue because printing was not possible as multicurrency regime was in operational. Usually, when the government spends more that what it would have collected, the action is called budget indiscipline.
To cater for the deficit the government had to issue what are called treasury bills. A Treasury Bill is a short-term debt obligation backed by the treasury debt of the Zimbabwean government with a maturity of less than a year?
The government had to borrow from the private sector because it can’t borrow from international financial institutions for Zimbabwe, I highlighted the reason before.
When this happens usually, there will be competition for money in the economy between government and the individual firms, giving rise to the crowding out effect. The government will borrow money which was supposed to finance production of goods. Shortages, and unemployment will start to be registered.
To get foreign currency to finance foreign trips and other demands, the government through the central bank sometimes will raid nostro accounts.
When nostro accounts are raided this will starve banks for foreign currency. When the situation arises, for banks to pay depositors, sometimes they will have limited amount to meet the demand deposits.
Hence, in Zimbabwe, this resulted in cash crisis as banks had limited forex to meet the demand deposits. The condition persisted in the country to an extent that, the government started to look for other ways of raising money.
The government started to print bond notes because nothing was left to borrow from the market. Banks, because of shortages of foreign currency, started to put withdrawal limits.
When individuals and firms discovered that, to get their deposits was now difficult, many had to withdraw money from their accounts, a sign of lost confidence with the banks because of fiscal indiscipline.
Currently, money is now circulating in the informal sector. The problem in Zimbabwe is hinged around confidence and discipline among other factors.
David Mhlanga is a doctoral fellow in economics at the North West University in South Africa. He can be contacted on firstname.lastname@example.org