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Douse inflation promptly lest it will raze economy to the ground

Opinion & Analysis
Inflation induces price instability.

INFLATION, at unwieldy high levels, promptly degenerates, through a somewhat viral mutation, into a terrible and brutal economic and psycho-social monster which petrifies lots of Treasury chiefs across the globe.

Often, many a Treasury chief the world over takes to behaving like a cat on hot bricks whenever inflation starts to show signs of its unwelcome visit. Untamed, inflation can callously decimate consumers’ buying power, savings and pensions.

Inflation induces price instability. Planning is rendered knotty in an environment with high levels of inflation. In simple terms, purchasing power is depleted ever so readily wherever inflation rears its ugly head. No wonder inflation induces ineluctable panic in economic agents.

Once economic agents are in panic mode, planning becomes quite a mammoth task even for seasoned and astute strategists.

Often, consequently, observers are treated to world-class knee-jerk reactions from economic agents whenever inflation decides to make its bed, thereby threatening to indulge itself in a protracted, albeit unwelcome, slumber on price pillars of an economy.

Reactions by economic agents to inflation appear to be steeped in rational fear. Generally, human beings appear to act rationally.

Humans have an innate knack and inherent mechanism that triggers prompt reactions to significant negative stimuli whether such undesirable provocations are internally or externally felt.

Upon being confronted with anything that threatens their existential comforts, humans tend to react whether proportionately or disproportionately to the magnitude of the threat. Inflation is one such threat that elicits such reactions.

The manner of reaction from Treasury chiefs and the rest of economic agents to inflation’s first raps on the economic door is the proverbial key that either unlocks higher levels of inflation or clears the path to curtailing it.

Inflation can be likened to wildfire. If a person catches fire, to douse it, one would need something that is able to deprive the fire of oxygen, for example pure water.

If one were to pour paraffin or most of the derivative products of petroleum simply because they normally exist in clear liquid form as does pure water, the burning person would be lucky to survive to tell their tale of misfortune to others later.

Such is the nature of inflation. If badly handled, it can figuratively burn economies to ashes; if inappropriate or ineffective strategies or methods or approaches are employed to extinguish it, an economy would be difficult to revive after being burnt by inflation.

Zimbabwe adopted a basket of multi-currencies as legal tender in 2009, that was after the country’s own currency had been protractedly knocked off balance and decimated by hyperinflation.

Had it been a boxing contest between inflation and the Zimbabwean currency, the latter could aptly have been described as having been handed a technical knockout punch by inflation.

Policymakers, prior to dollarisation, were incessantly working, ingenuously infused with copious doses of good intentions, to ensure economic agents continued to avail themselves of physical currency units for transactional purposes through a raft of measures including, but not limited to, printing of higher denomination currency units that were meant to track the ever-rising price levels.

Gradually, economic agents started refusing to accept local currency for settlement of debt, preferring what they perceived to be stable foreign currencies. Wholesale dollarisation had thus commenced on the main streets and byways of the country.

When the Zimbabwean government finally made an official pronouncement that the country had officially dollarised, the upward price spiral was finally en route to being stemmed.

For a short while though, some business players, impelled by nostalgic yearnings for unjustifiable and unsustainable windfall gains which had been precipitated hitherto courtesy of unsavoury yesteryear business practices, attempted to perpetuate the high frequency price hiking approach.

Business players that did that soon learnt, the hard way, how noxious to their own businesses such practices had suddenly turned out to be.

In the pre-dollarisation epoch, access to foreign currency had largely been a preserve of a relatively few individuals and corporates whereas post-dollarisation, foreign currency became apparently ubiquitous as the sole legal tender.

With foreign currency in consuming publics’ wallets then, economic agents suddenly realised that they had been given the much-needed wherewithal, hence the prerogative to exercise choice in powering cross-frontier transactions of both consumptive and non-consumptive forms whenever they felt like doing so.

Consumers could then readily shun buying exorbitantly priced products from those who would have imported said products. Consumers had suddenly been empowered to either buy directly from the foreign sources or from those who would have imported the goods they needed.

Many local economic agents were able to import a broad array of products into the country. Sanity in pricing of goods and services had finally been restored.

Consequently, businesses reverted to orthodox commercial practices such as putting reasonable mark-ups on goods sold in a way that made economic sense as opposed to the arbitrary pricing regime that had become the norm hitherto.

The United States dollar (USD) emerged as the anchor currency in the basket of currencies that was adopted. With the strengthening of the USD against regional currencies, the bulk of imported commodities’ retail prices plummeted, in USD terms, as most consumer goods (which were previously in short supply in Zimbabwe) were being imported from South Africa, Botswana and Zambia.

Economic agents in Zimbabwe could then afford to sit back and somewhat plan their expenditures as well as start accumulating savings in the knowledge that it had become misplaced to continue to worry about vagaries of inflation wreaking havoc with their savings as had been the case during the dying days of the first life of the Zimdollar.

During the dollarised era, industry could afford to embark on re-tooling initiatives via  lines of credit that were being availed by lenders in hard currencies.

Arguably, the biggest challenge that industry faced then was how to competitively price their output when their costs were denominated in hard currencies in an environment that had long become accustomed to and hence romanticized high prices. Salaries were then pegged in USD. Production enablers were also charged in USD.

Foreign competitor products were acquired at competitive prices after exchanging the then locally available strong US dollars for lower value regional currencies. Government policies that were in place had not migrated with alacrity as had the death of the first-born Zimdollar.

Thus, optimal re-tooling and re-industrialisation did not quite proceed as promptly as would have been desirable from a policymaking perspective. Some businesses, instead of embarking on import substitution industrialisation (ISI), resorted to short-term approaches to make quick profits.

They ramped up importation and re-selling of finished products for a profit during the dollarised period. Industry players could afford to make profits that way and a significant number of them were quite impressed by the windfall or bonanza that dollarisation had brought about. Government got its taxes, hence could be said to have been happy.

Consumers got hitherto scarce products at prices that were reasonable and hence those consumers could be said to have been happy too. Since industry was being gradually re-capacitated, a lot of people got to be formally employed for the first time in their lives while earning living wages. Those employed could very well be said to have been happy. In a nutshell, dollarisation was a boon. It had managed to make most previously melancholic people happy.

Let us now fast forward events to the day of the re-birth of the Zimdollar.

Let me reserve for another day a discussion of the arguments for and against reintroduction of the Zimdollar and delve brutally and straight into the effects of the reintroduction of the local currency. The local currency was revived through what were termed bond notes. Said bond notes were pronounced to be at par in value with the USD.

Not many people, myself included, really managed to grasp the economic basis, hence sense (which some chose to refer to as common sense) behind the parity in value of said bond note with the USD. The bond notes were said to be underwritten by an offshore bank facility. That is to say the bond notes were backed or supported by United States dollars, making up a novel form of currency board.

Some people questioned the logic behind unleashing the notes into the economy as opposed to simply releasing the actual United States dollars, which could be acquired through the same said facility.

Arguments like the need to keep the actual US dollars circulating within the country’s borders were proffered as reasons for having the greenback acquired through the facility staying in a vault somewhere with the bond notes serving as their proxy.

Since the bond notes were designated money for domestic debt settlement only and could not go beyond the country’s borders, the thinking was that the introduction of bond notes would stem the haemorrhaging of United States dollars from the country which was rampant through payments for imports.

The pronouncement that was made when the bond notes were introduced indicated that the two would be treated as equal in value. That is to say, they were to be exchanged at a ratio of US$:ZWL$1.

The notes were said to have come through principally to serve as small denomination units for purposes of providing unavailable change for higher denomination US dollars.

Economic agents embraced the notes for a while and that, to a great extent, maintained the decreed parity in exchange of the dollar and the bond note.

Before long, however, some economic agents started questioning the economic logic, hence validity of the pronouncement that the USD and the bond note were equivalent in value.

Thereafter, bond notes began to be disproportionately rated lower than United States dollars on the parallel market. United States dollars started retreating into hiding, as opined by Gresham’s law which says bad money drives out good money.

Once market participants realised that there were arbitrage opportunities that could be exploited in the foreign currency market, ever dwindling numbers of economic agents were willing to part with their United States dollars at the parity exchange rate proclaimed by the central bank.

With an ever-dwindling supply of US dollars, market forces kicked in and started swinging the exchange rate up in favour of the USD.

The high exchange rate meant that producers that required foreign currency had to part with ever-increasing amounts of bond notes for each unit of hard currency they required. In turn, that led to constant upward reviews of prices and reduced domestic output.

Another textbook case of an accumulation of building blocks of inflation had started to unfold right under our noses. The country had transitioned from payment system stability back to that unenviable scenario of having too much money chasing after too few goods.

With that established as the prevailing scenario then, that monster called inflation that had been tamed had managed to break loose with fury and vengeance from the lariat that had managed to hold it in check.

Courtesy of inflation, bond notes in circulation prior to the introduction of the novel 10 and 20 dollar local currency units had become too few and too small in value to power domestic transactions.

In USD terms, the higher of the two local currency denominations was at one time equivalent to just US$0,80 (80 cents) using the then pronounced central bank exchange rate, with the value being minuscule when quoted using parallel market rates that were prevailing then.

From an economist’s perspective, holding all else constant, that was too small a value for the highest currency denomination in a country that still had massive pockets of economic agents who still believed (whether justifiably or not) in using hard cash as the sole means of settling debts and effecting payments for goods and services.

In an inflationary environment, such as obtaining in Zimbabwe, introduction of higher denomination currency units also has a signalling effect.

It signals that the existing currency denominations would have been rendered too small to power transactions. It also signifies the belief that would be widely held by market players that inflation could be on the cards for a longer period may not be misplaced after all.

Inflation-triggered economic and social pressures have a weird tendency of causing people to dismally fail to put issues into proper perspective. Had the economy not been reeling under the weight of this inflation monster, the new currency units could have heralded a much welcome development.

Inflation makes the majority of people nervous. It fills people with unprecedented levels of melancholy and trepidation. Economic agents that lived through the dying days of the Zimdollar live in chronic fear of a repeat of what transpired during that period.

These agents fear a repeat of the past, that is, as had become the custom then most business players once new currency denominations were introduced, the latter immediately hiked all base prices to perch them at the nominal value of the newly-introduced highest denomination currency with knock-on effects on the rest of commodity prices, hence an increase in the general price level. Economic agents fear a repeat of that.

One of the potent arguments posited for the introduction of new currency denomination notes was that doing so was meant to go a long way towards solving liquidity constraints that were being experienced on the market.

That could only have been an effective solution had prices not continued their meteoric ascendance into the stratosphere coupled with remembering to institute robust safeguards to curtail the siphoning off of the new notes to parallel market players’ vaults. If prices continued to rise (as was the case then), more currency units than those that had been availed were required.

If the new currency denominations were to be promptly spirited off the official market only to find their way into safes of parallel market traders, then the new currency units would certainly suffer the same fate (that is, diminution and/or extinction) that their immediate forerunners had suffered. This is a potent lesson for monetary authorities today too. We should never forget that something can, indeed, be learnt from history, after all.

In an environment such as the one Zimbabwe finds herself in, inflation could be tamed in the medium to long term through, inter alia, by ensuring that the country curtails money supply growth; policymakers ensuring local industry starts vigorously producing (domestically) for export purposes; fiscal expenditure curtailing and discipline; and embarking on ISI.

The country could do the immediate foregoing through formulation of production enabling policies such as walking the talk, that is, showing political will to improve the ease of doing business in the country through removal of unnecessary hurdles in some of the largely aesthetic regulatory dictates; supporting genuinely promising small-scale and medium-scale enterprises and periodically assessing how the supported enterprises would be faring; embarking on practices and initiatives that significantly reduce the scale of the real budget deficit.

If the policy intention is to deal a lethal blow on inflation in the short run, policymakers could officially re-dollarise.

There is no shame in re-dollarising as most countries that de-dollarise always re-dollarise if de-dollarisation had been done prior to putting all necessary economic fundamentals in place for de-dollarisation.

Once the economy has re-dollarised, concerted efforts should be made in re-capacitating industry in the second phase of dollarisation.

In the same vein, policymakers should ensure that property rights are treated in a sacrosanct manner. Doing so would inspire confidence in investors (both domestic and foreign) to treat the country as a favourable destination for their hard-earned wealth.

Leveraging on agricultural potential through establishing model farms that could be run on a commercial basis dedicated to producing largely for food security and export purposes could also earn the country huge amounts of foreign currency while reducing the country’s import bill.

Having done the foregoing, the country could reap huge dividends if the responsible authorities really get committed to fighting corruption in word and in deed with corruption cases being tracked from date of reporting to date of finalisation with such progress reports being made public on a monthly basis using report reference numbers to enable those who would have reported cases to assess progress being made or made on cases they would have reported about as well as ensuring that no case dockets get “lost” or investigations go on forever without being finalised as well as ensuring that whistleblowers do not get victimised through such devices as wrongful dismissal from employment, being subjected to malicious and frivolous lawsuits as well as thuggish attacks perpetrated on their persons and property.

Corruption has the deleterious effect of making goods and services cost higher than they ought to hence among other ills, it too could very well be regarded as a driver of inflation, inter alia.

The beauty of it all is that corruption is the easiest to tackle as it requires no more resources being expended towards tackling it than those that are already in place. Authorities must douse the inflationary fire before it burns the economy to the ground.

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