THROUGHOUT history, nations have turned to dollarisation as a crucial part of their economic reforms, a path Zimbabwe has traversed. In early 2009, Zimbabwe officially adopted the United States dollar (USD), a hard currency that continues to be recognised as legal tender despite numerous attempts to implement a mono-currency regime.
This is because dollarisation has the potential to become a permanent feature as it can occur through a de facto market process without an official government decree.
When a local currency is too volatile, like the now dumped Zimbabwe dollar (ZWL), economic agents will be forced to diversify and protect their assets from domestic currency devaluation risks like high inflation.
Two main reasons behind the demand for foreign currency assets are currency substitution and asset substitution.
Currency substitution means that foreign money is essentially used as both a medium of exchange and a unit of account. Since high inflation increases the cost of using domestic currency for transacting purposes, agents will be prompted to look for cheap alternatives.
Asset substitution entails agents’ risk and return considerations between domestic and foreign currency-denominated assets.
Generally, forex-denominated assets provide insurance against macroeconomic risks. Incessant exchange rate instability and chronic inflation led to the abandonment of the ZWL.
The ZWL was replaced by a new structured currency termed Zimbabwe Gold (ZiG), which is reportedly backed by currency (mainly USD) and asset (primarily gold) reserve holdings.
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Following the unveiling of the 2024 Monetary Policy Statement (MPS), a pivotal moment in Zimbabwe's monetary trajectory, fiscal and monetary authorities have embarked on a series of measures to bolster the local unit (ZiG).
The nation’s ambitious Vision 2030, which aims to leave no one and no place behind, hinges on achieving a robustly stable ZiG.
Therefore, the significance of a stable ZiG in navigating Zimbabwe's debt crisis cannot be overstated.
With external public debt reaching alarming levels and the nation grappling to meet its financial commitments, the fragility of the ZiG exacerbates debt servicing costs and the likelihood of default. However, the achievement of ZiG stability could potentially mitigate devaluation risk, leading to a reduction in Zimbabwe’s risk premium on foreign borrowing.
In essence, a stable ZiG could eliminate interest premiums due to currency devaluation risk. It is important to note, though, that this may not necessarily result in a significant reduction in the default risk premium on foreign currency-denominated debt.
Be that as it may, the potential benefits of ZiG stability are a beacon of hope in navigating Zimbabwe's economic challenges.
Apart from raising borrowing costs, a volatile ZiG can also wreak havoc on the domestic economy. In theory, the exchange rate affects inflation; a perpetual depreciation of the ZiG is likely to cause inflation to increase.
Hard data shows that when the Zimbabwe local dollar (ZWL) plunged by 13% on average per month in foreign exchange markets between February 2019 and March 2024, headline inflation averaged a staggering 260%.
Chronic inflation affects business predictability, increases business operational costs, undermines consumer aggregate demand, and traps many households into abject poverty. While it is conceivable that a stable ZiG will not eliminate all risks, ZiG stability will hold the promise of steadier market sentiment. This is because removing currency risk limits the incidence and size of contagion episodes.
Also, durable price stability helps clamp down on poverty and income inequalities. According to the World Bank statistics, the unaffordable prices of essential goods plunged about 40% of the population into abject poverty in 2023.
All else being constant, a stable ZiG will encourage domestic and foreign investors to invest in the long term. It gives them a stable income stream not subject to frequent exchange rate fluctuations, thus powering investment, hiring, incomes, and national output growth.
More so, stabilisation of the ZiG is critical in circumventing the downside effects of exclusive USD use in local transactions. These downside factors include the loss of autonomy, as a foreign country will primarily dictate the country’s monetary policy.
An economic policy is a list of actions a country's central bank seeks to undertake to influence the quantity of money in the economy and how much it will cost economic agents to borrow.
It is implemented through various tools, including, among others, interest rate adjustments, trading of government securities, and altering the statutory reserve requirements.
This policy helps the government manage inflation or unemployment and maintain currency exchange rates and financial market stability. As such, rendering this policy arm ineffective by allowing full dollarisation will constrain the government from delivering a goldilocks economy, which is critical to improving living standards.
In addition, the relegation of monetary policy also means loss of seigniorage revenues. This is a profit a government can earn by issuing currency, especially the difference between the face value of notes and coins and their production costs.
Seigniorage revenue also relates to the interest rate central bank charges from lending commercial banks money.
The seigniorage loss can be caused by “stock” cost; that is, as USD is introduced and ZiG is withdrawn from circulation, the Reserve Bank of Zimbabwe (RBZ) will be forced to purchase the stock of ZiG held by banks and the public, thus effectively returning the seigniorage it accrued over time.
Also, the RBZ would give up all future seigniorage revenues that stem from the flow of new currency printed annually to satisfy money demand.
Furthermore, although full dollarisation can eliminate the banking sector's vulnerability to devaluation risk, it cannot avoid all sources of banking crises. In such crises, full dollarisation impairs the government’s lender-of-last-resort function, thus inhibiting RBZ from responding to financial emergencies.
Typically, a central bank is the ultimate guarantor of the stability of payments and financial systems in case of a systemic bank run. While the RBZ may be able to provide short-term liquidity to individual banks in distress, full dollarization can make it lose the ability to deal with sudden run-on deposits throughout the banking system.
A central bank can only undoubtfully guarantee all claims under any circumstance when it can print currency as needed. So, once this ability ceases to hold, the lender of last resort function becomes too limited.
Also, a country like Zimbabwe with thin foreign currency reserves might lack resources to respond to unforeseen contingencies.
Moreover, full dollarisation hurts small and open developing economies like Zimbabwe in the long term by rendering their domestic industries uncompetitive.
Using a strong currency like the USD increases the domestic cost of production since factors of production are priced in the hard currency (USD) against regional counterparts' pricing in their relatively weak national currencies (rand, pula, kwacha, etc.).
The huge exchange rate differentials also make locally manufactured goods relatively expensive in the eyes of foreigners while making foreign-produced goods relatively cheap in the eyes of locals.
This may lead to increased non-essential imports, leading to unsustainable trade deficits. In addition, full dollarisation in a developing country promotes the dumping of foreign goods and the externalisation of forex. Over time, this leads to acute forex shortages in the official channels.
Now that we have generalised the benefits of a stable local currency, we must evaluate policy measures announced or instituted by authorities in their quest to stabilize the ZiG.
This policy evaluation should mainly focus on these policies' medium to long-term impacts, as durable ZiG stability is the only sustainable way to successfully de-dollarise the economy.
- Sibanda is an economist. He is a research associate with Zimcodd. He is a staunch advocate for inclusive and sustainable development. He writes in his personal capacity.
