Source: Re-introducing local currency, not so fast – The Zimbabwe Independent January 25, 2019
THE government recently pledged to re-introduce a local currency to replace the current multi-currency regime within 12 months in its efforts to address a mounting economic crisis.
Financial Matters: Tinashe Kaduwo
Making the announcement, Finance minister Mthuli Ncube suggested that a domestic currency would be introduced within 12 months in a bid to address structural issues. The economy, however, still faces serious challenges and, as such, may fail to support a local currency. The fact that a de facto local currency (bond note) has failed indicates the underlying weak fundamentals to support a local currency. The government and the Reserve Bank of Zimbabwe (RBZ) have previously conceded that the re-introduction of a local currency will not be possible until two key conditions are met: a reduction of the budget deficit and the build-up of foreign reserves to at least three months’ import cover. The government, indeed, has implemented credible measures to tame the budget deficit; however, rising inflation and the associated wage increase demands from the civil service may reduce the pace of adjustment.
Statistics show that consumer price inflation accelerated to 42% year-on-year in December 2018 from 31% the previous month. There is, however, persistent speculation that the official figures understate the true levels of price increases with some estimating annual inflation at more than 200%. The main determining factor in accelerating inflation remains the country’s complex and unsustainable currency regime.
Shortages of United States dollars have led to a sharp fall in the value of bond notes and electronic dollars, the de facto local currency which the government values at par with the US dollar. This may act as a signal to what may happen if the authorities prematurely introduce a local currency. There is clear upside potential for inflation. The already continued over-valuation of the local currency points to a substantial degree of repressed inflation which weakens the appeal of the local currency even before its reintroduction. Another important factor is that reserves are currently totalling around two weeks of cover. The country needs to build up sufficient reserves that may act as a buffer and support a local currency. However, persistent current account deficit and limited investment inflows are hindering the build-up of reserves. Foreign investment and concessional lending, which are both linked to political and policy confidence, are unlikely to rise substantially in the short term to support the build-up of reserves.
Positively, the government is pledging reforms, including increased property rights and a wide-ranging privatisation programme which are critical to attracting investment, but in the absence of progress on such measures investors will also remain wary. Mounting debt from various facilities to ease liquidity is also a source of worry. RBZ has agreed a series of financing deals with the Africa Export and Import Bank (Afreximbank)—cumulative disbursements now exceed US$5 billion, with the most recent deal involving a loan facility to guarantee the 1:1 convertibility value of electronic balances into US dollars. Given the persistent and stubborn trade deficit, pressures continue to build which, on a positive note, will force the government to implement the required reforms aimed at unlocking inflows of investment and international assistance. However, these reforms and the re-engagement process with multilateral organisations such as the IMF and the establishment of a track record of reform is unlikely to be a rapid or smooth process, implying that the 12-month period may be optimistic.
The recent hike in duty of fuel, which resulted in more than 160% rise in the fuel pump price, is meant both to tame the current account deficit and also increase government revenue. It constitutes an attempt to reduce demand, tempering imports and reducing pressure on the country’s limited foreign reserves. Indeed, it may reduce some round-tripping by foreign motorists, as parallel-market exchange rates had created arbitrage opportunities, but is insufficient to address the continued deterioration of the external account position. Fundamentals are still weak to support a local currency and, as such, strong support and backing from foreign lenders and donors is required.
Kaduwo is a researcher and economist. — kaduwot@gmail.