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Thursday, May 30, 2024

ZWL: Cutting zeros and rebooting through monetary reset

Article by Kevin Tutani

Zimbabwe’s official month-on-month inflation figure for May was reported at, 75.4% (CPI), by the Zimbabwe National Statistics Agency (ZimStats). On the other hand, the annual inflationary pressures were 175%. There might be a difference between ZimStats’ and other unofficial figures but what is agreeable across all parties is that the country needs to eliminate a hyperinflationary environment. Hyperinflation can be described as a situation whereby, month-on-month inflation exceeds 50%.

Both Treasury and the central bank have previously intervened with responses aimed at quelling the turbulence. Some of the solutions have brought a level of stability. For instance, the Finance Ministry ordered that payments of taxes by corporates, be rendered mainly in the local currency (ZWL). Tax obligations which were previously paid in foreign currency will now be rendered using a 50% local currency component, instead of 100% forex. This has had the positive impact of creating demand for ZWL, with the result of a firming, of both the official and parallel market exchange rates. The official rate consequently gained 9% against the U.S. dollar, from $6927 to $6327, at the RBZ forex auction, on 27 June. The parallel market rate, which had been reported to have reached ZWL$ 10 000 for each U.S. dollar, also recovered, to the current reported rate, of around $8 400. The recent tax regulation has been reported to have caused an acute scarcity of the local currency on the market. However, some may argue that inflation and depreciation are a bigger risk than liquidity issues. Thus, liquidity is a better option to sacrifice, in the quest to control inflation.

Having gone through the recent improvements, further attention is required to remedy the crisis in a lasting way. It is in this regard, that the RBZ should consider another round of currency reforms and redenomination of the Zimbabwe dollar. The monetary values on supermarket shelves and payrolls are now difficult to interpret owing to the large figures. The massive numbers have a tendency of signalling a crisis and until they are reined in, the battle against inflation may continue to be lost. On a psychological standpoint, economists may argue that the propensity of businesses and consumers to raise prices and hoard, is higher, when prices become extreme.

Redenomination is the process of removing zeros on bank account balances and the face value of bank notes, to create a system where society and businesses can work with figures that are easier to calculate and manage. Thereafter, new bank notes, with lower values, will be issued and the older ones are phased out. The new, redenominated notes, will provide a chance for creating positive sentiment in the domestic economy, thereby, becoming a tool towards retaining depreciation and inflation. In other regions, the process has been historically characterised by renaming the national currency, so that the psychological impact on society is maximized. For example in China, in 1949, the Silver Yuan was introduced to replace the Gold Yuan, which had undergone excessive depreciation. One Silver Yuan was worth fifty million Gold Yuan notes.

In Zimbabwe, by removing three zeros, the ZWL$6 327 exchange rate, changes, to become ZWL$6.33 (after rounding to 2 decimal places). The removal of zeros from all bank balances and accounting transactions will ensure that there is no change in the purchasing power of the redenominated currency. The process may also be done in such a way that a new currency, for instance, the “Zambezi dollar”, is introduced and all domestic bank balances are transferred to the new sovereign money, at a rate of 1: 1000. The net effect will be the same as removing the three zeros.

Now that the technical side of redenomination has been explained, it is paramount to look at the type of environment required before, during and after the process. If certain economic principles are observed, then the country will not find itself coming back to another round of redenomination, in the future. Doing things right, once-and-for-all will be key, as failure would be a wasted opportunity that may come with adverse costs for the nation.

In this regard, the country needs a stable and clear, single exchange rate and thorough control on money supply growth. These conditions must be met, well-before the launch of the exercise. When there is stability prior to the program, the public will embrace and support the exercise. Issues around designing and launching of the new currency will also be discussed, later.

The choice of the exchange rate regime should be firmly decided on and known, by the public and on the international foreign exchange markets. The rate should be the same, for both formal and informal economic participants. A clear decision on whether the country will choose a fixed, floated, or managed-float rate, is vital before working on the reset. Proper communication of the choice, assists towards creating stability. On the other hand, when full information is not available, market participants will speculate with the new currency, until it undergoes the same obliteration of the current monetary system. A lack of clear and truthful information on the exchange rate regime will leave space for arbitrage. Therefore, timely communication and integrity, are invaluable economic tools for stabilization, which do not cost much, besides honesty and professionalism (competence).

With a fixed or pegged exchange rate, a predetermined value is set for the domestic currency. Thereafter, the central bank will use its resources to ensure that the pegged value does not deviate from the predetermined figure. For example, the RBZ sets the redenominated ZWL, at an exchange value of US$1: ZWL$6.33. When there is a high demand for forex in the market, the central bank will use its U.S. dollar reserves to increase supply in the same market, with the aim of maintaining the rate at the predetermined level (US$1: ZWL$6.33). This process is underpinned by the basic economic principle that, an increase in the supply of any commodity, including forex, results in lower prices. Conversely, when there is a high supply of U.S. dollars in the domestic market, the RBZ may increase demand for the same, by purchasing the greenback, using local ZWL balances, to maintain the 1:6.33 peg. However, it is eminent to state that, for a Reserve Bank to sustainably manage a fixed exchange rate, there need to be considerable amounts of forex reserves, which, the RBZ does not have at the moment. This means that a pegged rate, although possible, may be unlikely, for Zimbabwe.

On the other extreme, the central bank may choose a freely-floating exchange rate. In this case, market participants determine the value of the domestic currency through daily forces of demand and supply. To avoid a sharply fluctuating exchange rate, the apex bank will use monetary policy to bring relative stability. Increasing reserve requirements of ZWL balances and changing the level of interest rates, become the prime tools for influencing the exchange rate. In Zimbabwe, there is a stronger connection between money supply and the exchange rate, since average households use their excess local currency to purchase foreign exchange. A floating exchange rate is a more feasible option, with regards to RBZ’s available resources.

The central bank may also choose a managed float. In this case, the domestic currency is given leeway to move within a specified range, for example, between US$1: ZWL$6.33, to US$1: ZWL$9.5. When the rate begins to go towards the upper or lower end of the range, the central bank will intervene, using either forex reserves (U.S. dollar reserves) or the monetary policy, whichever is accessible to them.

A stable monetary policy is a prime requirement needed before launching the new currency. When there is monetary stability six months before redenomination, the public will not receive the new bank notes with an attitude of distrust. It is imperative for money supply growth to be restrained as much as possible. Containing money supply is rather, a “low-hanging fruit”, as it is a truism in economics, that, the growth of the money supply, invariably leads to inflation. Senior bureaucrats at the RBZ have to explain this to the political leadership, as frankly and clearly as possible. Government expenditure which cannot be supported by taxes and cash revenue has to be noted and qualified strictly. Treasury may be unable to operate on an outright cash basis, but there needs to be a reduction of spending, in a way that will not cause a recession.

The design and launching strategy for the new currency, are equally important aspects to carefully consider. Since design and printing may require 6 to 12 months, the central bank may release coupons in the interim period. Coupons will avert an acute shortage of notes, resulting from current inflationary levels. At some point, the current bank notes may fail to serve their intended purpose due to inflation. On the other hand, reprinting more notes of the same type may be expensive. Ultimately, it will be important to ensure that the coupons are secure, durable and difficult to counterfeit. After a brief period, the coupons can be phased out and replaced with new redenominated bank notes.

Good design of the new bills will assist in creating a favourable public perception. Thus, public input is vital, before arriving at the ultimate look of the new notes. For instance, the public may prefer the image of Archbishop Ezekiel H. Guti, over other landscapes or persons. Knowing public preferences and having their buy-in, goes a long way towards creating an atmosphere where the currency is embraced. The face value of the different bank notes and the total quantity of bills in circulation will also need to be determined. Thereafter, publicity and educational campaigns may be rolled out, to educate and inform the public.

A currency board may be proposed by some but it is most difficult to sustain when an economy is in a crisis. In such a set-up, all domestic currency is to be backed by reserves of foreign currency. Limited forex inflows may make the board impossible to establish. Additionally, although such an institution may do almost zero negative impact to the new currency, its ability to grow the economy directly is non-existent. However, indirect benefits such as high integrity of the banking system, may attract foreign investment into the country.

Resetting the system through redenomination will eventually resolve the problem of, having to carry bags of domestic currency, for settling basic transactions. As new bank notes are introduced, people will revert to settling cash (bank notes) payments in the form of bills that are easy to carry. Security is therefore improved. There will also be less pressure on cashiers in the retail and wholesale sectors. Bank services such as ATMs, will continue with less risk of breaking down, from handling massive amounts of cash. All of these, are just a fraction of the overall benefits, that a properly managed redenomination process will bring to the economy.

Kevin Tutani is a political economy analyst. He can be reached at tutanikevin@gmail.com

Disclaimer: The views expressed in this article are those of the writer and do not necessarily represent those of the Zimbabwe Broadcasting Corporation.

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