Currency crisis lessons from Zimbabwe - Currency is whose responsibility? Central banks or governments?

 

Article's Background

The central bank of Zimbabwe launched a new currency, Zimbabwe Gold, on 5 April 2024 and demonetized the existing currency, Zimbabwean Dollar. This is its sixth attempt to stabilize the country's currency and thereby the economy that have fallen from crisis to crisis for the past 25 years where the economy fell to poverty from the rich agriculture and mining in 2000s. However, the local currency system has collapsed where several foreign currencies formally operate as the legal tender and other functions of money.

All circumstances underlying the collapse of the economy are connected with lapses in country governance system although there is a central bank like in other countries.

Therefore, the purpose of the short article is to highlight the importance of the country governance system for the preservation of the trust in and stability of the national currency and its value to drive economic activities and living standards.

Ethnic conflict and authoritarian government

Zimbabwe is a land-locked African country earlier governed as a British colony. In 1965 white minority government unilaterally declared the independence as Rhodesia where black national forces continued a guerilla war until it secured independence as Zimbabwe in April 1980. President Robert Mugabe's authoritarian rule and corruption until his resignation in 2017 led the economy to disaster. The government-led confiscation of white-owned farms and firms by the black agents since 2000 ended up in the economic crisis in 2007-2009 due to the collapse of agriculture, mining and industries.

As a result, the unemployment rose to 80%. Annual inflation skyrocketed from 32% in 1998 to 11.2 mn percent in August 2008 and later to 500 bn percent.

In this background, the currency system collapsed in front of the central bank because, in such high inflationary regimes, the general public loose the trust in currency as it no longer serves standard functions of money, i.e., unit of account, medium of exchange, liquid store of wealth and a medium of differed payment.

Subsequent Currency Reforms

It has been a common practice in countries to resort to US Dollar and other stable hard currencies when their national currencies are not acceptable as money due to domestic economic crises that are involved in galloping inflation. Accordingly, Zimbabweans started using foreign currencies although the legal tender was Zimbabwean Dollar.

Although the central bank started issuing high face value currencies, finally 100 trillion dollar note, to deal with rising prices, it could not save the national currency system. As a result, several policy actions were taken to facilitate transactions. Some were intended to regain the local currency.

• In January 2009, Finance Minister permitted the use of other currencies alongside the local currency.

• In April 2009, local currency was suspended indefinitely.

• In 2016, several foreign currencies led by US Dollar were permitted as the legal tender.

• In February 2019, central bank introduced a new local currency, the Real Time Gross Settlement Dollar, while banning foreign currencies. However, the general public continued to use foreign currencies in the black market as the new Zimbabwean Dollar was not trusted. Therefore, foreign currency ban was removed.

• Later, Gold coins and Gold-Backed Digital Tokens (GBDTs) were issued to manage the local currency liquidity in the economy.

Current status of Zimbabwean Dollar introduced in 2019

• It was introduced as 2.50 Zimbabwean Dollar = 1 US$. However, the currency could not survive and ended up in collapse again. Its latest exchange rate was 1 US$ = 30,674 Zimbabwean Dollar. It tumbled this year alone from below 6,000 to above 33,000 per US$. Since January, it has lost over 70% of its value on the official market.

• Nearly 80%-85% of domestic trade transactions were in US Dollars.

• Annual inflation which is being fueled by the the rising exchange rate beyond the control of the central bank passed 55% in March 2024 over 26% in December 2023.

• Policy interest rate was miserably raised to 130% to control inflation.

Therefore, the real fact is the existence of the central bank without a national currency system accepted by the public and without any monetary policy teeth on inflation. However, the economy even in poor condition has survived on dollarization.

New Currency System announced on 5 April 2024

The central bank announced it as a structured currency issued on the strength of the central bank balance sheet and issued on cover of gold, precious metal and foreign currencies. As a result, the new currency termed as Zimbabwean Gold (ZiGs) is said be convertible into a basket of gold and foreign currencies. As per monetary policy statement, salient features of the new currency system are as follows.

• Initially valued at 1US$ = 13.56 ZiGs and the exchange rate will be determined by the market. The central bank will continue to provide trading liquidity to the foreign exchange market using a half of the 25% surrender proceeds from exports to stabilize the exchange rate.

• ZiG notes will be in 8 denominations, 1, 2, 5, 10, 20, 50, 100 and 200 to operate alongside foreign currencies as the legal tender.

• ZiG will be fully backed by foreign currency and gold assets and operate in the existing multicurrency system (foreign currencies). According to the central bank statement, on 5 April 2024, such foreign reserve assets amounted to US$ 285 mn as against the required cover of US$ 90 mn for total reserve money of 2.6 trillion Zimbabwean Dollars. Accordingly, foreign reserve cover was more than 3 times. 

• All Zimbabwean Dollars in bank accounts will be converted into equivalent amount of ZiGs. All Zimbabwean Dollars in cash will be swapped for ZiGs during next 24 days through banks.

• Swap rate will be guided by the closing inter-bank exchange rate and price of gold on 5 April 2024. For example, ZiG opened with an exchange rate of US$1 : 13.5616 ZiG. Based on the interbank rate of US$1 = old Zimbabwean Dollar 33,903 on Friday, one ZiG was worth 2,499 old Zimbabwean Dollar. The swap rate announced by the central bank will be used to convert old Zimbabwean Dollar values and prices into ZiG values.

• Upon the conversion, all bank assets and liabilities will be renamed as ZiG values.

• Policy interest rate is recalibrated to 20% from earlier 130%.

• Statutory reserve requirement of 15% on demand and call deposits in local currency, 20% on demand and call deposits in foreign currency and 5% on all time and savings deposits will be applied.

• The government is to mandate companies to settle at least 50% of tax liabilities through ZiGs.

• Gold coins and Gold-Backed Digital Tokens (GBDTs) without conversion to ZiG will continue to manage liquidity.

Concluding Remarks

• The central bank states that currency and exchange rate instability in the country has largely been driven by: 
• High demand for foreign currency as a store of value. 
• Reduced confidence due to continued currency volatility in recent months, and the widening margin between the interbank and parallel market exchange rates. 
• Reduced use of the local currency for domestic transactions. 
• Lack of certainty and predictability on the exchange rate front.

• Therefore, the new currency policy is launched with two strategic policy pillars of 
• restoring price and exchange rate stability, and 
• re-monetising the local currency for it to serve its role as a medium of exchange and a store of value. 

Therefore, the new currency policy seeks to rebuild market confidence and trust, as well as central bank policy credibility.

• However, given the past experience in the local currency system and rising inflation, nobody seems to have any respect on the new system. 

• Several technical factors also contribute to possible failure of the new currency system sooner or later.
• First, the local currency constitutes just under 20% of the total money supply in the economy. Therefore, the mandated conversion into ZiG will not have an impact on local monetary system and exchange rate movements of the new currency will drive the monetary sector valued in ZiGs.
• Statutory reserves, both in local and foreign currency, constitute about 98% of total reserve money (printed money) where currency (Zimbabwean Dollar) in hand constitutes only 0.8% at present. Therefore, the central bank has moped up almost all reserve money through statuary reserves where the monetary and banking system run on dollarization. As such, reserve money and currency are only book entries in the central bank balance sheet and have no practical purpose for the momentary and banking system.
• The backing up of ZiG is a fictitious idea as there is no statement whether central bank is willing to purchase ZiG from the public by paying in foreign currency and gold. The foreign asset cover stated as more than 3 times is misleading because foreign asset value is arrived at the current exchange rate for comparison. In fact, the central bank has only 285 mn US$ against 90 US$ min required to cover for 2.6 trillion Zimbabwean Dollars. Therefore, the exchange rate of one unit of reserve money is US$ 0.0001 per Zimbabwean Dollars or 9,123 Zimbabwean Dollars per US$. However, actual market exchange rate on 5 April 2024 was 30,674. Therefore, the central bank's backing up promise is a technical lie.
• The new currency seems to be a currency board system as the currency is backed by foreign  assets. However, total reserve assets of US$ 285 mn at present are peanuts for for an economy to run a currency board system. Therefore, exchange rate will skyrocket where foreign currencies or dollarization will drive the economy as at present.
• According to central bank statement, the banking sector performs on very high ROA of 24%, ROE of 69%, liquidity of 60% and capital base of 37% together with a very low NPL of 2%. These numbers may relate to dollarized banking sector results, given the poor status of the economy and national currency.

• Therefore, this currency reform also will surely fail as it is not a solution to the country's governance problem that has caused the economic crisis during several decades in the past.

Important Lessons

• Overall, given the collapsed currency and monetary system in national currency, the central bank in Zimbabwe remains as another bureaucratic agency operating on bank regulatory arm. The collapse of the currency system together with the poor economy is due to the country governance crisis. Therefore, central banks have no currency and monetary role if countries are saddled with political and governance crises that cause decades long economic contraction and hyper inflation. A Governor of the central bank of Sri Lanka resigned and the present Governor threatened to resign after few weeks of appointment in the middle of rising political crisis in 2022. Almost all countries suffering from high inflation, currency crises and poverty are the countries that are saddled with decades of poor country governance and geopolitical wars.
• High inflation in 2022 and 2023 in Sri Lanka was caused by the political crisis and not by money printing as the central bank claims. However, the crisis did not spread to the national currency system as the political stability and law and order resumed urgently and, as a result, markets started stabilizing gradually leading to a fast disinflation path. Therefore, central bank Governor's statement made recently that Sri Lanka did not reach the status of Zimbabwe due to prudent monetary policy is grossly incorrect.
• Therefore, what countries require for the stability of the economy and currency system is the stable political system and not the independent central banks, because central banks alone cannot stabilize the economies and currency values without the stable governments. The danger of independent central bank in crisis-hit countries is witnessed by the arbitrarily exorbitant wage hike determined recently by the Central Bank of Sri Lanka for its employees, despite employees of other sectors struggling to survive hit by higher taxes and rising cost of living in the contracted economy.

• Therefore, political leaders should promote long-term development and stability of the economy to protect the public trust in national currency and monetary and banking system as they are the pre-requisites of smoothly running economies and living standards which cannot secured by central banks alone as proved from Zimbabwe and many other countries. Therefore, in countries such as USA, the national currency is the responsibility of the government although monetary policy is outsourced to the central bank on conditions imposed by the Parliament.

(This article is released in the interest of participating in the professional dialogue to find out solutions to present economic crisis confronted by the general public consequent to the global Corona pandemic, subsequent economic disruptions and shocks both local and global and policy failures. All are personal views of the author based on his research in the subject of Economics which have no intension to personally or maliciously discredit characters of any individuals.)

P Samarasiri

Former Deputy Governor, Central Bank of Sri Lanka

(Former Director of Bank Supervision, Assistant Governor, Secretary to the Monetary Board and Compliance Officer of the Central Bank, Former Chairman of the Sri Lanka Accounting and Auditing Standards Board and Credit Information Bureau, Former Chairman and Vice Chairman of the Institute of Bankers of Sri Lanka, Former Member of the Securities and Exchange Commission and Insurance Regulatory Commission and the Author of 12 Economics and Banking Books and a large number of articles published.