Inflation in Zimbabwe: Causes and Consequences - Essay Example

Inflation in Zimbabwe Executive summary Since the attainment of its independence, the government of Zimbabwe experienced a rise in inflation which peaked at around 2008 with the rate of 231 million percent per year (Berger 2008). Repossession of land from White settlers crippled the manufacturing industry and cut on foreign currency inflow, further worsening the situation. More currency was printed for circulation which caused the loss in value of the dollar. The temporary dollarization in February 2009 does not provide a sustainable solution and thus this brief seeks to explore possible solutions that would permanently contain inflation in Zimbabwe, analysing the possible pros and cons, borrowing information from various sources including books, newspapers and journals, the brief gives four possible solutions targeting the policymakers including the government and the economists. These are permanent dollarization, joining the Common Monetary Area membership, usage of its dollar as the only legal tender and employment of variable regimes. However, in its conclusion and recommendation, the brief singles out joining of the CMA as the best choice for Zimbabwe to permanently curb its inflation. Situation brief When Zimbabwe attained independence in 1980, its dollar’s worth averaged $1.25 (Kramarenko et al. 2010). Over time, inflation rose steadily under the presidency of Robert Mugabe until towards the end of the 1990s when the confiscation of land from White settlers had negatively affected food production (Coomer & Gstraunthaler 2011). With the seizing of these commercial farms, foreign investors fled away leading to halting of manufacturing and reducing the supply of foreign currency needed for importation of goods. Tax revenue also reduced drastically. In order to ensure that the government funded its debts, the Reserve Bank of Zimbabwe increased its printing of currency causing a rise in inflation to triple digits as of 2001. By end of the year 2008, consumer prices doubled every other day with joblessness being on the increase. Coupled by recession, this inflation led to Harare, the capital city, suffering from electrical blackouts, unclean water causing water-borne diseases and a pile up of garbage on the streets. Wines (2006) referred to this as one of the world’s highest inflation. As of July 2008, Zimbabwe was suffering a high inflation at 231 million percent per year. President Robert Mugabe employed various strategies so as to bring this inflation into control. The economy was turned over to the president’s closest allies in the National Security Council. Intelligence officers and loyal army officers were used in controlling key functions including tax collection and food security. Key supporters of the president had their salaries increased drastically to cushion them from the effects of the inflation with the central bank printing more notes. This instead led to hyperinflation due to the circulation of too many worthless Zimbabwean dollars. By November 2005, the inflation stood at 400% which edged in January 2006 to over 600% (Wines 2006). By June 2008, this was at 11.2 million percent per year and kept increasing in the subsequent months to over 231 million percent in 2008 (Berger 2008). In January 2009, the 100 trillion Zimbabwean dollar note worth $30 was introduced into the circulation (Pindiriri 2012). The US dollar exchanged for Z$180 officially but fetched Z$8,000 in the black market. This was further worsened by the deadlock that existed between the Zanu-PF party of Robert Mugabe and the Movement for Democratic Change, the opposition. The closest Zimbabwe came to finding a solution was with the dollarization in February 2009 where authorities allowed for trade with five different currencies, though the US dollar became the principal (Pindiriri 2012). The use of the Zimbabwean dollar was discontinued. But this was considered as a short term measure that would not give a permanent solution to the problem of inflation in Zimbabwe. Therefore, the problem question is what policy should be best applied to sustainably contain inflation in Zimbabwe? Policy brief Since Zimbabwe has already introduced dollarization, though temporarily, full official dollarization should be the maiden monetary policy proposal for full implementation. The country currently has widespread dollarization coupled with non-functionality of its dollar. Full official dollarization appears to be the easiest option for short term institutional and operational implementation (Pindiriri 2012). If implemented credibly, it would eliminate future currency crises risk which reduces interest rate spreads determined by the market over those of the country from which the currency would have been adopted. Dollarization could also strengthen the institutions of fiscal policy, particularly by rejecting inflationary finance. Lastly, it would cut on the international transaction costs with the country from where the currency would be adopted hence promoting the much needed financial integration and trade. On the other hand, Zimbabwe could lose “seigniorage from issuing domestic currency” (Kramarenko et al. 2010, p.12). When the Zimbabwean dollar would be introduced in future, there would be high chances of persistent widespread dollarization. Reintroducing its dollar, Zimbabwe could join the Common Monetary Area whose current members include South Africa, Lesotho, Swaziland and Namibia. The Zimbabwean dollar would thus circulate simultaneously with the anchor currency with the reserve money having the full back-up of the international reserves through an arrangement of currency board. According to Kramarenko et al. (2010), the formation of CMA was propagated by the need to enhance sustainable economic development and propagate advancing of its less developed members. This provides Zimbabwe with the opportunity of external discipline provided by CMA membership hence more confidence in the monetary regime. In as much as Zimbabwean monetary policy would be determined by Reserve Bank of South Africa, consultation doors remain open. Transferring rand funds within CMA would be unrestricted. However, Zimbabwe would be required to agree with the members of CMA which could be time consuming and difficult. In addition, accessing capital markets weakens Zimbabwe’s fiscal discipline due to the perception that other members would bail it out. The third approach that Zimbabwe could pursue would be to issue its dollars as the only legal tender governed by rules of the currency board (Coomer & Gstraunthaler 2011). The buying and selling of its currency for foreign currency would be determined by demand at an exchange rate that would be fixed legislatively which would assure full asset backing of the foreign reserve. This bars the currency board authority from buying, borrowing or lending domestic assets apart from capital. With well defined and implemented board rules, discipline would be imposed on the monetary authority resembling that of dollarization. Zimbabwe would be able to receive seigniorage revenue equivalent to the national currency it issues. It would also make it easier to maintain stock of coins and notes that are fit. But this calls for considerable time to marshal political support for the adoption of fiscal responsibility and central bank legislation which match global best practice. This would also be vulnerable to attacks of speculative currency as the guarantee covers 100% of base money leaving out a lot of banking deposits. The final option could be adoption of regimes that vary between conventionally adjustable or fixed pegs or bands and crawling bands or pegs and also managed or free floating rates of exchange. These would enhance the level of monetary autonomy. Kramarenko et al. (2010) observe that the Reserve Bank of South Africa has adopted the inflation targeting regime. The limitation in this would be that Zimbabwe would encounter considerable challenges in the implementation of regimes with wholly flexible exchange rates because of its past history of high inflation, fiscal dominance and RBZ’s governance problems among other factors. Conclusion and recommendation Hyperinflation in Zimbabwe came about as a result of the government’s decision to repossess land from the White settlers who were key in the country’s manufacturing industry and inflow of foreign currency needed for importation. This was further propagated by the government’s decision to increase the amount of currency in circulation to try and contain the situation which led to decrease in the value of Zimbabwean dollar. The suspension of the Zimbabwean dollar up to 2012 opened way for five other currencies to be used with the dollar being popular. This brief provided four options that would benefit economists, policymakers and the government in determining a credible approach to permanently curb inflation in Zimbabwe which includes implementation of full dollarization, joining the CMA, employing its dollars as the only legal tender or adopting varying regimes. Of the four, joining the CMA provides the best opportunity for Zimbabwe to regain and sustain value for its dollar. Joining Lesotho, South Africa, Namibia and Swaziland, countries that could be considered to be doing well economically in the region, Zimbabwe would have the opportunity to be catapulted to their level, though steadily, as this is the major mission for CMA existence. Because of its universal regulations among the members, Zimbabwe’s monetary regulations would be put on check to ensure credibility, thus sustainability. Annotated bibliography Berger, S 2008, ‘Zimbabwe inflation hits 231 million per cent’, The Telegraph, 9 October, viewed 1 October 2012, www.telegraph.co.uk The author of this article focuses on the hyperinflation in Zimbabwe in the period around 2008. The article gives the government’s reaction to this situation and analyses the situation from a political aspect. It fails to give any measures taken by the government or that should be taken to curb the situation. It would therefore be an appropriate source for this brief in defining the political aspect of the hyperinflation. Coomer, J & Gstraunthaler, T 2011, The hyperinflation in Zimbabwe, The Quarterly Journal of Austrian Economics, vol. 14, no. 3, pp. 311 – 346. This journal seeks to unravel whether the hyperinflation in Zimbabwe was an isolated novelty or a repetition of political and economic blunders experienced in most modern countries. It gives a detailed historical chronology comparing this to past hyperinflations. This journal thus gives historians a chronology of events in the Zimbabwean economy. Kramarenko, V, Engstrom, L, Verdier, G, Fernandez, G, Oppers, SE, Hughes, R et al. 2010, Zimbabwe: Challenges and policy options after hyperinflation, International Monetary Fund Publication Services, Washington, D.C. This book analyses the post-hyperinflation Zimbabwe quoting relevant facts and figures to support its economical recovery. It analyses the adopted economic policy and discusses various other policies that could used in the long term. This targets economists that look into the economic aspect of the hyperinflation and policymakers seeking solutions to economic blunders. Pindiriri, C 2012, Monetary reforms and inflation dynamics in Zimbabwe, International Research Journal of Finance and Economics, vol. 90, pp. 207 – 218. It examines the post-dollarized Zimbabwe and the economic factors that still support inflation. Despite its relevant and elaborate economic analysis, the author provides flimsy recommendation. It would thus be suitable for economists seeking to analyse the effect of dollarization of the Zimbabwean economy. Wines, M 2006, ‘How bad is inflation in Zimbabwe?’ The New York Times, 2 May, viewed 1 October 2012, www.nytimes.com This newspaper article gives the situation that was in Zimbabwe as felt by the consumers, quoting useful financial and economic statistics. It borrows that analysis from some economists. The article however fails to mention any government measures taken to curb the situation or suggest any solutions. This would therefore be appropriate in discussing the effect of hyperinflation in this brief. Read More