Tuesday, October 25, 2016/ 5:21pm /BMI Research
BMI View: In the event of de-dollarisation in Zimbabwe, high levels of inflation would make a return to the economy as weak balance of payments dynamics would see the new currency sell off at a rapid rate. The RBZ would accompany the process with a series of interest rate hikes but with little effect.
While it is not our core view that the government and the Reserve Bank of Zimbabwe (RBZ) will choose to de-dollarise the economy before 2018, recent liquidity shortages have increased the risk that the government could implement such a policy.
Given the significant macroeconomic consequences of such a move in the near term, in this article we will take a closer look at the potential fallout of dedollarisation this year.
In recent months, sharply rising balance of payments pressures over the past 12 months, in which weak investment and falling export revenues have led to a shortage of liquidity, have led to speculation that the government could be considering such a move.
This has been exacerbated by the announcement that the government intends to print and issue USD200mn in bond notes to alleviate some of the pressures on the economy stemming from the shortage of dollars.
The most notable of the risks of de-dollarising at any point over the next year would likely be the impact such a move would have on inflation. Since dollarising the economy in 2009, Zimbabwe's declining money supply has resulted in deflation, a stark contrast to the years of rapid hyperinflation the economy saw in 2006-2008.
However, reintroducing a local currency would mark an end to this trend almost immediately:
• Weak balance of payments dynamics – encompassing falling export revenues and dwindling inward investment – would see the new currency depreciate at a rapid rate, translating into higher import costs. With around USD249mn in reserves (0.5 months of import cover) the central bank lacks the ammunition to prevent significant depreciation.
• Adoption of a local currency would inevitably result in a rapid increase in the supply of broad money, as the central bank looked to inject enough liquidity into the economy to alleviate the ongoing cash shortage, caused by the current reliance on the US dollar. Without a simultaneous increase in real production, this would increase inflationary pressures.
Precisely what level inflation would rise to would depend on the rate at which the RBZ printed the new currency. We believe that the spectre of hyperinflation remains sufficiently fresh in the mind of most Zimbabweans for the RBZ to be cautious in any implementation of a new currency, but inflation could realistically still climb well above 30%.
In so doing, the process de-dollarisation could be equally damaging for economic growth as the current liquidity shortage under a dollarised economy. Soaring prices, particularly for imports, would remove the production incentives for import dependent businesses as input costs rose.
In such a scenario, we would likely see the RBZ implement a number of interest rate hikes alongside de-dollarisation in an effort to raise real interest rates and encourage inward investment into the economy.
However, considering the likely scale of inflationary pressure after de-dollarisation, this would open up scope for the economy to face severe economic shocks via higher borrowing costs.
Given the potential fallout we would expect from de-dollarising the economy at any point over the next year, we do not expect the RBZ will reintroduce a local currency over this period. Indeed, we do not believe that de-dollarising would result in any real improvement in economic conditions while the country's macroeconomic fundamentals remain so weak.
As such, while there are significant drawbacks to maintaining a dollarized economy, evidenced by the current lack of liquidity, which ultimately make it an unsustainable option without painful structural adjustments, we do not anticipate a near-term change in the current regime.