Why Zimbabwe dollarised

President Robert Mugabe was forced to accept dollarisation after central bank governor Gideon Gono told him that the economy was in a “near death” state due to the collapse of the Zimbabwean dollar.

Gono is also reported to have told the President that he had no option but to accept dollarisation and pro-market reforms as dollarisation was the key to taming hyperinflation.

Asked how the government would finance its patronage system if dollarisation was introduced, Gono’s special advisor Munyaradzi Kereke said new opportunities to make money legitimately would compensate for the loss of state largesse.

Full cable:

Viewing cable 09HARARE61, GOZ TO ANNOUNCE DOLLARIZATION OF THE ECONOMY

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P 271525Z JAN 09

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RUZEJAA/JAC MOLESWORTH RAF MOLESWORTH UK

RUZEHAA/CDR USEUCOM INTEL VAIHINGEN GE

C O N F I D E N T I A L SECTION 01 OF 04 HARARE 000061

SIPDIS

AF/S FOR B. WALCH

AF/EPS FOR ANN BREITER

STATE PASS TO USAID FOR L.DOBBINS AND E.LOKEN

TREASURY FOR D. PETERS

COMMERCE FOR ROBERT TELCHIN

ADDIS ABABA FOR USAU

ADDIS ABABA FOR ACSS

E.O. 12958: DECL: 01/27/2019

TAGS: ECON EFIN PGOV ZI

SUBJECT: GOZ TO ANNOUNCE DOLLARIZATION OF THE ECONOMY

REF: HARARE 0049

Classified By: Ambassador James D. McGee for reason 1.4 (b) & (d).

——-

SUMMARY

——-

¶1. (C) According to Senior Advisor to Reserve Bank of

Zimbabwe (RBZ) Governor Gono Munyaradzi Kereke, the GOZ plans

to announce the “informal” dollarization of the economy and

further market and exchange-rate reforms this week. All

businesses will be allowed to transact in hard currencies,

but the Zimbabwe dollar will also remain in circulation. The

GOZ intends to begin paying civil servants in hard currency.

Tax revenues in hard currency and possibly diamond revenues

are expected to finance government expenditures. Embassy

business contacts regard the GOZ’s tax revenue projections as

“delusional,” and diamond revenue projections as equally

unreasonable. Pressure on the GOZ to source foreign exchange

is intense as formal economic activity has drawn to a near

standstill, dollarization of the economy is pervasive, and

demand for local currency, including from civil servants, has

evaporated. The GOZ’s muddled understanding of dollarization

and its failure to engage the international financial

institutions

makes it unlikely that the policy shift will arrest the

formal economy’s precipitous contraction. END SUMMARY.

—————————

GOZ to Accept Dollarization

—————————

¶2. (C) Kereke told econoff on January 23 that the GOZ planned

to announce the “informal” dollarization of the economy and a

handful of market reforms in a budget statement on January

29, to be followed soon after by a monetary policy statement.

He said the RBZ would continue to print Zimbabwe dollars,

which would remain in “co-circulation” with hard currencies.

Recognizing that the economy had fully dollarized since the

introduction of registered dollar stores in late 2008 and the

proliferation of unregistered hard-currency based vendors,

the government had decided to allow all businesses to sell

goods and services in hard currencies as long as they

registered with the RBZ; there would be no license or

registration fee. Kereke said prices would be freed and the

mandate of the widely reviled National Income and Pricing

Commission (NIPC) starkly reduced. Kereke maintained that

the amount of foreign exchange in circulation in Zimbabwe was

“much higher” than private sector estimates and that it would

be the e

ngine of growth. (COMMENT: He declined to provide a figure.

END COMMENT.)

¶3. (C) The RBZ, according to Kereke was still working on the

modalities for paying Zimbabwe’s 260,000 civil servants in

hard currency, backdated to January 2009. A paper,

“Comprehensive Economic Reforms Needed to Turn Around the

Economy,” leaked from the RBZ (reftel) in mid January,

suggested that the GOZ would begin paying civil servants 10

percent of their salaries in foreign exchange in January,

rising to 100 percent in six months when the monthly salary

and wage obligation to civil servants would be about US$240

million. The independent press has reported that the RBZ

also planned to issue U.S. dollar-equivalent vouchers,

redeemable for goods in shops. Kereke declined to confirm or

HARARE 00000061 002 OF 004

deny these reports.

———————–

And Some Market Reforms

———————–

¶4. (C) Kereke also said that the Grain Marketing Board (GMB)

would be stripped of most of its activities, and the Zimbabwe

National Water Authority (ZINWA) would return management of

Harare’s water delivery infrastructure to the Harare City

Council. He also stated that the RBZ would cease – not simply

ring-fence – all quasi-fiscal (i.e. off-budget) spending.

———————————–

Financing it all – Taxes, Diamonds?

———————————–

¶5. (C) Kereke told econoff that the RBZ had hardly any

foreign reserves. The GOZ therefore planned to begin to

finance its foreign exchange expenditures with hard-currency

denominated revenue from corporate taxes, customs duty, VAT,

and personal income tax. According to the leaked report, the

government envisaged raising US$1.7 billion annually from

taxes. Kereke said corporate taxes would fall from 30

percent to 15 percent to stimulate economic activity, and

import duty rates would increase. Under dollarization, the

government expected a sharp increase in formal employment,

personal income tax collection, and VAT revenue. The

exorbitant U.S. dollar prices in recently dollarized shops

would begin to fall with increased competition. Asked how

dollar-licensed businesses would react to the shift to no fee

for new businesses to sell in hard currency, Kereke admitted

that none of the licensed businesses had ever paid the

prescribed US$20,000 fee.

¶6. (C) The leaked RBZ report estimated that diamond royalties

could provide the GOZ with about US$1.2 billion per month in

revenue (reftel). David Govere, President of the Employers’

Confederation of Zimbabwe (EMCOZ), however, told econoff on

January 25, that Kereke, who is his former business partner,

had told him that the government in late December had given

up hope of securing an up front infusion of US$5 billion from

the Russians in return for rights to exploit the Chiadzwa

diamond deposit.

——————–

“Near-Death” Economy

——————–

¶7. (C) Kereke said Governor Gono had convinced President

Mugabe that the economy was in a “near-death” state due to

the collapse in value of the local currency, and no

alternative remained but to accept dollarization and

pro-market reforms. Gono had reportedly pitched

dollarization to Mugabe as key to taming hyperinflation.

Kereke said Mugabe had also agreed to give up the official

fixed exchange rate regime.

¶8. (C) Asked by econoff how the GOZ would finance its

patronage system without the highly preferential exchange

rate, Kereke suggested that new opportunities to make money

legitimately in a liberalized market would compensate for the

loss of state largesse to key supporters.

——————————

“Delusional” Revenue Estimates

HARARE 00000061 003 OF 004

——————————

¶9. (C) Our business contacts regard the government’s leaked

tax revenue estimates as wildly off the mark. Tinashe

Rwodzi, Territory Senior Partner at PricewaterhouseCoopers in

Harare, called the estimates “fantasy.” He told econoff on

January 26 that corporations were in dire straits, operating

at only 5-15 percent capacity, and in desperate need of

external support to jump start production. Phillip

Chigumira, former Deputy President of the Confederation of

Zimbabwe Industries (CZI), told us that almost 90 percent of

Zimbabwe’s production was now informal and most companies had

not re-opened since the Christmas holidays. In these

circumstances, Rwodzi said that companies would re-invest

their forex earnings rather than declare taxable profit to

the government. In his view, the amount of foreign exchange

in circulation was woefully inadequate to even begin to

finance private sector recovery. He also pointed out that by

keeping the government printing press running and maintaining

the Zimbabwe dollar alo

ngside hard currencies, companies might easily be tempted to

manipulate the books and declare profit in (worthless) local

currency terms and losses in their forex account. Chigumira

pointed out that the RBZ failed to take into consideration

the pace of emigration and of contraction of the formal

sector, and the increase in informal economic activity that

is not taxed. He said that CZI, in its submission to

government, had advised the Ministry of Finance to devise

ways of taxing informal traders.

¶10. (C) Rwodzi also said that the flow of remittances had

declined significantly in Q4 2008 with the slowdown in the

global economy. To make matters worse, remittances that

previously had sustained a family for 4 weeks, could barely

meet one week’s cost of living at Zimbabwe’s new inflated

local U.S. dollar prices. Furthermore, he noted that

remitted funds, for the most part, were primarily being spent

on imported food and goods and did not remain in the economy.

¶11. (C) Tony Hawkins, University of Zimbabwe economics

professor, called the tax revenue estimates, particularly

from corporate taxes and personal income tax, “delusional”

and “pie in the sky.” He told econoff on January 26 that

losses across the corporate sector were massive. The

manufacturing sector, for example, was operating at only 5

percent capacity. The leaked RBZ report’s diamond revenue

assumptions were “bizarre,” – more than four times Botswana’s

annual diamond exports. In regard to the possible

introduction of foreign exchange coupons, he said no sane

vendor would accept them. In his view, Gono’s latest

measures were an attempt to “stave off the inevitable.” His

advice to the opposition was to “sit on its hands” and watch

the decline accelerate.

¶12. (C) David Govere, for his part, told econoff that Gono

had “a kitty” of revenue from diamond sales that could cover

partial foreign exchange payment of January and February

civil servant salaries, but no more.

————————-

The Squeeze on Government

————————-

¶13. (C) In the past, Gono was able to keep government

operations going by printing Zimbabwe dollars, but that

survival strategy has practically collapsed. Although he

HARARE 00000061 004 OF 004

recently announced the introduction of Z$10, Z$20, Z$50 and

Z$100 trillion notes (after having lopped off 13 zeros from

the currency in the past one and a half years), the

evaporation of demand for Zimbabwe dollars means that he can

no longer turn to the parallel market to meet the GOZ’s hard

currency expenditure requirements. On a recent weekend

shopping tour, the only item emboff was able to buy for local

currency, except at astronomical prices, was bananas from a

street vendor. The collapse in value of the local currency

has driven civil servants, including soldiers and policemen,

to demand their salaries in foreign currency. Strikes by

civil servants including teachers, health care workers and

railroad employees over pay in hard currency have become

common. At US$240 million/month, civil servant wages would

exceed Zimbabwe’s GDP, accor

ding to some estimates. GDP estimates range anywhere from

US$1.5 billion to US$4 billion. Against this backdrop, the

pressure to find other steady sources of foreign exchange is

fierce.

—————————————–

Paranoia and Delusion Upstairs at the RBZ

—————————————–

¶14. (C) Prior to their meeting, Kereke asked econoff to

present herself to the RBZ reception as a UNDP official,

coming “to discuss the cholera situation.” During the

meeting, he pleaded that no reference be made to his name in

any Embassy reports for fear of leaks back to the GOZ. To

the suggestion of a meeting outside the RBZ, he said, if seen

with an Embassy official, he would become “a corpse.” On the

imminent policy shift, Kereke maintained that the latest

measures met all the policy recommendations outlined in the

IMF’s recent paper on overdue obligations. Asked if the RBZ

had sought the IMF’s advice on dollarization, Kereke said the

“politics” were not right now for Zimbabwe’s re-engagement

with that institution. But he did dare to ask econoff, in

closing, when Zimbabwe could expect to get USG backing for

balance of payments support from the IMF.

——-

COMMENT

——-

¶15. (C) The GOZ appears to have a muddled understanding of

dollarization. It wants to have it both ways: secure a hard

currency anchor to tame inflation, collect tax revenue in

forex, but persist in printing local currency with abandon.

Its home-grown concept of “informal” adoption of hard

currencies alongside the Zimbabwe dollar and not backed by

any foreign reserves will neither stabilize the economy,

attract desperately needed investment, nor meet the

requirements for balance of payment support. In addition,

foreign exchange is insufficiently available to anchor the

Zimbabwe dollar in a currency board, and the GOZ has no hope

of obtaining the needed funds. As Professor Hawkins

suggested, Gono’s latest “reforms” will not prevent the

inevitable implosion of the formal economy. END COMMENT.

MCGEE

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