Zimbabwe’s liquidity crisis, the curse of a strong dollar

Moreover, a study by the Reserve Bank of Zimbabwe (RBZ) concluded that the real exchange rate under the multicurrency regime is grossly overvalued by 45%.  The real exchange rate tells how much the goods and services in the domestic country can be exchanged for the goods and services in a foreign country.  When the real exchange rate is high—as is the case in Zimbabwe—the relative price of goods at home is higher than the relative price of goods abroad.  Consequently imports are likely to increase because foreign goods are cheaper in real terms than domestically manufactured goods.

Accordingly, Zimbabwe’s exports are not competitive because the same goods can be purchased more cheaply in competitor economies, in large part, because Zimbabwe’s de facto currency is the strong U.S. dollar — all pricing and 90% of trade is in U.S. dollars.  Generally, when a currency is overvalued the authorities will adjust the nominal exchange rate by depreciating its currency.  However, because Zimbabwe uses a foreign currency it cannot depreciate its currency to restore competitiveness.

Therefore, Zimbabwe must either reduce domestic production costs to enhance competitiveness, or reinstate the Zimbabwean dollar.  The latter is not a viable option.  The  largest  benefits  claimed  from  dollarization  derive from  the  credibility  it  carries precisely  because it  is  nearly  irreversible.  Among other positive economic indicators, high economic growth and accumulations of large   foreign   reserves   would   likely   enable   Zimbabwe   to   reinstate   the   national currency.  (Country perception and market confidence are also extremely important.)  Neither of these indicators describes the current state of Zimbabwe’s economy.   Thus, it would be imprudent to bring back the national currency.

The authorities must, therefore, introduce policies that reduce production costs.  This includes lower tax rates and less government regulation.  Moreover, the authorities must redress key infrastructure bottlenecks in electricity, water and transportation sectors.  For example, Zimbabwe’s commercial and industrial tariffs for electricity are higher than the regional averages due to ageing equipment and inefficiencies in the running of thermal power stations. Additionally, about 60 percent of treated water is lost due to broken pipes and illegal connections.  Indeed, remedying these cost drivers is the key to restoring competitiveness.

Finally, the U.S. dollar (and Zimbabwe’s real exchange rate) is expected to appreciate further when the U.S. Federal Reserve increases interest rates in 2016, as expected.  If the authorities do not urgently address the high domestic cost structures, Zimbabwe’s high import bill will continue to drain foreign exchange resources, further tightening liquidity conditions with constraining effects on economic growth potential.

By Chido Munyati- The Source

(304 VIEWS)