Foreign Currency

Devaluing Zim’s ZiG won’t fix the currency


The Reserve Bank of Zimbabwe devalued the ZiG by 43% on 27 September 2024, weakening the official exchange rate from 13.9 ZiG per US dollar to 24.4 ZiG per US dollar.

The ZiG (Zimbabwe Gold) is the nation’s newest currency and was launched in April 2024.

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The unexpected devaluation was prompted by the need to contain resurgent exchange rate pressure, which started back in August due to higher food import costs and a slide in mineral export sales. The central bank decided to ease this pressure by lowering the currency’s value instead of burning reserves to keep its value steady at 13.9 ZiG per dollar.

The strain on the ZiG has intensified in the aftermath of the devaluation. As of 18 October, it had weakened even further to more than 26 ZiG per dollar, raising speculation that it will continue to weaken.

Read: Zimbabwe says basic goods in limited supply after ZiG devaluation

This would have a number of negative consequences. It would keep upward pressure on import prices, hurting households and businesses. If this happened, Zimbabwean households already hit by falling paycheques and savings might cut back further on spending.

The strain on the currency also risks reigniting inflation. The risk comes after monthly inflation ticked up to 1.4% in August and then climbed to 5.8% in September. Resurgent inflation would also increase costs for businesses and threaten to stifle investment. That was on display in 2000-08 and 2019-20 when price instability dampened economic activity and created a costly business environment which discouraged investment.

A further risk factor from currency instability is that it would deter foreign investors worried about the ZiG as a reliable store of value. The prospect of declining business investment, loss of confidence in the ZiG, and anaemic consumption would in turn be a major drag on economic activity. Economic growth in 2024 is expected to slow down to 2% from 5% last year. El Niño-induced drought, lower mining prices, and macroeconomic instability are among the key reasons.

This is the sixth time Zimbabwe’s authorities have attempted to establish a stable national currency in the past 15 years.

The history of failed attempts has cast a long shadow on the ZiG. The recent devaluation has not eased concerns about Zimbabwe’s struggles to develop and maintain a domestic currency that can be widely used for transactions and as a store of value on a voluntary basis.

I have long thought the devaluation was inevitable. Authorities must confront the fundamental causes, which are rooted in a loss of faith in the ability of government to manage spending. In particular, its habit of printing money, overspending on its budgets and failing to expand the economy.

Interventions

The ZiG is part of a multicurrency system that allows individuals to use other major currencies, including the US dollar, euro, South African rand, and pound sterling.

To increase the ZiG’s uptake, authorities imposed a number of measures. The new unit must be used to pay a portion of company taxes and most government services. Fines are issued to traders who are unwilling to accept ZiG payments.

Measures like these are insufficient because they do not consider the real problems hindering the success of the Zimbabwe dollar.

The central bank also announced that it aims to slow the ZiG’s decline by imposing currency controls and raising the benchmark policy rate (the rate used to implement its monetary policy) from 20% to 35%. The jump in the cost of borrowing triggered by these measures will further weigh on business investment and consumer spending.

Read: Zimbabwe central bank put $50m in market before 43% ZiG devaluation

Gains to Zimbabwean exporters from a cheaper ZiG are unlikely to be substantial because of an El Niño-induced drought that has devastated crops in southern Africa. Lower commodity prices have also hurt dollar earnings for Zimbabwe’s mineral exports. On average, the agriculture and food sector contributes about 17% to GDP and 40% of total export earnings, while mining accounts for about 12% of GDP and 80% of total exports.

My worry is that a cheaper ZiG may not juice exports and reduce the trade shortfall of US$1,453 million recorded last year, given the hit to commodity prices and the adverse impact of drought on agricultural production. A bigger trade deficit will keep downward pressure on the currency.

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The weaker ZiG could, however, boost inbound tourism.

To retain a stable domestic currency, authorities will have to address deeper structural causes rooted in the country’s long history of printing money to pay for government overspending amid slow economic expansion. That means:

  • Slashing the budget while giving greater spending priority to health, education, public infrastructure and other critical investments;
  • Government weaning itself off dependence on printing money to finance fiscal deficits; and
  • Supporting credible policies for more sustainable and private-sector-led growth and policies for capturing more revenue from growth.

Precedents

This is not the first time the Zimbabwe dollar has been unstable and weak. In the 2000s, printing money to finance government deficit spending produced periods of high inflation amid slow growth, making the currency weak and unstable.

The currency eventually collapsed in 2009 due to hyperinflation, and the US dollar became the official currency.

Another local currency (the RTGS dollar) was later introduced in 2019. With the power to print more money restored, inflation rapidly accelerated and surpassed 500% in 2020. This made the new Zimbabwe dollar highly unstable, and its value quickly deteriorated.

Read: Zimbabwe must end ‘dollar grip’ to regain economic sovereignty

As a result, the US dollar continued to be the dominant currency used in transactions and as a store of value. Inflation remained elevated until April 2024, when the ZiG was launched as the new national currency. Its value is backed by gold and foreign currency reserves.

At first, the move seemed to have tamed inflation. But widespread voluntary use of the ZiG failed to materialise. That’s because people are still wary of the government’s power to print money, which has been the key driver of inflation and currency instability.

What policymakers can do

Authorities must tackle the root causes of the nation’s currency struggles once and for all. Steps that can be taken to resolve longstanding structural factors include:

  • Re-prioritising public spending by undertaking deep fiscal reforms that will divert more resources towards spending on health, education, public infrastructure and other critical investments needed to boost growth. These reforms should also aim to capture more revenue from growth, for example, through tax reforms;
  • Implementing reforms to address corruption and improve governance is essential for imposing the discipline necessary to push back against covering fiscal deficits by printing money and for restoring faith in government institutions; and
  • Pursuing credible policies for more sustainable and private-sector-led growth. Strong growth expands tax revenues and gives the government more policy space to spend on essential services and critical investment needs.

Read: Zimbabwe treasury secretary rules out exchange-rate convergence

Devaluation and other measures that have been imposed to support the ZiG are not the solution.The Conversation

Jonathan Munemo, Professor of Economics, Salisbury University

This article is republished from The Conversation under a Creative Commons licence. Read the original article.



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