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ACKNOWLEDGEMENT

The group members would like to thank Prof. C.S.Shyalajan for his guidance throughout the

completion of the project. Without his assistance, the flow or the structure of the report would

not have been possible. The group is also grateful to IBS Hyderabad IT department for enablingthem to use internet facility that has been a major source of the research done to prepare the

report. Last but not the least the group would also like to mention that without access to the

college library, the report could not have taken its present shape today.


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PARTICULARS

INTRODUCTION 4

HYPERINFLATION 5

HYPERINFLATION IN ZIMBABWE 6

CAUSES OF HYPERINFLATION IN ZIMBABWE 8

EFFECTS OF HYPERINFLATION ON THE ZIMBABWEAN ECONOMY 13

MEASURES TAKEN BY THE GOVERNMENT 14

ACHIEVING MACROECONOMIC STABILIZATION INZIMBABWE:RECOMMENDATIONS 16

HINT OF OPTIMISM 18

CONCLUSION 18

REFERENCES 19


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| A STUDY ON HYPERINFLATION IN THE ZIMBABWEANECONOMY}

A BRIEF OVERVIEW OF THE ZIMBABWEAN ECONOMY :

Zimbabwe is a landlocked country located in the southern part of the continent of Africa .Theeconomy of Zimbabwe is collapsing under the weight of economic mismanagement, resulting inmassive unemployment and spiraling hyperinflation. It currently has the lowest GDP real growthrate in an independent country in the world .The economy poorly transitioned in recent years,deteriorating from one of Africa's strongest economies to the world's worst.

Traditionally, mineral exports, agriculture, and tourism have been the main foreign currency

earners of Zimbabwe. The mining sector remains very lucrative, with some of the world's largest platinum reserves being mined by Anglo-American and Impala Platinum. But in the recent years,the industrial growth has slowed down due to the ongoing economic crisis.

Zimbabwe is experiencing a hard currency shortage, which has led to hyperinflation and chronicshortages in imported fuel and consumer goods. The Central Bank routinely prints money tofund the budget deficit, causing the official annual inflation rate to rise from 32% in 1998 to6000% in 2007. Inflation has surpassed that of all other nations at over 80 sextillion (10 21) %,with the next highest in Burma at 39.5. Meanwhile, the official exchange rate fell fromapproximately Zimbabwean dollar per US dollar in 2003 to more than 17,500 per US dollar in2007.However, the official CPI in Zimbabwe is likely to understate the inflation as one third of

the basket reflects price controlled items. The true rate of inflation seems to be substantiallyhigher.

Between 2000 and 2008, the national economy has contracted by 40%; inflation vaulted toover80 sextillion (10 21) %, and there were persistent shortages of foreign exchange, localcurrency, fuel, medicine, and food. GDP per capita dropped by 40%, agricultural output drops by51% and industrial production dropped by 47%. Price controls have been imposed on a widerange of products including food, fuel, medicines, soap, electrical appliances, yarn, school booksetc. Direct foreign investment has evaporated from US $400 million in 1998 to US $30 millionin 2008.The Zimbabwe dollar was redenominated by removing 10 zeroes on 1 August 2008.ZWD10billion became 1 dollar after the redenomination. More banknotes were issued

including$500 million and $10 billion.The general economic scenario is horrible with many items like bread,margarine,meat and eventhe morning cup of tea becoming unimaginable luxuries for thousands of Zimbabwweans.Poverty and unemployment are both endemic in Zimbabwe, driven by the shrinking economyand hyper-inflation. Both unemployment and poverty rates run near 85%


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The lowest 10% of Zimbabwe's population consume only 1.97% of the economy, while thehighest 10% consume 40.42%. (1995).In response to skyrocketing inflation the government hasintroduced price controls, but enforcement has been largely unsuccessful. Without an immediatestabilization and comprehensive reforms, prospects for Zimbabwes inflation to continueaccelerating are pretty high.

HYPERINFLATION

In economics, hyperinflation is inflation that is "out of control," a condition in which pricesincrease rapidly as a currency loses its value. According to Philip Cagans (1956) definition,hyperinflation begins in the month inflation first exceeds 50 percent (per month) and ends in themonth before the monthly inflation rate drops below 50 percent for at least a year. By thisdefinition, during 1920 and 1946 there were eight hyperinflations, while between 1947 and 1984there were none. Since 1984, however, there have been fifteen hyperinflation cases.

In neo-classical economic theory, hyperinflation is rooted in a deterioration of the monetary base; that is the confidence that there is a store of value which the currency will be able tocommand later. The perceived risk of holding currency rises dramatically, and sellers demandincreasingly high premiums to accept the currency. This in turn leads to a greater fear that thecurrency will collapse, causing even higher premiums.Rates of inflation of several hundred percent per month are often seen. Extreme examplesinclude:

y Germany in 1923 when the rate of inflation hit 3.25 106 percent per month (pricesdouble every 49 hours).

y The most severe known incident of inflation was in Hungary after the end of WorldWar II at 4.19 1016 percent per month (prices double every 15 hours).

A small amount of inflation is generally viewed as having a positive effect on the economy. Onereason for this is that it is difficult to renegotiate some prices, and particularly wages,downwards, so that with generally increasing prices it is easier for relative prices to adjust. .More generally, because modest inflation means that the price of any given good is likely toincrease over time, there is an inherent advantage to making purchases sooner than later. Thiseffect tends to keep an economy active in the short term by encouraging spending and borrowingand in the long term by encouraging investments.High inflation tends to reduce long-term capital formation by hurting the incentive to save, andto effectively reduce long-term spending by making products less affordable. Limitedinvestments will result in shortages of opportunities for corporates which will be forced into

speculation. In addition, corporates become less focused on core-business as they try to survive.This can lead to corporate cannibalization whereby companies essentially trade each othersshares without any meaningful investment in plant, equipment, stock or capacity.

Hyperinflation and Currency :

y When Hyperinflation occurs, the central bank often prints money in large denominationsas the smaller denomination notes become worthless. This can result in the production of


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some interesting banknotes, including those denominated in amounts of 1,000,000,000 or more.

y Banknotes are stamped to indicate changes of denomination. This is because it would taketoo long to print new notes. By time the new notes would be printed, they would beobsolete.

.

HYPERINFLATION IN ZIMBABWE

Zimbabwe has currently by far the highest rate of inflation in the world. Inflation, as measured by the official CPI, soared to 1,730 in February 2007. Since monthly inflation is still officiallyunder 50 percent, Zimbabwe currently does not qualify formally as a hyperinflation case byCagans definition. Zimbabwe can best be described as a country in stagflation, that is, high priceinflation combined with slow output growth, high unemployment, and recession.As explained above, Hyperinflation has a tormenting effect on the currency. So we have to tracethe evolution of the Zimbabwean Dollar.

Zimbabwean Currency

y First dollar: In 1980, the Reserve Bank of Zimbabwe introduced notes in denominations of 2, 5, 10 and 20 dollars. 50 dollar notes were introduced in 1994, followed by 100 dollars in1995, 500 dollars in 2001 and 1000 dollars in 2003.

In 2003, with mounting inflation, the Reserve Bank started issuing travelers cheques indenominations of 1000, 5000, 10,000, 20,000, 50,000 and 100,000 dollars. These weresuperseded later the same year by bearer cheques, initially in denominations of 5,000, 10,000 and20,000 dollars, with cheques for 50,000 and 100,000 dollars following in 2006.

y Second dollar: On 1 August 2006, the new currency was introduced, with bearer cheques in denominations of 1, 5, 10 and 50 cents, 1, 10, 20, 50, 100, 500, 1000, 10,000 and

100,000 dollars. There is also a 5 dollar denomination although the note does not appear on anyof the Reserve Bank advertisements. Bearer cheques of 5,000 dollars (dated 01 February 2007)and 50,000 (dated 1 March 2007) were issued in March 2007. Bearer cheques of 200,000 (dated01 August 2007) were issued in August 2007.

y Proposed third dollar: S ince the Zimbabwean dollar was revalued in August 2006,there have been repeated discussions and proposals regarding a further revaluation. As early asthe beginning of 2007 it appeared that a revaluation was planned with new banknote designs

being commissioned. However, nothing came of these plans. New plans were announced in

October 2007 and initially postponed until 2008 before, in November 2007, the revaluation wasdescribed as imminent and would remove as many as four zeros from the currency and would becalled Sunrise 2. However, on December 18, 2007, it was reported that a further printing of thecurrent Z$200,000 bearer cheques had been produced, seemingly instead of revaluing. Further new issues of bearer cheques have since taken place.

Zimbabwe has been characterized by both deep recession and high inflation. People do not wantto keep their money in banks because they only pay a meager amount of 4% to 10% and so


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people prefer to buy goods with them rather than keeping them in banks. People buy things because the value of their currency reduces every day by 5%. The bags of food now prove to bethe gilt-edged securities.In addition, hyperinflation has robbed people of their savings and financial institutions of their capital through real (inflation-adjusted) interest rates that are actually negative. This form of theft

occurs, in large part, because the laws and regulations governing financial institutions (pensionfunds, insurance companies, building societies, and banks) force them to either purchasegovernment treasury bills that yield only a small fraction of the current inflation rate or makedeposits at the Reserve Bank of Zimbabwe (RBZ) that pay no interest. The value of theZimbabwe dollar has been wiped out. Figure 1 tells the devastating story one that is followingthe same plot as that followed by the German mark during the great German hyperinflation of the1920s. Collapse is hyperinflation. The most recent official inflation figure is for February 2008: awhopping 165,000 percent year-over-year. At present (early June 2008), inflation is unofficiallyabout 2.5 million percent a year. Not surprisingly, the Zimbabwe dollar has lost more than 99.9

percent of its value against the U.S. dollar during the past year.Zimbabwes hyperinflation is destroying the economy, pushing more of its inhabitants into

poverty, and forcing millions of Zimbabweans to emigrate. Between 1997 and 2007, cumulativeinflation was nearly 3.8 billion percent, while living standards fell by 38 percent..

Year Real GDP percapita growth

Consumerpriceinflation

Lendingrate a

Realinterestrate b

1990 3.7 15.5 11.7 -5.61991 3.8 46.5 15.5 -8.51992 -11.2 46.3 19.7 -21.81993 -1.4 18.6 36.3 8.11994 2.3 21.1 34.8 12.61995 -3.1 25.8 34.7 12.21996 6.2 16.4 34.2 12.61997 2.4 20.1 32.5 13.71998 0.4 46.7 42 10.71999 -3.3 56.9 55.3 -2.62000 -7 55.2 68.2 12.62001 -2.4 112.1 38 -35.32002 -4.1 198.9 36.4 -96.7

2003 -11.3 598.7 97.2 -267.72004 -3.3 132.7 278.9 -712005 -4 585.8 235.6 -2.12006 -5.4 1281.1 496.4 -520.22007 -6.1 108,844.10 543.61 -565.62


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y On the surface, there is only one reason for hyperinflation: the money printing press. Without a too high speed of injecting money into the economy, there would be noinflation. And without an ever-increasing speed of doing so there would behyperinflation.

y As there is an excess supply of the Zimbabwean dollars in the market and the

corresponding demand for it being low, there is depreciation in the value of the currency.Super markets in Zimbabwe are accepting only US Dollar and South African Rand, andthose people who do not have access to foreign currency are in a complicated situation.

y With the spiraling prices there seems to be a cash shortage, the government has imposedstrict limits to the amount people can withdraw. Even so, Zimbabweans wait in vain for hours at banks that send their customers away empty-handed.

y But why is it that the money printing press is ordered to work in an ever-accelerating way? It is simply a reaction to the plummeting of state revenues from taxes,royalties and import duties. This, in turn, is the result of a steady decrease of production,employment and exports a tendency that has even accelerated over recent years and haseventually reduced GDP to a half of what it was around ten years ago.

Land Reform Policies

y The inflation was stable until of land reforms took place thereby taking the lands from thewhite farmers and redistributing them to the black farmers. The efficiency of the black farmers was far lesser than the white farmers, hence the output of the nation reduced.The export basket of Zimbabwe mainly constituted of agricultural products a decade ago.But due to the land reforms policies adopted by the government, there has been a greatdownfall in the agricultural production over the years.

Faulty central bank policies :

y The source of Zimbabwes hyperinflation is the ReserveBank of Zimbabwes money machine. The government spends,and the RBZ finances the spending by printing money

Relation with the International Monetary fund :

y IMF (International Monetary Fund) hit the last nail on thecoffin by adamantly asking for arrear payments of its earlier loans and refusing new loans as the Mugabe government refusedto accept any of the political reforms suggested in 2001. As aresult Zimbabwe defaulted on some of its loans

y Under such circumstances Zimbabwe was forced to go ona note printing spree to make interest payments and finance itsever increasing fiscal deficit. The four factors of production-land, labour, capital and entrepreneurship virtually beingcontrolled


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y Thus people spent whatever they earned immediately before the currency could lose itsvalue. Ultimately this led to one-third of the population fleeing to other countriestriggering a refugee crisis for the bordering countries.

y Sanctions and trade embargos drained the flow of foreign capital and the governmentcould not provide the necessary resources to recuperate the dwindling foreign reserves of

the economy. Conditions were such that people lost faith in the Zimbabwean dollar, a parallel black market was flourishing with the South African Rand and USD being the principal mode of exchange as the ZD was artificially overvalued against its current level.

Conservative attitude towards foreign capital :

y The foreign companies were not allowed to repatriate their profits and new investmentsin foreign currency were discouraged. This led to acute shortage of the foreign fundsrequired to get technology.

y The wages in the economy were fixed and the corporates were not allowed to hire or fireanyone without permission. This increased the expenses of the firms both in terms of time and wages.

y The public spending increased by leaps and bounds. This resulted in budgetary deficit.The govt. decided to issue currency notes in order to cover the deficit. This deficitfinancing led to the more alarming hyperinflation.

Foreign currency shortages :

y Foreign currency shortages as well as exchange rate misalignment have also resulted ingeneral increase in prices. Although foreign currency shortages have been a perennialeconomic problem for Zimbabwe since independence, the severity of the problem firstcame to light in 1987, before subsiding and reappearing again at a severe scale since2000.

y Added to the shortage is the exchange rate misalignment where by the official exchangehas been far below the market-determined rates, resulting in a growing black/parallelmarket for foreign currency. Due to this shortage, imports of raw materials have beenacquired using expensive foreign currency from the black market. The ultimate effect of this has been cost-push inflation.


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v d e

Zimbabwean inflati on rates (o fficial) since inde p endence

Date Rate Date Rate Date Rate Date Rate Date Rate Date Rate

198 0 7% 198 1 1 4% 1982 15% 1983 19% 1984 10 % 1985 10 %

1986 15% 1987 10 % 1988 8% 1989 14% 199 0 1 7% 199 1 48%

1992 4 0% 1993 2 0% 1994 25% 1995 28% 1996 16% 1997 2 0%

1998 48% 1999 56.9% 2 000 55.22% 2 001 11 2. 1% 2 00 2 198.93% 2 00 3 598.75%

2 00 4 132.75% 2 00 5 585.84% 2 00 6 1,28 1 . 11 % 2 00 7 66 ,2 12.3% 2 00 8 23 1,1 5 0,888.87%

(Jul)

2 00 9

STRUCTURAL FACTORS :

Structural factors are also believed to influence the rate of hyperinflation in Zimbabwe.y Examples include weather conditions and pricing policies of the government.y The governments intention of protecting the general consumers through controlled

market/consumer prices wrecked havoc in most production industries, especially the foodsector as the decreed prices have been far below production costs, resulting in somecompanies reducing production, reducing quality or diverting production to other relatedgoods.

y These production problems have resulted in shortages of some basic commodities,leading to demand pull hyperinflation. The effects of droughts since 2000 coupled withunder utilization of most commercial farms (after the land reform) have also resulted in

production decline and shortages of most locally produced consumption products.

POLITICAL FACTORS :

The political scenario in Zimbabwe was one of the key factors underlying the economic and political crisis. Some of these factors which have led to political unrest and economic slowdownare:

y The government and the judiciary have been militarized. Under the Mugabe governmentregime, people have lost faith on government and the judiciary system of the country.The main reason for this is the corruption that exists in the present government.


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y Tony Blair and Gordon Brown have been demonizing Robert Mugabe downplaying anyof his past achievements. This severed the Zimbabwe-United Kingdom relations and gave

both political actors the opportunity to blame each other for the ongoing crisis inZimbabwe.

y The international sanctions imposed on Zimbabwe were not carefully planned; some of

them affected regular Zimbabweans more than it affected politicians and members of thegovernment. For the last eight years, China has been the only major source of financingfor the Zimbabwean government, imposing harsh economic restrictions, a rather significant interest rate (6.4%) and other economic challenges. Chinese businesses inZimbabwe are keeping Mr. Robert Mugabe in power but are harming the overalleconomy.

y South African President, Thabo Mbeki has been poorly managing the crisis. Whilecommitting to principles of democracy and free elections, he has been trying to keep thedoor open to Mugabe by giving him full liberty of action. This helped Mugabe maintainhis status without being fully compromised. The relationship between Thabo Mbeki andRobert Mugabe is one of the causes of political and economic failure in the case of

Zimbabwe.y None of the alternative sources of financing in Zimbabwe (China, India or the Arab

League) put any pressure on Mugabes regime to redress economic problems or assurefree and democratic elections. These external forces financed the government (anestimated 20 % of the national GDP of Zimbabwe comes from China, India and the ArabLeague) but did not ask for any evidence of state accountability in return.

y The opposition in Zimbabwe has not proposed a sustainable alternative. The democraticchange is still to be seen but, until now, Tsvangirai has not convinced too many peoplethat he is so different from Mugabe ideologically or pragmatically. To put it mildly, theoppositions alternative policies that will help redress the economic problems Zimbabweis facing is rather light.

y Other African leaders have carefully avoided getting involved in the Zimbabweanaffair despite their demagogical speech that we all live in a global village and whathappens in Africa concerns us all. They claim Africans should be united againstdictators but make no step forward in securing real democratic elections on the continent.

y Mugabe is still seen as the great liberator of the 1980s. For that reason, any outsideinterventions or attacks are dismissed by Africans as being reminiscences of the colonialsystem

y Mugabe will only be removed from power once Africans start judging him for what hereally is: a despot in the 21st century.


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(ZIMBABWES MONTHLY INFLATIONTREND: 1999-2008)

EFFECT S OF HYPERINFLATION ON THE ZIMBABWEAN ECONOMY:

Zimbabwes hyperinflation has resulted in a 6 year economic recession, de-industrialization, lossof skilled labour through emigrating and increasing impoverishment. In addition, politicalviolence, erosion of the rule of law, and basic human rights has resulted in international isolation.Printing paper money to fund government expenditure and onerous debt payments whose valueis not linked to productivity has worsened the situation.

Some of the most significant effects are:

Redistribution of income :

The first effect of the hyperinflation is a gigantic redistribution of income and wealth.Holdersof savings accounts have of course lost since long the total former value of their savings.Wages and salaries of employees have been much less than fully inflation-adjusted.Inflation has redistributed income from those on fixed incomes, such as pensioners, and

shifted it to those who draw a variable income, for example from wages and profits whichmay keep pace with inflation -- any senior pensioner still receiving a couple of thousandZimbabwe dollars being a clear example.

Similarly, it has redistributed wealth from those who lend a fixed amount of money to thosewho borrow. For example, where the government is a net debtor, as is usually the case,inflation will reduce this debt by redistributing money towards the government. Thusinflation is sometimes viewed as similar to a hidden tax. This discourages savings andinvestment, the actual tax regime becomes impossible to calculate.Processing a cheque takes four days. That is enough reason for the seller of a good to demandthe ten-fold price compared to a cash payment


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Reduction in E fficiency of E conomy : Hyperinflation reduces the efficiency of economy by forcing the agents to switch fromfinancial transactions towards barter. This is what happened in Zimbabwe . The Zimbabwean

population started trading in commodities. If they are paid in commodities, they spend theamount as soon as possible. Thus, capital erodes continuously and the efficiency of an

economy falls.

Food Shortage and MalnutritionAbout 5 million people in Zimbabwe -- about 50 percent of the country's population are in needof food aid Serious child malnutrition has increased by nearly two-thirds in parts of Zimbabwecompared to last year. In normal times, Zimbabwe consumes 2 million tons of corn a year whichis their staple food.. The drought in the year 2007, described as the worst in 50 years by localfarmers, has reduced that amount to only 750,000 tons. The country used to export grain andtheir harvests were very successful. But World Food Programme (WFP) officials say disruptionto agriculture because of the government's land seizure programme has worsened the problem.Among the reasons for the rising malnutrition is a breakdown in Zimbabwe's farming sector,

where President launched a land reform project targeting white-owned farms Breakdown of utilities and unemployment :

Basic public services in Zimbabwe are in bad shape as tens of thousands of teachers,nurses, garbage collectors and janitors have simply stopped reporting to their jobs because their salaries become worthless literally by passing of every hour, their salaries can no longer cover the cost of taking the bus to work. This rampant hyperinflation has left 80% of the populationunemployed and schools are running without any students. No nurses in the hospital, no teachersin the school and no one to collect the garbage from the streets, 16 people were reported dead ina village since the outbreak of cholera. This is the collapse of the entire system in Zimbabwe.

International trade : As the rate of inflation is much higher than that abroad, a fixed exchange rate is underminedthrough a weakening balance of trade, and forex shortage has set in. The international trade hastaken a huge hit especially with South Africa, the biggest trading partner of Zimbabwe once..MEA S URE S BY GOVERNMENT :

The Zimbabwe central bank has unveiled a set of new monetary measures to curb the country'shyperinflation.

1. Monetary Policy measures2. Printing lump sum currency

3. Introduction of a new currency4. Raise of daily cash withdrawal limits5. Introduction of old coins in circulation.

Monetary policy measures

High interest rates and slow growth of the money supply are the traditional ways throughwhich central banks fight or prevent inflation, though they have different approaches The


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Reserve Bank of Zimbabwe has affected inflation by setting interest rates and through openmarket operations But these measures have been rendered ineffective .The inflation is at 24 000%, the RBZ borrows through treasury bills at 340% then on-lends the money at 25% .Thissequence of rates is a disaster. If monetary policy was to be an effective tool, using the abovenumbers, the RBZ would have to borrow at slightly above 24000%, then on-lend at even higher

rate say 24 050%. ON July 30, 2008, the Reserve Bank of Zimbabwe (RBZ) released the Mid-Term Monetary Policy which included currency reforms. The Mid-Term Monetary Policymentioned the need to invite private sector participation in various sectors. This is a positivemeasure but needs to go further and in fact pursue an aggressive privatization programme whichwills free State resources only to those areas in which the private sector has no capacity.

The currency reforms are welcome in as far as they address the strain on IT systems and thegeneral burden to the public of travelling with huge amounts of currency even for simpleshopping trip. But the economy is unlikely to improve. In the absence of an undisputed politicalsettlement, Zimbabwe will remain with the crisis of confidence and as such investment,

production and international support will remain at undesirably low levels. The Zimbabwe dollar will remain weak and under speculative pressure due to the depleted foreign currency reserves.In addition, the inflation differential between Zimbabwe and its major trading partners is so highthat the Zimbabwe dollar cannot sustain its newly acquired value for any foreseeable future.

Printing lump sum currency

The body responsible for printing the currency cannot physically print paper currency faster than the rate at which it is devaluing, thus neutralizing their attempts to stimulate the economy.This is clear with the new $750,000 bearer cheque. The countrys highest note cannot even buy aloaf of bread. Now, the question arises as to why the government prints such large quantities of money? This is because they had salaries to pay, projects to fund and things to buy. They weresuddenly faced with the crisis of having to pay much more for things and they didnt have

enough so they printed more money to cover it.Redenomination

The central bank has slashed off 10 zeros from the country's currency, thus turning 10 billion dollars into one dollar. At the same time, the governor announced the introduction of a500 dollar note. The new and old currency will co-circulate with the existing bearer checks andspecial agro checks. The removal of zeros only works if accompanied by an influx of forex tosupport the local currency. This can be in form of foreign aid, foreign direct investment or increased exports. he removal of zeroes would have been a perfect measure if supported bysignificant balance of payment support from various sources including IMF, Africa DevelopmentBank, PTA Bank and the wider international community

Raise of daily cash withdrawal limits

Further, the central bank chief raised the daily cash withdrawal limits by 1,900 percent to 2trillion dollars or 200 dollars in the new currency.

Introduction of old coins in circulation


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While introducing a new 25 cent coin, the RBZ introduced old coins which were hoped toincrease the amount of money in circulation. The old coins include 5 dollars, 2dollars, 1 dollar,and 50 cents, 20 cent and 10 cent coins.

ACHIEVING MACRO ECONOMIC S TABILIZATION IN ZIMBABWE:

RECOMMENDATION S

Accelerating inflation in Zimbabwe has been fueled by high rates of money growth reflectingrising fiscal and quasi-fiscal deficits. Quasi-fiscal losses reported by the RBZ, which haveincreased sharply since 2007, have reflected mainly large foreign exchange subsidies to publicenterprises and government, price supports to exporters (to partially compensate them for thehighly overvalued exchange rate), and interest payments on open market operations. These lossesnow reduce the traditionally measured government deficit. For Zimbabwe, the followingmeasures are recommended as an initial stabilization package:

Replacing the central bank : The most rapid and reliable way to stop hyperinflation in Zimbabwe is to replace central bankingwith a new monetary regime. That would signal a clean break with the practices that havecreated hyperinflation and would assure Zimbabweans that inflation will henceforth becontrolled.In Zimbabwes historical experience with a variety of monetary systems, only central bankinghas produced hyperinflation. Central banks can put a stop to inflation as fast as they can fuel it.


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All they have to do is stop the printing presses. Unfortunately, they can switch course again withease. Consequently, under central banking, inflation can return as easily as it was snuffed out.

DollarizationDollarization occurs when residents of a country extensively use the U.S. dollar or another

foreign currency alongside, or instead of, the domestic currency. Unofficial dollarization occurswhen individuals hold foreign-currency bank deposits or notes (paper money) to protect againsthigh inflation in the domestic currency. Official dollarization occurs when a country uses aforeign currency as the main, or only, component of the monetary base

Free banking A completely free banking system has no central bank, no lender of last resort, no reserverequirements, and no legal restrictions on bank portfolios, interest rates, or branch banking. Free

banking systems existed in nearly 60 countries during the 1800s and early 1900s. In general,these systems were relatively stable, issued currencies convertible into gold or silver at fixedexchange rates, and were not purveyor of inflation

A currency board A currency board is a monetary institution that issues notes and coins.Its monetary liabilities are fully backed by a foreign reserve currency, also called the anchor currency, and are freely convertible into the reserve currency at a fixed rate on demand. Thereserve currency is a convertible foreign currency or a commodity chosen for its expectedstability. As reserves, a currency board holds low risk, interest-earning securities and other assets

payable in the reserve currency. A currency board holds reserves equal to 100% or slightly moreof its notes and coins in circulation, as set by law.

Liberalizing the e x change regime This can be done by unifying the exchange rate and removing restrictions on currentinternational payments and transfers . The interbank exchange rate would need to be substantiallydevalued and all multiple exchange rates eliminated. The interbank rate should then bedepreciated steadily toward the parallel market rate (which would appreciate as fiscal andmonetary policies are tightened), and the unified exchange rate subsequently floated.

Deregulation of prices One of the most necessary steps is to deregulate prices and impose a hard budget constraint on

public enterprises . Enterprises need a hard budget constraint that requires them to cut costs and operate at preset levels of budget subsidies and agreed pricing formulas. Price deregulationwould likely lead to a spike in prices, but strong fiscal adjustment would ultimately reduceinflation pressures.

Structural Reforms Achieving sustained growth in Zimbabwe will require in addition to stabilization acomprehensive structural reform and better governance over the medium term.Improving governance, will be essential for reinvigorating investor confidenceA broad agreement among stakeholders on land tenure may be needed to achieve sustainedgrowth in agriculture and in the economy on a general basis.


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HINT OF OPTIMISM :

Things seem to be improving for Zimbabwe as Robert Mugabe has agreed to share power with the opposition party, MDC (Movement for Democratic Change). Investment outlook hasimproved as hotel occupancy rates in Harare hotels have gone up with an influx of foreigninvestors, showing confidence in this new political arrangement. The economist are united in theview that things would improve if people started going back to their jobs as the production cycleswould dissipate Zimbabwes woes.

The World Bank has also indicated in this direction by granting fresh loans of 21.4million in aggregate with the FAO (Food and Agriculture Organization) recently. This loan is

primarily aimed at providing fertilizers and seeds in the wake of the coming sowing season. Thiswill act as a starting point for Zimbabwes road to recovery. However, the Central Bank has todesist from its note printing spree. The chairman of RBZ (Reserve Bank of Zimbabwe), Mr.Gideon Gono, recently said I am going to print and print and sign the money until sanctions areremoved. Such overzealous attitude has to be replaced by Keynesian economics and soundmonetary policy. The challenges for Zimbabwe will not only test modern economic theories butalso the zeal of people to bounce back from the fangs of tyranny. Robert Mugabes continuanceat the helm of affairs casts doubt in the minds of the foreign investors. Even a benevolentMugabe will not necessarily enable a success in the fight against hyperinflation.

CONCLUSION :

Since 1998, Zimbabwes economy has been on a road to ruin. Per capita GDP has contracted ineach year; inflation has surged; real interest rates have been negative; the value of the Zimbabwedollar has been wiped out; personal savings have been destroyed; the nations capital stock hasshrunk; and businesses working capital has been decimated. This state of economic ruin hasforced millions of Zimbabweans to lose hope for Zimbabwes future and to emigrate. To restoreeconomic growth, hyperinflation must be extinguished rapidly, and people must have confidencethat inflation will not return. Otherwise, unstable expectations and uncertainty will arise andundermine the stabilization program and economic growth.Confidence can best be restored if Zimbabwes central banking system is replaced with one of the three options presented in this study: dollarization, a currency board system, or free banking.

None of these options requires preconditions prior to its implementation, and any one of themwould establish stability and restore economic growth. The challenges for Zimbabwe will notonly test modern economic theories but also the zeal of people to bounce back from the fangs of tyranny. Robert Mugabes continuance at the helm of affairs casts doubt in the minds of theforeign investors. Even a benevolent Mugabe will not necessarily enable a success in the fightagainst hyperinflation.


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R E F E R E NC E S :

(www.newzimbabwe.com) (www.cato.org/pubs/articles/Hanke_zimbabwe_091708.pdf)

(www.imf.org) http://www.nytimes.com/2008/10/02/world/africa/02zimbabwe.html http://www.nber.org/papers/w12163 www.thezimbabweindependent.co.zw http://www.freedomhouse.org. www.bloomberg.com www.economist.com http://www.swivel.com/data_columns/spreadsheet/8059577 www.cato.org/zimbabwe www.cnn.com/2008/WORLD/africa/11/03/zimbabwe.money/index.html web.up.ac.za/User Files/WP_2007_10.pdf

Hyper Inflation Group 3 Sec b

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Transcript of Hyper Inflation Group 3 Sec b