Hyper Inflation in Zimbabwe Report1

8/8/2019 Hyper Inflation in Zimbabwe Report1

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ZIMBABWE CRISISThe Hyperinflation Episode

Submitted By:

Aakash Rungta (32292)

Ankit Dhanuka (32273)

Gautam Arora (32154)

Kulin Shah (32294)

Kalash Pandey (32167)

Raveendra Singh (32196)

Saurabh Agarwal (32153)

Shivthilak Tallam (32298)


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Table of Contents

Inflation and Hyperinflation ................................ ................................ ................................ ............... 3

History of Zimbabwe ................................ ................................ ................................ .......................... 5

Road to hyperinflation and dollarization ................................ ................................ ............................ 6

1997 to 1999: Political vulnerability and economic breakdown ................................ ...................... 6

2000 to 2003: Land reform and destruction of the production base................................ ............... 7

2004 to 2007: Pseudo-Keynesian economics ................................ ................................ .................. 8

Impact on Economy ................................ ................................ ................................ ........................... 9

Loan Sanctions by IMF ................................ ................................ ................................ ..................... 10

Monetizing the Fiscal Deficit ................................ ................................ ................................ ............ 11

Revaluation of Zimbabwean Dollar ................................ ................................ ................................ .. 12

Impact of Revaluation ................................ ................................ ................................ ...................... 13

Challenges andPolicy Options after Hyperinflation ................................ ................................ .......... 14

Possible Approaches to Hyperinflation ................................ ................................ ............................. 15


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Inflation and Hyperinflation

Inflation is an increase in the overall level of prices or decrease in the value of money.Inflation is caused by:

y an imbalance between the money supply and the goods and services in an economy

y and/or when confidence in the currency is eroded.

Inflation is always and everywhere a monetary phenomenon.Milton Friedman, A Monetary History of the United States 1867-1960 (1963)

HyperinflationHyperinflation is a situation where the price increases are so out of control that the concept ofinflation is meaningless. A working definition (definitions vary from 100% p.a. for 3 years to 50%a month) is that a country is in hyperinflation when its annual inflation rate reaches 1000% p.a.

Where Pt = P0 (1+r)t

P0 = Current PricePt = Price after time tr = inflation rate

Possible indicators of hyperinflation:

y The general population prefers to keep its wealth in non-monetary assets or in a relativelystable foreign currency. Amounts of local currency held are immediately invested tomaintain the purchasing power.

y The general population regards monetary amounts not in terms of the local currency but interms of a relatively stable foreign currency. Prices may be quoted in that foreigncurrency.

y Sales and purchases on credit take place at prices that compensate for the expected lossof purchasing power during the credit period, even if the period is short.

y Interest rates, wages and prices are linked to a price index and the cumulative inflationrate over three years approaches, or exceeds, 100%.


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Hyperinflationary Models

Confidence Model: Some events or series of event cause the people to lose confidence on the

money issuing authority. Because of this, people prefer either keeping goods or money of someother nation. The suppliers start charging premium for their products which is much higher than

the actual price. To overcome this, the best policy is changing the backing of the currency byissuing a new currency.

Monetary Model: The money issuing bodies start printing money (not supported by grossdomestic product (GDP) growth, resulting in an imbalance in the supply and demand for themoney) to pay the debts or to cover costs coming up because of social unrest or war. Whenbusinesses perceive that the issuer is committed to a policy of rapid currency expansion, theymark up prices to cover the expected decay in the currency's value. The money issuing authoritymust then accelerate its expansion to cover these prices, which push the currency value down.

Seigniorage &Hyperinflation

Seigniorage is the revenue the government gets from printing new money.

SE = M/P

Seigniorage LafferCurve

Seigniorage Laffer Curve shows the relationship between steady state inflation rate and

Seigniorage revenue. It indicates that Seigniorage revenue must rise for a while and then fallagain as inflation rises. Therefore there is an inflation rate that produces a maximum amount ofSeigniorage with a stable rate of inflation. Above that rate, it is possible to collect moreSeigniorage only if inflation rate is increasing.

Hyperinflation can be experienced when the government face a greater need of Seigniorage tofinance its increasing fiscal deficit and after the Seigniorage maximizing inflation rate is reached.Above that rate, the curve indicates that revenue decreases.


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History of Zimbabwe

In 1980, the new nation of Zimbabwe rose as Rhodesia gained independence from the BritishEmpire. Rhodesia had long been considered the jewel of Africa as it was rich in fertile farmlandsand raw material such as gold and chromium. The rule of law was secure as much of the

population trusted the police and believed in equitable treatment in the courts. With low crime,strong banking, a sophisticated manufacturing base, and booming tourism; real GDP growth

averaged a strong 4.3%.

Prior to independence, Rhodesia had been administrated by Great Britain during the late 19thcenturys Race for Africa as part of the British South Africa Company. The Colony of SouthernRhodesia was created in 1923, granting self-rule to the white colonists, while leaving blacksdisenfranchised.

Rhodesia enacted the Land Apportionment Act in the year 1930, forbidding land ownership forblacks outside of tribal reserve areas. During that time, the British built an agricultural empire inthe colony, developing one of the most sophisticated water delivery systems in Southern Africa.

With only 7% of the land, Rhodesia had 86% of the areas dams and 93% of the reservoir surfacearea at the time of independence, serving an agricultural sector that was the backbone of athriving economy: strong enough to feed all of its seven million people and export the rest to the

world.

Around 70% of the Rhodesias vast farmland had been run by about 4,500white farmers whoproduced cash crops such as tobacco and cotton.These white-owned farms supported:

y a flourishing banking sectory loaning funds for machinery, seeds, tools

y most importantly, the water delivery system.

The farms employed some 350,000 black workers and provided money for local schools andclinics. With the Zimbabwean dollar replacing the Rhodesian dollar at par and trading for US$1.59,the economic future looked bright for the fledgling democracy of Zimbabwe.

That is, until Robert Mugabe came to power.

In 1960s, Mugabe became prominent and became the Secretary General of the Zimbabwe AfricanNational Union a militant organization that fought the British in the Rhodesian Bush Warthroughout the 1970s. In a nation where there was only 1 white for every 22 blacks, Zimbabwehadnt seen blacks in a position of power until 1979 and then only in lower ministerial positions.

The ZANU (Zimbabwe African National Union) fought this inequitable bi-racial rule side by side withthe Zimbabwe African Peoples Union comrades in arms united only by their desire to expel theBritish from their country. Once that end had been achieved, the two groups had divergentphilosophies about the governance of the country: Mugabes group had Maoist beliefs, while theZAPU (Zimbabwe African peoples Union) was Marxist.

When the war concluded in 1979, Mugabe was hailed as a national hero, and won election to thepost of Prime Minister in the first election following independence. Since then, the two opposinggroups have been embroiled in a bitter civil war for control of the nation, with Mugabes ZANUretaining control through force, intimidation, and outright murder. Elections are held from time totime; the results are usually rigged by the ruling ZANUs. In 1987, the position of Prime Ministerwas abolished, with Mugabe seizing new powers relegated to the position of Executive President ofZimbabwe and effectively becoming Dictator.

While Rhodesias white-owned farms thrived, as a result of the Land Apportionment Act some840,000 black farmers were crowded into eroded and over-farmed land unconnected to theirrigation grid, producing corn, groundnuts, and other staples. This land was without title, andsquabbling over land rights between villagers was rampant. As part of the Lancaster HouseAgreement the nations independence agreement with Britain the subject of land redistributionwas blocked until 1990. Mugabe sought to institute land reform, with the goal of redistributing thewhite-owned farms to black farmers. The nations constitution forbade the seizure of land withoutproper compensation, and the electorate rejected a 1999 referendum to amend the constitution toallow it.


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Road to hyperinflation and dollarization

1997 to 1999: Political vulnerability and economic breakdown

In August 1997, approximately 60,000 war veterans were granted ZWD 50,000 each

(approximately USD 3,000 at the time) plus a monthly pension of approximately USD 125 permonth outside the budget. The payouts amounted to almost three percent of GDP at the time and

this had the immediate effect of inflating the budget deficit at the end of 1997 by 55 percent from

the 1996 levels. Concerns were raised pertaining to the financing side of the transaction in view of

an already precarious fiscal position, and on that basis in September 1997, the World Bank

temporarily withdrew a USD62.5 million standing credit line for the balance of payments support

until the government had demonstrated that the payments would not result in a higher than the

projected 8.9 percent budget deficit in the 18 months leading to December 1998. As an ad hoc

decision, the government had intended to accommodate the gratuities payment through tax

increases in the 1998 budget but countrywide protests orchestrated by the trade unions forced the

government to backpedal and resolve to monetization of the transaction.

The second populist decision followed in November 1997 when the president, Mugabe, announced

plans to compulsorily acquire white-owned commercial farms, again without elaboration on thefinancing side of the transaction. This had the immediate effect of giving investors a perception of

an ensuing precarious fiscal position and consequently there were spontaneous and concerted runs

against the currency from the money and capital markets. The climax of these events was on 14

November 1997 when the Zimbabwean dollar crashed and lost 75 percent of its value against the

USD on a single day, on what is now known as Black Friday in Zimbabwean economic history.

The stock market also plummeted and the index was down by 46 percent by day end from the

peak August levels. The central bank had to intervene and raise interest rates by six percentage

points within that single month. The exchange rate continued to depreciate uncontrollably, thus

the 1997 financial and currency turbulence set the stage for a long and potentially long slump in

the real economy.

In September 1998 the president agreed to send 11,000 troops under the SADC protocol, to the

Democratic Republic of Congo (DRC) to back the discredited leader, Kabila, who was under attack

by Rwandan and Ugandan backed rebels. This act was simply the utilization of national military by

the political elite for private financial gain as it emerged that the Zanu PF bigwigs had been

promised mineral concession in the DRC. A letter written by the finance ministry to the IMF

seeking funds puts the funds to finance the war at USD 1.3 million per month in 1998 or 0.4

percent of GDP and in 1999 when additional troops were deployed at USD 3 million per month or

at 0.6 percent of GDP (IMF, 1999). The country could not spare forex outlays of such magnitude

and this consequently weakened the currency, again with pernicious effect on price stability. There

was intense pressure on the currency and in a bid to increase the flows of foreign currency which

were dwindling at precariously low levels, the central bank reintroduced widespread import

controls and banned foreign currency accounts. This decision was futile as in the first quarter of

1999 the central bank, had to devalue the currency by 50 percent to trade at USD1: ZWD38 from

USD1: ZWD25

The aforementioned events marked a period in which the inept handling of government

expenditure instigated investors to lose confidence in the currency with the consequence that they

ran away from it thereby putting a pressure on the exchange rate, which fuelled inflation through

the increase in the prices of import. Thus a characterization of inflation in this first period is that it

was of a cost-push nature.


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2000 to 2003: Land reform and destruction of the production base

y The presidents rhetoric on confiscation of white-owned farms was elevated to the next

level in early 2000, when war veterans, who courtesy of the gratuities, were now the

paramilitary wing of the ruling Zanu PF party, started invading white-owned farms as part

of an elaborate scheme by Zanu PF to terrorise people to vote for it in the parliamentaryelection in July 2000. The government delineated the parameters of its land redistribution

policy embodied in the fast-track land reform programme under which 300,000 households

and 51,000 black commercial farmers would be apportioned the previously white-owned

commercial farmers.

y As a result of the upheavals on the farms, agricultural output fell dramatically from the

level of 18 percent of GDP in 2000 to 14 percent of GDP in 2002 (World Bank, 2008).

Export proceeds from tobacco declined from USD612 million in 1999 to USD321 million in 2003.

y The government could not service its multilateral debts obligations and as a result in

October 2000, the World Bank suspended any extra lending to Zimbabwe under the IBRD

and IDA facilities due to non-payment of over six months (World Bank, 2000). On the

other hand the government could not import essential raw materials and fuel as a result of

the declining forex inflow, which further fed into falling production with the result that by

2004, total foreign currency earnings from the export of goods and services had declined

to less than half the 1996 peak of USD3,169 million (World Bank, 2008). In purported

retaliation to the perceived deterioration of human rights conditions in the country, the

European Union imposed sanctions against the country, after Mugabe had ejected a

Swedish election observer before the 2002 elections. Under the terms of the sanctions, the

European Union suspended budgetary support to Zimbabwe and terminated financial

support for all projects except those in direct support of the population.

According to this analysis the major driver of inflation in this period was the shrinkage in

aggregate supply sparked by the fall in the agriculture, which then spread to other sectors of the

economy. The shrinkage in aggregate supply would ceteris paribus, trigger price increases which

ignite the price-wage spiral.


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2004 to 2007: Pseudo-Keynesian economics

y On 1 December 2003 a new governor, Gono was appointed to head the central bank. The

battle against inflation, which now stood at 263percent on a year on year basis at the

end of2003, became Gonos first priority. He undertook money-targeting framework as

the monetary policy strategy and consequently set up a Framework for LiquidityManagement, which was to contain money supply growth to levels consistent with inflation

targets.

y The interest rate was the operational target and it was raised acutely in the first quarter of

2004, reaching a peak of 5,242 percent annually in March 2004. Inflation which had

soared from about 20 percent in December 1997 to a peak of 623 percent in January

2004, decelerated sharply from March to around 130 percent at the end of 2004 (RBZ,

2007).

y The high real interest rates and an increasingly overvalued official exchange rate was also

putting pressure on domestic producers and exporters, and in a move tobail out the ailing

industries, the central bank started engaging in quasi-fiscal activities. The quasi-fiscal

activities went beyond the operational realm of a normal central bank and had the effect of

undoing the ephemeral achievements in the inflation battle and firmly set course for the

drive towards hyperinflation. At the height of these quasi-fiscal activities, money (M1) wasincreasing at the rate of 66,659 percent annually in 2007 and this feed to demand pull

inflation during this period.

y The ravaging inflation standing at over 1000 percent meant that the people had to carry

large sums of currency to conduct the simplest of transaction and on 1 August 2006, the

Zimbabwean dollar was replaced by a new Zimbabwean dollar exchanging at a ratio of

1000:1 and it was subsequently devalued against the USD. A transition period of 21 days

during which both currencies co-existed was given and thereafter the old notes ceased to

be legal tender.

Given the cosmetic nature of the reforms, there was no sign of recess in inflation and Zimbabwe

formally entered hyperinflation in March 2007 when month-on-month inflation reached 50.54

percent and year-on-year 2,200 percent (RBZ, 2007). This period thus, marked the countrys

accelerated drive towards hyperinflation fuelled by the central banks quasi-fiscal activities meantto fund the political campaigns of an unpopular ruling regime. In terms of economics, the

characterization of inflation in this period is therefore of a demand pull nature


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Impact on Economy

y Financial investors fled the country, concerned that other businesses may go the way ofthe farms, with foreign direct investment falling 99% between 1998 and 2001.

y Since there were no more land titles, there was no collateral for bank loans, causingdozens of banks to collapse. The farmland lost an estimated three quarters of its valuebetween 2000 and 2001, amounting to $5.3B in losses.

y The collapse of the farmland led to widespread famine and, since it no longer had anyowners, the prized irrigation system was dug for scrap, some being melted for coffinhandles one of the few growth industries left in the country.

y As figure shows, agricultural production declined sharply, with 2005 output being onlyslightly above 1992 one of the worst drought years on record. For years afterward,

Mugabe used this drought to explain the drop-off in production. Real GDP followedagriculture, as could be expected in a primarily agrarian economy. In 2007, it returned tothe level it had been at independence 27 years earlier.


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Loan Sanctions by IMF

y Following the drought of 1992, the government of Zimbabwe began receiving loans fromthe International Monetary Fund. Repayment of these loans had been relatively steady

until 2000, when the confiscation of farms and the subsequent slowdown of productioncaused the government to fall behind in its payments.

y In response to the deteriorating political and economic situation in Zimbabwe, PresidentBush signed into law the Zimbabwe Democracy and Economic Recovery Act of 2001,enacting sanctions against the nation by instructing the US Treasury and US members ofinternational financial institutions to oppose the extension of any loans to Zimbabwe.

y The IMF declared Zimbabwe ineligible to access Fund resources and suspended theremaining payment support. Mugabe and the government of Zimbabwe have repeatedlycited these sanctions as the primary cause of their economic collapse. In 2004, due totheir inability to repay the loans, Zimbabwe was expelled from the IMF, and repaymentseffectively ceased (IMF).


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Monetizing the Fiscal Deficit

y In the first few months of 2000, the Mugabe government began an aggressive money-printing campaign with ZW$30B, hoping to use the newly-minted money to purchaseforeign currency to pay the IMF arrears, as well as to fund massive amounts of

government spending. Monetary production remained relatively linear until a veritableexplosion in 2000, flooding the monetary supply and causing hyperinflation the likes of

which hadnt been seen since Weimar Germany in the 1920s.

y As the quantity theory of money and common sense tells us, the result of this excessprinting with GDP in decline was that the value of the Zimbabwean dollar collapsedexponentially. As a result, the cost of living skyrocketed in tandem with the monetarysupply. In the thirty years of independence, the cost of living has increased by a factor of

97,072,150,785.138%, and 2,152,473,377.841% since January of 2000. (For comparison,the United States CPI has increased 274.68% since 1980 and 126.69% since Januaryof2000.)

y Estimates vary to the extent of this hyperinflation, as measuring such a behemoth hasbecome all but impossible. In November of 2008, prices were doubling every 24 hours.

The calculation of the CPI in Zimbabwe is an extremely precarious endeavor, as many ofthe goods in the basket are nowhere to be found. Supermarket shelves once full of meat,grain, and supplies have become completely empty.

y Residents of Zimbabwe have taken to substituting whatever is available for the disposablegoods they once purchased: instead of using newspapers for fire kindling, residents usethe abundance of worthless banknotes; instead of using toilet paper, residents have again

taken to banknotes.

y As a result of increasingly worthless bills, Mugabes government has been printing everlarger denominations. In 1980, denominations of 2, 5, 10, and 20 dollars were printed,with the addition of a $50 banknote in 1994 and a $100 note in 1995. When inflationstarted becoming problematic, $500 notes were introduced in 2001 and $1,000 in 2003.When inflation started becoming systemic, denominations up to $100,000 were introducedin 2006 and by July, these were trading for less than US$0.20 on the black market.

y When inflation started becoming endemic, the central bank of Zimbabwe issued a$10,000,000 bill in January of 2008 at the time insufficient to buy a hamburger in aHarare restaurant. It was followed by a $100,000,000,000 note in July of 2008 (Zimbabweintroduces), and a $100,000,000,000,000 bill the worlds first in January of 2009. At


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the time of its issue, it was worth about US$30 (Zimbabwe rolls) a stark contrast to the$1.59 the Zimbabwean dollar was worth at independence and no cash register on theplanet is capable of ringing up so many zeroes.

Revaluation of Zimbabwean Dollar

y In August of 2006, Mugabes government undertook the first of several redenomination ofthe Zimbabwean dollar, removing three zeroes: ZW$1,000 was now ZW$1. At the sametime, Mugabes government pegged the exchange rate at ZW$250, though this laggedbehind the parallel rate of 550.

y In July of 2008, the government redenominated the dollar once again, this time removingten zeroes, followed by the removal of another 12 zeroes seven months late.


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Impact ofRevaluation

As one might imagine, Mugabes monetary policies have been devastating for the people ofZimbabwe.

y

Limited support to the countrys orphaned and vulnerable children, with 79 per cent notreceiving any form of external assistance.y The country, once a net exporter of grain and considered the breadbasket of Africa, has

been reduced to a nation where the highest denominated bill is insufficient to buy a loaf ofbread.

The situation in Zimbabwe can be considered an experiment an outrageously expensive one inreverse. The quantity theory of money: In one broad incompetent swoop, Mugabe has provennearly every macroeconomic theory posited since Smith.

Unemployment:80% (#3 in the

world)

Literacy Rate:(above 15 years)

91.4%

Life expectancy at

birth: 44 years

Population belowPoverty Line: 80%

Public Debt: 218%of GDP

20 %increase inunder-five

mortality since1990 .

HumanDevelopment

Index: 146th of 178


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Challenges andPolicy Options after HyperinflationFollowing a decade of economic decline and hyperinflation during 200708,Zimbabwes economyhas started to grow. The nascent economic recovery has been supported by a significantimprovement in economic policies, but important policy challenges and significant vulnerabilities

remain to beaddressed.

In late 2008, hyperinflation led to abandonment of the Zimbabwe dollar in transactions and defacto widespread dollarization.The officialrecognition of the demise of the Zimbabwe dollar tookplace inFebruary 2009, when authorities established a multicurrency system. Underthis system,transactions in hard foreign currencies are authorized, payments of taxes are mandatory in foreignexchange, and the exchange system largely is liberalized. Since the abolition of all surrenderrequirements on foreignexchange proceeds on March 19, 2009, there has not been a functioning

foreign exchange market for Zimbabwe dollars. Bank accounts denominatedin Zimbabwe dollars(equivalent to about US$6 million at the exchange rateof Z$35 quadrillion per US$1) are dormant.Use of the Zimbabwe dollar asdomestic currency has been discontinued until 2012.

While five foreign currencies have been granted official status, the U.S. dollar has become theprincipal currency. Budget revenue estimates and the budget expenditure allocations for 2009were denominated in U.S. dollars,and the subsequent budget for 2010 was also denominated in

U.S. dollars.For noncash transactions, the market is exhibiting a strong preference for theU.S.dollar: banks estimate that some four-fifths of all transactions are taking place in U.S. dollars,

including most wage payments. Furthermore, stockexchange trading takes place in U.S. dollars,the payments systems operate inU.S. dollars, and the banking system and the Reserve Bank of

Zimbabwe(RBZ) maintain accounting in U.S. dollars. In cash transactions, the U.S.dollar is thecurrency of choice, but the rand is prevalent in the South of thecountry, and it also circulates inthe rest of the country, in particular coins.Wider circulation of the rand is prevented by SouthAfricas capital accountcontrol. Currencies other than the U.S. dollarand the rand have limited

circulation in Zimbabwe.

The multicurrency system has provided significant benefits.Inparticular, it fostered the re-monetization of the economy and financial reintermediation, helped enforce fiscal discipline byprecluding inflationary financing of the budget, and brought greater transparency in pricing andaccounting after a long period of high inflation. As a result, the price level inU.S. dollars declinedduring 2009, while the economy started to recover.

The multicurrency system also poses a number of challenges.First,prices and wages areusually agreed and quoted in U.S. dollars, while SouthAfrica is Zimbabwes main trading partner

and country of origin of capitalinflows. Movements in the U.S. dollar/rand exchange rate thereforehave considerable effects on Zimbabwes competitiveness and international investment position.Second, shortages of small-denomination U.S. dollar banknotes and coins pose difficulties forretailers. Third, some politicians have expressed concern that loss of the national currency andseigniorage isan undesirable erosion of sovereignty and monetary independence.

The government considers the multicurrency monetary regime a temporary arrangementuntil 2012 at least. Therefore, the pros and cons of maintaining the multicurrency regimeindefinitely are not discussed. Despite the remaining challenges, the multicurrency regime couldcontinue to operate with certain improvements until a new regime is chosen. The necessaryimprovements include aligning legislation,including the RBZ Act, with the prevailing practice of useof multiplecurrencies, making exchange controls more transparent, and facilitating thesupply ofcoins, possibly with an agreement with South Africa.

Zimbabwe has beenexperiencing a fragile recovery since early 2009. The jump start in growth hasso far been consumption-led, but Zimbabwes export sector, in particular mining, could potentiallyrecover quickly and provide much needed fiscal revenues to a cash-strapped government withlarge external obligations.

Zimbabwe continues to run large current account deficits financed by short term and volatilecapital inflows and accumulation of arrears. Zimbabwe is indebt distress: external debtof whichabout 64 percent corresponds toexternal arrearsis projected to be about 151 percent of GDP by2015.


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Possible Approaches to Hyperinflation The quickest way to stop hyperinflation in Zimbabwe is to replace central banking with a new

monetary regime. This would instill confidence in the currency. In Zimbabwes historicalexperience with a variety of monetary systems, only central banking has produced hyperinflation.Similarly, throughout the world, hyperinflation has been a phenomenon linked to central banking

or its close cousin, the direct issue of currency by a governments treasury.

During the transition, real interest rates have often been punishingly high, and long-term loans in

local currency have been difficult to obtain. As a result, economic growth has been relatively slow,general living standards have remained stagnant, and the scourge of poverty has spread.

For replacing the central bank with some other monetary regime Zimbabwe has 3 optionsavailable -

1) Dollarization2) Currency board3) Free banking

These options are not mutually exclusive. For example, a currency board system could becombined with official dollarization, as in the monetary systems of Lesotho, Namibia, andSwaziland.

Dollarization:

1. Unofficial

When individual holds foreign currency, bank deposits or notes to protect against theinflation in domestic currency. Zimbabwe was already unofficially dollarized to the extentthat Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreigncurrencies as stores of value. Zimbabwe is already unofficially dollarized to the extent that

Zimbabweans hold South African rand, U.S. dollars, pounds sterling, and other foreigncurrencies as stores of value.

2. Semi-official

Under semiofficial dollarization, foreign currency is legal tender and may even dominatebank deposits, but it plays a secondary role to domestic currency in paying wages, taxes,and everyday expenses such as grocery and electric bills. Unlike officially dollarizedcountries, semiofficially dollarized ones retain a domestic central bank or other monetaryauthority and have corresponding latitude to conduct their own monetary policy.

3. Official

Official dollarization could be based on, for example, the South African rand, the U.S.dollar, or the euro. If Zimbabwe used the rand, it could negotiate a profit-sharing

agreement such as Lesotho and Namibia now have, and which Botswana and Swazilandformerly had. Under these agreements, South Africa shares the profit (seigniorage) itderives from issuing currency, according to estimates of how many rand notes (papermoney) and coins are in circulation in the partner country.

Free banking system

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. Freebanking 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 purveyors of inflation. Zimbabwe had free banking from the time itsfirst bank was established in 1892 but it was replaced by currency board in 1940.

Currency board


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Zimbabwe had currency board in 1940. A currency board is a monetary institution that issuesnotes and coins. A currency boards monetary liabilities are fully backed by a foreign reservecurrency (also called the anchor currency) and are freely convertible into the reserve currency at a

fixed rate on demand. The reserve currency is a convertible foreign currency or a commoditychosen for its expected stability. a currency board holds low-risk, interest-earning securities and

other assets payable in the reserve currency. A currency board holds reserves equal to 100percent or slightly more of its notes and coins in circulation, as set by law.

Financial liberalization

With the elimination of hyperinflation, the rationale for price controls and foreign exchange

controls no longer exists. Both should be prohibited. Other forms of financial repression,including interest rate ceilings, the forced purchase of government bonds, minimum reserverequirements for financial institutions, and the compulsory allocation of credit to favored borrowersshould also be prohibited. This liberalization would permit the free flow of capital into and out of

Zimbabwe. It would also increase the return on savings and reduce the cost of capital inZimbabwe, removing major impediments to economic growth and improved living standards.

Hyper Inflation in Zimbabwe Report1

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