Hyper Inflation in Zimbabwe

HYPERINFLATION IN ZIMBABWE IBS

Macroeconomics project

ON

Submitted to

Prof. IRS Sharma

Prepared By(Section B)

Abhishek Khosla (seat no. 61)

Neelam S. Mandowara(seat no. 68)

Preeti choudary (seat no. )

Rayaz Ahmad (seat no. 70)


ACKNOWLEDGEMENT

Nothing concrete can be achieved without an optimal combination of inspiration and

perspiration. No work can be accomplished without taking the guidance of the import. It is only

the critiques for the ingenious intellectual that helps transform a product into a quality product.

A project is a major milestone during the study period of a student. As such this project was a

challenge for us and was an opportunity to prove our caliber. It would not have been possible to

see through the undertaken project without the guidance of Prof. IRS Sharma. It was purely on

the basis of their experience and knowledge that we were able to clear all the theoretical and

technical hurdles during the development phases of this project work.

We would like to thank Prof. IRS Sharma for his influential inputs and priceless guidance

during the preparation of our report, without which our project would not have been completed.

Also, the support and team work within the project group members was a key point in timely

completion of the project.

INTRODUCTION


During World War II, you could buy a loaf of bread for $0.15, a new car for less than $1,000 and an average house for around $5,000. In the twenty-first century, bread, cars, houses and just about everything else cost more. what is it and what causes this??

Inflation

Inflation is defined as a sustained increase in the general level of prices for goods and services. It is measured as an annual percentage increase. As inflation rises, every dollar you own buys a smaller percentage of a good or service. The value of a dollar does not stay constant when there is inflation. The value of a dollar is observed in terms of purchasing power, which is the real, tangible goods that money can buy. When inflation goes up, there is a decline in the purchasing power of money. According to Prof. Crowther, “Inflation is a state in which the value of money is falling and prices are rising.” According to Prof. Kemmerer, “Inflation means too much currency in comparison to the physical volume of business done”. Keynes stated that “the rise in the price level after the point of full employment is true Inflation.”

Types of Inflation

By Cause1. Demand-Pull

Inflation caused by increases in aggregate demand due to increased private and government spending, etc. Demand inflation is constructive to a faster rate of economic growth since the excess demand and favorable market conditions will stimulate investment and expansion. The failing value of money, however, may encourage spending rather than saving and so reduce the funds available for investment.

2. Cost-PushPresently termed "supply shock inflation," caused by drops in aggregate supply due to increased prices of inputs, for example. Take for instance a sudden decrease in the supply of oil, which would increase oil prices. Producers for whom oil is a part of their costs could then pass this on to consumers in the form of increased prices.

3. Built-In/AnticipatedInduced by adaptive expectations, often linked to the "price/wage spiral" because it involves workers trying to keep their wages up (gross wages have to increase above the CPI rate to net to CPI after−tax) with prices and then employers passing higher costs on to consumers as higher prices as part of a "vicious circle." Built−in inflation reflects events in the past, and so might be seen as hangover inflation.

4. Pricing Power/AdministeredIt occurs whenever businesses in general decide to boost their prices to increase their profit margins. This does not occur normally in recessions but when the economy is booming and sales are strong. It might be called oligopolistic inflation, because it is oligopolies that have the power to set their own prices and raise them when they decide the time is ripe. One can at such times read in the newspapers that business is just waiting a bit to see how soon they might raise their prices.

By Coverage


1. Sectoral The term applies whenever any of the other factors of inflation hits a basic industry causing inflation there, and since the industry hit is a major supplier of many other industries, as for example steel is, or oil is, that raises costs of the industries using say steel or oil, and forces up prices there also, so inflation becomes more widespread throughout the economy, although it originated in just one basic sector.

2. CoreInflation which covers the economy as a whole and not the specific sectors.

By Rates1. Deflation

It occurs when prices are declining over time. This is the opposite of inflation; when the inflation rate is negative, the economy is in a deflationary period.

2. WalkingThe rate of inflation doesn’t exceed the rate of production growth; walking inflation is less than 10%.

3. RunningThe rate of inflation doesn’t exceed the rate of production growth; running inflation is from 10% to 40%.

4. CreepingThe rate of inflation doesn’t exceed the rate of production growth; creeping inflation is greater than 40%.

5. GallopingThe rate of inflation exceeds the rate of production growth; Galloping inflation is from 40% to 100%. Money loose purchase power, people hold as little money as possible.

6. HyperinflationInflation that is "out of control", a condition in which prices increase rapidly as a currency loses its value. Hyperinflation is over 100% per year. Prices as well as wages are extremely erratic and money has no value.

By Degree of Control1. Open

When there is an economic imbalance, no control and everything is allowed freely which leads to rise in price level.

2. SuppressedIf state authorities damp or even stop the rise of price level by administrative means. But, by this way causes of inflation cannot be removed. Such situation is followed by existence of scarce commodities, shadow economy etc.

3. HiddenIf official price indexes do not reflect the price of goods and services produced by shadow economy.


TOP 10 Countries Having High Inflation are the Following

Effects of High Inflation

1. Hoarding (people will try to get rid of cash before it is devalued, by hoarding food and other commodities creating shortages of the hoarded objects).

2. Distortion of relative prices (usually the prices of goods go higher, especially the prices of commodities).

3. Increased risk - Higher uncertainties (uncertainties in business always exist, but with inflation risks are very high, because of the instability of prices).

4. Income diffusion effect (which is basically an operation of income redistribution).5. Existing creditors will be hurt (because the value of the money they will receive from

their borrowers later will be lower than the money they gave before).6. Fixed income recipients will be hurt (because while inflation increases, their income

doesn’t increase, and therefore their income will have less value over time).7. Increased consumption ratio at the early stages of inflation (people will be consuming

more because money is more abundant and its value is not lowered yet).8. Lowers national saving (when there is a high inflation, saving money would mean

watching your cash decrease in value day after day, so people tend to spend the cash on something else).

9. Illusions of making profits (companies will think they were making profits while in reality they’re losing money if they don’t take into consideration the inflation rate when calculating profits).

10. Causes an increase in tax bracket (people will be taxed a higher percentage if their income increases following an inflation increase).

11. Causes mal-investment (in inflation times, the data given about an investment is often deceptive and unreliable, therefore causing losses in investments).

12. Causes business cycles (many companies will have to go out of business because of the losses they incurred from inflation and its effects).


13. Currency debasement (which lowers the value of a currency, and sometimes cause a new currency to be born)

14. Rising prices of imports (if the currency is debased, then it’s purchasing power in the international market is lower).

Steps taken by Government and Central Banks to curb inflation

1. Increased interest rates will help reduce the growth of Aggregate Demand in the economy. The slower growth will then lead to lower inflation. Higher interest rates reduce consumer spending because:

Increased interest rates increase the cost of borrowing, reducing spending Increased interest rates make it more attractive to save money Increased interest rates reduce the disposable income of those with mortgages

2. Supply side policies aim to increase long term competitiveness and productivity. For example, privatization and deregulation were hoped to make firms more productive. Therefore, in the long run supply side policies help to reduce inflationary pressures.

3. Fiscal policy involves the government changing tax and spending levels, in order to influence the level of Aggregate Demand. To reduce inflationary pressures the government can increase tax and reduce government spending this is also known as contractionary policies, this reduces AD.

Top 10 Countries having Low Inflation Rates

Effects of Low Inflation Rates


1. If deflation is cause by falling AD then this is serious economic problem because it indicates a recession with problems such as unemployment, lower output and a negative multiplier effect.

2. Those who have debts will see the real value of debts increase; this will lead to lower consumer confidence and possibly lower AD and economic growth.

3. Companies cannot alter real wages easily because workers are very resistant to any cut in nominal wage wages. Therefore, real wages may rise.

4. Deflation affects an economy by decreasing the velocity of money or the number of commercial transactions more or less permanently. This leads to the emergence of a remarkable contraction in the supply of money.

5. Discourages bank savings and decreases investment as holding of money increases.

Steps taken by Government and Central Banks to Curb Deflation

1. During severe deflation, targeting an interest rate (the usual method of determining how much money to create) may be ineffective, because even lowering the short-term interest rate to zero may result in a real interest rate which is too high to attract credit-worthy borrowers. Thus the central bank must directly set a target for the quantity of money (called "quantitative easing") and uses extraordinary methods to increase the supply of money, e.g. purchasing financial assets (such as mortgage backed securities etc.)

2. Fiscal policy involves the government changing tax and spending levels, in order to influence the level of Aggregate Demand. To reduce deflationary pressures the government can decreases tax and increases government spending this is also known as expansionary policies, this increases AD.

3. Supply side policies aim to decrease long term competitiveness and productivity. For example, nationalization and regulation were hoped to make firms less productive. Therefore, in the long run supply side policies help to reduce deflationary pressures.

HYPERINFLATION

In economics, hyperinflation is inflation that is "out of control," a condition in which prices increase rapidly as a currency loses its value. According to International Accounting Standards Board's hyperinflation is a cumulative inflation rate over three years approaching 100% (26% per annum compounded for three years in a row) and according to Cagan’s “inflation exceeding 50% a month.

In easier terms it can be explained with the help of an example let’s say today is June 1st 2009, if you have $20 today, with an inflation of 100% a month, your $20 will only have the value of $2.50 at the end of the September 2009 .

The main cause of hyperinflation is a massive and rapid increase in the amount of money that is not supported by a corresponding growth in the output of goods and services. This results in an

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imbalance between the supply and demand for the money, accompanied by a complete loss of confidence in the money.

In both classical economics and monetarism, it is always the result of the monetary authority irresponsibly borrowing money to pay all its expenses causes the Hper Inflation.

In Neoliberalism, hyperinflation is considered to be the result of a crisis of confidence. The monetary base of the country flees, producing widespread fear that individuals will not be able to convert local currency to some more transportable form, such as gold or an internationally recognized hard currency. This is also called as the Quantitative theory of Hyper Inflation.

According to 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 to command later. In this model, the perceived risk of holding currency rises dramatically, and sellers demand increasingly high premiums to accept the currency. This in turn leads to a greater fear that the currency will collapse, causing even higher premiums.

Causes of Hyperinflation

A hyperinflation is mainly caused by an extremely rapid growth in the supply of paper money. This occurs when the monetary and fiscal authorities of a nation regularly issue large quantities of money to pay for a large stream of government expenditures.

Rapid and massive increase in the amount of money printed. Total loss of confidence in the money (because of its ever decreasing value). If the entity responsible for printing a currency promotes excessive money printing, with

other factors contributing a reinforcing effect, hyperinflation usually continues. Often 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.

During Periods Of Civil war, or internal conflict government needs to make the expenditure and to fund this expenditure it might resort to Printing of Currency.

Hyperinflation in the past

Hungry

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Hyperinflation in the Hungarian economy was caused due to the Great Depression and the Second World War. The effects of the Great Depression reached Hungary after 1930 and it hit predominantly agriculture. The pengő had to be devalued and the debt of the country increased. After a short period of recovery, the war preparations - amongst which the most important was the Győr-program - had loosened the financial and monetary discipline which in turn led to the depreciation of the pengő currency. The war caused enormous costs and, later, even higher losses to the relatively small and open Hungarian economy. The national bank was practically under government control, the issue of money was proportional to the budget demands.

Greece

In Greece also the hyper inflation was caused due to the Second World War. The Government in order to fund its non Productive war expenditure resorted to Printing of more currency this resulted in higher amount of Inflation. Greece went through its worst inflation in 1944. In 1942, the highest denomination was 50,000 drachmai. By 1944, the highest denomination was 100,000,000,000,000 drachmai. In the 1944 currency reform, 1 new drachma was exchanged for 50,000,000,000 drachmai. Another currency reform in 1953 replaced the drachma at an exchange rate of 1 new drachma = 1,000 old drachmai.

China

During periods of warfare, civil war, or intense internal conflict of other kinds: governments need to do whatever is necessary to continue fighting, since the alternative is defeat. Expenses cannot be cut significantly since the main outlay is armaments. Further, a civil war may make it difficult to raise taxes or to collect existing taxes. While in peacetime the deficit is financed by selling bonds, during a war it is typically difficult and expensive to borrow, especially if the war is going poorly for the government in question. The banking authorities, whether central or not, "monetize" the deficit, printing money to pay for the government's efforts to survive. The hyperinflation under the Chinese Nationalists from 1939-1945 is a classic example of a government printing money to pay civil war costs.

A BRIEF OVERVIEW OF THE ZIMBABWEAN ECONOMY

Zimbabwe is a landlocked country located in the southern part of the continent of Africa .The economy of Zimbabwe is collapsing under the weight of economic mismanagement, resulting in

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massive unemployment and spiraling hyperinflation. It currently has the lowest GDP real growth rate 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 was experiencing a hard currency shortage, which had led to hyperinflation and chronic shortages in imported fuel and consumer goods. The Central Bank routinely prints money to fund the budget deficit, causing the official annual inflation rate to rise from 32% in 1998 to 11200000 in 2010. 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 substantially higher. For example Cato Senior Fellow Steve Hanke had developed the Hanke Hyperinflation Index for Zimbabwe (HHIZ). This new metric was derived from market-based price data and is presented in the Appendix for the January 2007 to November 2008. As on 14 November 2008, Zimbabwe’s annual inflation rate was 89.7 Sextillion (1021) percent. Since mid-November 2008, the weekly update of the HHIZ has been put on hold.

GDP per capita dropped by -5.7% in 2007 and -3.6% in 2008, agricultural output drops by 51% and industrial production dropped by 47%. Price controls have been imposed on a wide range of products including food, fuel, medicines, soap, electrical appliances, yarn, school books etc. Direct foreign investment has evaporated from US $400 million in 1998 to US $30 million in 2008.

On January 16, 2009, Zimbabwe announced plans for imminent issue of banknotes of $10 trillion, $20 trillion, $50 trillion, and $100 trillion. At the time of the announcement, the last was valued at around 30 US dollars, but that value was expected to evaporate swiftly. Notably, those plans open a gap in the banknote series: there are none on the order of $200 billion or $1 trillion. It would take 100 of the $100 billion notes to make the same value as the next larger note, $10 trillion.

Public Debt is 282.6% of GDP. It has partly been financed by printing money, which has led to hyperinflation. State enterprises are strongly subsidized, taxes and tariffs are high. State regulation is costly to companies, starting or closing a business is slow and costly. Labor market is highly regulated, hiring a worker is cumbersome, firing a worker is difficult and unemployment has risen to 94% (at the end of 2008; the figure was 80% in 2005).

Zimbabwe’s economy is a mixed economy with a dominating public sector. Traditionally, the Zimbabwean economic profile used to be one of the strongest in Africa. However, increasing

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cases of money embezzlement at the administrative level has led to the rise of a severe economic crisis. In 2004, Zimbabwe’s economy saw negative GDP growth (-13.6%). In the following years, the administration initiated economic reforms to put the growth back on track. However, the 2009 famine was a severe blow to the economic reforms. This, coupled with political instability, resulted in GDP growth of -14.1%. The country’s GDP stands at US$332.1 million, according to the 2009 figures. GDP per capita is US $200.

Zimbabwe Economy: Major Statistics

Here are some of the major statistics of Zimbabwe’s economy:

Labor force 3.84 million (2009 est.)Unemployment rate 95% (2009 est.)Budget revenues $133 million (2009 data)Budget expenditures $258 million (2009 data)Industrial production $597.4 million (2009 est.)Exports $1.09 billion (2009 est.)Imports $2.03 billion (2009 est.)Foreign Exchange Reserve $111 millionExternal Debt $5.821 billion

HYPERINFLATION IN ZIMBABWE

Zimbabwe is in the late stages of a classic hyperinflation. Inflation is galloping ahead as the supply of Zimbabwe dollars surges and the demand for them shrinks. Eventually, the currency will totally collapse as people simply refuse to accept it.” In recent months, facts on the ground have validated this prognostication. The Zimbabwe dollar is dead.

Inflation figures for Zimbabwe is given below in the graph for the period 2000-2007.


The hyperinflation index for Zimbabwe began on 5 January 2007, a month before Zimbabwe entered the hyperinflation zone. Due to a lack of reliable data, It stopped reporting the inflation on 14 November 2008. This index was based on non-cash Zimbabwe dollar transactions. These had accounted for the bulk of transactions in Zimbabwe. By the end of November, however, there were virtually no non-cash Zimbabwe transactions taking place and the Zimbabwe Stock Exchange had stopped trading. The non-cash Zimbabwe dollar is, therefore, dead.

Ashes are all that is left of the Zimbabwe dollar a remnant of paper money. During Zimbabwe’s hyperinflation, foreign currencies replaced the Zimbabwe dollar in a rapid and spontaneous manner. This “dollarization” process was legalized in late January 2009. Even though the Zimbabwe paper money remnant circulates alongside foreign currencies, its real value is tiny, its use is limited, and its value against the U.S. dollar is cut in half every two days.

Zimbabwe failed to break Hungary’s 1946 world record for hyperinflation. That said, Zimbabwe did race past Yugoslavia in October 2008. In consequence, Zimbabwe can now lay claim to second place in the world hyperinflation record books. Rates of inflation of several hundred percent per month are often seen. Extreme examples in the table below is given:


Highest Monthly Inflation Rates in History

Country

Month with highest inflation rate

Highest monthly inflation rate

Equivalent daily inflation rate

Time required for prices to double

Hungary July 1946 1.30 x 1016% 195% 15.6 hours

Zimbabwe

Mid-November 2008 (latest measurable)

79,600,000,000% 98.0% 24.7 hours

YugoslaviaJanuary 1994

313,000,000% 64.6% 1.4 days

GermanyOctober 1923

29,500% 20.9% 3.7 days

GreeceNovember 1944

11,300% 17.1% 4.5 days

China May 1949 4,210% 13.4% 5.6 days

Causes of Hyperinflation in Zimbabwe

Hyperinflation is an extreme case of money supply growth exceeding the growth in the production of goods and services in an economy. Excessive money supply growth occurs because the government spends more money than it collects through taxes and charges, leading to the printing of money to fill the gap between revenue and expenditure. This causes the hyperinflation cycle. The public tries to spend the money it receives quickly to avoid the inflation tax; the government responds with even higher rates of money issue. The current hyperinflationary situation in Zimbabwe is a result of various economic, structural and political factors.

The major factors responsible for the hyperinflationary situation in Zimbabwe are as follows:

Economic FactorsLand Reform Policies


Hyperinflation in Zimbabwe began in the early 2000s, shortly after Zimbabwe's confiscation of white-owned farmland. 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 great downfall in the agricultural production over the years.

One of its effects is the decrease in farm production which led to food crisis and extravagant increase in the food inflation. This is inflation from supply side contraction. From the graph below we can see how wheat production decreased after land reform in Zimbabawe.

Excess printing of currency notes

Another cause is a government that forces the Reserve Bank of Zimbabwe to print money. The government finances its spending by issuing debt that the RBZ must purchase with new Zimbabwe dollars. The bank also produces jobs, at the expense of every Zimbabwean who uses money. Between 2001 and 2007 its staff grew by 120%, from 618 to 1,360 employees, the largest increase in any central bank in the world. Still, the bank doesn't produce accurate, timely data.

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, and those people who do not have access to foreign currency are in a complicated situation. The reason for printing money 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 has eventually reduced GDP to a half of what it was around ten years ago.

Relation with IMF

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

Under such circumstances Zimbabwe was forced to go on a note printing spree to make interest payments and finance its ever increasing fiscal deficit. The four factors of production- land, labor, capital and entrepreneurship virtually being controlled

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

Sanctions and trade embargos drained the flow of foreign capital and the government could 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. Government domestic debt has also been increasing after inflation struck Zimbabwe in 2000. It can be seen from the graph below.


Other reasons

The hike in salaries of government staff was another reason of RBZ printing more money. Because of the confiscation of land from whites and chronic inflation foreign investment evaporated which led to unemployment, decrease in savings, reduction in living standards of common people and which again led to reduction in national output which again caused inflation.

On 16 February 2006, the governor of the Reserve Bank of Zimbabwe, Dr. Gideon Gono, announced that the government had printed ZWD 21 trillion in order to buy foreign currency to pay off IMF arrears. In early May 2006, Zimbabwe's government began printing money again to produce about 60 trillion Zimbabwean dollars. The additional currency was required to finance the recent 300 percent increase in salaries for soldiers and policemen and 200 percent for other civil servants. The money was not budgeted for the current fiscal year, and the government did not say where it would come from.

In recent years, there has been considerable economic hardship in Zimbabwe. Many western countries argue that the Government of Zimbabwe's land reform program, recurrent interference with, and intimidation of the judiciary, as well as maintenance of unrealistic price controls and exchange rates has led to a sharp drop in investor confidence which led to decrease in investment in the country.

On 1 November 1989 a former government minister in Rhodesia, Denis Walker, produced a paper in London for the Conservative Monday Club's Foreign Affairs Committee on Land

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Reform in Zimbabwe. In his last paragraph he stated that "once the land has been redistributed, the commercial farms will be broken up, the remaining white farmers reduced by exile or imprisonment; Zimbabwe's government, already morally bankrupt, will decline towards economic collapse."

Between 2000 and December 2007, the national economy contracted by as much as 40%; inflation vaulted to over 66,000%, and there were persistent shortages of hard currency, fiat currency, fuel, medicine, and food. GDP per capita dropped by 40%, agricultural output dropped by 51% and industrial production dropped by 47%.

Direct foreign investment has all but evaporated however there is renewed activity in indirect investment via international partnerships with South Africa in particular. In 1998, direct foreign investment was US $400 million. In 2007, that number had fallen to US $30 million

The money spent in the country's involvement in the war in the Democratic Republic of the Congo is also one of the reasons and it has never been reported nor the benefits derived from the military's involvement in commercial mining in that country. Price controls have been imposed on a wide range of products including food (maize, bread, steak), fuel, medicines, soap, electrical appliances, yarn, window frames, building sand, agricultural machinery, fertilisers and school textbooks and due to which black-marketing and hoarding.

Some observers attribute Zimbabwe's inflation to sanctions imposed by the Western powers, a thesis also advanced by the Mugabe Government. It has been argued that the sanctions imposed by Britain, the US, and the EU have been designed to cripple the economy and the conditions of the Zimbabwean people in an attempt to overthrow President Mugabe's government. Critics point to the so-called "Zimbabwe Democracy and Economic Recovery Act of 2001" signed by Bush in 2001 as an effort to undermine Zimbabwe's economy. Soon after the bill was signed, IMF cut off its resources to Zimbabwe. Financial institutions began withdrawing support for Zimbabwe. Terms of the sanctions made it such that all economic assistance would be structured in support of democratisation in respect for human rights and the rule of law. The EU terminated its support for all projects in Zimbabwe. Because of the sanctions and US and EU foreign policy, none of Zimbabwe's debts have been cancelled as in other countries.

Other observers also point out how the asset freezes by the EU on people or companies associated with Zimbabwe's Government have had significant economic and social costs to Zimbabwe.

As of February 2004 Zimbabwe's foreign debt repayments ceased, resulting in compulsory suspension from the International Monetary Fund (IMF). This, and the United Nations World Food Programme stopping its food aid due to insufficient donations from the world community, has forced the government into borrowing from local sources.

Zimbabwe began experiencing severe foreign exchange shortages, exacerbated by the difference between the official rate and the black market rate in 2000. In 2004 a system of auctioning scarce foreign currency for importers was introduced, which temporarily led to a slight reduction in the

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foreign currency crisis, but by mid 2005 foreign currency shortages were once again chronic. The currency was devalued by the central bank twice, first to 9,000 to the US$, and then to 17,500 to the US$ on 20 July 2005, but at that date it was reported that that was only half the rate available on the black market.

In July 2005 Zimbabwe was reported to be appealing to the South African government for US$1 billion of emergency loans, but despite regular rumours that the idea was being discussed no substantial financial support has been publicly reported.

All these are attributed to hyperinflation and worsening economic situation in zimbabwe. Conservative attitude towards foreign capital is another reason of hyperinflation in Zimbabwe. The foreign companies were not allowed to repatriate their profits and new investments in foreign currency were discouraged. This led to acute shortage of the foreign funds required to get technology. The wages in the economy were fixed and the corporate were not allowed to hire or fire anyone without permission. This increased the expenses of the firms both in terms of time and wages.

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 deficit financing led to the more alarming hyperinflation.

Foreign currency shortageForeign currency shortage is another reason of hyperinflation in Zimbabwe. Foreign currency shortages as well as exchange rate misalignment have also resulted in general increase in prices. Although foreign currency shortages have been a perennial economic problem for Zimbabwe since independence, the severity of the problem first came to light in 1987, before subsiding and reappearing again at a severe scale since 2000.

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

As the figures of 2008 and 2009 were very large it was not able to fit in the table


Structural Factors

Structural factors are also believed to influence the rate of hyperinflation in Zimbabwe.Examples include weather conditions and pricing policies of the government. The government’s intention of protecting the general consumers through controlled market/consumer prices wrecked havoc in most production industries, especially the food sector as the decreed prices have been far below production costs, resulting in some companies reducing production, reducing quality or diverting production to other related goods. These production problems have resulted in shortages of some basic commodities, leading to demand pull hyperinflation. The effects of droughts since 2000 coupled with under 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 slowdown are:

The government and the judiciary have been militarized. Under the Mugabe government regime, 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.

Tony Blair and Gordon Brown have been demonizing Robert Mugabe downplaying any of 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 in Zimbabwe.

The international sanctions imposed on Zimbabwe were not carefully planned; some of them affected regular Zimbabweans more than it affected politicians and members of the government. For the last eight years, China has been the only major source of financing for the Zimbabwean government, imposing harsh economic restrictions, a rather significant interest rate (6.4%) and other economic challenges. Chinese businesses in Zimbabwe are keeping Mr. Robert Mugabe in power but are harming the overall economy.


EFFECTS OF HYPERINFLATION

Zimbabwe’s hyperinflation has resulted in a 6 year economic recession, de-industrialization and loss of skilled labor through emigrating and increasing impoverishment. In addition, political violence, 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 value is not linked to productivity has worsened the situation.

Some of the most significant effects are:

Income redistributionThe first effect of the hyperinflation is a gigantic redistribution of income and wealth. Holders of 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 which may keep pace with inflation any senior pensioner still receiving a couple of thousand Zimbabwe dollars being a clear example.

Similarly, it has redistributed wealth from those who lend a fixed amount of money to those who 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. Thus inflation is sometimes viewed as similar to a hidden tax. This discourages savings and investment, 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 demand the ten-fold price compared to a cash payment


Reduction in Efficiency of EconomyHyperinflation reduces the efficiency of economy by forcing the agents to switch from financial transactions towards barter. This is what happened in Zimbabwe. The Zimbabwean population started trading in commodities. If they are paid in commodities, they spend the amount as soon as possible. Thus, capital erodes continuously and the efficiency of an economy falls. This can be explained with table below.

Year Real GDP per capita growth

Consumer price inflation

Lending rate a

Real interest rate 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 -96.72003 -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

We can see from the graph below that annual GDP has been continuously on the decreasing trend after 1999.


Malnutrition and shortage of FoodAbout 5 million people in Zimbabwe about 50 percent of the country's population are in need of food aid Serious child malnutrition has increased by nearly two-thirds in parts of Zimbabwe compared to last year. In normal times, Zimbabwe consumes 2 million tons of corn a year which is their staple food. The drought in the year 2007, described as the worst in 50 years by local farmers, has reduced that amount to only 750,000 tons. The country used to export grain and their harvests were very successful. But World Food Program (WFP) officials say disruption to agriculture because of the government's land seizure program 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 unemploymentBasic 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 95% of the population unemployed and schools are running without any students. No nurses in the hospital, no teachers in the school and no one to collect the garbage from the streets, 16 people were reported dead in a village since the outbreak of cholera. This is the collapse of the entire system in Zimbabwe.

We can see from the graph below how unemployment has been increasing after 1999, one of the effect of hyperinflation.


International tradeAs the rate of inflation is much higher than that abroad, a fixed exchange rate is undermined through a weakening balance of trade, and foreign exchange shortage has set in. The international trade has taken a huge hit especially with South Africa, the biggest trading partner of Zimbabwe once.

Valueless Zimbabwean DollarFour hundred seventeen Zimbabwean dollars is the value of a single two-ply sheet. A roll costs $145,750 in American currency, about 69 cents. The price of toilet paper, like everything else here, soars almost daily, spawning jokes about an impending better use for Zimbabwe's $500 bill, now the smallest in circulation. But what is happening is no laughing matter. For untold numbers of Zimbabweans, toilet paper and bread, margarine, meat, even the once ubiquitous morning cup of tea have become unimaginable luxuries. All are casualties of the hyperinflation that is roaring toward 1,000 percent a year, a rate usually seen only in war zones.

Public-school fees and other ever-rising government surcharges have begun to exceed the monthly incomes of many urban families lucky enough to find work.

Although there is no credible threat to Robert Mughabe’s 26-year rule, Zimbabwe's political opposition is calling for mass protests against the economic situation. So Mr. Mugabe has tightened his grip on power even further, turning the economy over to a national security council of his closest allies. In addition, he has seeded the government's civilian ministries this year with


loyal army and intelligence officers who now control key functions, from food security to tax collection. At the same time, Mr. Mugabe's government has printed trillions of new Zimbabwean dollars to keep ministries functioning and to shield the salaries of key supporters and potential enemies against further erosion.Hyperinflation is a cradle-to-grave experience here. The government recently announced that the price of childbirth, now $7 million, had increased 463 percent by October 2006. Funeral costs were to double over the same period.

Other EffectsIn Zimbabwe, the depreciation of assets has been exceeding investment for some time, resulting in capital consumption and the atrophy of the nation's plant and equipment. In addition, the combination of hyperinflation and price controls has wiped out much of the country's stock of working capital.

STEPS TAKEN BY THE ZIMBABWE GOVERNMENT TO CURB HYPERINFLATION

The Zimbabwe government in order to curb the inflation includes the introduction of a new currency, raise of daily cash withdrawal limits and the introduction of old coins in circulation.

Main Steps taken by the Zimbabwe government are as follows

Representing his 2008 mid-term monetary policy statement in Harare, the central bank governor 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 a 500 dollar note.

While introducing a new 25 cent coin, Gono also announced the introduction of old coins which he hoped will increase the amount of money in circulation. The old coins include 5 dollars, 2dollars, 1 dollar, and 50 cent, 20 cent and 10 cent coins.

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

The new and old currency will co-circulate with the existing bearer checks and special agro checks, which will expire .

To fend off the threat of a wholesale loss of confidence among depositors and investors, it has become necessary to increase withdrawal limits and lop off additional zeros, the Herald commented.

The proliferation of zeros has made calculations difficult as the banking system could not read numbers excess of 10 billion.

The removal of zeros only works if accompanied by an influx of forex to support the local currency. This can be in form of foreign aid, foreign direct investment or increased exports.


The Zimbabwean government introduced price controls as the price of even basic goods skyrocketed. But the price cutting destroyed the production chain of the retail sector and companies lost billions of dollars.

Government needs to restrict its borrowing from the Reserve Bank as Sighs of Fiscal discipline.

Zimbabwe maintained subsidies and price controls for key commodities like fuel , bread, fertilizers and said that if anyone raised the prices they shall be arrested and punished .

Dollarization Because of the chronic depreciation of ZWD dollarization was done in April 2009. In this process US dollar and South African Rand was started to be used as national currency which helped in international trade.

Increase in denomination of Zimbabwe Dollar

Because of continuous depreciation of ZWD against major currencies because of inflation, The Reserve Bank of Zimbabwe has to redenominated its currency. The Reserve Bank of Zimbabwe issued a ZWD 10,000,000 note in January 2008, roughly equivalent of 4 US dollars. Zimbabwe's inflation soared to a record high of 26,470.8 percent as the economy contracted by 6 percent, the central bank said.

In April 2008 the Reserve Bank of Zimbabwe issued a ZWD 50,000,000 note, which was then worth approximately 1.20 US dollars. In May 2008 the Reserve Bank of Zimbabwe issued bank notes or rather "bearer cheques" to the value of ZWD 100 million and ZWD 250 million. Meanwhile inflation had surged to an estimated 165,000 percent with some unconfirmed reports putting the figure as high at 400,000 percent. Ten days later, new notes with a value of ZWD 500 million (then equivalent to about USD 2) were issued.

On 19 July 2008, the Reserve Bank of Zimbabwe announced plans to introduce a Z$100 billion bank note.


On July 30, 2008, the Governor of the RBZ, Gideon Gono announced that the Zimbabwe dollar would be redenominated by removing 10 zeroes, with effect from August 1, 2008. ZWD10billion will become 1 dollar after the redenomination.

On 17 November 2008, Johns Hopkins University Professor Steve H. Hanke released a document estimating Zimbabwe's annualized and monthly inflation rates were 89.7 sextillion percent and 79.6 billion percent, respectively, as of 14 November 2008. This placed Zimbabwe’s hyperinflation as the second worst hyperinflation in world history. According to Prof. Hanke’s calculations, prices in Zimbabwe increased roughly 64 times between 7 November and 14 November.

On December 6, 2008, the Reserve Bank of Zimbabwe announced plans to circulate the ZWD 200,000,000 note, just days after introducing the ZWD 100,000,000 note. Even with the circulation of both notes amid the entrenched hyperinflation, the Reserve Bank of Zimbabwe left in place caps on daily cash withdrawals at 500,000 Zimbabwe dollars, which is the equivalent of about 25 U.S. cents.

In late December 2008 and early January 2009, the use of foreign currency as a common medium of exchange became increasingly popular, as fewer goods and services were being offered in local currency. In a move to help businesses suffering from chronic shortages of foreign currency to import goods and spare parts the Zimbabwe's central bank licensed around 1,000 shops to sell goods in foreign currency.

On 12 January 2009, Zimbabwe introduced the $50,000,000,000 note.

On January 16, 2009, Zimbabwe announced plans for imminent issue of banknotes of $10 trillion, $20 trillion, $50 trillion, and $100 trillion. At the time of the announcement, the last was valued at around 30 US dollars, but that value was expected to evaporate swiftly. Notably, those plans open a gap in the banknote series: there are none on the order of $200 billion or $1 trillion. It would take 100 of the $100 billion notes to make the same value as the next larger note, $10 trillion.

SUGGESTIONS FOR IMPROVING THE ECONOMY OF ZIMBABWE

1. Stabilize the currency situation


With runaway inflation approaching 231,000,000%, Zimbabwe is sure to face some difficulty getting ordinary Zimbabweans to trust the currency, much less the financial markets. But Zimbabwe will not have time to lose and currency stabilization is a vital step toward stabilizing the economy as a whole. Pegging the Zimbabwean dollar to a foreign currency might not send a strong enough signal to reassure the markets, because abandoning the peg in the future is relatively easy. The government should therefore continue having the South African Rand as its national currency, since the European Union is one of the Zimbabwe's main trading partners it can also adopt euro as its national currency and the possession, use, and exchange of other currencies should be freely permitted. Since most Zimbabweans have already seen their savings eaten away by inflation, and have either turned to foreign currency or been reduced to barter, the switch should be relatively easy to accomplish.

2. Liberalize trade

Zimbabwe's weighted average tariff rate is almost 19 percent, with additional non-tariff barriers including import and export bans. Customs officials are corrupt and inefficient. However, Zimbabwe also lacks strong domestic industries seeking protection from overseas competition—an unintended consequence of Mugabe's mismanagement of the economy. The government should exploit that weakness and immediately abolish all tariff and non-tariff barriers to trade.

Doing so would mean ignoring the advice of Oxfam and Zimbabwe-based Seatini, both of which oppose unilateral trade liberalization and favor protecting infant industries. Historical evidence suggests that domestic protectionism tends to encourage inefficiency and increase the cost of consumer goods and services, rather than encouraging cub industries to become globally competitive. The liberalization would permit the free flow of capital to and from Zimbabwe. It would also increase the return on savings and reduce the cost of capital, removing major impediments to economic growth and improved living standards.Such has been the experience of other countries that have ended financial repression

3. Reform taxes

The government should abolish the existing plethora of taxes and eliminate all subsidies, thus sending a powerful signal that Zimbabwe is committed to establishing a friendly and non-discriminatory business environment. To raise enough revenue to pay for the state's most basic functions—primarily maintenance of law and order—the government should instead introduce a low-rate and broad-based consumption tax. Consumption taxes are relatively neutral with respect to altering behavioral patterns and spending habits, leading to minimal misallocation of resources. Along with the economy, the provision of public services has totally collapsed in Zimbabwe; the government cannot be expected to reintroduce those public services in the short run. Thus, radical tax reform is all the more achievable—and a radical tax overhaul could substantially increase future revenue without increasing the tax rate.

4. Secure property rights


Securing private property is a fundamental requirement for economic growth. Unfortunately, over the past seven years Mugabe has severely undermined Zimbabweans' property rights. Pre-Mugabe Zimbabwe had a long history of protecting private-property rights, so returning to the status quo ante should be possible. Zimbabwe is likely to rely on agriculture as the main source of revenue and employment for the foreseeable future. Land reform will thus have to be revisited. Mugabe's expropriation of white farms was an unmitigated catastrophe; the collapse of agricultural production clearly demonstrates the need to end the state-sponsored subsistence farming experiment and reconstitute large-scale commercial farming. Such a shift cannot be achieved without restoring at least some of the land to white farmers and compensating them for expropriation, perhaps with bonds that would mature in 15 or 20 years. Nicaragua undertook a similar and moderately successful compensation scheme after the end of the Sandinista rule. The rest of Zimbabwe's government-owned agricultural land ought to be auctioned off, with small-scale farmers who already occupy the land among the potential buyers.

Of course, these four steps will be just the beginning for Zimbabwe. Additional reforms must include liberalization of the labor market and of business regulation. With unemployment rate of 94 percent in 2008, Zimbabwe will need to create new jobs, and quickly. For the private sector to recover, obstacles to entrepreneurship must be reduced: currently it takes 90 days (2011 figure) to start a business in Zimbabwe (as opposed to 24 hours in Hong Kong, and a world average of 48 days). To maximize foreign investment, exchange-rate restrictions and capital controls should be eliminated. And just as most Iraqi debt acquired by Saddam Hussein was forgiven after the 2003 U.S. invasion, the new Zimbabwean government should request that public debt acquired by Mugabe's regime be forgiven on "odious debt" grounds. But just as the first step to recovery is admitting you have a problem, a new Zimbabwe would do well to begin by repudiating Mugabe-era economics and taking the above four steps to get rid of any lingering traces of Mugabe's failed policies.

BIBLIOGRAPHY


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Hyper Inflation in Zimbabwe

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