Will Zimbabwe's dedollarization efforts through bond notes succeed?

The recent introduction of a new currency by Zimbabwe’s central bank the Reserve Bank of Zimbabwe (RBZ) result in a process called reverse dollarization. Baliño, Bennett, and Borensztein (1999) note that reversing dollarization may be difficult because changes in practices regarding the settlement of transactions may be a slow process that depends on institutional changes and takes place only when there are significant benefits to be gained by switching currencies. The process will not be easy as people’s preferred choice of holding and storing value remains United States dollars and not the surrogate currency. There are no significant benefits to be gained by switching from foreign currency to bond notes. Forced dedollarization has had limited success, while dollarization may have fallen in the short run and was sustained in some cases, countries that tried to force dedollarization experienced financial disintermediation and capital flight (Menkulasi, Erasmus, & Leichter, 2009). In Zimbabwe the bond note introduction is a forced dedollarisation mainly because people are forced to accept it as there are no alternatives because of the cash shortages. Of the countries that implemented measures to force rapid dedollarization, only Mexico and Pakistan succeeded in keeping dollarization low (2.5 and 5.2 percent respectively at end-2007), although in both there were adverse macroeconomic consequences (Menkulasi et al., 2009). In the short run bond notes are going to reduce dollarization, as of January 2017 $75million worth of bond notes are already in circulation in the long run the policy is likely to cause problems because of macroeconomic consequences.

Though Mexico and Pakistan managed to reduce dollarization, they did so at some cost in the form of capital flight, lower remittance inflows, and less financial intermediation. Zimbabwe is already suffering from capital flight, lower foreign direct investment (FDI) inflows, and less financial intermediation with a lot cash circulating outside the banking system estimated between US$2 to US$7 billion see Mugova and Sachs (2016). According to Reinhart, Rogoff, and Savastano (2003), in Mexico these policies caused a 100 percent increase in capital flight and a dramatic decrease in bank credit to the private sector. The proposition of bond notes to revive local industry and increase exports will suffer the same consequence of decrease in bank credit to private sector therefore local industry will not be capitalised. For other countries, forced dedollarization proved to be a failure and had significant macroeconomic costs (Menkulasi et al., 2009). In the first half of the 1980s, Bolivia and Peru implemented measures to rapidly dedollarize the banking system by forcing conversions of foreign currency deposits to local currency. These efforts, undertaken while inflation was high, were followed by an abrupt depreciation of the local currency, resulting in capital flight and financial disintermediation. Continued macroeconomic instability over the next few years led to a reversal of policies, which lifted the restriction on foreign currency deposit and led to rapid redollarization. Bolivia is now again one of the most highly dollarized economies in the world (Menkulasi et al., 2009). The effort to dedollarise by Zimbabwe through bond notes is likely to result in limited success.

References

Baliño, T. J., Bennett, A., & Borensztein, E. (1999). Monetary policy in dollarized economies (Vol. 171): International Monetary Fund.

Beck, T., Demirgüç-Kunt, A., & Levine, R. (2009). Financial institutions and markets across countries and over time-data and analysis. World Bank Policy Research Working Paper Series, Vol.

Menkulasi, J., Erasmus, L., & Leichter, J. (2009). Dedollarization in Liberia-lessons from cross-country experience: International Monetary Fund.

Mugova, S & Sachs, P.R (2016) Corporate governance structure and accountability as affected by national governmental infrastructure in developing countries Corporate Ownership & Control Vol 13 Issue 4

Reinhart, C. M., Rogoff, K. S., & Savastano, M. A. (2003). Addicted to dollars. Retrieved from

Schneider, F., & Enste, D. (2000). Shadow Economies around the World Size, Causes, and Consequences.