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Why
Mugabe is unlikely to survive hyperinflation in Zimbabwe
Econometrix ecobulletin (SA)
July 10, 2007
Bottomline
No country has
ever endured true hyperinflation without there being a change in
leadership or type of government within a fairly short space of
time. Zimbabwe is unlikely to be different.
Already one
is beginning to see the significant fissures within the ranks of
the leadership of that country, most notably now between Mugabe
and the Reserve Bank of Zimbabwe . Mugabe thinks he can solve the
problem by freezing prices without recognizing that this is going
to cause dramatic shortages of key products and inputs into production
processes. This in turn is likely to cause dramatic social unrest
even within the ranks of ZANU PF.
To think that
the problem can be solved by nationalising the business sector,
is naive. The same outcome of shortages and rationing would emerge
with nationalisation, except that this time the government would
not be able to hide behind the accusation that the private sector
was responsible for such shortages.
In the final
resort, even members of Mugabe's own security establishment will
be unable to survive an intensification of hyperinflation without
enduring impoverishment themselves and this would cause them to
rise up against their leadership.
Unfortunately,
the only solution to end hyperinflation is massive fiscal cutbacks
by the government and drastic tightening of monetary policy, both
of which will lead to a disruptive implosion of economic activity
in the country before recovery sets in.
It has been
suggested that Zimbabwe should become part of the Common Monetary
Area (CMA), formerly known as the Rand Monetary Area (RMA), in order
to save its economy. Although the size of the Zimbabwean economy
relative to the South African economy is small enough in theory
not to cause major disruption to the CMA, one fears that there would
be significant psychological damage to the Rand on currency markets
in the event of such an idea being put into practice. In return
for the implementation of such a measure, the South African government
for its own good would need to ensure drastic political and economic
changes within Zimbabwe . These would include the insistence of
a change in leadership.
Ironically,
it is reported that the Dollar prices of Zimbabwean property are
rising and that there is significant interest in investing in the
country. This illustrates the extent of the global liquidity glut
and the decline in risk aversion towards emerging markets. However,
one fears that undue optimism about the outlook for the Zimbabwean
economy post-Mugabe is premature.
Zimbabwean
hyperinflation set to intensify
It is now common knowledge
that the inflation rate in Zimbabwe has officially reached over
4500%. Last month it was around 3700% and the preceding month around
2200%. The country has clearly therefore entered the realms of hyperinflation.
Once the latter process gets going one tends to see inflation rates
rising exponentially as more and more money needs to be printed
in order to prevent a major economic fallout from the process. Essentially,
the rate at which prices increase from day to day does not have
to increase all that much for the rate of inflation on a y-o-y basis
to escalate dramatically. It is the compounding process which drives
up y-o-y inflation so prolifically. For example, a 4500% annual
inflation rate entails roughly a doubling of prices every month,
or an escalation of prices by 2.33% per day. On the other hand,
if daily price increases accelerate to 2.8% per day, this entails
prices increasing by 135% per month and on an annualised basis is
equivalent to 20,000% inflation. Some people argue that even the
4500% official inflation rate underestimates the "true"
inflation rate in Zimbabwe. Whilst this may be true one must recognize
that when prices start escalating at more than 2% per day on average
even minor changes in the composition of the consumption basket
according to which inflation is measured, can make substantial differences
to the annual inflation rate which one would like to measure. In
other words, it becomes very difficult to be dogmatic about whether
inflation is 5000% or 7000%, say. In any case, it is irrelevant
from a medium-term perspective, because the process of hyperinflation
feeds on itself into pushing up the rate of price increases ever
faster until this forces dramatic changes to come about in the socio-political
as well as economic environment.
No country
endures hyperinflation without major political changes
Whatever the true inflation
rate, if one believes that the Zimbabwean economy is now embroiled
in hyperinflation, then it is logical to suggest that the country
is headed in the fairly short term for major political and economic
changes. The fact is that no incidence of hyperinflation in global
history, i.e. inflation in the thousands of percent, has ever dissipated
without a fundamental change in leadership of a country or in its
political regime. Examples are Germany in the 1920s which saw the
collapse of the Weimar Republic, Brazil in the 1970s, which ushered
in a dictatorship, Bolivia in the 1980s and Argentina in the early
1990s, which saw a change in leadership in that country. Zimbabwe
is unlikely to be any different. When prices start escalating at
more than 2% per day it becomes extremely difficult for business
to operate or consumers to survive in a normal day to day manner.
Relative prices of different goods change by such huge amounts from
one day to the next that it is easy for businesses and consumers
to incur significant economic losses due to minor mistakes in spending
or other business decisions. The result is an intensification of
social tensions that spill over into forcing a change in the political
landscape. One might argue that so long as the Zimbabwean leadership
manages to suppress political unrest with Draconian security enforcement,
there can be no change in the political environment in the country.
However, when hyperinflation takes hold, it becomes ever more difficult
for a government even to prevent its own security forces from feeling
the negative impact of impoverishment and economic distortions.
Eventually, the security establishment itself rises up against its
leadership leading to a change in regime, quite frequently in the
form of a military junta. In Zimbabwe's case, one of the very reasons
for why the country has been plunged into hyperinflation is that
the government has tried to maintain support by granting its own
membership and in particular its own security forces special privileges
and salary hikes to keep them on sides. This in turn has led to
ever larger budget deficits, contributing to the need to print ever
more money to service government's growing debt. To be able to keep
on doing so indefinitely will simply exacerbate the hyperinflationary
process and will just prolong the problem before it ultimately implodes
upon itself.
Shortages
of goods set to cause sociopolitical tensions to overflow
Fissures of the kind
envisaged within the ruling party are already beginning to emerge.
The government of Zimbabwe has dealt with the situation by trying
to force businesses into cutting prices or freezing them. It has
been arresting businessmen for not complying. In some instances
in which businesses have complied, there has been a stampede to
buy goods by consumers who know that in real terms they are buying
such goods at artificially low prices. Furthermore, they know that
the production of such goods will become so unprofitable that production
will cease before long. Ultimately, massive shortages loom. Even
if whatever goods are available are channelled into the hands of
party members, it will not be long before even the supply of such
goods will dry up and party members will begin to squabble amongst
themselves over the scraps remaining. It has now become apparent
that the Reserve Bank of Zimbabwe itself is not in agreement with
the measures taken by its government, purportedly calling them "suicidal".
At least it understands that attempts at keeping prices artificially
low will lead to acute shortages which will see an escalation of
social unrest. The government has responded by suggesting that it
might resort to nationalising businesses and running them itself.
Without appropriate business acumen, one wonders how long such procedures
could last never mind succeed? Even with nationalisation, shortages
would emerge before too long.
Massive
government expenditure cutbacks and positive real interest rates
required
Unfortunately there are
no easy solutions for a country to extricate itself from hyperinflation
once the process is underway. Attempts are sometimes made to knock
the last two or three zeros off the currency and introduce a new
currency in the hope that psychologically this will end the process.
Whilst there is some merit in adopting a new currency, this cannot
have the desired psychological impact unless such action is accompanied
by drastic economic policy changes that encourage people to believe
the government is serious in trying to tackle the inflationary problem.
In Zimbabwe's case, as in the case of most other examples of hyperinflation,
this requires massive cuts in government spending as a means of
trying to rein in the budget deficit. Thus far such measures have
been unpalatable because they involve massive cutbacks in personnel
and salaries in the public service. This would go against the strategy
of the Mugabe regime in buying support from public servants including
the security forces. Policies to defuse hyperinflation also involve
raising interest rates to levels which make it uneconomic to contemplate
borrowing. Zimbabwe 's inflation has been exacerbated in recent
years by the maintenance of artificially low interest rates, way
below the inflation rate. This has encouraged ridiculous levels
of borrowing which make a lot of sense when real interest rates
are so low. In the process, however, the money supply has been boosted
dramatically. Unfortunately, both cutbacks in government spending
and much tighter monetary policy would lead to a severe downturn
in economic activity over and above the halving of the country's
GDP which has occurred over the past decade.
Incorporation
of Zimbabwe into common monetary area being mooted
Reports have surfaced
to the effect that the South African Development Community (SADC)
of southern African states has suggested that a solution to the
Zimbabwean economic crisis is for that economy to be incorporated
into the Rand Monetary Area, now known as the Common Monetary Area
(CMA), in the same way as Namibia, Lesotho and Swaziland are currently
incorporated into the CMA. Effectively, membership of the CMA implies
that the monetary policy in the smaller countries, which together
account for less than 4% of the GDP of the CMA, becomes subservient
to the policy of the South African Reserve Bank. In a sense it implies
that the SA Reserve Bank can dictate a significant portion of economic
policy within those countries. In return, the Rand is effectively
legal tender in those countries. It also means that capital can
flow freely between them and this encourages cross-border trade
and investment as well as business activity more generally. Incorporation
of Zimbabwe into the CMA in theory would be possible assuming the
Zimbabwean authorities were happy to allow monetary policy to be
dictated from Pretoria. The size of the Zimbabwean economy is now
so small in relation to that of the South African economy that even
with Zimbabwe's hyperinflation, integration ought to be possible
theoretically without causing too much upheaval in South Africa
. Indeed, one could argue that the psychological benefit of Zimbabwe's
monetary policy being dictated to by Pretoria, would make it substantially
easier to defuse hyperinflationary pressures in that country. However,
there is one huge stumbling block to such an idea. It is extremely
doubtful whether the Mugabe regime would be agreeable to becoming
subservient to the dictates of South African technocrats. Associated
with this, South Africa would carry a huge risk to its own currency
if it could not convince the world that it would take charge of
the situation in Zimbabwe . In order for it to do so, it would basically
need to topple Mugabe and oversee the installation of a new leadership
in that country.
Can
Zimbabwean crisis disrupt the South African economy?
The fear in most people's
minds is the knock-on effect which the Zimbabwean economic crisis
might have on the South African economy? The interesting thing in
this regard is comparison of the domination of movements in the
Rand in 2001 supposedly on the basis of concerns that the type of
land seizures which were being undertaken at that time in Zimbabwe
would be replicated in South Africa . There were also concerns about
the adverse social and economic impact posed by the threat of thousands
of Zimbabweans fleeing illegally across the border into South Africa.
Amazingly, even though the Zimbabwean economy has plunged deeper
and deeper into crisis since then and even though illegal immigration
from Zimbabwe has gathered momentum, it barely enters news nowadays
as regards the movements in the Rand and the impact on the South
African economy. The simple answer is that the Zimbabwean crisis
was a convenient excuse in 2001 for foreign investors to sell the
Rand in tandem with the huge increase in risk aversion towards emerging
markets at the time. Commodity prices were plunging in line with
worsening investor sentiment in a world economy which was suffering
a sharp downturn.
At present,
global liquidity glut renders Zimbabwean crisis relevant
In contrast, in the current
global environment of excess liquidity and record low risk aversion
towards emerging markets, together with buoyancy in the trend of
commodity prices, the Zimbabwean crisis barely features in discussions
about the South African economic environment. Similarly, the presidential
succession issue domestically, which ought to have been causing
jitters on local financial markets, has been conspicuous in not
having much bearing on such markets thus far. Perceptions of a possible
change in the direction of economic policy domestically towards
the left at the ANC Policy Conference a fortnight ago, hardly caused
any ripples on financial markets. Whether one can remain complacent
about such issues, remains to be seen. However, on the evidence
thus far, a much more important determinant of sentiment on domestic
financial markets appears to be global liquidity and the extent
to which the abundance of cash waiting to be invested in emerging
markets, stands to continue? Indeed, some reports suggest that foreign
investors are even looking at opportunities in Zimbabwe right now
and that the US Dollar prices of property in Zimbabwe are soaring.
This reflects the extent to which risk aversion towards investment
in emerging markets has fallen. Clearly, some investors see enormous
profit opportunities in a post-Mugabe Zimbabwean economy. However,
we believe that such commitment to the country at present could
be premature. The nature of hyperinflation is such that policies
needed to eliminate it could cause that economy to plunge deeper
into depression before recovery can set in. Nonetheless, it is a
fair bet that Mugabe will not be president of Zimbabwe by year end.
Hyperinflation will prove to be his nemesis.
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