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Adopting the rand not the answer for Zimbabwe
Gavin Keeton, Business Day
February 12, 2009

http://www.businessday.co.za/articles/topstories.aspx?ID=BD4A937533

President Kgalema Motlanthe has suggested that Zimbabwe could adopt the rand to end its hyperinflation woes. While ending hyperinflation is a necessary first step for economic recovery in Zimbabwe, the rand is not the answer.

No country has ever grown while suffering from hyperinflation; indeed, every experience of hyperinflation has been accompanied by the kind of economic collapse Zimbabwe is currently witnessing. In looking for a cure, Zimbabwe can look to a surprisingly large number of countries that historically experienced hyperinflation — eight from 1920-1946 and 16 since 1984. As a recent Brenthurst paper shows, in all countries the cause was the same: hyperinflation was preceded by a long period of very high inflation , followed by an event in which an already high budget deficit suddenly increased sharply. An institutional ability to use the central bank to print money to fund the large deficit caused prices to spiral to ever-higher levels. In hyperinflation, government tax revenue inevitably collapses as economic activity contracts. Moreover, taxes are paid only monthly, quarterly or annually, by which time hyperinflation has made their value virtually worthless. As a result the deficit rises further, requiring the central bank to print more money, which in turn drives hyperinflation ever higher in a cycle of sky-high prices and economic collapse.

What makes Zimbabwe-s experience of hyperinflation unusual is the extraordinarily high level that hyperinflation has reached. At 231-million percent in July last year, Zimbabwe-s hyperinflation has been surpassed by only the Weimar Republic (Germany) in 1923 (where prices doubled every two days) and Hungary in the aftermath of the Second World War (prices doubled every 15 hours).

Zimbabwe-s experience of hyperinflation is also unusual in that it has now lasted for almost two years. Most other hyperinflations lasted only a few months or maybe a year because the economic collapse that accompanied hyperinflation brought about a swift change of government or at least a U-turn on the policies that caused hyperinflation in the first place. The price Zimbabwe has paid is that its economic collapse has been especially severe.

To end hyperinflation, the budget deficit must be slashed — international experience suggests by at least 10% of gross domestic product (GDP), but in Zimbabwe the fact that the true deficit may be approaching an astonishing 80% of GDP suggests that the cut may have to be much greater than this.

Second, the misuse of the central bank to fund the deficit by printing money must be ended by removing the bank from government control. None of this is easy, as reducing the deficit in a situation where tax revenue has collapsed means slashing government spending (for which read employment in the civil service) at a time of very high unemployment and collapsed delivery of social services.

A third condition for ending hyperinflation is the establishment of what economists call a "nominal anchor" — replacing a valueless local currency with a yardstick against which future prices can be measured and their rate of increase brought under control. Often this anchor has been a fixed exchange rate or at least a "crawling peg" in which the exchange rate depreciates at a slowing rate.

Adopting the rand as Zimbabwe-s currency would provide such a peg. At the same time it would prevent the Zimbabwe Reserve Bank from printing money to fund the budget deficit as it cannot print rands. This in turn will force the government to slash the deficit and hyperinflation will indeed end. But such a solution is not workable in practice.

The Zimbabwean government has already taken the extraordinary step of allowing local prices to be set in a range of currencies (including the rand, dollar and pula). But the Zimbabwe dollar remains legal tender and the reserve bank can continue to print these dollars for government to pay its public servants, not least the army. If the rand becomes the official currency, where will the Zimbabwean government get the rands to pay its employees? In time, taxes will be paid in rands, but these will not meet the current huge deficit of revenue versus spending. Such a hole can be filled only if foreign aid is available. In the absence of aid, SA would be called upon to supply the needed rands or face possible unrest and the complete collapse of remaining public services in its northern neighbour.

Adopting the rand can therefore happen only once the other ingredients to end hyperinflation are in place. First there must be political consensus on slashing the deficit as well as ending the central bank-s ability to fund future deficits. Only then will a nominal anchor be effective. Most probably this should mean fixing the Zimbabwe dollar exchange rate to the rand. Under such conditions, adopting the rand itself will probably be no longer necessary.

* Dr Keeton is in the department of economics and economic history at Rhodes University.

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