Zimbabwe's Rampant Inflation

June 25, 2007.

ZIMBABWE'S RAMPANT INFLATION

Although authorities in Harare declared inflation the country's number one enemy, it appears they have run out of ammunition to subdue the charging "bull elephant". This is only one of a long list of hardships Zimbabweans have to endure since an economic meltdown that began in 1997. In addition, Zimbabweans also have to grapple with rising poverty caused mainly by unemployment of 85%, a crumbling health system with unaffordable drugs, rising food prices, electricity cuts, shortage of fuel and just about every basic survival commodity.

Today Zimbabweans talk about the good old days when a dollar would buy something. You even hear such preposterous pronouncements as "we had it better during the Ian Smith regime". What happened to that dollar? Why won't it buy as much as it did last month or last year? What happened is inflation. Over the past twenty-seven years, inflation has increased from 10.5% in 1980 and then frog-leaped to 104.9% in 2000 and now at 4,530% in May 2007, a figure regarded as very conservative.

Economists talk of the inflation rate, which is the rate of increase in the price of goods and services over a given period of time. The most generally used measure of inflation is the Consumer Price Index, which is calculated monthly by the Central Statistical Office. This is the current rate at which a basket of goods and services has increased for a year. The two current leading indicators that measure the current inflation rate are the Consumer Price Index (CPI) and the Producer Price Index (PPI).

Without involving ourselves into what may turn into "textbook economics", there is then what is called cost-push inflation. This is a rise in prices due to an increase in the cost of production. Increases in the cost of labour, raw materials, equipment, and borrowing money push up the cost of production. Sometimes called supply-shock inflation, this is caused by large increases in the cost of important goods or services where no suitable alternative is available. A situation that has been often cited as of this was the oil crisis of the 1970s, which some economists see as a major cause of the inflation experienced in the Western world in that decade. It is argued that this inflation resulted from increases in the cost of petroleum imposed by the member states of OPEC.

Then there is the demand-pull inflation caused by price increases as a result of supply not meeting demand. It is a rise in prices due to too much spending (demand). In other words it is "too many dollars chasing too few goods." In Zimbabwe, this arises from increased money supply. However, in practice both cost-push inflation and demand-pull inflation are linked together as increases in demand may cause labour shortages, which in turn push up wages. Firms, which have to pay the higher wages, are then forced to put their prices up to maintain their margins.

Economists rarely agree about anything, and inflation is no exception! Over the years, a wide range of causes have been suggested. The fact that inflation can be caused by different things at different times only complicates the picture further. This article explores some causes of inflation in the Zimbabwean economy. It is necessary to note that as inflation can be caused by a variety of different factors, for each factor there are several different theoretical explanations, into which this paper will not go.

One obvious problem that has caused inflation in Zimbabwe is people's expectations of inflation itself. When one considers that people build their expectation of inflation into their wage claim, it then becomes clear that this in itself can be a cause of inflation. To take the Zimbabwean scenario, if one expects inflation to be 4,530%, one may reasonably expect a wage rise in excess of this. If the Zimbabwe Congress of Trade Unions (ZCTU) manages to get that wage increase, then that may cause further cost-push inflation as companies are then facing higher costs. The higher inflation may then raise people's expectations further - a vicious circle. In other words, higher expectations can actually cause higher inflation.

Recently, President Robert Mugabe chided the outgoing Minister of Finance, Herbert Murerwa for applying "textbook economics". While it is appreciated that the government is giving civil servants salary increases and allowances of up to 900%, it should be remembered that these are unbudgeted for and only add fuel to inflation. The allowances which range from Z$2 million to Z$4 million for the teachers, lecturers, nurses and soldiers came barely two weeks after the civil servants got their May salaries. This was over and above the 639% salary hikes awarded to civil servants effective from June 2007. However, these salaries are immediately eroded because they are paid out of the central bank's printing press to cover people's expectations of inflation.

It is obvious that the President seems to forget that the government has to borrow the money from the Reserve Bank of Zimbabwe. Government borrowing to pay wages and recurrent expenditure increases inflation unlike the business sector, which borrows money for productive purposes.

This brings into focus the question of money supply. Successive finance ministers, and the outgoing Reserve Bank governor Leonard Tsumba, were guilty of creating the basis of a systematic financial sector crisis. Notes and coins in circulation increased 70% in the first eight months of 2002, while money supply reached 148.9% in November 2002 - twice as much as it was at the same time in 2001. At the end of October 2003, money supply growth was estimated at more than 300%, fuelled on by hyperinflation, and the introduction of high denomination bearer's cheques, much of which money was being used for speculative and consumptive purposes. The amount of notes and coins in circulation jumped from Z$58.3 billion in January to Z$63 billion in February 2003, according to the central bank's August economic bulletin.

At the end of January 2007, Gideon Gono unveiled a battery of belt-tightening measures including slashing the money supply to put brakes on four-digit inflation. In his monetary policy statement he said, "The urgency of the need to reduce inflation impels that 2007 be the year for unprecedented fiscal and monetary policy restraint. To this end, the Reserve Bank will reduce broad money supply growth from the current levels of over 1,000 percent to between 415 and 500 percent by December 2007 and subsequently to under 65 percent by December 2008."

Broad money supply he was referring to comprises narrow money and quasi-money. Narrow money represents demand deposits and notes and coins in circulation, while quasi-money refers to time deposits and other instruments that cannot be easily converted into cash. Economic experts said the persistent growth in annual broad money was a cause for concern because it impacted on the country's surging inflation rates.

Inadequate fuel supplies as experienced in Zimbabwe since 2000, induce inflationary pressures. Production constraints as a result of poor fuel supplies translate into increased unit costs and higher prices. The black market, where fuel fetches much higher prices than those obtaining on the official market, also aggravates the situation. Statistics show that fuel accounts for between 15% and 20% of total production costs hence increases in fuel prices directly impact on the cost of production. Mines and the manufacturing sector which rely on huge amounts of diesel for production are forced to scale down operations. Productivity also takes a battering as employees spend most of their time queuing for fuel at petrol stations.

The devaluation of the Zimbabwe dollar pushes up import costs, hence prices of imported goods and raw materials, which feed into inflation. The exchange rate adjustment of July 21 2005 amounted to a cumulative 182% devaluation and was expected to provide relief to exporters who, however, would now access more expensive funds following the decision on interest rates. At the end of April 2007, the governor of the RBZ introduced a secondary exchange rate of Z$15,000:US$1 for foreign currency holders and exporters but insisted that all other transactions be done at the official rate of Z$250:US$1. On the parallel market, though, one greenback was trading at Z$150,000 by the last week of June.

The surge in lending to troubled banks also point to higher inflation. At the end of May 2004, loans to banks were Z$2.8 trillion - or more than 12% of GDP. In a report released at the beginning of October 2005 following a visit to Zimbabwe by the IMF, the Reserve Bank of Zimbabwe was criticised for its doling out of funds to the banking sector in 2004. The central bank was also sinking further into the red by subsidising exporters, gold and tobacco producers through support prices and a higher preferential exchange rate. Cheap funds doled out to agriculture at 20% interest also triggered massive money supply growth.

The budget deficit has always negatively contributed to Zimbabwe's hyper-inflationary economy. The 2004 budget showed a deficit of Z$1.85 trillion which translated to 7.5% of GDP. The 2005 budget, in the same vain, showed total expenditure of Z$27.5 trillion compared to a total of Z$23 trillion in revenue. This translates into a budget deficit of Z$4.5 trillion, i.e. 5% of GDP.

The domestic debt surged by over 600% during the first three months of 2007, breaching the trillion-dollar mark for the first time since the country lopped off three zeros from its currency. Statistics from the Reserve Bank of Zimbabwe showed that total government domestic debt, excluding government deposits with the central bank, increased from Z$176 billion on January 5 to Z$1.3 trillion by March 30. It is hard to reconcile how the government was going to raise the Z$1.3 trillion in revenue given the dismal performance of the economy.

The escalating domestic debt level was likely to seal the fate of the country's inflation rate this year, already projected to reach 10,000% by independent forecasters. The absence of balance of payments support from offshore financiers has forced the government to aggressively rely on domestic bank sources for funding requirements, normally through costly Treasury Bill (TB) instruments, which have largely been short term.

Zimbabwe's domestic debt is a major contributor to inflation. Rather than financing ongoing and exhaustive expenditures, most of the funds were now being used for transfer payments and consumption purposes. Economists have predicted that the debt will expand further as the government borrows to finance the budget deficit.

Zimbabwe's overall balance of payments deficit deteriorated from US$335 million in 2003 to US$523 million in 2004. Exports went down by 60% since 2000 on the back of systematic destruction of the tobacco industry and horticultural exports. Tobacco production, which contributed 40% of export earnings before the fast-track land reform programme that started in 2000, has crashed by 70% and exports have also slumped significantly. This negatively affected efforts to rein on inflation.

Total foreign payments arrears increased from US$109 million at the end of 1999 to US$2.5 billion by the end of 2006. The worsening of the country's creditworthiness and its risk profile has led to the drying up of sources of external finance. The withdrawal of the multilateral financial institutions from providing balance of payments support to Zimbabwe has also had an effect on some bilateral creditors and donors who have followed suit by either scaling down or suspending disbursements on existing loans to the government and parastatals.

The rampant inflation or hyperinflation means shops and services can no longer function and people would resort to barter and illicit trading only in hard currencies. Some firms are already partly paying their workers in food, rather than money, it is reported. This is in order to bear the brunt of inflation themselves and avoid increasing wages in cash. Many firms pay their staff weekly or every two weeks instead of monthly and possibly would move to daily payments.

Shops are doubling their prices twice a month, so they can purchase replacement goods. Price quotations for work ordered from local businesses until recently were valid for between seven and 14 days. Prices are now being quoted as valid for one day or even one hour. Thus, it is difficult to have meaningful purchasing power in a country where prices of commodities increase on a daily basis.

Power and water supplies are already near collapse. In May, electricity was rationed to just four hours a day to save power for farmers. Because of shortages of electricity and foreign currency as well as a skewed exchange rate and government price controls, the manufacturing sector now contributes 15.5% to Zimbabwe's gross domestic product, compared with 24% a decade ago. Manufacturing output contracted by seven percent in 2006 compared to a 3.2 percentage growth in 2005, and is expected to register a two-percentage decline this year. A number of factories stopped trading in mid-June to enable them to determine the replacement cost of their products and raw materials and/or to re-cost their products.

Meanwhile, the well-to-do Zimbabweans drive top of the range cars. But then, a visit to townships like Mbare or Chitungwiza reveals the real story. In a report released in mid-June, the Consumer Council of Zimbabwe (CCZ) said that the cost of living (poverty datum line) for a family of six had increased 65.6% from Z$3.3 million in April to Z$5.5 million (US$45.80) in May. What this means in practical terms is that 80% of people live on less than two US dollars a day. Notable increases were in the prices of water and electricity, which went up 251% during the month; clothing and footwear, 241%; and transport, which went up 150%. It is quite common for the majority Zimbabwean families skipping meals or doing without items such as milk and meat in order to stretch their income to the next pay day. A loaf of bread costs Z$30,000 (Z$30 million if one reverts to the old currency before three zeroes were knocked off). Zimbabweans have to carry large bundles of cash for even small purchases.

There is a big trek by Zimbabweans to South Africa, the UK, North America, Australia and New Zealand fleeing their country's penury to find a way to support their families back home. A rising number claim to be refugees from persecution by Mugabe's ZANU (PF) and Green Bombers. But most are fleeing hyperinflation and not persecution. Research has shown that remittances from the Diaspora keep the economy afloat: half of all households get most of their money from distant friends and relatives.

If this hyperinflation is not brought under control, it will result in the increase in crime and possible civil disturbances. This acceleration of economic collapse signifies an end game for Zimbabwe's First Republic. Inflation, which is the highest in the world, is the most visible sign of Zimbabwe's deep recession that has left more than 80% of the labour force without jobs, 80% living bellow the poverty datum line and four million people in need of food help.

In order to forestall what seems an imminent economic collapse, the over-riding criteria should be the approval of the international community and the willingness of the donor countries to fund projects tailored towards the creation of wealth and employment. This calls for a political solution involving not just the ruling ZANU (PF) party and the opposition Movement for Democratic Change, but other stakeholders that include all the civic organisations.

The elimination of quasi-fiscal activities and the need to let the Zimbabwe dollar float against other major currencies are critical elements of a successful stabilisation process. Exchange rate unification and full liberalisation of the exchange regime for current international payments and transfers should be considered.

Elimination of price controls would ease shortages and restore private sector confidence. Because many businesses have defied price controls, essential food stuffs have disappeared from shops but some have re-emerged on the black market where prices are higher. The staple maize-meal, sugar and cooking oil have disappeared from most shops in Harare's city centre and suburbs while most pumps at fuel stations have run dry, forcing motorists to brace for long queues.

There is a need to impose strict budget control for public enterprises. This can be implemented by urgent reduction of the cabinet and public sector, including reductions in the number of civil servants - especially soldiers. Civil servants now constitute more than 50% of the workforce in the country. The government's wage bill is an astounding 20% of GDP.

There is a need for an orderly land-reform programme in line with international norms where the rule of law applies. The government continues to grab land although it declared in August 2003 that the exercise had been wound up. There is also an urgent need to establish an independent anti-corruption commission which should start a cleanup of both the public and private sectors. Because of corruption in the corridors of power, it has been impossible to come up with proper instruments to curb corruption.

Political manipulation is the main cause of failure to tame inflation. The only way that appears plausible for the revival of Zimbabwe's economic fortunes is fundamental political changes. Instead of the government curbing its reckless spending (most of it to buy political patronage), it brands those urging it to embrace fiscal discipline and austerity as enemies of the people. The government should bite the bullet and start by admitting its inherent weaknesses and failures. It should set the stage for meaningful reconstruction and the restoration of livelihoods with the help of the UN and other partners.

The constant chest beating about Zimbabwe's determination never to be "a colony again" does not make much sense. The country may not be a colony again in the literal and original sense of the word but it is definitely now beholden to new "masters" in more complex and costly ways.