Understanding inflation in Zimbabwe

In 2007/2008, Zimbabwe was ravaged by hyperinflation of Guinness record proportions. We had studied similar inflationary records like that of war-time Germany, Italy and, of course, many Latin American countries which ended up dollarising like we did in 2009.

But in 2008 too much money was chasing too few goods. Inflation was the archetypal Milton Friedman monetary phenomenon. A rhetorical question can be asked 12 years later: what is the nature of Zimbabwean inflation?

Professor Steve Hanke extensively studied Zimbabwe’s inflation but I doubt whether he understood the complex factors causing serial inflationary pressures in Zimbabwe. I use the term “inflationary pressures” advisedly because there is no single phenomenon that can adequately explain the character and nature of Zimbabwean inflation.

In my view, a number of issues explain the causes of inflation in Zimbabwe. The point of entry into this debate is the issue of imported inflation. Zimbabwe is a net importer of oil and oil products. Fluctuations in global oil prices may cause shocks that affect our domestic prices. Food and raw material imports similarly create transmitted inflation. The wage structure can also create inflation. However, in Zimbabwe there has been wage repression for many years and wage inflation is very negligible.

Similarly, interest rates do not feature quite significantly because capital and money markets are presently shallow. The investible surplus has been decimated by the poor performance of the economy. On the other hand, production or supply bottlenecks cannot fully explain the Zimbabwe inflation because over 60% of product lines are imported anyway. So what causes inflation in Zimbabwe? I argue that four factors have been at the epicentre of inflation in Zimbabwe. In my view, the causes of inflation in Zimbabwe are as follows:

1. The budget deficit;

2. Fuel prices;

3. Imported food inflation;

4. Profiteering, and

5. Currency debauchery.

I have deliberately left out productivity because it is a long-term structural issue which will take generations to address. It will take dramatic measures to reverse the de-industrialisation that has taken place in Zimbabwe.

In Bulawayo, the manufacturing sector has been decimated. Industries in Kwekwe, Gweru, Mutare and Harare have been turned into museums. Agriculture is cyclical due to low productivity and the vagaries of weather.

I now discuss each of the five causes of inflation in Zimbabwe.

The budget deficit

Zimbabwe’s fiscal deficit has been very toxic. During Robert Mugabe’s tenure, the accumulated budget deficit had breached the US$10 billion mark by December 2017. The budget deficit was caused by huge expenditure on defence, employment costs, security and command agriculture and not on social service delivery. The health sector and education sector were underfunded.

Government borrowed extensively through the Reserve Bank Overdraft Facility. The constitution allows government to borrow not more than 20% of the previous year’s revenues. Yet the government’s overdraft stood at more than 200%.

On the other hand, government issued Treasury Bills in excess of US$6 billion. This created money supply growth and increased M3 growth, thereby creating fertile ground for inflation. In short, government monetised the deficit, which means it was financed in an inflationary manner. Fiscal pressures sparked inflation. Borrowing to fund command agriculture contributed a large chunk of the Treasury Bills.

Profiteering

With due respect, our retailers and shopkeepers have not made the situation any better. Their mark-up models have been speculative and inflationary. Greed and avarice has driven prices upwards. There cannot be a convincing justification for daily mark-ups despite the difficult trading environment.

Imported food inflation

Most commodities are imported from South Africa. Retailers simply mark the same product prices in US dollars. For example, a product purchased for R25 was priced US$25 on the local shelves. This is ridiculous.

Fuel prices

There is no doubt that fuel prices have driven prices upwards. In January 2019, fuel price increases even triggered public protests and mass uprising with fatal consequences.

However, fuel price increases had nothing to do with global oil prices. Rather it was a rationing and demand management mechanism. Frequent fuel price increases are now the order of the day. The increases are absurd and defy logic.

Currency

The trade-off between bond notes/Real-Time Gross Settlement (RTGS) and the parallel market caused inflationary pressures. The 1:1 exchange rate created arbitrage opportunities. The result was that the cost of procuring forex was passed on to the final consumer.

The debauchery of the surrogate currencies meant that the market rejected the usage of the bond note and RTGS preferring the use of the US dollar. In fact, the economy self-dollarised and cross-rated prices in the surrogate currencies. This caused huge inflation, leading to the abandonment of the US dollar.

Paradoxically, Finance minister Professor Mthuli Ncube had promised to dump the bond note before his appointment.

But he made a volte face after his appointment as minister. When the bond note was introduced, I argued that it was going to create fertile ground for arbitrage and cross-rating which would lead to inflation.

I further argued that the bond, far from being an export incentive, would be widely used as a domestic currency on a day-to-day basis. The governor of the Reserve Bank of Zimbabwe was not convinced. I hope with hindsight he may now be seeing my point.

The turning point

As inflation became footloose and uncontrollable, civil servants demanded salaries in US dollars. The situation was untenable. At an official inflation rate of 95% (month-on-month) Zimbabwe entered hyperinflation. Economists classify hyperinflation as rates above 50%. Government panicked and abruptly announced the de-dollarisation of the economy.

In the next article I will look at the fundamentals that are required to sustain the re-introduction of a sovereign currency.