The Zimbabwe ZiG, a currency launched in April, has imploded, raising fears of sticky inflation and more US dollar demand. The official USD to ZIG exchange rate was listed at 25.13 on October 2, much higher than the initial price of 13.5.
Are you looking for signals & alerts from pro-traders? Sign-up to Invezz Signals™ for FREE. Takes 2 mins.
It is doing worse in the black market, where the exchange rate has surged to 40, meaning that the currency has fallen by over 207%.
Why is the ZiG imploding?
The current phase of the Zimbabwe ZiG sell-off happened after the central bank devalued it by 43% last week.
This happened as the bank worked to bridge the gap between the official and the black market rate. It argued that the devaluation would work as a shock absorber and that it would stabilise the currency in the long term.
The central bank also decided to hike interest rates from 20% to 35% to make the currency attractive for savers. It also introduced new currency caps that reduced the amount of money that one can take out of the country to $2,000 from $10,000 before.
Recent intentional currency devaluations have not worked out well. For example, the Nigerian naira and the Egyptian pound have all crashed to their record lows after the central banks devalued their currencies.
The odds of the Zimbabwe ZiG’s success were always stacked against it, as I have written several times before.
First, the Zimbabwean economy is not doing well because of a recent prolonged drought that has led to more food imports. Higher imports lead to more demand for US dollars since many users abroad do not accept the Zimbabwean currency. Some of Zimbabwe’s top exports like tobacco have also been affected. In a note, an analyst at Capital Economics said:
“While this is a positive step, it is unlikely to be a one-time adjustment. The country’s wide current-account and fiscal deficits, along with limited access to external capital markets, will continue to place significant pressure on the currency.”
Second, the Zimbabwe ZiG has plunged because of the elevated US dollar demand in the currency. While many businesses accept the currency, data shows that most convert their profits into US dollars.
Third, the ZiG is competing with the more established US dollar, which is used to handle most transactions in the country. Data by the central bank shows that the greenback is used in over 70% of all transactions.
A crisis of confidence
The most important reason why the Zimbabwe ZiG has crashed is that many people in the country don’t have confidence in the currency and the central bank.
Besides, the bank has launched six currencies, which have all imploded, leading to substantial losses, especially to savers.
Before the ZiG, the central bank launched the RTGS dollar, which dropped by more than 80% in the first three months of the year as its demand collapsed. Savers who allocated their savings in the currency when it was launched in 2019 saw their funds almost disappear.
History shows that many people have a hard time trusting troubled currencies. This explains why the Turkish lira has dropped to a record low even after the central bank delivered several interest rate hikes, pushing the benchmark to 50%.
It also explains why the Argentine peso has crashed by over 20% this year and by 180% in the last twelve months.
Other highly troubled currencies like the Nigerian naira and the Egyptian pound have also crashed because of low confidence among businesses and individuals.
For starters, Zimbabwe ZiG is a unique currency in that it is backed by dollars and gold. When it was launched, the currency was backed by $100 million in cash and 2,500 kilograms of gold. The central bank has added more money and gold to back it up.
It is an experiment that has not been tried before. The closest approach that has been fairly successful has been to peg local currencies to others. For example, Namibia has pegged its currency to the South African rand.
Similarly, the Hong Kong dollar has been pegged to the US dollar. As we have seen before, countries that peg their currencies often need to intervene in terms of pressure. For example, the Hong Kong Monetary Authority (HKMA) intervened in the market three times in 2023.
HKMA is able to do that because it sits on some of the highest dollar reserves in the region. Recent data shows that the city has over $425 billion in reserves, which are higher than its GDP of $359 billion. Zimbabwe, which has also intervened recently, does not have these buffers.
As I have written before, I believe that odds of the Zimbabwe dollar success are limited and that the country will most likely continue using dollars for a long time.
Ad
Want easy-to-follow crypto, forex & stock trading signals? Make trading simple by copying our team of pro-traders. Consistent results. Sign-up today at Invezz Signals™.
Source link