Different writers have defined the concept of dollarization differently. Bloch (2009) defines dollarization as the substitution of a domestic currency by a more stable foreign currency. It occurs when the inhabitants of a country decide to fully or partially adopt the foreign currency as a medium of exchange within the domestic country. However, the term does not necessarily mean adopting or usage of US dollar, but rather any foreign currency.
REASONS FOR DOLLARISATION (ZAMBIA AS A CASE)
In the 80’s and 90’s, Zambia, like many developing countries was faced with several economic hardships, which culminated the whole country to halt in development. It was characterized with both microeconomic and macroeconomic reversals where inflation was ever increasing to three digits, the foreign exchange market was in a crisis and both capital and money market were performing poorly. The oil crises and the plummeting of the price of Zambia’s main forex earner, copper, grounded the whole economy. This was worsened by the mismanagement of the parastatals by the government officials. As such, the kwacha was fast depreciating which made it becoming worthless in comparison to other currencies in the region. Generally, the whole economy had collapsed completely, and when there was change of government 1991, some economists and politicians in 1994, as one of the major economic reforms meant to attract investment, allowed other foreign currencies like US dollar to be used besides the falling kwacha. These harsh economic conditions gave a very good reason for dollarization. Thus, Chitambara (2009) supports that dollarization is predominantly a response to a loss of confidence in the local currency owing to severe bouts of microeconomic instability such as hyperinflation, currency crisis as well as high and volatile interest rates. Therefore, Zambia, which initially experienced economic instability in command economy and during structural reformation, hence creating a crisis in the kwacha, adopted the dollarization policy to rescisitate the “drawing economy”. Generally, most of the countries which dollarized in the past like Argentina, Bolivia, Peru, Zimbabwe, Russia etc were experiencing serious economic stabilities which included fast rising inflation and serious lose of value of their domestic currencies (Robertson. 2009)
Further, the Zambian kwacha had shown to be very unstable against other currencies, hence would not inspire confidence to the much needed investors. Between 1991 and 2003, Zambian government really needed foreign investment to boost up the economy, but this was partly hindered by the unstable kwacha and high inflation rate, which stood at 118% in 1998. Therefore, by adopting US dollar in transaction and trade it meant making the economy foreign investor friendly as that would reduce the transaction costs, exchange rate risks and the general inconveniences as a result of exchanges. We really needed to be very attractive to the investors by giving them confidence of our economy. Savastano, M (1996), showed that dollarization economies could invoke greater confidence among international investors inducing investments and growth. Investors from US.A, Canada and many other countries who readily use US dollar, found it cheaper and easier to come to the dollarized Zambia due to the currency uniformity in short. Dollarization was one of strategies adopted to attract foreign direct investment to rescisitate the Zambia economy in a ‘coma’.
BENEFITS OF DOLLARIZATION TO BUSINESS PEOPLE
Since dollarization was adopted mainly due to crisis in the economy and our currency, kwacha, it is clear that the firms and traders who were practicing it reduced the losses because of sudden changes in currency market.
Business people that hold on the dollar gain more kwacha when the same kwacha depreciates (as what has been happening recently). During depreciation of kwacha, a dollar buys more kwacha hence the trader gains. So quoting prices in dollars or any stable currency will ensure that a trader does not lose the purchasing power when the kwacha suddenly depreciates. Instead, such a businessperson will gain more kwacha in times of economic turmoil. For Instance, many traders who were quoting and selling their goods in dollar here in Zambia, during the global financial crisis in 2008, did not experience any lose of income but ended up acquiring more kwacha as this same kwacha was fast depreciating. Therefore, most cash crop traders who rely on export revenues gain more during the dollarization as their capital and profits are stored safely in a more stable currency.
Besides, cross border trade is accelerated when business people use the same currency as transaction costs are reduced. So transaction costs reduced when Zambian businesspersons who were holding US dollars traded with the dollarized Zimbabweans, as there was no need to be involved in foreign exchanging, which is not only costly but also inconveniencing. Businesspersons involved in cross border trade accrue more benefits when there is currency uniformity since costs because of currency exchange, reduce, hence more profits.
BENEFITS TO THE ECONOMY /COUNTRY
Firstly, it must be understood that it is a cheaper and easier for countries using the same currency to trade in goods and services. For instance, before banning of dollarization, traders from other countries would easily bring and sell their goods to Zambia and Zambian to those countries without any complications of currency swapping. Rose (2000) applied the gravity model of trade and provides empirical evidence that countries sharing a common currency engage in significantly increased trade among and benefits of dollarization for trade may be large.
Dollarization of Zambian economy can bring out greater confidence among foreign investors, which can cause the increase in the investment levels and economic activities. The elimination of the currency crisis because of dollarization leads to a reduction of country risk premia and then lower interest rates. We know that the reduction in the interest rates have a potential of promoting small and medium enterprises among local investors.
Besides, official dollarization to a country like Zambia can promote greater fiscal and monetary discipline and this greater macroeconomic stability and lower inflation rates, lower real exchange rate volatility. Adopting a strong foreign currency as legal tender helps to eliminate the inflation-bias problem of discretionary monetary policy. For instance, Zimbabwe saw the hyperinflation reduce from 1300 % to less than 10% after dollarization.
Further, dollarization imposes stronger financial constraint on the government by eliminating financing of the deficit by issuing money, which has the potential of increasing aggregate demand and thereafter inflation.
Dollarization has several disadvantages to the dollarized nation. These are some of the demerits which made the government of the Republic of Zambia ban it.
Soko. E. (2012) explains that dollarization has the capacity to depreciate the Zambian Kwacha and render it worthless. Since, the government realized that if dollarization is left unbanned could lead to a further depreciation of the local currency, kwacha. For sure given chance between using a local currency and the strong and stable foreign currency, citizens and more especially traders and businesspersons in the country would easily switch to a foreign one. This would mean further lose of demand of the local currency against major currencies, hence depreciate further and further. So in order to strengthen the kwacha against dollar by increasing its demand, the government of Zambia decided to ban the usage and quoting of dollar during transactions. It realized that once the dollar continues to circulate, it would make kwacha even depreciate further and finally become worthless. The officials did not want to be like Zimbabwe. Dollarization did not strengthened Zimbabwean Dollar but has made it even become worthless.
Further, Hanke (2008) argues that dollarization deprives a government of its money printing inflationary powers to financial fiscal deflects. This entails that a country cannot print the adopted cash to finance any project. For instance, Zimbabwe cannot print or reprint the US dollar to cover up the deficit incurred in the economy, as she has no right to do so. This shows that the country loses its seigniorage revenue, as well as monetary policy autonomy .The country might not be free to execute monetary policy without prior notice of the owner of the currency.
Again another disadvantage is that full dollarization results in the loss of an important emblem of national identity and pride, the national currency. Since citizens are allowed to engage in currency substitution, they may lose all the confidence in their local currency and completely stop using it, hence rendering it useless completely. Because of this, the local currency goes into extinction and that country will be known not to have any currency of its own, hence no national identity and pride. The government of Zambia did not want to lose grip on this important identity and asset, kwacha, and then leave Zambia without any currency.
Dollarization can easily be used as tool by the country whose stable currency is being used by a nation adopting its currency in influencing policy. Hanke (2008) clearly points out that dollarization may lead to loss of political autonomy and sovereignty as the dollarizing country may leverage its currency as coercive tool to force the dollarized county to adopt certain policies that may not be in their interest.
PERSONAL VIEWS ON DOLLARISATION
On my personal perspectives, I feel the move taken by the government to ban dollarization is a positive move. This is due to several reasons below.
Firstly, dollarization is mostly adopted by nations experiencing galloping inflation pressures.
Ize and Lvey-Yeyati (1998) commented that dollarization will increase with inflation volatility…” But then the Zambian economy today in 2012 has a very low inflation rate at 6.8% showing that the reason for dollarization in far as inflation volatility is concerned is invalid. Zimbabwe had to dollarize the economy in 2005 because of hyperinflation, which stood at 1000% in 2003. Zambia had also dollarized in 1994 because of the escalating inflation levels of 183% in 1993. However, inflation of 6.8 % today 2012, provides no valid reason for dollarization.
Besides, Zambia has been experiencing a steady deterioration in the foreign exchange market in recent years. Kwacha had depreciated for more than 10% from August 2011 to April 2012. Each dollar sold at K4, 840 in 2011 but depreciated to K5, 210 by April 2012. However, since our objective is to see a stronger kwacha that will provide confidence to the new investors, allowing dollars as a legal tender or medium of exchange would not help, instead it sends a bad signal to other countries on how worthless Zambian kwacha is. Allow local currency substitute for other foreign currencies can marginally attract investment, but can largely signal the worthlessness of a local currency and the entire economy. For instance just after dollarization of Zimbabwe, the signal was sent to other countries that Zimbabwean Dollar and whole economy have deteriorated. Moreover, this is deterrent to the new investment. Dollarization of Zambia’s economy will not assist the depreciating kwacha. In fact, it will make it weaker. But we want the demand for kwacha increased by allowing all dollars brought to Zambia to buy the excess kwacha in the forex market and so mop up this excess kwacha thereby appreciating it to required equilibria.Having a stronger Kwacha will inspire confidence to the investors.
Further, a sovereign country is not only shown by boundaries but also the national identity, currency. So Zambian kwacha defines Zambia and it uplifts this country. The world map showing different currencies will show Zambia with a Zambian Kwacha tag. When dollarization is allowed, this national identify, kwacha, will be submerged or obscured by other foreign currencies and render it and our country insignificant and uncultured. There will be no national pride, and nothing to show for when dollar continues to show itself in Zambia.
Even though certain sectors like Tourism are complaining that tourism will be affected negatively because tourists understand dollars more than kwacha, but it must be known that any foreigner in Zambia should be subjected to local terms and conditions of doing business in Zambia. It is the Zambians themselves who should make these tourists understand our Zambian currency. There is no country in the world apart from Zambia itself, which can allow Zambian kwacha to be used as a medium of transactions. All Zambians who go as tourist in U.S.A or Mexico or Madagascar are obliged to change kwacha for respective local currencies. If a tourist wants to buy locally made sculptural work, he should buy kwacha at bureau of exchange outlets and then buy what he needs. So on entry all foreigners including tourists should be directed to forex houses to buy the kwacha. As such we will not only increase the demand for kwacha and hence appreciate it, but also send a signal to the world on how much value we bestow on our national identity, kwacha. The fact is that many tourists from USA and Europe are undermining Zambian Kwacha and that is why they still want to stick to their currencies in other countries. So Zambians and any other entrepreneurs especially in the tourism industry should not assist in portraying Zambian Kwacha as a worthless currency by defending the usage of dollars.
Finally, when we continue allowing dollars to be used in transactions, and later rendering kwacha worthless, Zambian government will be unable to have freedom to print or reprint the US dollar and so, we lose the freedom of seigniorage especially when badly needed. We needed BOZ to continue having monetary and exchange rate instruments, which are usually used in covering deficits, control of inflation and project financing. For instance, Zimbabwean Reserve Bank has no freedom to print U.S Dollar or SA Rand in circulation in order to finance a project, as the Zimbabwean Dollar, which is worthless, is no longer used.
COUNTRIES THAT HAVE DOLLARIZED
Apart from Zimbabwe, many countries have allowed other currencies to be used exclusively or trade by side with local one. Nations like British Virginia Islands, Palau, Ecuador, Panacea, Turk and Caicos Islands etc. These countries implemented full dollarization of their economies; hence, their local currencies have ever since diminished from circulation and their respective central Banks lost the freedom to print or sovereignty in seigniorage.Some of countries have allowed dollar other major currencies to circulate and be used as medium of exchange alongside their domestic currencies. Countries such as Liberia all owed U.S.A dollar besides Liberian dollar, in Haiti the Gourde with U.S Dollar, Vietnam (U.S Dollar alongside Dong), Lebanon (U.S Dollar with Lebanon pound) etc.When we view almost all countries that dollarized economies, they were experiencing ever-increasing inflation.
Thus, Robertson (2009) noted that dollarization has been adopted in the past by countries like Argentina, Bolivia, Mozambique… because most of them were due to hyperinflation.