Amit Matani10P066

Lokesh Harnal10P086
Mukund Murali10P091
Prateek Maheshwari10P096
Richa Gupta10P105
Sethu Ramalingam M10P108
Contents
INTRODUCTION.....................................................................................................................................3
Hyperinflation:.......................................................................................................................................3
Hyperinflation in Zimbabwe:.................................................................................................................3
Timeline of Zimbabwe:..........................................................................................................................5
Land Reforms post 2000:.......................................................................................................................7
Wheat production:............................................................................................................................7
Tobacco Industry:..............................................................................................................................8
Manufacturing sector:.......................................................................................................................9
The effect on GDP:...............................................................................................................................10
The Problem of unemployment:..........................................................................................................10
Government Debt:...............................................................................................................................11
Causes of Government expenditure:...................................................................................................11
Theories of inflation:...........................................................................................................................12
Cost-push theory:............................................................................................................................12
Demand-Pull Theory:.......................................................................................................................13
Dollarization:.......................................................................................................................................13
Unofficial Dollarization:...................................................................................................................13
Semi-official Dollarization:...............................................................................................................14
Official Dollarization:.......................................................................................................................14
Multicurrency system:.........................................................................................................................14
Benefits............................................................................................................................................14
Challenges.......................................................................................................................................14
Conclusion- The Road Ahead:..............................................................................................................16
References...........................................................................................................................................17
 INTRODUCTION

Hyperinflation:

Hyperinflation is inflation that is very high or "out of control". While the real values of the
specific economic items generally stay the same in terms of relatively stable foreign currencies, in
hyperinflationary conditions the general price level within a specific economy increases rapidly as
the functional or internal currency, as opposed to a foreign currency and loses its real value very
quickly, normally at an accelerating rate. It occurs when there is a large increase in the money supply
not supported by gross domestic product (GDP) growth, resulting in an imbalance in the supply and
demand for the money. Left unchecked, hyperinflation causes prices to increase, as the currency
loses its value.

Hyperinflation in Zimbabwe:

The hallmark of Zimbabwe’s economic collapse is hyperinflation. The most recent official
inflation figure is for February 2008: a whopping 165,000 percent year-over-year. In early June 2008,
inflation is unofficially about 2.5 million percent a year. Not surprisingly, the Zimbabwe dollar has
lost more than 99.9 percent of its value against the U.S. dollar during the past year. Zimbabwe’s
hyperinflation destroyed the economy, pushing more of its inhabitants into poverty, and forcing
millions of Zimbabweans to emigrate. It has robbed people of their savings and financial institutions
of their capital through real (inflation-adjusted) interest rates that are actually negative. Between
1997 and 2007, cumulative inflation was nearly 3.8 billion percent, while living standards fell by 38
percent. The source of Zimbabwe’s hyperinflation is the Reserve Bank of Zimbabwe’s money
machine. The government spends, and the RBZ finances the spending by printing money.
Timeline of Zimbabwe:

In the year 2000, Mugabe’s supporters invade and seize white-owned commercial farms,
saying the land was illegally taken by white settlers. The War veterans were the supporters of
Mugabe. The Government of Mugabe did not assent to the Mugabe’s plan to redistribute white-
owned farms to blacks. So the war veterans forcibly did it.

In the year 2001, Zimbabwe suffers food shortages that government critics blame on farm
seizures. But Mugabe blames drought and Several Western governments quietly withdraw economic
aid over rights abuses by the government and Mugabe's land policy.

In 2002, Collapse of commercial agriculture and poor weather contribute to serious food
shortages, leaving about half of Zimbabwe's population in need of emergency food aid. The collapse
of commercial agriculture happened because of the inefficiency of the black farmers as they couldn’t
produce quality crops for exports.

In 2003, Hundreds of companies are forced to shut down due to economic hardships and
rising inflation. This completely led to the economic downfall of Zimbabwe and the country couldn’t
recover from this loss. Thus hyperinflation started to play its part in the Zimbabwean economy as
the nation had to print money to sustain its economy.
 In 2004, a system of auctioning scarce foreign currency for importers was introduced, which
temporarily led to a slight reduction in the foreign currency crisis.

Currency was devalued by the central bank twice, first to 9,000 to the US$, and then to
17,500 to the US$ on 20 July 2005, but at that date it was reported that that was only half the rate
available on the black market.

In 2006, the government had printed ZWD 21 trillion in order to buy foreign currency to pay
off IMF arrears. In early May 2006, Zimbabwe's government began printing money again to produce
about 60 trillion Zimbabwean dollars. Exchange rate had been frozen at Z$101,196 per U.S. dollar
since early 2006, but as of 27 July 2006 the parallel (black market) rate has reached Z$550,000 per
U.S. Dollar. In August 2006, the Zimbabwean government issued new currency and asked citizens to
turn in old notes; the new currency (issued by the central bank of Zimbabwe) had three zeroes
slashed from it.

On 1 April 2007 the parallel market was asking ZWD 30,000 for $1 USD.[28] By year end, it
was down to about ZWD 2,000,000. In March 2007, inflation surged to a new high of 1,730%, and in
June the government released a figure of 7,638%. The government then circulated a Z$200,000 note
and reports of extreme shortages of basic foodstuffs, fuel, and medical supplies abounded. The
government instituted a six-month freeze on wages on September 1, 2007.

The Reserve Bank of Zimbabwe issued a ZWD 10,000,000 note in January 2008, roughly
equivalent of 4 US dollars. In April 2008 the Reserve Bank of Zimbabwe issued a ZWD 50,000,000
note, which was then worth approximately 1.20 US dollars. On 30 July 2008, the Governor of the
RBZ, Gideon Gono announced that the Zimbabwe dollar would be redenominated by removing 10
zeroes, with effect from 1 August 2008. ZWD10billion became 1 dollar after the redenomination. On
December 6, 2008, the Reserve Bank of Zimbabwe announced plans to circulate the ZWD
200,000,000 note, just days after introducing the ZWD 100,000,000 note.

In late December 2008 and early January 2009, the use of foreign currency as a common
medium of exchange became increasingly popular. On 12 January 2009, Zimbabwe introduced the
ZWD 50,000,000,000 note. On February 2, 2009 a final denomination was implemented, cutting 12
zeroes, before the Zimbabwe dollar was officially abandoned on April 12, 2009.
Land Reforms post 2000:

Land Reforms were instituted by Robert Mugabe to redistribute the land between blacks
and whites. White farmers had achieved economies of scale with their advanced technology and
knowledge. The production by the white farmers was used for the exports. The black farmer did not
possess title deeds of the farm land. The black farmer had lesser experience in running a farm. They
lacked the adequate knowledge and technology to produce good yields. Consequently farm output
took a serious hit as banks did not agree to finance black farmers due to lack of expertise. The
production of the blacks was enough only to support the internal or local needs and not good
enough for the exports. Later after some time, the yield was not sufficient even for the local needs
resulting in acute food shortages which Mugabe called “Drought”.
Wheat production:
The wheat is the major crop of Zimbabwe. The production of this crop which accounted for
most of Zimbabwe’s exports was affected because of the land reforms. The annual production of
wheat was more than 300,000 tons in 1990 and it plummeted to less than 50,000 post land reform
in 2000.
Tobacco Industry:
Tobacco is the Zimbabwe’s single largest generator of foreign exchange. It accounted for
almost a third of Zimbabwe’s foreign exchange earnings in 2000. The crop that earned some US$600
million in 2000 generated less than US$125 million in 2007. This was the effect of the land being
distributed to the locals.

Manufacturing sector:
Manufacturing industry also faced some adverse effect post 2000. manufacturing sector has
shrunk by more than 47 percent between 1998 and 2006, which carried output levels back to figures
recorded in 1972. There were some policies which were formulated for the manufacturing sector.
The law requires exporters to sell up to 30 percent of their foreign exchange earnings to Zimbabwe’s
Reserve Bank at an artificial exchange rate that is a fraction of the real market rate. Members of the
ruling regime and their associates have become rich by buying up foreign currency at the official
exchange rate and then selling it at the black market rate, pocketing the difference. To stem
runaway inflation, the government announced halving all prices. Manufacturing output fell by more
than 50 percent. Many manufacturing firms had to shut down because of this.
The effect on GDP:
Gross domestic product (GDP) declined by about 43 percent between 2000 and 2007.
The Problem of unemployment:
Employment level have been sharply decreasing at a fast pace since 1999. Rising wage rates
caused employers to continuously increase salaries which led to further inflation as labour became
expensive.

Government Debt:
The Government debt was increasing rapidly. Govt could not pay back IMF loans and the
debts from the other countries. RBZ raised money from the internal economy, which led to an
increase in the interest rates thus fuelling inflation.
Causes of Government expenditure:
The government has run huge budget deficits. The budget deficit was as high as 22% of GDP
in 2000. To recover from the deficit problem, the Government printed money to cover the gaps.The
Government expenditure increased year by year.

 In 1997 there was an unbudgeted government expenditure of 1997 to pay the war veterans
gratuities. The war veterans are the supporters of Mugabwe.
 Zimbabwe’s intervention in the Democratic Republic of Congo (DRC)’s war in 1998
 The expenses of the controversial land reform (beginning 2000)
 The parliamentary (2000/2005) and presidential (2002) elections
 Introduction of senators in 2005 (at least 66 posts) as part of ‘widening the think tank base’

Theories of inflation:
There are various theories to explain the inflation.

Cost-push theory:
The cost-push theory underscores the fact that prices rise due to increasing cost of the
factors of production. This theory maintains that prices of goods and services rise because wages are
pushed up by trade unions’ bargaining power, or by the pricing policies of oligopolistic and
monopolistic firms with market power. Thus labour market rigidities and changes in the cost of
labour are considered a major cause of inflation in developed countries, albeit not generally
considered a major cause of inflation in most developing countries.

Zimbabwe’s situation, since the new millennium has proved that wages are a force to reckon
with when analyzing hyperinflationary trends. Whilst before hyperinflationary started, wages were
generally reviewed twice a year both in the government and private sectors, the situation has since
changed. Even though up to now the public sector unshakably continued to review its salaries as
before, the private sector has since changed the review process. In most private companies since
2000, salaries have been reviewed quarterly and upwardly ‘in line with inflation trends’, with some
other private companies reviewing them on monthly bases. Another important factor of production
costs for the country has been imported raw materials. Given the acute shortage of foreign currency
in the country since 2000, most imports have been financed by expensive foreign currency from the
black market, thus resulting in higher output costs surfacing in higher market/consumer prices.

Demand-Pull Theory:
This school of thought postulates that inflationary pressures arise because of excess demand
for goods and services resulting from expansionary monetary and fiscal policies. Over and above
these suggested monetary expansion and fiscal policies, the Zimbabwean situation has been
compounded by shortages of basic commodities (i.e., mealie-meal (staple diet), cooking oil, flour,
fuel, sugar, to mention a few), thus result in pent-up upward pressure in the overall price.
Dollarization:
The Dollarization can rapidly slash the inflation rate and restore stability and growth to the
Zimbabwean economy. This option would replace the discredited Zimbabwe dollar with a foreign
currency, such as the U.S. dollar or the South African rand. Dollarization occurs when residents of
country extensively use the U.S. dollar or another foreign currency alongside, or instead of, the
domestic currency. There are three types of Dollarization

 Unofficial Dollarization
 Semi-official Dollarization
 Official Dollarization

Unofficial Dollarization:
Unofficial dollarization occurs when individuals hold foreign-currency bank deposits
or notes (paper money) to protect against high inflation in the domestic currency. Zimbabwe is
already unofficially dollarized to the extent that Zimbabweans hold South African rand, U.S. dollars,
pounds sterling, and other foreign currencies as stores of value. It involves holding of foreign bonds
and other nonmonetary assets, foreign-currency deposits (either abroad or domestically), and
foreign notes.

Semi-official Dollarization:
In this case, foreign currency is legal tender and may even dominate bank deposits.
The foreign currency plays a secondary role to domestic currency in paying wages, taxes, and
everyday expenses.
Official Dollarization:
Official dollarization occurs, when a country uses a foreign currency as the main, or
only, component of the monetary base. The monetary base is the medium accepted for final
settlement of payments in the local financial system; in other words, it is what banks typically use for
clearing. Foreign currency (or currencies) has exclusive or predominant status as full legal tender.
Domestic currency is confined to a secondary role. It is also called Full Dollarization.

Multicurrency system:

The official recognition of the demise of the Zimbabwe dollar took place in February 2009,
when authorities established a multicurrency system. Under this system, transactions in hard foreign
currencies are authorized, payments of taxes are mandatory in foreign exchange, and the exchange
system largely is liberalized. Since the abolition of all surrender requirements on foreign exchange
proceeds on March 19, 2009, there has not been a functioning foreign exchange market for
Zimbabwe dollars. Bank accounts denominated in Zimbabwe dollars (equivalent to about US$6
million at the exchange rate of Z$35 quadrillion per US$1) are dormant. Use of the Zimbabwe dollar
as domestic currency has been discontinued until 2012. While five foreign currencies have been
granted official status, the U.S. dollar has become the principal currency.

Benefits:

The multicurrency system has provided significant benefits. In particular, it fostered the re-
monetization of the economy and financial re-intermediation, helped enforce fiscal discipline by
precluding inflationary financing of the budget, and brought greater transparency in pricing and
accounting after a long period of high inflation. As a result, the price level in U.S. dollars declined
during 2009, while the economy started to recover.

Challenges:

The multicurrency system also poses a number of challenges. First, prices and wages are
usually agreed and quoted in U.S. dollars, while South Africa is Zimbabwe’s main trading partner and
country of origin of capital inflows. Movements in the U.S. dollar/rand exchange rate therefore have
considerable effects on Zimbabwe’s competitiveness and international investment position. Second,
shortages of small-denomination U.S. dollar banknotes and coins pose difficulties for retailers. Third,
some politicians have expressed concern that loss of the national currency and seigniorage is an
undesirable erosion of sovereignty and monetary independence.
 The government considers the multicurrency monetary regime a temporary arrangement
until 2012 at least. Despite the remaining challenges (see above), the multicurrency regime could
continue to operate with certain improvements until a new regime is chosen. The necessary
improvements include aligning legislation, including the RBZ Act, with the prevailing practice of use
of multiple currencies, making exchange controls more transparent, and facilitating the supply of
coins, possibly with an agreement with South Africa.

Conclusion- The Road Ahead:

1. Transparent transfer of quasi-fiscal activities to the government budget, as announced by

the 2007 budget. No entity outside the budget should undertake any activity of a fiscal
nature (including interest payments, subsidized credits etc.) without offsetting transfers
transparently provided for in the budget. For instance, any QFAs carried out through the
RBZ, FISCORP, the Industrial Development Bank of Zimbabwe or any other public entity
should be covered via budgetary transfers. The purpose of this step, which by itself would
not reduce inflation, is to increase transparency and accountability and strengthen fiscal
 governance by having actions of a fiscal nature subjected to normal budgetary scrutiny and
procedures.

2. Substantial fiscal tightening, including the newly-absorbed QFAs of the RBZ or any other
public entity. For instance, estimates based on preliminary data for 2006 suggest that a
reduction of at least 10 percentage points of GDP in the adjusted primary balance
(including the newly-absorbed QFAs) relative to the outcome in 2006 would be needed to
lower inflation by about 800 percentage points. A tightening of this order of magnitude or
more would be in line with large fiscal adjustments made by other countries, as discussed
above.

3. Liberalizing the exchange regime by unifying the exchange rate and removing restrictions
on current international payments and transfers. The interbank exchange rate would need
to be substantially devalued promptly and all multiple exchange rates eliminated. The
interbank rate should then be depreciated steadily toward the parallel market rate (which
would appreciate as fiscal and monetary policies are tightened), and the unified exchange
rate subsequently floated.

4. Deregulating prices and imposing a hard budget constraint on public enterprises.

Enterprises need a hard budget constraint that requires them to cut costs and operate at
preset levels of budget subsidies and agreed pricing formulas. Deregulating prices and
allowing public enterprises to introduce cost-recovery pricing would be an essential
element of a plan to move the operation of these enterprises to a commercial footing. Price
deregulation would likely lead to a one-off spike in prices, but strong fiscal adjustment
would ultimately reduce inflation pressures.

5. Establishing a strong money anchor to reduce inflation and inflation expectations. Once
exchange rates are unified and the RBZ disengages from QFAs, a broad money anchor and a
flexible exchange regime could be established, with reserve money as the operational
target. (An exchange rate anchor would be difficult to implement because international
reserves are low). To ensure that monetary policy is effective and reduce liquidity risks in
the banking system, interest rates would need to be gradually moved to market
determined levels.

References:

http://www.cato.org/pubs/dpa/dpa6.pdf
http://www.imf.org/external/pubs/ft/wp/2007/wp0799.pdf
http://www.imf.org/external/pubs/ft/dp/2010/afr1003.pdf
http://web.up.ac.za/UserFiles/WP_2007_10.pdf
Wikipedia