Advantages and disadvantages of rebasing the currency

Published December 20, 2012 by betterzambia

“Knowledge is power” -Francis Bacon

That is why I want to be one of the first to add to the body of knowledge over the announcement a few hours ago by the government that it would “rebase the Zambian [currency the] Kwacha by dividing the current notes by 1000”. This will effectively make a K5000 equal K5; a K10,000 will be K10 and so on.

The unsurprising question on most Zambian’s minds will be; what does that mean for me? Let us now explore some of the pros and cons of effecting such a decision. To begin with, the implications of the move need to be established.

This move is in effect a REVALUATION (opposite of devaluation) of the kwacha. Its value with respect to other currencies is being increased. The United States dollar will be taken as an example because of its universal use. Before effecting such a decision, about K5000 = $1. However, after implementation of the revaluation about K5 will be needed to obtain$1.

This has a number of implications from the Zambian perspective. To start with, it makes the Zambian Kwacha more expensive relative to other currencies. In the case of the dollar, Zambians would now get more dollars for fewer Kwachas. All else being equal, it also makes Zambian exports more expensive. Taking airtime as an example, currently there are K5000 airtime scratch cards in Zambia. If a solely Zambian company produces and sells these to the U.S, they get approximately $1 for every K5000 card. However, if the Kwacha is now rebased to K5 for every $1, the airtime selling company would now have to get $1000 for K5000 worth of talk time to an American consumer. Hence the conclusion, exports from Zambia will be more expensive to foreign markets (all else being equal). On the other hand, if a U.S producer of airtime currently sells to Zambia, they get approximately $1 for every K5000 of airtime produced. This is assuming the current approximate rate of K5000 per U.S dollar. If this rate suddenly changes to$1=K5, the Zambian importer would get $1 worthof U.S airtime for only K5.

Presuming the Zambian’s earnings and all else remain equal, Zambian imports are now cheaper by K4,995. If you are Zambian, do not be excited yet because everything becomes messed up when that ‘all else being equal’ is lifted. For instance, if your salary is K5million before the change, you would expect your employers to ‘rebase’ it to K5000 as well-effectively meaning no real change for you.
In summary, the implications of ‘knocking off’ the zeroes from the kwacha are mainly threefold:

(1) The kwacha becomes more expensive relative to other currencies. (2) Exports from Zambia become more expensive in international markets. (3) Imports from other countries into Zambia become cheaper.

As has been established from the preceding paragraphs, these three only hold true if all other factors are held constant.

Implications aside! What are some of the advantages and disadvantages of such a move.

ADVANTAGES:
Stolen money
There has been public outcry of recent that some people have stolen and hidden away huge amounts of cash. Many people are of the view that introducing new notes based on the ‘rebased’ currency would force those people to try and bring that money back into circulation.

Imports become cheaper
Zambia’s balance of trade has a leaning towards imports. For Zambians a revaluation of the currency would be a chance to import more goods. This may however be argued to be economically wrong in the long run.

Investor confidence
It may also be argued that the psychological ‘increase’ in value of the Kwacha creates an impression to citizens and investors that the Kwacha is a strong currency. Coupled with the relatively stable political and economic environment, such impressions raise investor confidence.

Simplification of statistics
There is no doubt that statistical and accounting/finance calculations may be made easier with lesser zeros on the currency.

DISADVANTAGES
Printing costs
The most obvious cost and disadvantage of this on the Zambian people will be the cost of reprinting the new notes. This is likely to be exacerbated by recent situations where people cry foul over those in governance not following tender procedures in the allocation of public contracts and hence not doing things in the public’s best interest.

Mindset change/pricing
Another foreseeable problem is possibility of failure to change the mindset of the Zambian public. The biggest hurdle here will most likely be teaching the common man how not to be taken advantage of by unscrupulous traders.

Competitiveness of exports
As discussed above, revaluing a currency increases the cost of local products relative to foreign ones. This makes locally produced goods less competitive on the international scene and may suffocate local industries.

Despite all these advantages and disadvantages, various factors influence Zambia and its interactions with the foreign markets. A better analysis of will be possible with the benefit of hindsight. For now, Zambia can only look to China which has re-valued its currency the Renminbi (Yuan) before.

A RESPONSE TO GOVERNMENT’s INITIATIVE TO REVALUE THE KWACHA
There is nothing new in government’s initiative to re-denominate the Zambian currency. Ghana managed to revalue its currency a few years ago and there have been some tangible benefits that have been felt as a result of this like greater confidence in the economy and increased local and foreign investment. This is because of the sense of stability that currency revaluation brings with it and the sense of discipline that it can help to communicate about the government’s economic plans.

The problem with the revaluation in Zambia, however, is that the underlying causes of the current economic instability (fluctuating kwacha and no jobs for the majority of employment seekers) have not been addressed. There is no substitute for the need to address the underlying causes of inflation and lack of more broad-based development.

Revaluing currency without addressing the fundamental things that are wrong with our economic planning (poor taxation of mining industry, lack of jobs, lack of rural development, erratic decision-making, lack of long-term planning on excessive government expenditure, hasty and costly decisions on appointments, lack of adequate investment in training and developing Zambians) will only make the exercise less effective than it can be.

It is important to note that this is in fact re-denomination and not revaluation. There is a big difference. Government is not saying that the kwacha is now worth more than before (although that is how it might appear). What they are saying is that everyone will now have to get used to using less numbers when they add up their bills or get their pay-check or borrow money or pay tax. The main benefits are psychological and can help to keep a check on inflation and increase faith in a particular currency.

In order to work properly, government must provide a full explanation of how this revaluation (i.e. redenomination) will be conducted. When will the revaluation come into effect. This is a major undertaking and will affect many people, particularly those that do not have access to regular media in rural communities so a major exercise will have to be undertaken.

In the past, a similar exercise – the changing of Zambia’s paper money – was able to help in getting those that had hoarded money to bring it into the banking system. Many of those that had buried kwacha away were forced to bring it out and it gave an opportunity for the authorities (particularly the taxman) to ask the relevant questions about how the income had been earned. This time, that effect will not be so easy to bring about because the kwacha can be easily traded for US dollars. Because of this, we are likely to see at least one drawback to this otherwise useful idea of currency revaluation – a rise in the value of the dollar as people scrambleto convert their billions stashed away in their homes and other hiding places. The demand for dollar could weaken the kwacha so Bank of Zambia would have to weigh in to mitigate any prospect of this outcome.

In summary, the move can be very positive if it is handled well and not simply by making an announcement. Care should be taken to ensure that it does not cause an unnecessary loss of value of the kwacha (as people scramble to change their hidden kwacha into dollars before the deadline).

Further, we need to put in place measures to address the fundamental problems of our economy which revaluing currency will not necessarily address. Revaluation alone will not put more money in people’s pockets but could even have the effect of taking out whatever little money might have been there if not handled properly.

Written by Unza Narep

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