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The dollarization of weak and underdeveloped economies

Dollarization is a phenomenon that has become increasingly familiar to inhabitants of weak or troubled economies, invariably developing or underdeveloped economies. It is the official adoption by a country of the United States dollar (USD) as a legal tender side by side with its national currency or as the only and exclusive legal tender for a number of years, which is not usually predetermined. On the other hand, it is or could be the unofficial adoption of the USD as a legal tender or an increasing or overwhelming preference for the USD by business people and other key economic agents in a country. The latter is what by and large approximates the Nigerian experience in recent times: the phenomenal ascendency of the USD as a preferred means of transaction, store of value, or currency speculation. This has been due to the poor economic management of the previous decade, which has plunged the nation into avoidable economic crises. The consequent weakening or unprecedented depreciation of our national currency, the naira, led to a flight to safety in strong foreign currencies, especially the USD.

Quite a few small countries, and especially a good number of island countries in the world with an eye on serving as foreign direct investment or tourism destinations, have adopted the USD as legal tender alongside their national currencies. But I will like to dwell briefly on two countries, one in Central America and the other in Southern Africa, that have used dollarization as deliberate monetary and exchange rate policies for different reasons: El Salvador (with a 2024 GDP of $35.3 billion) and Zimbabwe (with a 2024 GDP of $34.4 billion), respectively. In 2001, El Salvador embarked on dollarization for purely strategic economic reasons. The economy was doing relatively well, inflation was low and stable, external debt was manageable, and the financial system was stable. The dollarization policy was adopted to align the Salvadoran economy more closely with the US economy, attract foreign direct investment (FDI), and spur trade and economic growth.

Q: “The consequent weakening or unprecedented depreciation of our national currency, the naira, led to a flight to safety in strong foreign currencies, especially the USD.”

In the case of Zimbabwe, the economy was ravaged by an unprecedented level of hyperinflation, which, according to a September 2019 report by Al Jazeera cable news service, was “79.6 billion percent month-on-month and 89.7 sextillion percent year-on-year in mid-November 2009. Hyperinflation only ended the following year with the adoption of the US dollar.” These mind-boggling, terribly incomprehensible figures show how totally useless the Zimbabwean dollar has become, necessitating the adoption of the USD.

A month ago, on April 5, 2024, Zimbabwe introduced a new currency, the ZiG, which stands for “Zimbabwean Gold” and is backed by the country’s gold reserves. It was introduced electronically, but currencies and coins have since been issued. But there are early signs that the newest currency in the world will experience turbulence. And predictably so. It will inevitably be faced with the challenges that led to the abandonment of the Gold Standard by the rest of the world in 1971: the limitation it places on economic growth and the volume of financial transactions and economic activities since the value of ZiG is directly linked to gold and Zimbabwe’s gold reserves are limited in supply. Second, the ZiG limits the flexibility of the Reserve Bank of Zimbabwe to respond creatively and strategically to emerging changes and opportunities in the economy.

Coming closer home, the avoidable and wasteful economic mismanagement of the last decade combined with the roller coaster experience of the economy in the last year have combined to make the naira one of the worst performing globally. Mr Aliko Dangote succinctly describes the heart-wrenching experience as the biggest mess created” in the last year with the naira plummeting from N460 to N1,400 to the dollar between May 2023 and the first quarter of 2024. For a precariously import-dependent economy, the pass-through effect on inflation was significant. Headline inflation spiked from 22.41 percent in May 2023 to 33.2 percent in March 2024, the highest in 28 years.

Even the 22.41 percent inflation rate in May 2023 was already indicative of a distressing economic scenario. It revealed that the destruction of our economic fundamentals started manifesting about a decade before in de-industrialization, the stultification and near collapse of the power sector, the unprecedented level of oil theft and mineral theft in the oil and gas sector and solid mineral sector, all combined to limit the productive base of the Nigerian economy, its ability to produce for local consumption, its ability to produce for exports, not to mention hostile economic policies that led to the flight of capital. The net effect of this unpleasant narrative has been our heightened import dependency syndrome, the resultant massive devaluation of the naira, and the consequent dollarization mentality, which has willy-nilly been hoisted on a cross-section of economic agents in Nigeria, albeit unavoidably.

Mr Dangote, speaking from a microeconomic perspective, was right about the mess the massive depreciation of the naira has done to the finances of his businesses and his fortune. On the other hand, President Tinubu was equally right in his macroeconomic perspective when he said at the recent World Economic Forum in Riyadh, Saudi Arabia, that Nigeria was on the brink of public finance insolvency and economic collapse at the point where he introduced fundamental economic reforms by merging the naira exchange rates and largely removing fuel subsidies.

The unofficial dollarization of the Nigerian economy is a consequence of many years of economic mismanagement. It is a national economic challenge that we should all join hands with the government to reverse through enabling policies and decisions to invest and produce locally and to be intentional about buying and consuming locally made goods.

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