Poor nation’s pricey mess: Why Zimbabwe hiked interest rate by 200%

Zimbabwe, the South African country with an inflation problem, is taking drastic measures to give it’s economy a fillip. On Monday, the country’s central bank hiked interest rates to an all-time high, and the government formally reinstated the US dollar as a legal currency in order to curb rising inflation and stabilise the country’s plummeting exchange rate.

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Surging commodity prices caused by the Russia-Ukraine war, as well as the lingering consequences of COVID-19 lockdowns, have added to the pressure on Zimbabwe’s local currency.

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Governor John Mangudya said in a statement that the monetary policy committee doubled the benchmark rate from 80% to 200%. This puts the total increase this year to 14,000 basis points, the biggest in the world.

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“The monetary policy committee expressed great concern on the recent rise in inflation,” Mangudya said. 

“The committee noted that the increase in inflation was undermining consumer demand and confidence and that, if not controlled, it would reverse the significant economic gains achieved over the past two years,” he added.

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The impact of the Ukraine war has worsened Zimbabwe’s already shaky economy. Since the invasion began, the price of wheat has been skyrocketing internationally since Russia and Ukraine sell around a quarter of the world’s wheat.

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Its ramifications are wreaking havoc on developing countries like Zimbabwe, as shipments of essential goods are hampered by both the war and the sanctions imposed by the West on Russia and some of its allies.

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Zimbabwe relies largely on Eastern nations for commerce, notably Russia, China, Belarus, and Singapore, and imports at least half of its wheat from Russia.

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Rising fuel and bread costs have caused a wave of price increases for basic goods across the country, exacerbating the situation for many Zimbabweans who are already struggling with widespread poverty as a result of stagnating wages and uncontrolled inflation.

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Central banks around the world have unleashed what might be the most severe tightening of monetary policy since the 1980s in order to curb high inflation, avert capital outflows, and currency weakening as investors seek higher yields.

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Reasons behind the inflation in Zimbabwe?

Government printing money in response to:

High national debt

The decline in economic output

The decline in export earnings

Price controls exacerbate shortages

Lack of confidence in government and economy

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Since the mid-1960s, Zimbabwe has experienced tremendous inflation. People were accustomed to anticipating more inflation. This is then self-fulfilling. When individuals anticipate hyperinflation, they demand higher wages and raise prices in anticipation of future inflation.

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The annual inflation rate in Zimbabwe reached 192% in June as food prices more than tripled. Prices have risen due to a dramatic devaluation of the Zimbabwe dollar, which has shed more than two-thirds of its value versus the US dollar this year and is Africa’s worst-performing currency.

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The government will allow the use of the US dollar for the second time in more than ten years, according to Finance Minister Mthuli Ncube.

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“Government has clearly stated its intention of maintaining a multi-currency system based on dual use of the US dollar and the Zimbabwe dollar,” said Ncube.

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“To eliminate speculation and arbitrage based on this issue, the government has decided to embed the multi-currency system and the continued use of the US dollar into law for a period of five years,” Ncube added.

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The central bank also announced a hike in deposit rates to 40% from 12.5% and the launching of gold coins as an alternate store of value. Mangudya said the coins, which will be minted by the state-owned Fidelity Gold Refineries Ltd., will be traded via banking channels.

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The central bank is also working on plans to establish currency forward pricing, according to Mangudya. Details will be released later.

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The measures unveiled represent the most recent effort to address a currency crisis that dates back to 2009 when the Zimbabwe dollar was replaced by the US dollar during a period of hyperinflation. Zimbabwe’s currency was reinstated in 2019 and soon began to fall in value.