In April 2024, Zimbabwe introduced a new gold-backed currency, the Zimbabwe Gold (ZiG or ZWG), hoping to stabilize the country’s economy and reign in rampant inflation. The government touted it as a bold move to restore public confidence in the local currency, which had suffered through decades of hyperinflation, devaluation, and dependence on the US dollar. However, only five months into its introduction, the ZiG is already facing severe depreciation, raising concerns about the effectiveness of the gold-backing strategy.

Despite an increase in global gold prices, which should theoretically strengthen the currency, the ZiG has plummeted from its initial value of ZWG13.56 per US dollar to ZWG24.30 as of late September 2024, following a Reserve Bank of Zimbabwe (RBZ) devaluation. On the parallel market, the currency has fared even worse, trading at ZWG30 or higher per US dollar, demonstrating a significant divergence from official exchange rates. The rapid depreciation of the ZiG has raised questions about whether Zimbabwe’s gold reserves are sufficient to back the currency effectively and stabilize the country’s economy.

Why is the ZiG Depreciating?

Several factors are contributing to the rapid depreciation of the ZiG, despite the increase in global gold prices. One of the main issues is that Zimbabwe’s gold and foreign currency reserves are far too meagre to support the currency adequately. Upon the currency’s introduction, Zimbabwe’s gold and foreign currency reserves stood at US$285 million. By June 2024, this had risen to US$370 million, as reported by RBZ Governor John Mushayavanhu. However, this is still far below the threshold necessary to back the currency and instill confidence in both domestic and international markets.

According to the World Bank and International Monetary Fund (IMF), a country seeking to back its currency with gold typically needs reserves that are equivalent to 20-40% of its circulating money supply, as well as enough reserves to cover 3-6 months of imports. In Zimbabwe’s case, this would amount to approximately US$3.5-6 billion in total reserves—far more than the US$370 million currently available. Furthermore, Zimbabwe’s gold reserves are only 2.5 tonnes, translating to approximately US$155.7 million based on September 2024 prices. Even with additional foreign currency reserves, this is insufficient to stabilize the ZiG.

Economic Context and Challenges

Zimbabwe has long struggled with economic instability, currency volatility, and inflation. The country’s economic woes have been exacerbated by years of mismanagement, corruption, and a lack of transparency. The economy is heavily reliant on exports of tobacco, gold, platinum, diamonds, lithium, and other minerals. However, these exports alone are not enough to build the substantial reserves needed to back the ZiG adequately. In fact, Zimbabwe is reportedly losing about US$1.8 billion annually to the smuggling of its valuable minerals, further depleting its reserves.

The RBZ’s devaluation of the ZiG in September 2024 was intended to address currency imbalances and close the gap between the official exchange rate and the parallel market rate. However, this move has not had the desired effect of stabilizing the currency, as the ZiG continues to lose value on the parallel market. The devaluation has also failed to curb inflation, which remains a persistent problem in the country. Zimbabweans continue to grapple with rising living costs, which have been compounded by a weak currency and low wages.

The Need for Larger Reserves

For Zimbabwe to stabilize the ZiG and avoid further depreciation, the country must build its gold and foreign currency reserves to levels that meet international standards. Experts suggest that Zimbabwe needs at least US$3.5 billion in reserves to support the ZiG effectively, though the ideal range is closer to US$6 billion. To reach this target, Zimbabwe will need to ramp up its gold production and exports, as well as diversify its economy to include other sectors such as agriculture, manufacturing, and tourism.

Increasing gold production is essential, but it is not a panacea. Zimbabwe must also address the rampant smuggling of its minerals, which has been a significant drain on the country’s economy. By cracking down on illegal mining and smuggling, Zimbabwe can retain more of its valuable resources and build up its reserves. Additionally, the government must work to improve the overall investment climate by enhancing governance, improving infrastructure, and reducing corruption. Zimbabwe currently ranks 149th out of 180 countries on the Transparency International Corruption Perception Index, placing it among the most corrupt countries in the world.

International Comparisons

Other countries have successfully implemented gold-backed or foreign currency-backed systems to stabilize their economies, offering valuable lessons for Zimbabwe. Singapore, for instance, backs 100% of its currency with gold and foreign reserves, amounting to US$340 billion in 2022. China, meanwhile, maintains 2-3% of its currency backed by gold, but its foreign reserves are substantial, at US$3.2 trillion in 2022. South Africa maintains 15% gold backing, with foreign reserves of US$45 billion. Hong Kong backs its currency entirely with foreign reserves, providing a stable model for Zimbabwe to consider.

In comparison to these countries, Zimbabwe’s reserves are woefully inadequate. The country’s gold reserves amount to only 2.5 tonnes, and its total reserves of US$370 million are a fraction of what is needed to sustain a stable currency. To achieve the level of stability seen in countries like Singapore and Hong Kong, Zimbabwe must significantly increase its reserves and diversify its economic base.

The Path Forward

To address its reserve shortfall and stabilize the ZiG, Zimbabwe must take several important steps. First, the government should develop a comprehensive reserve-building plan that includes increasing gold production, cracking down on smuggling, and improving the overall business environment. Public-private partnerships could play a crucial role in helping Zimbabwe attract investment, boost exports, and diversify its economy.

In addition to building reserves, Zimbabwe must also address issues of transparency and governance. Corruption has long plagued the country, and without meaningful reforms, it will be difficult to attract the foreign investment necessary to bolster the economy. By improving governance and accountability, Zimbabwe can create a more attractive investment climate and build the trust needed to support its currency.

Finally, Zimbabwe should consider engaging international experts to provide guidance on best practices for managing gold-backed currencies and building reserves. By learning from successful examples in countries like Singapore and China, Zimbabwe can develop a more robust strategy for stabilizing the ZiG and achieving long-term economic growth.

Conclusion

Zimbabwe’s introduction of the ZiG represents a bold attempt to stabilize the country’s economy and reduce reliance on the US dollar. However, the rapid depreciation of the ZiG in just five months has highlighted the challenges the country faces in building the reserves necessary to support the currency. With gold reserves of only 2.5 tonnes and total reserves of US$370 million, Zimbabwe falls far short of the reserve levels required to sustain a stable currency.

To overcome these challenges, Zimbabwe must take decisive action to increase its gold and foreign currency reserves, diversify its economy, and improve governance. By addressing these issues, Zimbabwe can restore confidence in the ZiG, attract foreign investment, and achieve long-term economic stability. The path forward will not be easy, but with the right reforms and strategies, Zimbabwe can turn the ZiG into a symbol of economic resilience and growth.

photo source: Google

By: Montel Kamau

Serrari Financial Analyst

4th October, 2024