Dealing with the current account deficit through internal devaluation

THE use of the multi-currency exchange system puts Zimbabwe in a special circumstance that takes away the flexibility of adjusting the nominal exchange rate to maintain relative competitiveness.

This unique situation is similar to the experience of countries within the Euro-area, for example, which are unable to reverse a loss of competitiveness and balance of payments imbalance through a nominal devaluation of the currency.

For countries in this predicament, the loss of competitiveness can only be reversed internally, through relative gains in the efficiency in production and or through action to reduce cost of production, that is, internal devaluation — aimed mainly at reducing wages and other related labour costs.

Historical experiences with internal devaluation have been mixed. Some have been successful whilst other “successful” internal devaluation have been accompanied by falling demand and recession. The truth of the matter is that there are always pros and cons with devaluations, whether it is nominal or internal devaluation. Management and choice of internal devaluation is therefore critical.

Whilst there is general acceptance across the board in Zimbabwe about the need for internal devaluation in the country, there is no consensus on its form and format. Statistics at the Reserve Bank show that the country would need to gradually devalue by up to 45 percent over a three-year period to restore competitiveness.

Internal devaluation in Zimbabwe can be achieved through two possible approaches. The first approach would be for reduction in wages and salaries, accompanied by a similar reduction in the cost of finance and utility charges.

Once this is done, the country would need to find a comparator to benchmark with to ensure that costs would not increase again without being checked. The challenge of this approach is that it can lead to further reduction in aggregate demand and to depression and recession. An equilibrium position would therefore need to be determined for this approach to produce desirable results.

The second approach, which also takes account of peculiarities in Zimbabwe, would be to achieve internal devaluation by a combination of improving