Finance ministry, RBZ must focus on fundamentals

THE month of May was very eventful in both the monetary and fiscal sectors in Zimbabwe. Several policies and measures were announced as the authorities try to curtail the galloping inflation and stabilise the exchange rate in their efforts of yet again trying to resurrect the Zimbabwe dollar.

Both the Reserve Bank of Zimbabwe (RBZ) and the ministry of Finance made some interesting policy pronouncements in the month of May. The RBZ introduced a digital token backed by gold while the Finance ministry issued a policy statement armed with both monetary and fiscal measures that stirred a lot of debate among economic agents. The RBZ further responded to the minister’s statement with only one key takeaway: “We are not going to be moved”.

But they all have one goal, to bring the Zimbabwe dollar back from its death bed. The Finance minister’s stabilisation measures and the RBZ’s implementation plan sound political rather than key policies that are worth analysing. As such, only one key intervention stands out: introduction of a digital currency, the digital token backed by gold.

As the saying goes, it is money that makes the world go round. But that is not true. It is actually trust that makes the world go round. As many countries around the world pilot central bank digital currencies (CBDCs), like what the RBZ is doing with the digital token backed by gold, there is urgent need for caution and a back-to-basics approach by focusing on CBDCs’ purpose, mitigating their risks, and implementing a high bar for their technology.

With so many countries planning and piloting central bank digital currencies (CBDCs), that trust is crucial because of the role this new money will have in terms of financial stability. Why mention this? Actions of the minister of Finance through his stabilisation measures seem like he is overriding the RBZ and the issue of the central bank’s independence re-emerges. It is trust that makes the economy go round and it is our institutions and governance that build that trust.

Excessive intervention by a partisan institution in the form of the ministry of Finance in monetary affairs destroys the little trust and confidence that the RBZ was trying to rebuild through issuance of a digital currency.  The RBZ was spot-on in diplomatically dismissing the minister’s statement. Let monetary authorities deal with monetary issues and play their role of being advisers to central government while fiscal authorities concentrate on fiscal issues obtaining advice from monetary authorities. Financial stability is of the essence in this disruptive environment precipitated by new technologies.

Focusing on the digital token, the recent run on Silicon Valley Bank, as well as the collapse of the terraUSD stable coin, is a reminder that runs on deposits in the future could be exacerbated by new technology and new forms of money. Money is the core of any financial system and relies on broad-based trust.

A central bank digital currency is no exception. As such, there is need to focus on the fundamentals and there are three principles that should inform the design of CBDCs. Firstly, there needs to be a focus on the purpose and objectives and an avoidance of “mission creep”. Secondly, the financial stability risks should be identified and effectively mitigated. And lastly, there should be a high bar set for the technology used for CBDCs.

With the first principle of purpose, there needs to be a focus on the problem that is being solved. What is the problem being solved by a digital token in Zimbabwe? One may say that everyone needs to access gold and making it digital allows divisibility. Another key motivation is the safety the central bank money provides because it is viewed as a safe and trusted asset. Cash under normal circumstances serves that purpose because it is issued by the central bank and backed by the state.

However, this is not the case with Zimbabwe as Zimdollar cash has lost favour, with the majority preferring to hold other forms of money, a key motivation for digital tokens. This is also true in most countries that are piloting CBDCs as the use of cash is declining. So many central banks are designing CBDCs, to ensure that central bank money can remain available and useful in a modern economy in order to support monetary sovereignty and financial stability.

On the second principle of identifying and mitigating financial stability risks, there is the question of whether a CBDC such as the digital coin would challenge the commercial banks and ultimately disintermediate them if it becomes more popular and individuals choose to hold more value of it in their accounts over regular bank deposits. This could impact on deposit levels at commercial banks as well as their ability to lend.

Also, with more money held in the form of a digital token, monetary policy could also be impacted. If – unlike cash – a digital token is remunerated and can earn interest then a central bank may have more direct control over its monetary policy, for example. Base rate changes would be directly passed on through its own money, rather than the central bank relying on commercial banks to pass on the rates. There are particular concerns about how this kind of scenario would play out during a crisis, and whether the digital token – and its accompanying policies of bank liquidity regulations – would be a stabilising factor when the system is under stress.

And on the third principle of the choice of technology, here the bar must be set high, particularly given the central role a digital token would have in the financial system and the reputational implications for the central bank of any flaws. So far, we are not aware of the technology being used to roll out the RBZ’s digital token backed by gold.

Once the initial model has been decided – such as a “platform” or “two-tiered” model – the highest standards need to be implemented for privacy, security, resilience, performance, extensibility and energy use. All of these have serious challenges that need to be addressed.

As with the first two principles, these issues need to be thought through clearly to ensure that the trust in central bank-issued money is maintained. And with trust, perhaps one day it will be the RBZ’s digital token that will make the Zimbabwean economy go round. Trust can back money more than gold.