Recent steep depreciation of the Liberian dollar against the value of the US dollar is reigniting the perennial debate over the sustainability or culpability of the dual currency regime in the country’s deteriorating economic circumstances.
Liberia’s economy has slowed dramatically, at only 0.3 percent growth in 2015, compared to 0.7 percent (CBL Annual Report of 2015) and there are fears that in the short run, the consequences could be felt at all rungs of Liberian society. Some are blaming the country’s hybrid monetary system of two currencies.
The truth is, Liberia’s dual currency regime, with both the United States dollar and the Liberian dollar as legal tenders freely floating has effectively stabilized price levels and supported the country’s economic recovery efforts in the postwar period.
Inflation has been in single digits, from 9.9 percent in 2014 to 7.8 percent in 2015 according to the CBL Annual Report of 2015.
However, the increased dollarization of the nation’s broad money supply (M2), which according to the Central Bank of Liberia was at a ratio 70:30 at the end of 2015 limits the ability of monetary authorities to control the money supply and interest rates and obstructs the creation of a myriad of interventions to spur economic development.
Accordingly, the dual currency regime can be counterproductive in the long run, as it does not support the creation of a domestic financial architecture that can readily mobilize resources and expand economic activities.
The Central Bank, working with fiscal authorities should have the ability to sync policies that can control inflation while supporting the demands of the financial system.
Accordingly, the country’s dual currency regime, which is effective in controlling inflation, by limiting the ability of the CBL to print money and instilled confidence in Liberia’s economy, is also a hindrance to the long term development of the country’s financial system.
However, the one overarching factor limiting the accelerated implementation of a single currency regime of Liberian dollars is the lack of productivity in the country’s economy (real GDP is only 899 million dollars according to the CBL Annual Report of 2015).
Money is a store of value and Liberia’s economy has limited values due to structure defects, including overreliance on the extractive industries, with current volatility causing the prices of primary exports of rubber and iron ore to plummet, impacting growth rates, estimated at 0.3 percent at the end of 2015, and projected to be only around 2.5 percent in 2016.
In the last fiscal period, the government began a policy of increasing the ratio of Liberian dollar payment for certain kinds of expenses. The Policy Circular issued on May 20 in 2015 changed the proportion of payment to be made in Liberian dollars for domestic expenses, such as salaries, honorariums, allowances, fuel, rents and contract payments.
At the time, the government said the policy would be limited to one fiscal period, and the prescription was necessitated by a huge build-up of Liberian dollar revenues during the Ebola crisis that needed to be spent in that fiscal period.
Government officials said the budget could not be fully executed without spending the huge build-up of Liberian dollar cash, which at the time was an equivalent of about US$40 million dollars.
Fiscal authorities realized that certain expenses, such as foreign travels, support to foreign missions, payment of external debt and other expenses had to be defrayed by US dollars and thus the implementation of this policy was restricted to certain domestic outlays.
The total of the excess liquidity in Liberian dollars in the GOL coffers would amount to around 2.5 billion Liberian dollars. In order to lessen pressures on the Liberian dollars, the fiscal authorities at the Ministry of Finance asked the monetary authorities at the Central Bank to issue 2 billion Liberian dollars in treasury bills to mop up excess liquidity.
In the main time, the authorities changed the ratio from 100 percent of salaries and benefits as per the circular of May 20, 2015, to 50:50 in Liberian and US dollars and were watching the effects to determine future policy measures.
That was then. Today, the policy is morphing into something more permanent due to decline in the country’s net reserve position, deterioration in the terms of trade and slower than anticipated growth.
If the ostensible reason for increasing the proportion of payment in Liberian dollars a year ago, was due to build of Liberian dollars on account of Ebola-related expenditure, as claimed by policy planners, than the recent increases in that proportion is something out of the ordinary as the value of the Liberian dollar has plummeted to nearly 97 to one in recent street level trading.
Theoretically then, the sell rate for US dollar has hit the magical 100 to one and if one listens to the tea leaves, it could plummet even further.
The Liberian dollar had been aggressively supported by the CBL in auctions, but recently in Title 4 consultations with the International Monetary Fund (IMF), officials of the Fund have bluntly told Liberian authorities that they can no longer aggressively support the value of the Liberian dollar through interventions except under extraordinary circumstances and they do not view equilibrium in the market place as extraordinary.
According to the most recent Central Bank of Liberia figures, the percentage of US dollars in the country’s broad money supply, M2, was 70 percent and Liberian dollars at only 30 percent.
The US dollar component, when converted into Liberian dollars shows a gross amount of 39 billion Liberian dollars out of a total money supply of 54.3 billion.
Clearly, the degree and magnitude of dollarization in the Liberian economy is a major factor that would contribute to any major alteration in the transactional relationships or proportion of payment of government obligations in Liberian dollars.
Central to increasing the ratio of payment of civil servants’ salaries in Liberian dollars is the perennial debate about the economic value or disadvantages in having a dual currency regime.
There are many expert opinions, including working papers from the IMF and Liberian professionals. They range from immediate dedollarization as in making a law to create a single currency regime to gradually phasing in the process.
In order to assess the impact of the dual currency on the Liberian economy, a key question that needs to be answered for now is:
Has the dual currency (use of the Liberian dollar along with the United States dollar as legal tender) been effective in instilling confidence in the country’s financial system and promoting growth or has it restrained growth?
From empirical analysis by experts, including working papers from the International Money Fund, by Jironda Honda and Lillian Schumacher the dual currency, even with some distinct disadvantages has been good for the country’s economic recovery and growth.
Is the country’s economic recovery now so advanced that policy makers should begin the efforts to forcibly deodollarize by going to a single currency (meaning use of the Liberia dollar) in order to reap the benefits?
Should the Liberian dollar be that official medium of exchange or should policy makers require dollarization as an official policy implement (increase use of the US dollar, where the United States dollar is the singular medium of exchange?)
In order to answer these questions, one must understand the role foreign currencies played in the country’s economic history. Since Liberia was established as an independent country in 1847, its economy has been either fully or mostly dollarized, meaning the United States dollar has been a substantive medium of exchange.
Foreign currencies have always been important to the Liberian economy, both as a store of value and as a medium of exchange. The choice of currencies was dictated by the country’s close economic ties with British West African colonies and the United States.
Liberian dollar coins have circulated since independence, but banknotes have been used more sparingly. After circulating from the 1850s to the 1890s, the notes were not reintroduced for almost a century.
As a result of the 1980 coup and the massive capital flight associated with lack of confidence in the new regime, President Samuel Doe minted Liberian dollars (five dollar coins) in the 1980s. During the civil war “J.J. Roberts” banknotes were issued starting in 1990 in areas controlled by the National Patriotic
Front of Liberia under Charles Taylor and “Liberty” notes were issued starting in 1991 in areas controlled by the Interim Government of National Unity under Dr. Amos Sawyer.
While both were issued at par with the U.S. dollar, there were substantial fluctuations in exchange rates in the parallel market. In January 1998 the exchange rate peg was abandoned and the exchange rate with the U.S. dollar was devalued from L$1/US$1 to L$43/US$1.
In 2001 the CBL began issuing Liberian dollar notes, which are considered legal tender along with the United States dollar today.
Since the 1998 devaluation, the Liberian dollar has depreciated on average by 5 percent a year, roughly in line with the inflation differential between Liberia and the United States, except for 2014 when serious depreciation of the Liberian dollar occurred.
According to the CBL, the bank spent more than 70 million dollars in intervention to bring the rate down from 90:1 and have it stabilized at 85:1 as at June 1, 2015. Future interventions are now prohibited by the IMF.
Is increasing dollarization a restraint of growth or has it positively affected economic activities? It is clear that a country with a low economic base, coming from conflict and also characterized by mismanagement of its economy over several decades cannot expect the international financial system to have confidence in that country’s own currency.
There must be some fears that the global financial system would reject the Liberian dollar as a tradable asset if we sought to enforce a single currency regime and we could suffer the fate of a country such as Zimbabwe, that saw hyperinflation as a result of bad governance and low productivity.
Accordingly, the use of the dual currency regime has indeed been a blessing for Liberia’s economic recovery. If the true value of foreign currencies in circulation can be ascertained, it is possible that Liberia could be the second highest dollarized country in Sub Saharan African, more closely to the dollarization in Sao Tome and Principe at nearly 100 percent.
While Liberia has officially sanctioned use of the United States dollars a legal tender, it is not the only country in the world with high dollarization. Other countries, such as Ecuador, El Salvador, Panama and Timor Leste have higher proportions of foreign currency deposits to broad money. In these countries, that ratio is at nearly 100 percent!
The use of the dual currency has distinct advantages and disadvantages. There are inherent complications in the ability of the Central Bank of Liberia to effectively use monetary policies to impact the country’s economy in an underdeveloped financial system.
The Liberian economy is more vulnerable to exogenous shocks. The country could have lower international reserves, because when transactions are conducted in the foreign currency, the central bank accumulates less of that currency as reserve.
The dual currency regime reduces the power of the Central Bank in setting up an effective exchange rate policy—the authorities cannot manage the exchange rate in response to exogenous shocks, so that adjustment through the real economy will be necessary.
Additionally, the CBL loses the lender of last resort role to a financial sector that holds large amounts of foreign currency deposits.
The confidence in the United States dollar has spurred economic growth and development especially during the critical post war reconstruction period.
The dual currency has made printing of additional bank notes by Central Bank authorities to gain additional more liquidity in the banking system a very unattractive option, acting as an inflation cure.
The dual currency regime has increased the flow of consumer goods into the country despite current accounts deficits, placed foreign currencies in the hands of Liberian economic actors without cumbersome bureaucratic red tape and promoted exchange rate stability.
Despite the high rate of dollarization, Liberia’s economic recovery has in fact been supported by the use of the dual currency system both for technical reasons driven by market forces and by the politics of time.
Thus efforts to reduce dollarization by going to a single currency should be studied very carefully to avoid the associated shocks.
Despite seemingly more advantages in decreasing dollarization, yet there are several pitfalls. There is no guarantee that moving to a single local currency would decrease dollarization. Many countries that sought to decrease dollarization had in fact changed tract and supported increased dollarization.
Finally, it must be stated clearly that moving toward a single currency requires making a determination of the optimum economic circumstance. In doing so, policy makers should not only base their determination solely on technical empirical analyses, such as increased export earnings or growth in GDP but also in the confidence of economic actors in the ability of Liberian monetary and fiscal managers.
No matter how strong the reasons for a technical market driven compulsion to go the route of a single currency, if economic actors are unsure of the level of financial probity in the country, the drive toward a single currency could be disastrous. In other words, corruption could undermine faith in the Liberian economy and devalue any national currency.
As a result, I am convinced that now is not the time to go to a single Liberian dollar currency as we are still mostly an unproductive economy, with too many structural defects that need to be repaired. We cannot be sure that we can withstand the “epic shocks” to use the words of one of Liberia’s leading financial minds. And so it goes.
Samuel P. Jackson is a trained banker, economist and financial consultant. [email protected]