by Abdulqafar Abdullahi
Monday, March 25, 2013
Recent news reports suggest that over the last few months the value of the US Dollar has been declining and by extension the value of the Somali Shilling has been increasing. In response, both the Minister of Finance and the Vice Minister of Finance announced that the federal government will take action to address this problem by printing new currency.
As we all know, the economy of Somalia is a dual currency economy where people generally hold US Dollars as asset (store of value) for future transactions and current transactions are either conducted in US Dollars or Somali Shillings. Generally, expensive transactions are conducted in US Dollars but smaller transactions in Somali Shillings. For example, if one wishes to take a bus, buy a cup of tea, buy one litre of milk, half kilo of goat meat, etc. one probably has no choice but to use Somali Shillings. On the other hand, if one is purchasing a car, 50 kilo of sugar, or a lunch in an upscale restaurant, etc. one would have to use US Dollars.
Not only are prices of most goods and services priced in US Dollars, but also income of the people is generally measured in terms of US Dollars, meaning workers are paid in US Dollars. In addition, recipients of remittances from overseas have a choice to be paid in US Dollars or in Somali Shillings. This means people have a choice of how much of their US Dollar income to convert to Somali Shillings for immediate transactions and how much to keep in US Dollars for future transaction. Debts among citizens are also settled in US Dollars.
Reasons and consequence of falling value of the US Dollar
Reasons are many, but they generally can be attributed to peace dividend. Somalia has experienced a period of sustained stability after a long period of instability. The current political stability and positive outlook about the future of the country has led to increased economic activity thereby resulting in more income and more demand for goods and services. Some of the observed activities that indicate a positive economic outlook and increased influx of US Dollars are:
1) Private investors and businesses are once again investing in new business ventures and construction activities.
2) The relatively stronger Somali government recognized and supported by the international community is now able to spend limited amounts of money to buy goods and service including paying its increasing number of public servants and reconstruction of its institutions.
3) As more and more non-governmental agencies and aid agencies move their operations into Somalia; the will spend a larger share of their budget in providing services in Somalia rather than spending it in Nairobi.
4) As more of the Somali Diaspora and refugees return to Somalia as a result of increased stability, they will bring hard currency to invest, rebuild their old properties, or buy new properties. The Diaspora still out of the country may also be sending money to their relatives to invest or buy properties on their behalf in preparation for their eventual return to Somalia.
Given that both incomes and prices of most goods and services are generally in US Dollars, the above listed activities will lead to increase in the amount of US Dollars in circulation. As the circulation of the US Dollar in the market increases, its value will decline and by extension the value of the Somali Shilling will increase.
This situation is being made worse by the fact that there is limited Somali Shillings in circulation. The Somali currency in circulation is in debilitated form and in one-denomination (1000 shilling). That means there are no sufficient amounts of Somali Shillings in circulation to meet current transaction demand. As people demand more goods and services they will need more Somali Shillings to purchase goods and services. The limited supply of the Shilling is further contributing to the increase of its value against the US Dollar.
Increased economic activities generally create inflationary pressure. In the case of Somalia, this should be observed initially in the US Dollar priced goods and services and eventually prices of all goods and services. Economic theory suggests that if the circulation of US Dollar is increasing and its value is declining, then the prices of US Dollar priced goods and service should increase. Therefore, if the general price level is not rising as one would expect and despite what economic theory suggests, it is an example of the Somali economy defying economic theory yet again.
For a single currency economy, the strengthening of the local currency would be considered a good sign and a positive development because imported goods will become cheaper and the local currency will be able to buy more goods and services. However, for a dual currency economy like Somalia, the decline of the value of the US Dollar, the dominant currency, will have negative consequences since the income of the people will buy less goods and services. The most impacted by this event are people who either receive a fixed income from their relatives overseas or earn wages in US Dollars. Their purchasing power will be eroded by the declining value of the dollar, increasing prices, or both; because their income will buy smaller and smaller number of goods.
The decision to print money:
The federal government of Somalia has already announced that the new Somali currency will be printed and circulated soon. So we can reasonable assume that this decision has already been made and it is now just a matter of time before a new currency is introduced in the market. Readers of my previous article on the Central Bank of Somalia will note that I do not believe that printing money should the first priority of the CBS. I think the first priority should be to reconstitute the banking system.
However, given the decision to print new Somali currency has already been made, a different question has to be asked: Would printing the new currency alleviate the shortage of the Somali currency and the suffering of the people? In my opinion the answer to this question is emphatically YES, but only if the release of the new currency is handled correctly. If it is not done properly it may lead to more serious crisis – hyperinflation. Hyperinflation is a situation where prices spiral out of control leading the currency to become worthless because too much currency is being released in to the market.
Who should lead the process of releasing the new currency:
The CBS should lead the process of releasing of the new Somali Shillings, after all that is its job. Article 123.3 of the Constitution of Somalia makes the production of the Somali Currency, inflation control, and stabilization of exchange rates the exclusive domain of the CBS. Although the announcement about the new currency came from the Ministry of Finance, I can only assume that the officials were making the announcement on behalf of the CBS, which I found its silence unusual given the extremely important role it has to play.
What steps could the CBS take to ensure smooth introduction of the new currency:
Build public confidence:
1) The CBS should set the release date well in advance and announce publicly that it is going to release the currency in a controlled fashion so as not to repeat the consequences of past releases of Somali Shillings.
2) It should make very clear that it will have total control of the new money and that the government will not be able to use this money to buy goods and services or pay salaries using the new printed currency.
3) A Public explanation of the process will also be very helpful.
These actions will increase the confidence of the people and may encourage them to use the Somali Shillings again and accept the new currency when released.
Design and denomination of the new currency
1) The new currency denomination: The current single denomination (1000 Shs) of the Somali currency is limiting and is impediment to proper economic transaction. Therefore, the new currency should be in several denominations (1000, 5000, 10000, 20,000, and 50,000).
2) A new look and feel: To distinguish the current Somali Shillings in circulation from the new currency, the new currency should be sufficiently different, may be completely a new design. This will allow the central bank to ultimately take control of the money supply. The CBS could determine a reasonable conversation mechanism where the old currency will be equivalent to smaller denomination of the new currency. For example, 1000 of the old shillings could be deemed to equal 1 new shilling or 5000 Shillings to 1 new shilling. That means the CBS would produce the normal and traditional denominations of 1, 5, 10, 50, 100 Shillings. The first step of taking a complete control of the nation’s money supply is for the CBS to know how much of money is in circulation. A currency with a new look and feel will help the bank to eventually achieve this goal.
Once the question of the design and denomination and/or conversion is determined, the next question is how to release the money into the market. This is the most critical step.
Gradual roll-out of the new currency.
1) Reduce the US Dollars in circulation: The CBS should first start by buying the US Dollars in circulation to make sure that people start using the new currency right away. The action of replacing the US Dollars currently in circulation with the new Somali Shilling will not increase the total effective money supply (US Dollars in circulation plus current Somali Shillings in circulation) in the economy; it will only be replacing one currency in circulation with another.
2) Release the new money into the market over a period of 1-2 years or more. This will be slow process and will demand the patience of the public and the government. First the CBS should encourage the businesses, money changers and money transmission companies (XAWAALDAHA) to convert their old currency for the new currency. The temptation to force business to convert their old currency should be resisted. Given that the federal government does not control most regions of the country and nomadic culture of Somalis, the currency conversation should be voluntary and the public should be given a reasonable time, say one or two years, to convert all their old currency for the new. A quick release that floods the market with the new currency or and/or forced conversion of old currency will do more harm than good.
3) Ensure the new money is under the total control of the CBS: The US currency that the CBS has purchased should not be available to the government to buy more goods and services. Here is where the independence of the CBS from government becomes critical. If the US Dollar taken out of circulation or for that matter the new Somali Shillings is made accessible to the government and is used to buy goods and services, this will undermine the actions of the CBS. In other words, it would create a vicious circle where the supply of the new currency keeps on increasing and thereby reducing its value potentially leading to a hyperinflation.
If the government has free access to either the new currency or the US Dollars in the CBS account, the public pressure to deliver on its commitments will be forced it to use the money to maintain the good will of the public. If this were to happen, businesses and the public will have no incentive to part with their US Dollars for a currency that is increasingly becoming worthless – they will feel cheated. Hoarding the US Dollar and incentive to refuse to accept the new currency for exchange of goods and service could become a common occurrence. Therefore, the only way that the government should have access the new currency should be to convert its US Dollar reserves or money received from international donor community to the new currency at the CBS. The CBS should make clear to the public well in advance that the government will have no access to the money in its accounts.
4) Reconstitute the banking sector to help with control of the nation’s money supply and foreign currency inflow.
As you can imagine there is no magic solution to the current problem and it will take time for the CBS to take full control of the country's money supply to be able to effectively control inflation.
The CBS needs the support of the federal government and the cooperation of the public particularly the business community to achieve a smooth release of the new currency. I was glad to learn that the government is taking its time to study how best to release the new currency into the market. I hope this article will contribute to this ongoing discussion.
Contact the author at [email protected] or through his blog www.economicscorner.com.