Opinion

High-Denominated Banknotes, Macroeconomic Transmissions, and their Economic Complications

Gen. Philip Marol Mading

Former Minister of Finance- Lakes State government

(2005-2009)

This article explores the fundamental macroeconomic policy complications in high-denominated banknotes, high interest rate, high exchange rate and inflation. Taken together, they play a critical role in determining and influencing the real and nominal economy of a country.  The fiscal and monetary authorities should have the temerity to harmonize their fiscal and monetary policy variables to avoid contradicting their macroeconomic performances, if we are to combat inflation and improve the economy and living conditions of the citizens.  .

A good starting point is to first strike the balance between increased interest rate and increase exchange rates to be more favorable to the monetary policy and decrease interest rate and decrease exchange rates being more effective under fiscal policy.  Same scenario applies to fiscal policy being more effective under pegged exchange rate system (closed economy), and monetary policy being inversely effective under perfectly flexible exchange rate regime (open economy).  

South Sudan should not be confused by macroeconomic literatures of the developed countries that advocate for depreciation of their local currencies and increase in exchange rates and interest rates. Such theories are applicable in developed economies, which have much to export than to import, thus they tend to increase interest rates and devalue their local currency to stimulate exports and to attract hot money inflows and reduce inflation.

However, those hypotheses work differently in the least developed countries, which are largely dependent on imports and have less to export. South Sudan is no exception in that respect, for its imports almost everything- a situation that need much more stronger local currency than weaker currency in order to access foreign exchange more cheaply and to induce cheaper local market prices and stimulate the economies of scale.

Comparatively, if a country wants to stimulate exports because it has more to export than to import, then it has to devalue its local currency through either, increase of interest rate, exchange rate, and other macroeconomic variables, or by an executive order. By contrast, if a country wants to stimulate imports because it is dependent on imports, it has to strengthen its local currency by keeping interest rate and exchange rate as low as possible, and by increasing productivity rate.

The underlying economic conditions imply that South Sudan should foster for imports boosting through appreciating the value of its local currency, as the country invests in exports-oriented investments to create jobs, create internal market (industrialization), and reduce the volume of imports to trigger sustainable economic growth and development. 

In this regard, the government has the authority to change exchange rate and its system depending on the policy option between devaluing local currency to boost exports (contractionary policy) and strengthening local currency to influence imports (expansionary policy).

It oughst to be understood clearly that contractionary policies of high interest rate and depreciation of local currency in a developing economy like South Sudan can lower the demand as borrowing becomes more expensive to afford, thus reducing spending capacities, reducing employment opportunities, increasing commodity prices, escalating inflation, and lowering economic growth.

Inversely, lower interest rate increases access to borrowings, strengthens the value of the domestic currency, stimulates imports, leads to more spending, creates jobs, increases domestic savings, and improves financial sector performance, and its growth.  

The recent increase of interest rate from the already relatively high interest rate of 10% to 15% is distressful to the economy. Interest rate is widely link to inflation and increased exchange rate alike. A reduction in interest rate allows borrowers to borrow more money with relatively lower cost and therefore, lower prices and consumers will have an opportunity to spend more money and stimulate aggregate demand as income increases and tax base widens.

There exist two exchange rate markets in South Sudan, the official exchange rate and the black market exchange rate. The same vice exists in the interest rate- the official interest rate of 15% and the black market interest rate of 100% on borrowing with only one-month maturity period- unprecedented monetary transmission mechanisms that no country has ever experienced. 

Although increased interest rate is favorable to lenders, yet the central bank must be sensitive to such alarming contractionary policies that raise interest rate at the expense of the economy. Even non -professionals can understand with intuition and common sense that a rise in interest rate is often contemporaneous with an increase in inflation. Therefore, South Sudan should hold the interest rate as low as possible given the global economic slump and the slowdown of the GDP as the world’s oil prices decline due to devastating Covid19, which significantly reduced international trade and economic activities. 

Most of EACs hold less than 10% interest rate and other countries hold zero percent interest rate to encourage borrowings and investments to create more jobs and to expand the economy. With COVID 19 economic impacts, USA government willingly gave out trillions of dollars to rejuvenate the affected local businesses in the country.

Given the above analyses, it is recommendable that the government adapts Managed-Float Exchange Rate System (the hybrid of float and pegged exchanges rates). This system can address the current fragile foreign exchange market, as it does not only allow variation against that of other countries as  determined by market forces of demand and supply, but also it gives the monetary authorities awareness of currency risk in the face of deteriorations in current accounts. That is to say, it gives warnings when the market exchange rate threaten to depart from normal rate, and the concerned authorities should preempt such a situation by doing the necessary to curb probable problems and anomalies to ensure that the rate stays at the equilibrium levels.  

In addition, the system prevents the unscrupulous to manipulate the exchange rate market and keep the target rate of inflation within the true exposures of the economy. In other words, managed-flexible system will provide incentives to control anomalies and crimes.

Other advantages with the choice for managed-float exchange rate regime is that it enables the monetary authorities preclude the black market as predators are rooted out of the market and the sources that feed the black market as blocked, including entities, which  remunerates in U.S Dollar in the country.

Most importantly, Managed-float Exchange Rate System serves both open and closed economies efficiently. However, the monetary and fiscal authorities need to reinforce it by focusing on important macroeconomic variables and various deregulating instruments that are useful under managed-float exchange rate regime, and which at the same time, underpins healthy monetary and fiscal policies such as domestic money supply and current account balance to attain both external and internal equilibriums.

There is a dire need that South Sudan should strengthen the value of its local currency, lowering of interest rate, introducing managed-float exchange rate regime, increasing national output and productivity, controlling demand and supply of money. The harmonization of all these macroeconomic factors take into consideration economic conditions, such like the existing economic disposition in terms of demand for and supply of money as well as in terms of imports and exports (balance of trade/current account balance), market structures, and most importantly, the inexistence of industrial base.

In addition, the monetary authorities should undertake stern administrative measures to reorganize and streamline the central bank foreign exchange operations and new mechanisms for bank supervision altogether to ensure a competitive and efficient exchange market environment that curtail cartels and malpractices in macroeconomic transmissions.

Above all, the central bank and the ministry of finance should uphold with the principles of transparency and accountability, and sound public financial management systems. They should harmonize, digitalize and set monetary and fiscal targets, to avoid excess currency notes to finance fiscal deficits, and must make sure that they service the debt burden, and repay commercial banks their vandalized cushions to streamline their operations so that they can be able to operate and serve customers fairly.

Also required, is prudential monitoring and supervision of foreign exchange bureaus, financial and nonfinancial institutions, businesses and humanitarian agencies, including UN agencies, NGOS and any other sources that feed the parallel market with hard currency as the bank holds the principles of disinflationary measures. This implies that the government should ensures UN agencies, NGOs, and any other entities, which pay their employees in local currency, and exchanging or transacting their businesses in hard currencies, are restricted and must transact their businesses in domestic currency and through official market systems.

Foreign exchange is principally the province of the central bank to keep as reserve as well as for foreign trade and imports through standard ‘Letters of Credit’ (LCs), which should rigorously be managed consistently with international best practices.

South Sudan should consider regional currency trade to ensure Kenyan Shillings, Ugandan Shillings, Sudanese Pound, Ethiopian Ber, and any other necessary foreign currencies for exchange in the foreign exchange bureaus and commercial banks like in the past.

The strength of the South Sudan’s national currency to trade with regional currencies implies that, the dollar demand will drastically reduce since majority of customers come from neighboring countries and the tenth of thousands of South Sudanese families residing in those countries will no longer face pressures of high dollar demand. For instance, individuals travelling to and from any of the neighboring countries, say, Kenya for example, will not again bother to scramble over dollars since Kenya Shillings will be accessible in any of the foreign exchange bureaus. African Continental Free Trade Area Initiative and its unified model of payment will create an enabling environment for South Sudan currency trading.

The introduction of 1000-pound bill is a clear manifestation of inflation since the value of pound will not change for the better. High currency denomination has more disadvantages than advantages on the economy. The negative effect is that the big notes bloated with multiple zeros are psychologically linked to inflation while low denominated notes are despised, and consequently, they disappear from circulation since their values are reduced, and prices increased indirectly.

The third biggest 100-bill, which was the highest bank note before 500 banknote was introduced recently, will also fall into the same pit. Another disadvantage with big notes is that they are susceptible to various risks, such as crimes of counterfeiting and the risk of idleness’ and discomfort of human psychology in handling large calculations with no significant direct impact on the economy.  

There is no any economic benefit in introducing high-denominated bills. The only advantage, and which has nothing to do with the economy, is that bulkiness and awkward handlings is reduced compared to small notes.  

The article advises the monetary authorities to introduce a low-denominated new currency with different names and different features altogether and with new standards essential to impact psychological disinflationary effect and in a bid to stabilize the value of South Sudanese currency. The writer has a private contribution on currency transformation.  – A pamphlet of 45 pages titled ‘Currency Change Strategy Proposal’ and is yet to be launched to help in this regard.

Although the change of national currency is not by itself, a universal remedy for the underlying exchange market inefficiency and economic crisis. However, apart from smoking out the stashed pound, it helps the situation indirectly in many ways: Firstly, it will create a new monetary era that will enable the government to convince the public that hyperinflation is over. Secondly, it will enable the government to reassert the currency sovereignty and its credibility by addressing currency malpractices, eliminating distortions in the foreign exchange market, therefore, stabilizing the currency value and influencing psychological effects on inflation and currency destabilization. 

The author can be reached through:

Tel. 0921774433/0917830038

Email: pmarolmading@gmail.com

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