Can dollar ban actually work? Unpacking the challenges and solutions

TANZANIA: During the presentation of the 2024/25 government budget, Finance Minister Dr Mwigulu Nchemba emphasised that starting July 1, 2024, Tanzania will no longer permit payments in US dollars for various local expenses.

However, despite similar statements in the past, this ban has seemingly not been effective. Why does this prohibition appear to be ignored? Swahili proverb says “sikio la kufa halisikii dawa”.

Examining the history of Tanzania’s efforts to curb dollar usage for local transactions reveals ongoing debates and challenges. Since the central bank’s previous restrictions, there has been controversy over the effectiveness of these measures.

This article aims to explore the impact of using dollars for local goods and services and why past attempts to address this issue have fallen short.

The previous attempts to limit dollar usage, including announcements in August 2007, December 2017 and June 2023, alongside the recent caution from Minister Nchemba, suggest a pattern of non-compliance with the central bank’s 2006 regulations. The question arises whether insufficient incentives or inadequate strategies are to blame for the continued use of dollars.

Other countries, such as South Africa and India, have successfully eliminated dollar usage for domestic transactions. This raises questions about why Tanzania has struggled to achieve similar results.

Are there lessons to be learned from these countries about how to prioritise local currency in payments? Have they implemented measures that compel all transactions to be converted to local currency through banks or bureaus de exchange?

The Bank of Tanzania Governor reported on June 8, 2023, that measures to address the dollar deficit in circulation are necessary. Despite this, there are concerns about non-compliance with the Bank of Tanzania Act of 2006.

It is essential to investigate whether the strategies employed are adequately researched and effective in encouraging adherence to the law.

The root of the problem may lie in issuing restrictions and alerts without proper research or incentives.

Consumers might view these measures as ineffective if they do not address their needs. To address this issue, Tanzanians need to foster better understanding and collaboration with the central bank to design effective solutions.

Tanzanians need to better understand each other and, if possible, assist the central bank in grasping the effects so that they can devise an effective strategy. I want to clarify that my intention is not to criticise any individuals or organisations. Rather, I aim to highlight the impact of using the dollar when local currency could be utilised.

Dollarisation, or the use of foreign currency in place of the local currency, poses several risks to the economy. It can complicate monetary policy, lead to instability due to exchange rate fluctuations and strain foreign exchange reserves.

Increased dollarisation may prompt government intervention in the foreign currency market, potentially worsening market inefficiencies and increasing the banking system’s vulnerability to capital flight and currency swings.

Although Tanzania’s level of dollarisation may not be extreme, it is significant enough to warrant attention in economic policy development.

To prevent full dollarisation, the government should implement measures to maintain low inflation and discourage the use of foreign cash for non-essential items.

Additionally, providing disincentives for dollar usage and ensuring fiscal responsibility are crucial steps.

This is important because maintaining low inflation and limiting the temptation to utilise foreign cash for superfluous items unsuitable for the broader economy are the apparent solutions to the dollarisation problem.

In summary, dollarisation can lead to increased exchange rate volatility, decreased monetary policy effectiveness and heightened inflation susceptibility. Monitoring dollarisation trends will provide insights into the macroeconomic environment and highlight the need for fiscal discipline and financial responsibility.

Along with attempting to maintain fiscal responsibility, the government should closely check the degree of dollarisation by providing disincentives for its use.

Currency substitution, or dollarisation, has several adverse effects on the economy, particularly on the government’s ability to manage it.

Dollarisation can lead to short-term economic instability with severe repercussions. For example, it often results in a decline in the currency’s value or, in a fixed exchange rate system, a run on the country’s foreign exchange reserves.

This can trigger a liquidity crisis and higher domestic interest rates, potentially harming future economic growth and employment opportunities.

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Long-term dollarisation can further impact the economy by reducing the government’s ability to manage resources through non-inflationary seigniorage. This refers to the ability to run a deficit that increases the money supply proportionally to demand without causing inflation.

Second, dollarisation limits the government’s ability to impose an inflation tax, as deficits may exceed public support for additional reserves or lending. This complicates the use of monetary policy to stabilise the economy.

Third, it increases the likelihood of government intervention to curb dollarisation, such as banning foreign exchange accounts.

However, poorly designed measures could worsen market inefficiencies, making the banking system more vulnerable to capital flight and exchange rate fluctuations and raising exchange costs compared to a stable single currency.

Finally, these issues will make it increasingly difficult for the government to effectively tax all income sources. With many taxpayers not currently within the tax net, it will be challenging to collect sufficient revenue to fund public expenditures.

Failure to collect adequate taxes will lead to a fiscal deficit, compelling the government to increase the money supply to meet its spending needs. If GDP grows and the public’s demand for money remains stable relative to GDP, this expansion won’t necessarily lead to inflation, as long as it doesn’t exceed the growth in money demand. In this case, the government benefits from a surplus of spending over revenue.

Dollarisation has further implications, notably increasing exchange rate volatility, reducing the effectiveness of monetary policy and making the economy more prone to inflation. This occurs because dollarisation heightens sensitivity to changes in interest rates on domestic monetary assets.

Once an economy is fully dollarised, the exchange rate can no longer mitigate the effects of external shocks, such as declines in trade terms. Dollarisation often reflects underlying macroeconomic issues rather than being a standalone challenge. It limits the government’s ability to use inflation taxes and underscores the importance of sound fiscal policy for macroeconomic stability.

Monitoring dollarisation is crucial for assessing economic health and signals the need for stringent financial and fiscal discipline.