Zambia's De-dollarisation Strategy: A Comprehensive Economic Analysis

Zambia’s decision to implement de-dollarisation—reducing reliance on the US dollar in domestic transactions—marks a bold move to stabilize the kwacha and strengthen the efficacy of its monetary policy. Critics often cite failed attempts in countries like Venezuela and Zimbabwe, but these critiques overlook deeper economic contexts and policy missteps. By adopting a structured, gradual approach and learning from global experiences, Zambia has a unique opportunity to avoid similar challenges and successfully de-dollarise.

Global Experiences with De-dollarisation: Lessons for Zambia

The IMF has extensively documented global cases of de-dollarisation, where success or failure often hinged on broader economic conditions.

Israel and Poland: Macro-Stability as a Foundation

In Israel, macroeconomic stability, disinflation, and a strong exchange rate anchor drove successful de-dollarisation. Israel introduced indexed assets, such as dollar-indexed deposits (Patzams), which helped transition away from dollar dominance while maintaining stability in local currency usage. Regulatory frameworks, such as a one-year holding period on foreign currency deposits and a ban on direct transfers of foreign currency among residents, complemented this approach.

Similarly, Poland implemented de-dollarisation by raising interest rates on domestic currency deposits, creating a favorable environment for the local currency. Both countries illustrated that targeting inflation and stabilizing the exchange rate were crucial lessons Zambia can apply in its de-dollarisation efforts.

Uruguay and Peru: Prudential Policies and Regulatory Tools

Uruguay and Peru successfully reduced dollar reliance by applying macro-prudential policies. In Peru, the IMF highlighted the importance of implementing targeted measures to curb financial dollarisation. Peru used higher reserve requirements for foreign currency deposits to make holding USD less attractive than local currency deposits. Furthermore, the Peruvian Central Bank introduced additional prudential measures like provisioning requirements for dollar-denominated loans to address credit risks associated with dollarisation. These measures discouraged the use of USD for lending and deposits, ultimately boosting confidence in the Peruvian sol.

Uruguay adopted a similar strategy by increasing reserve requirements, specifically on dollar-denominated deposits, making foreign currency holdings more expensive than local ones. These measures reduced liquidity for dollar transactions, pushing the economy toward using more local currency. Additionally, Uruguay complemented these tools with fiscal consolidation and a credible inflation-targeting framework, which played a pivotal role in stabilizing the peso. The IMF commended Uruguay for mitigating financial fragility caused by dollarisation, showing that well-coordinated monetary and fiscal policies are essential to success.

Key Takeaways for Zambia

Uruguay and Peru demonstrate the need for a multi-pronged strategy that includes macroeconomic discipline, robust regulatory frameworks, prudential policies, and confidence-building measures for the kwacha. Zambia can successfully de-dollarise by incorporating these elements into its approach.

The Negative Effects of Dollarisation: Why Zambia Must Act

While dollarisation may provide short-term stability in times of economic crisis, its long-term consequences can be detrimental, as highlighted by the IMF.

1.     Loss of Monetary Policy Efficacy: Elevated dollarisation weakens a country's ability to manage interest rates, money supply, and broader economic challenges. In Ecuador, dollarisation was a planned, deliberate policy shift in response to severe hyperinflation and a financial crisis. By adopting the U.S. dollar in 2000, Ecuador stabilized its economy but forfeited the ability to control its monetary policy. As a result, the Ecuadorian central bank could not respond to domestic inflation through traditional means, like adjusting interest rates. On the other hand, Zambia faces de facto or unplanned dollarisation, which has emerged gradually over time due to economic instability and a lack of confidence in the kwacha. Unlike Ecuador, Zambia did not consciously choose to dollarize; market forces drove this shift. This unplanned dollarisation is particularly harmful, leaving Zambia's economy vulnerable, with limited tools to manage inflation or control currency volatility. Moreover, Zambia's dollarisation levels exceed the IMF's acceptable threshold of 30% for import-heavy economies, highlighting the urgency of addressing this issue to improve the efficacy of its economic policies.

2.     Increased Vulnerability to External Shocks: Countries heavily reliant on foreign currencies are more exposed to exchange rate volatility and external financial shocks. When local businesses and consumers borrow or transact in foreign currencies, even minor fluctuations in the exchange rate can have significant negative impacts, creating financial instability.

3.     Banking Sector Risks: The banking sector in dollarised economies is particularly vulnerable, as banks carry foreign currency liabilities but often generate local currency income. This currency mismatch increases the risk of banking crises. It poses a substantial risk to financial stability, limiting the BoZ's capacity to act as a lender of last resort in times of crisis.

4.     Constrained Exchange Rate Flexibility: Fear of currency devaluation can limit a government's willingness and ability to adjust its exchange rate, as using foreign currencies creates a strong pass-through effect from exchange rates to domestic prices. This pass-through effect can make the local economy more rigid and less flexible in responding to external shocks, such as commodity price fluctuations.

These effects underscore why Zambia's move toward de-dollarisation is critical for long-term economic stability. By reducing reliance on the US dollar, Zambia can regain control over its monetary policy and minimize the risks associated with external shocks and financial fragility.

Zambia’s Unique Challenges: Global Dollar Dominance and Speculative Pressures

One of Zambia's primary challenges is the global dominance of the US dollar. According to the Bank for International Settlements (BIS) 2022 Triennial Central Bank Survey, the US dollar was on one side of 88% of all foreign exchange trades globally. While Zambia's economy, heavily reliant on dollar-denominated exports like copper, cannot eliminate the dollar's role, reducing its dominance in domestic transactions is a crucial goal of the de-dollarisation strategy. This shift can grant Zambia greater control over its currency, better insulating the economy from external shocks.

Speculative trading against the kwacha poses significant risks, as businesses and individuals frequently purchase or externalize USD to hedge against local currency depreciation. Zambia's recent FX structure reforms, which introduced limitations on speculative trading, have assisted with curbing this behavior. Moreover, the Export Proceeds Tracking Framework (EPTF), a system that tracks and monitors the inflow of foreign exchange from exports, and the electronic Balance of Payments (eBOP) system, a digital tool for recording all economic transactions between a country and the rest of the world, allow the Bank of Zambia (BoZ) to track foreign exchange movements more precisely.

The chicken-and-egg dilemma—where instability drives dollarisation, and dollarisation exacerbates instability—must be resolved for long-term economic reform. Zambia's structured regulatory approach offers an opportunity to break this cycle, as seen in Peru and Uruguay.

Addressing Criticism: Venezuela and Zimbabwe as Misleading Comparisons

Critics often point to the failed de-dollarisation attempts in Venezuela and Zimbabwe as reasons for concern. However, these cases were not failures of de-dollarisation per se but deeper economic mismanagement. In Venezuela, for instance, de-dollarisation was accompanied by hyperinflation, lack of fiscal discipline, and political instability, collectively making monetary reform impossible.

Similarly, Zimbabwe's attempt at de-dollarisation failed mainly due to governance failures and an inability to control inflation. De-dollarisation efforts were implemented without the necessary macroeconomic stability, making the currency collapse inevitable.

Zambia's de-dollarisation strategy stands apart from Venezuela and Zimbabwe's experiences, as the government implements the policy through a gradual, measured approach. The BoZ and government have extensively consulted with stakeholders across the private sector and financial industry to ensure a smooth transition.

Rather than forcing an abrupt currency conversion, the focus is on creating incentives to use the kwacha for domestic transactions while maintaining the use of the dollar for international trade. This phased approach allows Zambia to mitigate short-term shocks and manage the risks of capital flight and currency depreciation more effectively. By adopting a step-by-step implementation strategy—similar to that of Poland and Israel—Zambia can build the confidence necessary for de-dollarisation to succeed without destabilizing the economy.

Preferential Lending and Interest Rate Reform

De-dollarisation provides the Bank of Zambia (BoZ) a pivotal opportunity to regain more significant control over monetary policy, potentially lowering borrowing costs as the kwacha strengthens. This shift could reshape Zambia's credit environment, particularly by addressing long-standing disparities in the financial sector.

One major issue is the preferential lending rates enjoyed by bank employees, who often access loans at significantly lower rates than the general public, with interest rates sometimes exceeding 25%. These imbalances favor privileged groups, while ordinary Zambians face higher borrowing costs that hinder economic growth and financial inclusion. Eliminating these preferential lending practices entirely (as banks currently account for them as costs and still offer lower interest rates to employees) would compel banks to reevaluate their lending models comprehensively, encouraging them to adopt more competitive, volume-driven approaches.

By subjecting bank employees to the same financial pressures as the broader economy, there is a higher likelihood of spurring innovation in lowering interest rates. When financial sector workers personally experience the high costs of borrowing, they are more likely to feel the urgency to find and implement solutions that can benefit everyone. Senior bank executives—many of whom hold significant loans—would also feel this pressure, motivating them to push for reforms and more creative financial products.

Addressing fiscal dominance is equally critical. Nevertheless, it is important to note that although banks argue that the government is a less risky borrower and should enjoy lower rates, there are instances where corporations can secure loans at even better terms than the government. This selective application of risk assessment highlights the need for more inclusive and tailored credit models that reflect Zambia’s local economic realities.

One viable solution is formally integrating village banking groups into the formal financial system. These community-based lending models could be a powerful tool for expanding credit access, especially to underserved populations. By formalizing and regulating these groups, the financial sector can enhance credit risk monitoring while tapping into a more grassroots lending market. In addition to building trust in the formal financial system, integrating village banks could broaden the base for lending, promoting financial inclusion and enabling a more diverse set of borrowers to access credit. This integration would help shift the credit landscape away from its dependence on large corporations and government clients, creating a more dynamic financial environment.

To mitigate the crowding-out effect caused by fiscal dominance, the BoZ should consider placing a cap on bank exposure to GRZ securities and direct government lending. By doing so, banks will allocate more resources toward lending to the private sector and invest in innovative credit models. This policy could spark competition in the banking sector, encouraging more diverse lending practices and reducing the over-reliance on government debt as a source of revenue.

The BoZ and the banking sector have an opportunity to push for reforms, but they must act quickly. Years of benefiting from ‘lazy banking’ practices, where easy returns from GRZ lending have stifled innovation, have led to complacency across the sector. While the BoZ should continue to foster a conducive regulatory environment, the drive for reform must come primarily from the private sector. It is up to institutions like the Bankers Association of Zambia (BAZ) to create a think tank or collaborative platform to drive financial innovation. Rather than relying solely on regulatory guidance, the private sector must push for more dynamic credit models and products.

At present, BAZ appears focused on ceremonial tasks like handing out awards or delegating responsibilities to treasurers. However, its role should be much more consequential. The banking sector must prioritize genuine financial innovation instead of trivial matters like LinkedIn posts celebrating inconsequential achievements. Where is the think-tank fostering collaboration for real change in banking? The Zambian banking sector needs to develop new credit models tailored to local borrowers, including small and medium enterprises (SMEs) and village banking groups.

The BoZ can support these efforts by imposing caps on GRZ lending and ensuring regulatory flexibility, but it is ultimately up to banks to drive the change. Bank executives and employees—who currently benefit from preferential lending—should face the same pressures as ordinary Zambians, incentivizing them to innovate and create solutions that reduce borrowing costs across the board. The cycle of ‘lazy banking’ must be broken if Zambia is to evolve into a more competitive, innovative financial environment that supports the country’s broader economic ambitions.

Ultimately, innovation must become a core focus of the Zambian banking system, moving beyond LinkedIn posts and trivial accolades to meaningful reforms that genuinely benefit the economy. Without bold action from the private sector, Zambia risks remaining trapped in a cycle of complacency that stifles growth and financial inclusion.

Finally, Zambia could benefit from adopting macroprudential policies similar to those used in Peru and Uruguay, which successfully reduced financial dollarisation through higher reserve requirements on foreign currency loans and deposits. By encouraging local currency lending through similar measures and fiscal reforms, Zambia can reduce its reliance on foreign currency holdings, lower borrowing costs, and build confidence in the kwacha. The BoZ's focus on increasing reserve requirements for dollar-denominated products would be essential to achieving a more sustainable and resilient financial sector.

Speculative Trading and Capital Flight

One of the significant risks associated with de-dollarisation is the potential for speculative attacks on the kwacha, as investors and businesses externalize their USD holdings out of fear of currency depreciation. Historically, speculative trading in Zambia has exerted considerable pressure on the kwacha, with individuals and firms buying large amounts of USD to hedge against instability.

However, Zambia's recent reforms to its FX structure have proven instrumental in curbing these speculative behaviors. The government has already alleviated some pressure on the kwacha by limiting opportunities for businesses and individuals to engage in USD speculation. Tools such as the Export Proceeds Tracking Framework (EPTF) and electronic Balance of Payments (eBOP) are critical in monitoring capital flows. These systems equip the BoZ with the tools to closely monitor foreign currency movements, effectively limiting capital flight and mitigating speculative pressures on the kwacha.

The IMF's Primer on Dollarization emphasizes the importance of monitoring capital outflows and ensuring financial institutions manage their foreign exchange exposure prudently. While outright capital controls are unnecessary, robust monitoring frameworks—such as Zambia's current systems—are essential to mitigating speculative behavior and maintaining systemic stability.

The Risk of Black Markets: Mitigating Informal Currency Transactions

A standard critique of de-dollarisation policies is the potential for black markets to emerge, where individuals circumvent official exchange rates and use foreign currencies for transactions. However, the experiences of countries like Nigeria and Kenya, where black markets thrive despite the absence of formal de-dollarisation policies, highlight that black markets frequently emerge due to inadequate regulatory oversight rather than as a consequence of de-dollarisation policies themselves.

To mitigate this risk, Zambia must ensure comprehensive enforcement of de-dollarisation policies, complemented by strict oversight of the Export Proceeds Tracking Framework (EPTF) and electronic Balance of Payments (eBOP). The government can limit the conditions that foster black market activity by monitoring foreign currency inflows and outflows and tightening controls on informal exchanges. In particular, targeting loopholes that allow individuals to conduct informal currency transactions will reduce the possibility of parallel currency markets.

The Risk of Too Many Exemptions: Diluting the Impact of De-dollarisation

Excessive exemptions seriously risk Zambia's de-dollarisation efforts by undermining the policy's integrity. Widespread exemptions dilute regulatory frameworks, enabling businesses and individuals to bypass key de-dollarisation measures. For instance, Uruguay's success in reducing dollarisation hinged on limiting exemptions, ensuring that higher reserve requirements on foreign currency holdings applied uniformly across sectors. Zambia must enforce consistent regulations to prevent parallel currency markets and illicit USD transactions, adopting an approach similar to Uruguay's successful reduction of exemptions.

The IMF's studies on de-dollarisation in countries like Uruguay and Peru emphasize that excessive exemptions can undermine macroprudential policies designed to reduce reliance on foreign currencies. In Uruguay, for example, differentiated reserve requirements successfully reduced financial dollarisation by making it more costly to hold foreign currency. Extensively granting exemptions would have compromised the policy's effectiveness by allowing certain entities to avoid these additional costs. Similarly, Peru's higher provisioning requirements for foreign currency loans played a crucial role in curbing loan dollarisation; widespread exemptions would have weakened these measures' impact.

It is imperative for Zambia to take a firm stance against granting widespread exemptions to avoid such pitfalls. By ensuring that the regulatory structure remains coherent and uniformly enforced, the government can prevent the creation of loopholes that circumvent de-dollarisation measures. Limiting exemptions will reduce the risk of parallel currency markets emerging and deter the development of unofficial avenues for USD transactions, thus supporting the shift to a kwacha-centric system.

Similarly, Zambia can reinforce the credibility of its de-dollarisation strategy by strictly enforcing policies like the Export Proceeds Tracking Framework (EPTF) and electronic Balance of Payments (eBOP) without undue exemptions. This approach aligns with the IMF's findings that robust, consistently applied regulatory measures are essential for reducing financial dollarisation and strengthening the local currency's role in the economy.

Short-Term Challenges and Long-Term Benefits

De-dollarisation has its short-term challenges. Businesses that have long transacted in USD may hesitate to switch to the kwacha, fearing instability. However, the long-term benefits are clear. A better-insulated kwacha, supported by more significant control over domestic monetary policy, will allow the BoZ to manage inflation more effectively, lower interest rates, and foster economic growth.

As confidence in the kwacha grows, the financial sector must adapt. Banks must shift from high-margin lending strategies to volume-driven models, especially as interest rate structures undergo reform.

Conclusion: A Path to Economic Sovereignty

Zambia anchors its de-dollarisation strategy in a thoughtful, gradual approach supported by solid regulatory mechanisms like EPTF and eBOP. Drawing lessons from countries like Israel, Peru, Uruguay, and Poland, Zambia's policy aims to avoid the pitfalls experienced in other economies.

The success of this policy hinges on maintaining strict regulatory oversight and minimizing exemptions to avoid diluting the impact of de-dollarisation. Black market activities, a risk commonly associated with currency reforms, can be curtailed with rigorous enforcement and a robust framework for monitoring currency flows. By managing speculative pressures, controlling capital flight, and reforming the interest rate structure, Zambia can strengthen the kwacha and reduce reliance on the US dollar for domestic transactions.

Ultimately, Zambia’s journey toward economic sovereignty will require managing short-term disruptions while securing long-term gains. By maintaining strict regulatory oversight and involving key stakeholders at every step, Zambia is well-positioned to strengthen the kwacha, control inflation, and achieve sustainable economic growth. With strategic implementation and lessons from global success stories, Zambia’s de-dollarisation could set a benchmark for other emerging economies striving for monetary sovereignty.

List of References:

1.     IMF - Dollarization: A Primer (2003 Oct 20)

2.     IMF - Risks and Benefits of Dollarization (1999 Mar 15)

3.     IMF - Taming Financial Dollarization: Determinants and Effective Policies – The Case of Uruguay (2023 Nov 24)

4.     IMF - Financial De-dollarization: A Global Perspective and the Peruvian Experience (2016)

5.     IMF - Drivers of Financial Dollarization and the Role of Prudential Policies – The Case of Uruguay (2023 May 23)

6.     IMF - International Experience of De-Dollarization (2006 Feb 23)

Dean N Onyambu is the Founder and Chief Editor of Canary Compass, a co-author of Unlocking African Prosperity, and the Executive Head of Treasury and Trading at Opportunik Global Fund (OGF), a CIMA-licensed fund for Africans and diasporans (Opportunik). Passion and mentorship have fueled his 15-year journey in financial markets. He is a proud former VP of ACI Zambia FMA (@ACIZambiaFMA) and founder of mentorship programs that have shaped and continue to shape 63 financial pros and counting! When he is not knee-deep in charts, he is all about rugby. His motto is exceeding limits, abounding in opportunities, and achieving greatness. #ExceedAboundAchieve

The Canary Compass Channel is available on @CanaryCompassWhatsApp for economic and financial market updates on the go.

Canary Compass is also available on Facebook: @CanaryCompassFacebook.

For more insights from Dean, you can follow him on LinkedIn @DeanNOnyambu,  X @InfinitelyDean, or Facebook @DeanNathanielOnyambu.