Why Covid-19 is proving to be an important reality check for Somalia’s economic “reforms” under the debt relief programme
“Flight to quality” is a well-known aspect in times of financial markets stress. It simply means the United States dollar (USD) is generally the one thing everyone wants. The expectation is that the USD is backed by the US Federal Reserve (the lender of last resort) which can ease any dollar market crunches. This market confidence in the currency sustains the dollar as the global trade currency and is shared equally by large global corporates as well as the hawker selling watermelons on carts in Hamarweyne market. The dollar is, in essence, the ultimate safe haven. However, the mistake is to assume it can be a substitute for a country’s national currency.
The perils of riding on the greenback
We are now in the midst of a Covid-19-induced market-wide stress and a large number of companies are stuck in a double-bind: rapidly depleting revenues because of the global lock-downs and continued commitments to meet liabilities (eg. fixed costs, supply chains and debts) falling due often in dollars. All of this means the demand for the greenback has peaked, pushing the dollar to appreciate against a basket of other currencies. Given Somalia uses it as a de-facto national currency, it is not difficult to see the adverse consequences.
Somalia’s Shilin is mostly counterfeit and the Central Bank of Somalia (CBS) has not issued any new currency denominations for 30 years. The Shilin is not used for key goods or services and all economic transactions are in dollars. This over-reliance on the dollar means the country is materially exposed to what happens in global financial markets.
A country’s currency is the vital artery that supports its economic well-being and critical to its path to sustainable economic development. Somalia remains unique in the world as having a recognised government but without a viable national currency. Somalia’s monetary system, which is anchored on the dominant (USD) currency, makes its economy vulnerable to the financial markets’ acrobatics and global economic stress events happening today.
Second, most of the dollar liquidity inflows into Somalia (eg. the remittance from overseas from which a significant proportion of the population directly or indirectly benefits) are used to buy imported consumer goods “Bariis, Baasto, Barafuun” and eventually materialise as outflows over time, hence Somalia’s large current account deficit. Without a central bank with sufficient USD liquidity buffers, the effects of dollar scarcity become easily amplified in the economy, leaving households and the wider financial system exposed to the risks of dollar illiquidity.
How Covid-19’s is exposing the illusion of “reforms”
When there is a scramble for dollars, as we see today, two things happen: businesses start to hoard USD and increase prices, injecting inflationary pressures into the economy; and wider economic activities grind to a halt (i.e. most households defer non-essential expenditures, other economic activities – eg. construction, wage payments stop). The dollar market sizes up quickly.
In other countries, this will be the time when the central bank steps in and uses its monetary policy levers to open up dollar liquidity lines by purchasing the local currency through open market operations, thereby bringing down the overall demand for dollars. The central bank also supports the government’s fiscal stimulus to mitigate the hit to livelihoods. Somalia’s problem is that dollar is the de facto national currency and there is no monetary policy lever to pull. In fact, the Central Bank of Somalia cannot do anything.
When the central bank does nothing, further consequences follow: the liquidity held outside of Somalia is both reduced and trapped (because of reliance on cash transportation in bags and lack of access to inter-bank payment and settlement systems), whilst outflows from Somalia continue as people transact in dollars for their daily necessities. This is why Hawala companies are the first to feel the dollar squeeze, hence their rationing of remittances.
In the absence of dollar liquidity lines, or the banking infrastructure that can shift liquidity into the country quickly, investments and remittances, sent through the Hawalas, also dry up. Overtime, the whole economy starts to seize up as cash runs out and viable businesses become illiquid with ruinous wider economic consequences.
Moreover, this liquidity risk could be the contagion that breaks the Electronic Mobile Money Transfer (E-MMT) system – currently the main payment system artery of the country. If, because of dollar scarcity, enough people realise that they would be better off having cash in hand, rather than in an E-MMT wallet (flight to quality again) and there is a chorus of “Doolarkayga ii Soo Bixi”, the liquidity crunch in Somalia would be much worse indeed in the weeks and months ahead.
Credible reforms or mere recrudescence?
Having USD as the country’s monetary and economic backstop is economically perilous. Somalia had the opportunity to implement currency reforms but these opportunities were squandered. The country is exposed to these financial markets acrobatics precisely because it neither has a viable national currency nor anchored in any of the basic key reforms (eg. regulation of mobile money operators, banking payment system infrastructure) that would have mitigated these risks.
We may of course all recall that most of these reforms were in the IMF Staff Monitored Programmes (SMPs) in one shape or form. The first SMP in May 2016, that was agreed with the then Federal Government of Somalia, included a structural benchmark on “initiating the first stage of comprehensive currency reform”. That was five years ago and we are still talking today about why the country has no viable currency!
Over the years, Somalia “successfully” completed SMPs I, II, III and IV, all of which included several other milestones on currency, monetary policy, central bank and other fiscal milestones. If we were to believe the official announcements, Somalia is now at the debt-relief “Decision Point”, having apparently delivered on all of these reform benchmarks. It does not, of course, take much to see the inherent contradictions in this story.
Sacrificing important reforms for a spot of good news on the debt relief journey is never in Somalia’s national interest. Perhaps, this is a sign of low expectations for Somalia and these reform achievements are convenient milestones to tick off.
That is why it is important not to be caught up in this collective euphoria about the Decision Point. The Shilin travesty is an obvious example of what happens when ends (debt relief) is prioritised over means (locking in credible reforms first).
Somalia would have been in a much better place today to mitigate the economic impact of Covid-19 if the right reforms were in place. This is why Covid-19 is an important reality check for many and shows once more that reforms in Somalia are merely comforting illusions.
By ABDI ALI
You can contact Abdi Ali @ firstname.lastname@example.org