Somaliland’s economy is daunted by the dual tender where two currencies are legally acceptable in the domestic markets. Economists call this effect as currency substitution which is a situation that occurs when the citizens of the country use, fully or partially by foreign currencies. This effect is not specific to one market, but, is common to all markets and transactions in Somaliland Economy.
The prime implication of the dollarization is currency depreciation as domestic currency loses value over the Dollar. Currency depreciation is a favorable by itself when the country is an export maximizing and striving to gain competitiveness in the international markets. In import dominated economies like Somaliland, currency depreciation leads to inflation as domestic prices rise, which in effect raises the living costs of the nation and put pressure to the working class.
Although the causes and the curries of the inflation is beyond the scope of this section. This paper assumes that inflation in these economies, is partially caused by dollarization. How inflation could be targeted in existence of dollarization is this paper ‘s purpose.
DOLLARIZATION – THE MAIN SOURCE OF SOMALILAND’S INFLATION
Dollarization is a procedure in which one country embraces to substitute its currency with a foreign currency in all main basic roles of money. Previously in Somaliland, dollarization was mostly linked to the role of money as a medium of exchange where people use foreign currency to buy some of the imported goods. Somaliland Shilling’s defacement led a new term financial dollarization that refers to the substitution of the role of store of value of domestic currency to the foreign currency.
Dollarization in Somaliland is a more limited form of dollarization, real dollarization, which is the use of the foreign currency for price and wage contracts. It is a phenomenon that is very common in many countries in Latin American those fully dollarized their currencies, gave up their monetary policy autonomy and spared all the stabilization policies to be undertaken by monetary authorities.
Although the dollarization is a universal issue resulted from the globalization and openness of financial markets, dollarization in Somaliland reaches the highest value as the economy suffers from high inflation, lost trust in home currency, currency devaluations, fiscal deficits or illegal trade.
Monetary economist argues that dollarization has the advantage of lower transaction costs and higher involvement in the international markets. These advantages are outweighed by its hindrances those are loss in monetary policy independence, inability to adopt strict fiscal policy and the vulnerability of the banking system. In addition, dollarization devalues the home currency and as result inflation accelerates. Monetary authorities that aim to achieve price stabilization need to consider the pitfall pose by dollarization.
WHAT DO WE MEAN BY INFLATION TARGETING, AND IS IT REALIZED?
The most common definition of the inflation targeting is a monetary policy aiming to achieve price stability in the economy. Put it in another way, any policy that attempts to eliminate the inflationary pressure is said to be inflation targeting. Macroeconomist agree that the inflation target should not be zero, but in somewhere that balances employment and inflation.
Inflation can be targeted by a central bank by taking these measures:
- Defined quantitative targets for inflation in the medium term should publicly be declared by the central bank. The central Bank’s main goal of monetary policy is to attain price stability; and know that target of the aggregate demand.
- The central bank needs to be highly transparent and accountable during the application of the monetary policy and its performance in achieving the target. The central Bank constantly communicates to the public the objectives set, choices made by the bank authorities and outcome;
- The policy framework of the central bank would emphasis on future inflation by taking into account a lot of information in defining the settings of policy instruments.
Unless these characteristics are developed by the central bank of Somaliland, any policy taken to achieve the inflation target would ineffective and unable to attain its nominated goals.
The results from the Somaliland Consumer Price Index and the empirical findings of the research confirm there is high food inflation in Somaliland. Somaliland has experienced continual inflation since independence but the price of food has historically risen only gradually. However, there has been drastic food price inflation in the first half of 2017 which shows no signs of abating. The current food price inflation has caused almost all prices of food items to augment significantly while prices of some items have doubled in a very short space of time. Income and salary can no longer buy as much and this has adversely affected the standard of living of many Somaliland households particularly the most vulnerable groups in the society such as the low wage earners, those who earn their salary with domestic currency and those on a fixed income. It also led in to worsening levels of poverty in the country.
Factors that have contributed to the existing food price inflation being experienced in Somaliland can be classified into two categories:
- The first are those factors which have accelerated the excessive increase of food prices in the last nine months. These factors include the rise of the US Dollar exchange rate which has influenced price levels directly through imported goods. This is particularly important as most locally consumed food is imported from abroad. The livestock ban, printed notes, dollarization system, Khat importers switched to buying Khat using US Dollars and prolonged droughts which have reduced local crop production have also contributed to the recent sharp rise.
- The second category is factors that cause long term existing and more gradually increasing food price inflation in Somaliland. These include a lack of monetary policies, ineffective government institutions, seasonality and low production of local crops, lack of trade segmentation / Trading classification, population growth and rural to urban migration.
Importunate inflation in Somaliland has damaged government income and expenditure and undermines national economic growth and can potentially have adverse effects on risk-taking, investment, and other activities that are essential to the prospects for future economic stability.
- The Government of Somaliland, particularly the Central Bank and relevant ministries, should put in place sustainable and visionary foreign exchange and economic policies such as a monitory policy and fiscal policy and must initiate strong rules and regulation for food suppliers.
- Policies should be introduced which ensure that local currency is used in all transactions and which encourage market segmentation by reducing the number of importers who are also wholesalers and retailers.
- Local products must be promoted by the Government, such as traditional stable foods (for example maize and other cereal products).
- Commercial farming sectors must be encouraged and supported by the Government in order to improve food production at local levels, and reduce food imports.
- Incentives should be given to anyone who is interested in establishing viable commercial agricultural projects.
However, the most significant measure which could control and resolve the current food price inflation issue is to make the Dollar exchange rate more stable. A number of techniques could be employed to tackle the issue including settling the issue of trading in Khat with the Dollar currency from Ethiopia, working towards relieving the livestock ban, increasing locally produced food and exported items.
Abdi Halim Musa