2014

A Comparative Study of
Hyperinflationary Episodes in Asia,
Africa and South America
MTP PROJECT

By
Karan Chabra
Mihir Talnikar
Rohit Patnaik
Santosh Kanbargi
Siddhanth Garg

B14149
B14155
B14166
B14171
B14173

XLRI Jamshedpur

INTRODUCTION
Philip Cagan defined a hyperinflationary episode as starting in the month that the monthly
inflation rate exceeds 50%, and as ending when the monthly inflation rate drops below 50%
and stays that way for at least a year. Hyperinflation is often the result of the interplay
between geo-politics of the region and the economic policies of the country.
The objective of this study is to understand the circumstances underlying the beginning of
hyperinflationary episodes in countries. For this study we classify hyperinflationary episodes
into two categories as proposed by Kiguel and Liviatan:a. Classical hyperinflation: These are cases similar to post-war Germany, Austria, Greece
etc. Classical hyperinflation has clear causes - exceptionally large budget deficits
financed by money creation, and in most cases can be brought to a sudden end,
through a comprehensive stabilization program.
b. Recent hyperinflation: These are relatively recent cases seen in Brazil, Argentina, Peru
etc. in the late 1980s and the early 90s. Here, hyperinflation is the final stage of a long
process of high and increasing rates of inflation and is seen in countries with a long
history of high inflation.
Generally there are three fundamental aspects of the rise of hyperinflation.
1. First, there is a cutoff in international lending and the increase in international
interest rates.
2. The second important characteristic of the inflation dynamics is that the recourse to
seigniorage (i.e., the inflation tax) jumps as the net international resource transfer
turns negative, with seigniorage fluctuating around a new ,high plateau.
Seigniorage Laffer Curve: Seigniorage Laffer curve shows the relationship between steady
inflation rate and seigniorage revenue. It indicates that seigniorage revenue must rise for a
while and then fall again as inflation rises. There is an inflation rate that produces the
maximum amount of seigniorage with a stable rate of inflation. Above the steady state
inflation rate it is possible to collect more seignorage than SEmax but only if the inflation rate
is constantly increasing. This is the essence of hyperinflation.
Seigniorage Laffer curve
20Source:

Amadou Dem, Gabriela Mihailovici, Hui Gao

3. The increasing inflation leads to Olivera-Tanzi effect and causes the tax system to
collapse.
Olivera-Tanzi Effect: During any period of high inflation, governments upkeep costs for
everything rises. However, since inflation hurts both trade and diminishes buying power of
the consumer, business revenues fall. The actual real tax proceeds gathered by the
government, after adjusting for inflation, will be less than in a period of normal inflation,

due to both increased operating costs and decreased tax revenues from businesses. This
reaches extreme levels in hyperinflationary episodes as any lag in tax collection leads to a
drastic drop in the real monetary value of the taxes collected.
The general causes of hyperinflation are known to be:
1. Fiat money: Hyperinflation is systemic to a fiat base monetary system and is not
possible under the gold standard
2. Taxation system breaks down/external borrowing becomes difficult
3. Wars/civil war: Large deficits, mostly from civil wars, revolutions, deep social and
political unrest are monetised through seigniorage
4. Weak government/coalitions: Government may not be able to raise taxes,
implement budgetary reforms
5. External shocks: Lead to increased budget deficits and cause debt crises (as seen in
the case of Latin America)
Amadou Dem, Gabriela Mihailovici, Hui Gao posit:
Increasing the inflation rate beyond its steady state level can allow an increase of
seigniorage revenue even when the economy is on the wrong side of the Laffer curve. The
reason is that there are lags in the adjustments of prices to new money creation i.e.
inflationary expectations tend to lag behind actual price increases. The dynamic of
hyperinflation relies on these lagged inflationary expectations. As households realise that
inflation rate is rising they revise upward their inflationary expectations and therefore their
real money balances holding, reducing the seigniorage revenue that was collected
previously. In order to face the reduction of revenue, the government has to increase the
rate of money creation. Once the rate of inflation is beyond the peak of the Laffer curve, the
government is forced to continue to increase the rate of monetary growth simply in order to
maintain the same level of seigniorage revenue. The inflation rate rises without bound
resulting eventually in hyperinflation.
Stopping hyperinflation as per Fischer/Marco involves:
(1) Fundamentals: to restore internal and external balance. Permanent budget balance,
upfront devaluation, bolster central bank independence, external finance, social
safety net
(2) Multiple nominal anchors: to achieve rapid synchronized disinflation. Initial
exchange rate peg, money and/or credit ceilings, wage freeze through social
contract, temporary/partial price controls
(3) Extra nuts and bolts: to facilitate quick move to new macro equilibrium. E.g. interest
rate conversion rules for nominal assets; de-indexation or de-dollarization of liquid
assets; internal debt rescheduling between firms, banks and governments.
(4) Structural reforms: to remove micro-distortions (and tackle structural links with
inflationary processes) Liberalization and deregulation; fiscal reforms; financial
sector reform; Stimulating real growth, cutting government expenditure, improving
tax collection system, increase net external flow/ default on external debt
(5) Political reforms (where necessary). Consolidation of a fully-fledged democracy.

BOLIVIAN HYPERINFLATION 1984-85

The case of Bolivian hyperinflation is unique in the sense that it was not triggered by any kind of war
or political revolution. South American countries like Brazil, Peru, Argentina and Bolivia were struck
by external shocks in 1980-81 namely rise in world interest rates and cutoff in lending from
international capital markets. But the extent of economic collapse in Bolivia point to internal factors
majorly the turbulent political situation and large reliance on select commodity exports like tin and
natural gas. As a result, the annualized inflation rate touched a maximum of 60000% from April 1984
to September 1985, preceded by a period of high inflation.

CAUSES:
Bolivia, like any country, had four major avenues to finance its activities
1.
2.
3.
4.

Borrowing from foreign investors

Raise taxes
Diversify and increase exports
Inflation tax (print more money)

Bolivia has historically had an unstable central government. Bolivia was under a military regime from
1964 until 1978, 1971-78 under General Hugo Banzer Suarez (Banzer). A period of political chaos
followed during 1978-82 with rapid alternation of military and civilian rule military rule being antipopulist and anti-labor while civilian rule being populist. This kind of alternation was common in
Latin American countries but was particularly sharp in Bolivia. Governments of the left generally paid
for higher public salaries through printing money (i.e., the inflation tax) or through foreign
borrowing, since they were forestalled from raising taxes. Governments on the right, on the other
hand, rejected higher taxes outright and subsidized favoured industries, and instead sought to
finance the government through a reduction of public-sector wages (often with overt repression of
labor), and also through foreign borrowing.
Since both the leftist and the rightist government relied heavily on external borrowing, till 1981
Bolivia had built up a big pile of external debt which had to be serviced debt had increased from
46.2% of GNP in 1975 to 102.6% of GNP in 1982. Bolivias external debt rose dramatically in the
1970s, mostly during the Banzer era. Bolivias rapid accumulation of external debt in the 1970s
reflected three forces at work. One, part of the foreign borrowing financed a plausible attempt to
generate a more diversified export base through various investment projects. Two, the government
did not attempt to raise taxes (and indeed rejected a detailed tax reform proposal of the Musgrave
Commission). And three, some of the foreign borrowing had the purpose and effect of enriching a
narrow set of private interests via the public sectors access to foreign loans.
Bolivian exports have always been dominated by commodities mainly mining silver in the colonial
period followed by tin starting from the 1900s. Tin and Natural gas accounted for close to 70% of the
total Bolivian exports during the 1980s. Any fluctuation in international prices of these commodities
had a big impact on the current account deficit and hence the fiscal deficit of the country. Cocaine
was one of the major illegal exports from Bolivia. Conservative estimates gave about the same value
for cocaine exports as for legal exports. Cocaine producers were major suppliers of foreign exchange
to the crucial black market.

In 1977 and 1978, General Banzer faced growing pressure from the Carter administration for a
return to democracy and was ousted in a coup. There ensued a four year period of intense political
instability, with several interim presidents, coups, and deadlocked elections, producing in all nine
different heads of state between Banzer and Siles. Bolivia reached its political nadir in 1980 and
1981, under the Garcia Meza regime which was deeply implicated in the burgeoning cocaine
industry, and therefore never received international support, except for the backing from the
similarly corrupt and violent military regime in Argentina. Capital flight reached new highs in the
period, with errors and omissions in the balance of payments in 1980 and 1981 totalling $590
million, or about 10 percent of 1980 GNP. The commercial banks stopped all lending, and negotiated
an emergency rescheduling agreement which was soon defaulted upon. The rest of the international
community also ceased new lending.
The transitory nature of the governments from 1978-81 ensured that no government had the
political backing to raise taxes or implement economic austerity. Commodity prices started to slide
in 1981 and interest rates on existing loans soared. This left only option open for the government
seignorage or inflation taxing i.e. printing money to service the foreign debt.

Seignorage per quarter (percentage of annual GNP)

*Source: Developing Country Debt and the World Economy by Jeffrey D. Sachs, 1987

HYPERINFLATION
The hyperinflation under Siles was not so much a result of an explosion of new spending as the
inability to restrain spending in the face of falling foreign loans, falling tax revenues, and higher debt
service payments abroad. A coalition government implied that neither taxes were raised nor
spending was cut.
Government revenues in Bolivia in the early 1980s relied heavily on three main forms of taxes:
internal taxes (mainly sales, property, and income taxes); taxes on trade (mainly tariff collections);
and taxes on hydrocarbons and minerals (mainly paid by COMIBOL and YPFB, the state owned tin
and natural gas companies). Overall, revenues of the central administration fell from more than 9
percent of GNP in 1980 to just 1.3 percent of GNP in the first nine months of 1985. This combined

with the Olivera-Tanzi effect ensured that simple lags in collection reduced the real value of
collections almost to nothing by 1985.
The official exchange rate was overvalued relative to the black market rate. This encouraged
smuggling, on which tariffs are typically not collected. Even when goods were imported legally,
however, the tariff in pesos was collected on the basis of the official exchange rate, and therefore
the real value of the tariff collections was substantially reduced. The taxes on mining and
hydrocarbons were similarly squeezed. The overvalued exchange rate reduced the profitability of
the state enterprises in these sectors, and reduced tax receipts further.

STABILIZATION
The successful stabilization program was carried out by the newly elected center-right government
of Paz Estenssoro. The fiscal part of the program was to operate on four fundamental bases:
1. A stable unified exchange rate backed by tight fiscal and monetary policies
2. Increased public-sector revenues, via tax reform and improved public sector prices especially
an increase in domestic oil prices
3. A reduced public-sector wage bill, through reductions of employment in state enterprises
(particularly COMIBOL) and reduced rates of real compensation
4. A resumption of concessional foreign financial assistance, from foreign governments and the
multilateral institutions signing of an IMF standby agreement.
There was a fifth implicit part - an effective elimination of debt servicing, through a combination of
rescheduling with official creditors, and a unilateral suspension of payments to private creditors until
a more fundamental debt settlement could be arranged.
The rise in public sector prices had the biggest short term impact and raised government revenue
considerably. In fact, with the combination of the five points above the central government did not
have to rely on fiscal credit from the central bank at all during the final months of 1985. Within ten
days the inflation was halted, and prices actually began to fall. In December 1985 and January 1986,
prices rose by just 9 percent.
Thomas Sargent argued that such a dramatic change in price inflation results from a sudden and
drastic change in the public's expectations of future government policies, essentially requiring a
regime change as a necessary condition. In Bolivias case, the peso had already foregone two of the
three classic roles of money - the unit of account and the store of value to the US dollar. Prices were
set in US dollars but transactions were done in Bolivian pesos converted at spot exchange rates.
Therefore, by stabilizing the exchange rate, domestic inflation could be made to revert immediately
to the U.S. dollar inflation rate. But stabilizing the exchange rate did not by itself lead to return of
confidence. Exchange rate stabilization brought short term relief which was followed by fiscal
balance through a revamped fiscal policy.
Thus, the Bolivian authorities employed an orthodox approach of exchange rate stabilization to reign
in hyperinflation.

HYPERINFLATION IN BRAZIL
INTRODUCTION:
Inflation is a problem that was plaguing the Brazil economy for a long time. In the 1980s, its
economy went through one of its worst phases with inflation touching astronomical heights
becoming hyperinflation and it lasted for 14 years until 1994. The Brazilian Government had
resorted to deficit spending in order to boost the economy. This increased the debt burden. The
government continued to obtain loans despite not being able to raise money from tax revenues. As
the risk factor for the creditors increased, they demanded higher interest rates making it difficult for
the Brazilian Government to repay the loans. In this scenario, the Government resorted to printing
money and thereby increasing the money supply in the economy. The situation subsequently
worsened due to lack of adequate controls and inflation became hyperinflation. In 1990, the
inflation rate was about 3000%. The Plano Real was implemented by the government in 1993 and
subsequently the hyper-inflation was controlled. The Brazilian hyperinflation was comparatively
short-lived when we take a look at the classical hyperinflation. In this paper, we discuss the causes
that led to the hyperinflation and the remedial measures taken the by the government in Brazil to
bring it back under control.
EVENTS LEADING UP TO THE HYPERINFLATIONARY PHASE:
From the mid-sixties to the years leading up to the crisis, the Brazilian economy was experiencing a
healthy phase. Growth was strong and inflation was well within control. The government decided to
go for expansion by taking on debts. Subsequently, the Brazil started running a fiscal deficit. Inflation
had reached 50% in the seventies and had entered three digits in the early eighties. Below chart
explains the scenario that was present.

The demand for public debt increased and in the late sixties, the demand for public debts was more
than the financial needs of the government. This led to an increase in the spending capacity of the
government and led to institutionalised mechanisms which helped local governments increase their
spending capacity too. Brazil saw growth rates which were above 10%. Private savings were
channelled into public investments which led to a string mechanism and the idea that public debt is
necessary to fuel investments. In 1973, the oil crisis hit the world and Brazil maintained its strategy

of ballooning public debt to maintain its pace of growth. The increasing public debt mechanism was
based on factors like the growth in wealth of private institutions/people and the way the debt,
which ultimately were private savings, was used by the government. According to a study, the
increase in inflation in mid to late seventies was not associated with an increase in seigniorage. The
increase in inflation found its roots in devaluation which in turn was based on easy money and wage
indexation. The relatively stable seigniorage made the Brazil story quite perplexing. During the later
part on the seventies decade, growth dipped and inflation rose even more. Interest rates started to
show an increase and which partly was a result of interest rate ceilings being removed. The
government then, in an effort to contain the inflationary pressures, started with reducing the real
value of public bond debts.
Inflation had been rising steadily until 1985 partly because of the second oil shock and increase in
frequency of wage readjustment and partly because of the devaluation of the national currency by
30%. Despite this, the government was largely focussed reducing imbalances than on containing
inflation. The macroeconomic policy of 1981 and 1982 was more inclined towards reducing
dependence on foreign capital. In case of Brazil, some stabilization plans were implemented this
resulted in causing more imbalances and letting inflation spiral out of control.
Cruzado Plan (1983):
This plan involved changing the currency from cruzeiro to cruzado. The plan relied on wage controls
and price control. Interest rate conversion schedule was set for fixed interest rates. All nominal
interest rates were based on inflation expectation of 0.45% a day. The Cruzado Plan initially saw
success by helping curb inflation. However, there were clear indications of overheating and
equilibrium prices themselves were increasing. Interest rates were kept low despite still high
inflation. Scarcity of products increased prompting the government to resort to measures like
compulsory loans on fuel, vehicle purchases, international airline tickets and forex sales. The small
measures introduced by the government had the exactly opposite effect than desired. Due to high
demand, imports kept on increasing and exports were already falling. Due to rumours of devaluation
the future, exports were put on hold. In February 1987, the government stopped all payments of
interest on external debt leading to a default. Their aim was to renegotiate the debt.
Bresser Plan (1987):
It was a sort of a hybrid plan which integrated fiscal and monetary policies with the aim of
containing inflation. It proposed price freezing just like the Cruzado Plan. An automatic trigger was
incorporated for wage-setting in case inflation rose up to a certain level. In the short term, real
interest rates were positive. Rather than going for zero-inflation, it aimed at only reducing it which
was a departure from the previous plan. This plan also failed to meet its expectations with inflation
showing no signs of going down.
Summer Plan (1989):
This plan again involved price freezing. Here the focus was to curb inflation with by reduction in
public debt, reducing public expenditure and increase revenues. This plan incorporated almost
everything that the previous plans lacked. However, the government did not have enough political
power to carry through with the plan. This led to reforms not being implemented.

THE REAL PLAN:

A new currency was created under this plan called the Real. It was valued at 2750 Cruzeiros Reais.
The IMF however, did not approve of the plan. The plan was based on the inflow of foreign capital
which had resumed with the long-drawn renegotiations coming to an end and Brazil getting back on
good terms with other countries. The Plan created an index named URV, which was pegged at 1:1
with the US dollar. Prices continued to rise in Cruzeiros Reais but since the URV was pegged to the
dollar, it had very low variation. On 1st July 1994, Brazil transitioned completely to the URV which
became the Real and Cruzeiros Reais was discarded.

The Real Plan reduced the inflation but the core issue of budget deficit was yet to be addressed. As it
was pegged at 1-to-1 with the US dollar, the Real increased in value as the US dollar increased,
making Brazil suddenly expensive for foreign markets leading to a fall in demand for Brazillian goods
and services. Due to exodus of capital out of the country, further reforms were initiated which led to
Real becoming a free-floating currency. This change led to devaluation of Real and thereby reducing
the value which made Brazillian goods and services cheaper and more appealing to international
investors.

HYPERINFLATION IN ZIMBABWE
One hundred trillion dollarsthats 100,000,000,000,000is the largest denomination of currency
ever issued. The Zimbabwean government issued the Z$100 trillion bill in early 2009, among the last
in a series of ever higher denominations distributed as inflation eroded purchasing power. When
Zimbabwe attained independence in 1980, Z$2, Z$5, Z$10 and Z$20 denominations circulated,
replaced three decades later by bills in the thousands and ultimately in the millions and trillions as
the government sought to prop up a weakening economy amid spiralling inflation. Shortly after the
Z$100 trillion note began circulating, the Zimbabwean dollar was officially abandoned in favour of
foreign currencies. Post-independence the value of one Zimbabwe dollar was equal to US$1.54.
From 2007 to 2008, the local legal tender lost more than 99.9 percent of its value.
CAUSES:
The last half of 1997 marks a turning point from the relatively disciplined policies that the
government had pursued since the attainment of independence in 1980. A string of decisions largely
to shore the governments waning political support and appease powerful disgruntled groups
through the transfer of economic resources in that period inexorably set in motion a rollercoaster of
events that resulted in the economic collapse of the country. These decisions had the effect of
damaging confidence in the local currency, exerting pressure on the Zimbabwean dollar in the
currency markets, which fed to inflation via a pass-through from more expensive imported goods.
Firstly, in August 1997, approximately 60,000 war veterans were granted ZWD50,000 each
(approximately USD3,000 at the time) plus a monthly pension of approximately USD125 per month
outside the budget. The pay-outs amounted to almost three percent of GDP at the time and this had
the immediate effect of inflating the budget deficit at the end of 1997 by 55 percent from the 1996
levels.
The second populist decision followed in November 1997 when the president, Mugabe,
announced plans to compulsorily acquire white-owned commercial farms, again without elaboration
on the financing side of the transaction. This had the immediate effect of giving investors a
perception of an ensuing precarious fiscal position and consequently there were spontaneous and
concerted runs against the currency and from the money and capital markets. The climax of these
events was on 14 November 1997 when the Zimbabwean dollar crashed and lost 75 percent of its
value against the USD on a single day, on what is now known as Black Friday in Zimbabwean
economic history. The stock market also plummeted and the index was down by 46 percent by day
end from the peak August levels. The central bank, had to intervene and raise interest rates by six
percentage points within that single month. Thenceforward the exchange rate continued to
depreciate uncontrollably, thus the 1997 financial and currency turbulence set the stage for a long
and potentially long slump in the real economy. The crash of the Zimbabwean dollar in the foreign
exchange markets was immediately mirrored by its loss of value on the domestic markets, as in
January 1998 there was an upsurge in consumer prices of 25 percent. In response to the attendant
fall in real wages, the Zimbabwe Congress of Trade Unions organized protests which paralysed the
whole country for two days, dangerously threatening the governments grip on political power. In an
effort to assuage the masses, the government reintroduced price controls and simultaneously
attempted to deflect negative public sentiment by shifting its rhetoric against industry, whom it
blamed for excessive profiteering by charging exorbitant prices. The immediate consequence of
these price controls was widespread shortages of basic commodities in official markets and the

genesis of the in-formalization of Zimbabwes economy, which was to eventually spread to financial
markets due to government submarket controls on the forex rates. Paradoxically, the governments
price controls, via the informal economy fuelled prices higher further eroding living standards and
further alienating the masses.
The economic crisis the country endured as a consequence of the maladroit expenditure
management persisted, and to add harm to injury, in September 1998 the president agreed to send
11,000 troops under the SADC protocol, to the Democratic Republic of Congo (DRC) to back the
discredited leader, Kabila, who was under attack by Rwandan and Ugandan backed rebels. This was
simply the utilization of national military by the political elite for private financial gain as it emerged
that the Zanu PF bigwigs had been promised mineral concession in the DRC. The precise costs of the
ensuing war are open to speculation, as the government was tight-fisted with casualty and financial
information pertaining thereto. A letter written by the finance ministry to the IMF seeking funds
puts the funds to finance the war at USD1.3 million per month in 1998 or 0.4 percent of GDP and in
1999 when additional troops were deployed at USD3 million per month or at 0.6 percent of GDP
(IMF, 1999). However on the basis of a leaked memorandum from the ministry, it can be stated that
the costs were at least ten times the official figures. The situation, be that as it was, the country
could not spare forex outlays of such magnitude and this consequently weakened the currency,
again with pernicious effect on price stability. There was intense pressure on the currency and in a
bid to increase the flows of foreign currency which were dwindling at precariously low levels, the
central bank reintroduced widespread import controls and banned foreign currency accounts. This
dirigisme was futile as in the first quarter of 1999 the central bank, had to devalue the currency by
50 percent to trade at USD1: ZWD38 from USD1: ZWD25.
The presidents rhetoric on confiscation of white-owned farms was elevated to the next level
in early 2000, when war veterans, who courtesy of the gratuities, were now the paramilitary wing of
the ruling Zanu PF party, started invading white-owned farms as part of an elaborate scheme by
Zanu PF to terrorise people to vote for it in the parliamentary election in July 2000. Terror
notwithstanding, the newly formed MDC party went on to secure almost half of the contested
parliamentary seats. As a result of the upheavals on the farms, agricultural output was to fall
dramatically from the level of 18 percent of GDP in 2000 to 14 percent of GDP in 2002 (World Bank,
2008). Tobacco, the countrys major foreign currency earner was not spared. Export proceeds from
tobacco declined from USD612 million in 1999 to USD321 million in 2003. The consequences of the
falling agricultural output were as immediate as they were harmful. The government could not
service its multilateral debts obligations and as a result in October 2000, the World Bank suspended
any extra lending to Zimbabwe due to non-payment of over six months. This marked the closure of
the countrys relations with the World Bank to date and paved way for, on a political front, the
governments isolationist stance and, on the economic front, free-fall of the unsupported currency.
On the other hand the government could not import essential raw materials and fuel as a result of
the declining forex inflow, which further fed into falling production with the result that by 2004,
total foreign currency earnings from the export of goods and services had declined to less than half
the 1996 peak of USD3,169 million.
On 1 December 2003 a new governor, Gono, was appointed to head the central bank. The
battle against inflation, which now stood at 263 percent on a year on year basis at the end of 2003,
became Gonos sole objective. He undertook money-targeting framework as the monetary policy
strategy and consequently set up a Framework for Liquidity Management, which was to contain

10

money supply growth to levels consistent with inflation targets. The interest rate was the
operational target and it was raised acutely in the first quarter of 2004, reaching a peak of 5,242
percent annually in March 2004. Inflation which had soared from about 20 percent in December
1997 to a peak of 623 percent in January 2004, decelerated sharply from March to around 130
percent at the end of 2004. Consequent to the high interest rates, financial institutions could not
utilize the central bank accommodation window sparking a huge liquidity crisis in January 2004
which resulted in the collapse of Century Discount House on 3 January. Century Discount House was
a subsidiary of asset management companies. Its collapse was triggered by the fact that it could not
raise depositors funds totaling ZWD61 billion. The fall of Century Discount House triggered a
contagion as too many financial institutions were exposed to ENG, thus triggering a liquidity crisis to
mostly indigenously owned banks. In the light of this crisis, which threatened monetary stability, the
central bank came to the rescue of the ailing institutions in the form of the Troubled Bank Fund
(TBF). The TBF was not a free lunch as onerous conditions were attached thereto, such as change of
organizational structure in the affected banks, change in management and directors had to step
down. Moving on with the same issue, the high real interest rates and an increasingly overvalued
official exchange rate was also putting pressure on domestic producers and exporters, and in a move
sold as though it was to bail out the ailing industries, the central bank started engaging in quasi-fiscal
activities. The quasi-fiscal activities went beyond the operational realm of a normal central bank and
had the effect of undoing the ephemeral achievements in the inflation battle and firmly set course
for the drive towards hyperinflation.
By December 2008 the use of foreign currency as a medium of exchange was now almost
complete albeit unofficially and in a move sold by the central bank as though to help businesses
suffering from chronic shortages of foreign currency to import goods and spare parts, it licensed
around 1,000 shops to sell goods in foreign currency. This constituted the first conscious recognition
of unofficial dollarization in Zimbabwe. The institution of official dollarization underlined by the
political accommodation had the obvious immediate effect of stopping hyperinflation and the
country actually entered into deflation with consumer price inflation standing at -2.34 percent and 3.26 percent at the end of January and February respectively.
There are three approaches, or a combination thereof, that Zimbabwe could adopt in the
event that it does indeed, decides to dedollarize and reintroduce a national currency. The first
approach is market-based, that is the pursuance of macroeconomic policies that give the national
currency stability on both the internal and external markets. The second alternative is non-market
based approach in the form of regulatory reforms. These would aim to change the incentive
structure of holding a portfolio of currencies in favour of the envisaged national currency. The third
approach would be to employ another non-market means which is administrative enforcement.
Basically, this is simply to outlaw totally or limit by law, the use of foreign currency in the country.
CONCLUSION:
The issues at the core of Zimbabwes hyperinflation predate the fast-track land reform programme.
The first impetus to the cataclysm lie in the string of policies aimed at pacifying certain disgruntled
social groups through the transfer of economic resources in order to retain political power. The
combined effects of these measures were to give a perception of fiscal instability to investors which
led to currency depreciation hence inflation. In the latter part of the Zimbabwes case, the quasifiscal activities of the central bank were responsible for the growth in money supply which fed to
inflation.

11

HYPERINFLATION ZAIRE (Rep. Congo)

Since 1990, Zaire has experienced an extraordinary period of very high inflation-among the longest
on record. From 56 % in 1989, the annual increase in consumer prices surged to 256 % in 1990,
2,500-4,500 % during 1991-93, and 10,000 % in 1994, before returning to 370 % in 1995 and 657 %
in 1996.
Zaire's hyperinflation experience in the 1990s is typical in many respects. The country's predicament
was brought about by a prolonged political crisis, which led to an explosion of government spending
financed almost entirely by printing currency, an extended period of very high inflation, and a
dramatic contraction of external trade and output. The case is also relatively simple to analyse, in so
far as Zaire's financial system has remained largely underdeveloped- without any market for
government bonds, in particular.
FROM HIGH INFLATION TO HYPERINFLATION
In the 1970s, Zaire's currency-the Zare-was pegged to the SDR. Under the fixed peg, supported by
trade restrictions, expansionary financial policies yielded high inflation and a steady appreciation of
the currency in real effective terms. The SDR peg was abandoned in September 1983, with a sharp
devaluation of the currency (78 % in nominal effective terms) and the introduction of a marketdetermined exchange rate system. However, the authorities interfered recurrently with the
operation of the new system, and there was a thriving parallel market for foreign exchange. Annual
inflation averaged 62 % in the second half of the 1970s, 44 % in the first half of the 1980s, and 69 %
in the second half of the 1980s. Throughout the 1980s, the velocity of circulation of money in Zaire
remained very high (albeit lower than in the 1970s), which testified to the widespread use of foreign
currency for domestic transaction.
In 1990, Zaire entered a protracted period of political transition, and inflation accelerated to 265 %.
During 1991-94, the political and economic situations worsened in parallel: as the one-party state
crumbled, inflation surged to 3,000-4,500% in 1991-93, and 9,800% in 1994 (or nearly 50 % a month
on average). By end-1993, the traditional forms of government had ceased operating, and monthly
inflation peaked at 225 % during November 1993-January 1994. Over the 12 months ending in
September 1994, broad money growth was 12,850%; currency depreciation, 99.9%; and annual
inflation reached a record 90,000%. Inflation slowed markedly in 1995, to 370%, but rose to 657% in
1996, thus remaining in the vicinity of hyperinflation level.
THE GENESIS OF HYPERINFLATION
A series of events in 1990 set the stage for the gradual disintegration of the political system and the
loss of control over economic and financial management.
First, on April 24, 1990, President Mobutu announced an upcoming process of
democratization and the establishment of a multi-party system within a 12-month period.
Second, political opposition gathered forces and organized widespread demonstrations to
demand an acceleration of the democratization process.
Third, with a view to appeasing demonstrators, the authorities awarded unsustainably large
increases in government wages.
Fourth, the government's financial difficulties were compounded by a drop in mining sector
revenue.
The period from 1990 to 1994 was marked by strong discontent between President Mobutu and the
then Prime Minister Tshisekedi.

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Steady Hyperinflation, 1994-96

From 1989 to 1994, the Zairian economy contracted cumulatively by some 40 %, and consumer
prices rose by a factor of 21 million; government revenue collections fell from nearly US$900 million
in the late 1980s to US$138 million in 1994. During 1995-96, the contraction in economic activity
bottomed out, and even showed some signs of reversal, while prices rose by a factor of about 35. By
end-1996, Zaire's infrastructure had fallen into disrepair: most roads, railways, and rivers had
become impracticable; the government had all but stopped providing health and education services;
and many public enterprises had ceased operating. The informal sector showed an amazing
resilience, which partly buffeted the plummeting activity in the formal economy. But the
development of "survival reflexes'-with greater autonomy of provinces and generalized selfsubsistence, in particular-also translated into "non-civic" behaviour, including the extension of
corruption and the ransacking of the population by unpaid soldiers. Hyperinflation in Zaire in the
1990s thus left a trail of deleterious consequences on the fabric of society, which will take many
years to remedy.
THE TANZI EFFECT
The Tanzi effect refers to the erosion of the tax base by inflation. There is unavoidably a lag between
the time tax payments are assessed and the time they are collected by the Treasury. In the case of
indirect, domestically based taxes (such as turnover taxes), the collection lag is generally four to six
weeks; for direct taxes, the lag is much longer, and may reach well over a year for personal income
taxes. Even in the case of customs duties, where the assessed base is denominated in foreign
currency, taxpayers are generally allowed several weeks to make payments to the Treasury. As
regards nontax revenue such as licenses and fees, the amounts due are normally set in local
currency terms, which tend to make their value insignificant under conditions of hyperinflation.
In Zaire, where the bulk of government revenue consists of indirect taxes, the average collection lag
may be on the order of one to three months. The Tanzi effect on government revenue is thus quite
large: with inflation running at 10 % a month, real revenue collection drops by 9.1 % if the collection
lag is one month, or 17.4 % if the lag is two months (relative to the case with no inflation). As
inflation reaches 50 % a month, the drop in real revenue collection amounts to 33.3 % or 55.6 %,
respectively. Under such circumstances, taxpayers will always endeavour to delay the settlement of
tax obligations; moreover, tax and customs agents will often use their prerogatives to allow delayed
payments and share some of the taxpayers' gains.
STOPPING HYPERINFLATION
Stopping hyperinflation is no easy task. To reverse its root cause, the government must live within its
means, which is precisely what it has been utterly unable to do to start with. Even if a political
consensus could emerge, and all parties agreed to join efforts to mobilize government revenue and
control expenditure, the constraints might well be such that available means and needs may not be
balanced without exceptional measures and/or external assistance.
Zaire's predicament during 1995-96 illustrates the difficulty. Major efforts aimed at securing a
minimum level of government revenue succeeded in doubling tax revenue collections; expenditure
controls were strengthened at the Treasury; and the disorderly issuance of currency was halted.

13

HYPERINFLATION IN CHINA
The Chinese Hyperinflation period lasted, with several breaks, from a period of Early July, 1943 to
Mid-1949. In June 1937, 3.41 yuan traded for one USD. By December 1941, on the black-market
18.93 yuan could be exchanged for a USD. At the end of 1945, the yuan had fallen to 1,222 Yuan for
a Dollar. By May 1949, one USD fetched 23,280,000 yuan. During the peak of Hyperinflation,
Inflation rate was an incredible 5070%, with prices in yuan doubling every 5.4 days.
The Chinese Hyperinflation episode is a Classic example of War-driven inflation. It started out with
the Chinese Governments attempts to raise money for the Sino-Japanese War back-firing upon
them , loss of confidence of the people in the Government & the Banks as well as the recession
brought about by the War itself. The incident was also influenced by War-time activities in other
nations such as the US- demonstrating how recessionary & inflationary tendencies in one nation can
quickly spread to another through trade- and affect badly-managed economies very quickly.
FROM HIGH INFLATION TO HYPERINFLATION
Till 1927, the Chinese banking sector was dominated by informal moneylenders as well as private
banks operating autonomously in different parts of the country. Most banks printed their own notes
which were backed by Silver, the traditional medium of exchange in China. These notes were
accepted by both the Government and among other banks.
Given the problems in maintaining a string tax base in China, the escalation of conflicts & growing
Civil unrest had compelled the Chinese Government (led by Chiang Kai-Shek) to depend heavily on
these Private banks for loans. According to the Currency System of China, 1980, these loans
accounted for as much as 49% of the Governments revenue by 1928. Concerns over the
governments ability to repay the loans led to the establishment of the Central Bank of China- chinas
first centralized National Bank. The Central Bank offered the private banks large quantities of bonds
guaranteed and backed by government revenue from custom taxes that carried high rates of
interest. These bonds did not fix the financial situation, in fact they made it much greater, but they
did delay the repayment time.
Unfortunately for the Chinese, losses in the War had affected their industrial output as well as
confidence among investors. The economy, already suffering due to corruption & mismanagement,
went into recession. By 1934, the Chinese GDP had fell by 26%.
As the Great Depression in the US arose, the US Government started the Silver Purchase Act which
enabled the US Treasury to purchase Silver. Massive amounts of Silver went out of China- thus
intensifying a Deflationary inflation; this helped appreciate the Yuan a little but increased burden of
debt & decreased industrial output. Despite export controls on Silver, problems increased. When
Private Banks started selling off their holdings of Government bonds at a loss, Chinese government
started taking over them. In 1935, The Central Bank of China announced the Currency Decree and
officially took the country off the silver standard and placed the country on a fiat currency called faipai or Chinese National Yuan.
While this allowed China to monetize its debt & stabilize the economy- just helping it in the War, it
increased inflation rates & damaged the economy & Savings of the Public.

14

THE GENESIS OF HYPERINFLATION

Hyperinflation in China was sparked off by a series of avoidable as well as unavoidable events in
1941.
First, the World War & the Chinese Civil War had necessitated the printing of vast amounts
of currency. The monetary expansion was so severe that the Government had to import
money printed in England.
Second, Civil & Foreign War had virtually destroyed Chinas industrial capacity and the
Middle Class. The Government was unable to either collect taxes or manage the economy
properly.
Third, vast amounts of Gold & Silver were being transported to Taiwan for fears of Civil War.
Hyperinflation, 1943-1949
Between 1941 and 1948, the Money supply grew over 2000 times. Both the Government & the
Revolting Communists printed their own currencies to fund the War. The figures for increase in
quantity of money in circulation was:1937:- 3.6 Billion Yuan.
1941:- 22.8 billion Yuan.
1942:- 50 billion Yuan. (Hyperinflation starts)
1943:-100.2 billion Yuan.
1944:- 275 billion Yuan.
1945:- 1506.6 billion Yuan.
1946:- 9181.6 billion Yuan.
1947:- 60965.5 billion Yuan.
1948:-399091.6 billion Yuan.
Ebeling writes: The value of Chinas paper money on the foreign-exchange market reflected this huge depreciation
of the currency. In June 1937, 3.41 yuan traded for one U.S. dollar. By December 1941, on the black
market 18.93 yuan exchanged for a dollar. At the end of 1945, the yuan had fallen to 1,222 to the
dollar. And by May 1949, one dollar traded for 23,280,000 yuan.
The Hyperinflationary episode in China also coincided with massive loss of tax base (called the Tanza
Effect); there was massive Capital Flight to countries like Taiwan & the US- sparking off economic
problems in Taiwan in the 1940s too.
The situation stabilized by late 1950, and was mostly over by 1952.

15

STOPPING HYPERINFLATION
The Communist government took several steps to stop Hyperinflation.
A new Yuan- pegged at 3 million fai-pi to 1 new Yuan was introduced. Price controls & Austerity
measures were introduced & dependence on Deficit financing was curbed. Alternately, the
Communist Government also started an (technically illegal) program of acquiring properties of the
defeated former Government in order to fund its reconstruction & welfare programs. Tax collection
& Land redistribution systems were reformed.
Chinese reconstruction was also financed partly by American & Soviet grants for War
Reconstruction. Soviet Engineers were also instrumental in restoring the countrys industrial centres
in Manchuria as part of their aid program. Printing of new Money was curbed until the problem
gradually resolved over the next 5-10 years.

16

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