Can Zimbabwe Recover? The Fiscal Impact of Inflation and Exchange Rate Manipulation

Zimbabwe's monetary and exchange rate distortions cost its treasury $3.12 billion between 2020 and 2023, eroding 16.3% of total tax revenue through inflation-induced tax losses, undervalued customs duties, and rising informality. Urgent reforms in exchange rate management, inflation control, and tax administration are crucial for fiscal stability and economic recovery.

The World Bank, in collaboration with the University of Zimbabwe and the Confederation of Zimbabwe Industries, has published a critical working paper detailing the fiscal consequences of Zimbabwe’s monetary and exchange rate policy distortions. Authored by Victor Steenbergen, Carren Pindiriri, Jimmy Psillos, and Marko Kwaramba, the study quantifies the extent to which inflation, exchange rate misalignments, and informal economic activity have eroded government revenue. Zimbabwe has long struggled with macroeconomic instability, largely driven by excessive money supply growth, inflation, and foreign exchange distortions. The Reserve Bank of Zimbabwe (RBZ) has played a central role in these distortions through quasi-fiscal operations, including the financing of state-owned enterprises, imposing foreign exchange surrender requirements on exporters, and manipulating the auction system. These interventions have led to hyperinflation, a sharp depreciation of the Zimbabwean dollar, and an increase in informal business activity. By April 2024, these policies resulted in the collapse of the Zimbabwean dollar, forcing the government to introduce a new currency.

Inflation’s Hidden Tax and the Olivera-Tanzi Effect

While inflation provides the government with short-term revenue through seigniorage, the long-term damage to tax collection is severe. The study quantifies the impact of the Olivera-Tanzi Effect, where inflation erodes the real value of tax revenue due to delays in payments. Most taxes in Zimbabwe are collected with a lag—some monthly, others quarterly or annually—which means that by the time the government receives payments, inflation has already diminished their real value. The study found that while the government gained $1.4 billion from seigniorage between 2020 and 2023, it lost $2.8 billion due to tax revenue erosion from payment lags, resulting in a net fiscal loss of $1.38 billion. These losses worsened over time, with 2023 being the most damaging year, as inflation reached 700% and revenue losses exceeded $1 billion. Although money printing may appear to provide a short-term fiscal solution, this analysis confirms that inflation’s impact on delayed tax revenue far outweighs its benefits.

The Exchange Rate Trap: Losing Revenue on Imports

Zimbabwe’s foreign exchange policies, particularly the manipulation of the auction system and exchange rate controls, have resulted in an artificially overvalued official exchange rate. This has had a significant impact on customs duty revenue, as import taxes are calculated based on the official exchange rate rather than the actual market rate. The government, therefore, collects much lower customs revenue than it would under a market-driven system. The estimated loss in customs duty revenue due to exchange rate distortions totaled $582 million between 2020 and 2023, with 2023 alone accounting for $130 million. Chronic backlogs in the auction system further worsened the situation, leading to exchange rate losses for businesses and creating additional gaps in tax revenue. The study emphasizes that exchange rate distortions not only undermine government income but also create incentives for under-invoicing imports and smuggling, compounding the country’s fiscal problems.

The Shadow Economy: How Informality Shrinks Tax Collection

Another major challenge to Zimbabwe’s tax system has been the rapid growth of the informal sector, where businesses operate outside regulatory frameworks and avoid taxation. The study shows that high inflation, combined with rigid exchange rate controls, has pushed many businesses out of the formal economy. Using data from Zimbabwe and a global dataset covering 148 countries over 28 years, the analysis confirms that inflation strongly correlates with rising informality. A 1% increase in inflation leads to a 0.72% rise in informal economic activity, which in turn reduces tax revenue by 0.45%. Between 2020 and 2023, the government lost $1.15 billion due to informalization. This effect is particularly concerning because even if macroeconomic stability is restored, reversing the shift toward informality takes years. Informal businesses tend to remain outside the formal tax system long after the initial shock that caused them to exit. This means that the negative impact of past monetary and exchange rate distortions will linger, delaying Zimbabwe’s fiscal recovery.

The Road to Recovery: Policy Reforms for Fiscal Stability

In total, Zimbabwe’s treasury lost an estimated $3.12 billion in tax revenue between 2020 and 2023 due to monetary and exchange rate distortions. This figure represents 2.5% of GDP and 16.3% of total tax revenue over the period. The losses peaked in 2023 when nearly $1.4 billion in potential tax revenue was lost due to a combination of hyperinflation, exchange rate distortions, and rising informality. The study suggests that in the absence of these distortions, Zimbabwe’s tax revenue in 2023 could have reached $6.7 billion, raising the tax-to-GDP ratio from 15.7% to nearly 20%. To restore fiscal stability, the report recommends eliminating exchange rate distortions by allowing the official rate to reflect market conditions, improving tax administration to reduce collection lags, and implementing disciplined monetary policies to control inflation. While addressing exchange rate misalignments and improving customs revenue collection could yield quick benefits, reversing informalization will be a long-term challenge.

Zimbabwe’s case serves as a cautionary tale on the risks of excessive money printing, distorted exchange rate policies, and economic informatization. While short-term monetary expansion may seem like a viable strategy to finance government expenditure, the long-term costs—measured in billions of dollars in lost revenue—far exceed any temporary benefits. The study makes it clear that stabilizing inflation and exchange rates is the only sustainable path to restoring government revenue and ensuring long-term economic growth. Without urgent policy reforms, Zimbabwe risks further deepening its fiscal crisis and delaying any meaningful economic recovery.