What lessons we can learn from past experience

By Mohamed Dalmar

In the last thirty years, Somalia has had a very sad monetary experience marked by financial chaos, currency collapse, runaway inflation and economic ruin. The source of the problem was and is the tendency on the part of governments leaders, of factions and now of private businessmen to create money at will to finance their personal, political and clan interests. The problem is the habit, now accepted, of using the domestic currency not as a means for economic prosperity but as a tool for political manipulation and bribery. The problem is the lack of financial discipline, transparency and accountability. It is no exaggeration to say that the chaotic financial situation of the 1980s was mainly responsible for the social unrest in Somalia, the spread of the civil war and the collapse of the Somali State. And it is still the reason for the ongoing civil strife in the country. Conflict arises because lack of financial accountability encourages the factions, the interest groups, the clans, the greedy businessmen etc. to compete for the power of creating money, and, in doing so, they plunge the country into civil war.

In this short presentation, I will briefly review some monetary experiences of Somalia in the last forty years. I will consider four different periods: the 1960s or the period when the civilian government was in power, the 1970s or the scientific socialism years, 1980s or the years of financial crisis, and finally the 1990s the civil war period.

This period is remembered for its stable macroeconomic environment. Inflation was very low, the shilling was strong, the economy was free and the financial system was sound. This favorable economic condition was possible because the government was not printing money at discretion and was not in a position to interfere in the banking system. In fact, The commercial banks were all foreign owned, the central bank was headed by an expatriate, and the share of the public sector in the economy was small. Financial stability did not, however, mean better management of financial resources. The government run a huge budget deficit which was covered through subsidies from Italy and Britain, the former colonial powers. Britain terminated its subsidies in 1964 following the break up of diplomatic relations between the two countries. Financial mismanagement arose because both the Prime Minister and the Minister of Interior had at their disposal political funds of several million Somali shillings allocated to them in the budget, the so called "Capitolo buio" or the dark line item. These were substantial funds, at that time, for which neither the Prime Minister nor the Minister of Interior was required to account for. And they used them to buy votes, bribe the members of parliament, appease tribal chiefs, reward supporters, and why not, align their pockets. More funds for political manipulation meant, of course, fewer funds for schools, for hospitals, for public works, for basic needs etc. Moreover, the system of distributing political funds bred corruption, neglect of public services, and vote rigging. It is believed that this state of affairs paved the way for the military takeover.

What lessons can we learn from this experience? First, donors should never give cash to the government. If they do so, they should know that they are contributing to political instability in the country. Aid should be transparent, directed to specific developmental projects and initiatives, and implemented with community participation and supervision. When I say government, I mean all sorts of governments, national, provincial, local, whether recognized by the international community or not. Another lesson is that when the government does not print money at discretion, or has no means to do so, the danger of a total collapse of the economy is not present.

This is the period when heavy-handed statist interventions and misguided socialist economic policies were in full swing. On October 1970, the Government of Somalia adopted scientific socialism. It nationalized the banks, insurance companies, major industries and all import trade. To carry out its nationalization policies, the government established some 40 public enterprises, with no adequate capital, no qualified personnel and no sound accounting and management systems. It ordered the banks, which were under state control, to extend unlimited credit facilities to the newly established enterprises. With loans from the banks, the public enterprise built offices, bought furniture, imported cars and managed to cover their losses, their inefficiencies and mismanagement. The result was economic stagnation, huge loss of foreign reserves and inflation repressed by price controls. Repressed inflation manifested itself in long queues, commodity shortages, black markets, and rationing.

What can we learn from this experience? Fortunately, the free market economy is now flourishing in every corner of Somalia, and the spirit of entrepreneurship, characteristic to the Somalis, is ever strong. There is no reason to fear that we will ever go back to a public sector dominated economy. However, the danger will arise when the government gets involved in the banking business, in the sense of owning or controlling the banking system or parts of it. If that happens, it will be a recipe for financial disaster.

This period saw the worst of all worlds: half hearted liberalization policies, state monopoly in many sectors of the economy, massive devaluations, social unrest, political repression etc. The saga starts with the War with Ethiopia, the break up of relations with Russia, the shift of alliance to the West and the adoption of IMF programs. It could be argued that the government was not serious about implementing the IMF programs and, at times, it may have concealed some facts from the IMF. However, the one figure the government could not conceal was the black market exchange rate. And on the basis of that indicator, the IMF ordered massive devaluations of the Somali shilling, which fueled the inflationary pressure, and eroded the real income of the population, especially those on fixed income. Consider the lot of a government employee who earned the equivalent of 100 U.S. dollar a month in 1970 just to make the ends meet. That employee saw his or her income dramatically reduced to less than 10 dollars by 1989.

While in the 1970s the government used the banking system to cover the wasteful operations of the public enterprises, in the1980s the banks were used to enrich the regime's clients. Immense personal fortunes were attained overnight through access to banks. As banks became more politicized, they indulged in more corruption and irregularities and flooded the market with cash, cheques, bills, vouchers etc. causing the worst banking history in the country. In fact, by the end of 1989 the financial system was practically dead. It was replaced by a multitude of small private banks that provided a wide range of banking services.

What lessons can we learn from this experience? One important lesson is that the process of money creation must be protected from political pressure so as to reduce the scope for corruption and abuse of power. For this reason I recommend the abolition of the central bank of Somalia and the introduction of a currency board system. A currency board is a monetary authority that issues notes and coins in exchange for a reserve currency, example the U.S. dollar. Unlike the central bank, the currency board cannot print money at will since it is required to maintain foreign reserves equal in value to the total amount of notes and coins in circulation. Also, it provides for a stable and credible currency and, as a result, creates an environment conducive to economic development.

A striking monetary development in this period is the printing of banknotes by some regions, faction leaders and businessmen. It is estimated that between 1991 and 2000, the value of printed currency exceeded 300 billion Somali shillings. What does this mean? Well, it is a looting by other means. In fact, whenever a faction leader prints fresh money he obtains goods and services in exchange for these new pieces of paper, e.g. he pays his militia, travels abroad to meet some dignitaries, buys weapons, maintains his family abroad etc. The amount of goods and services he obtains is called seignorage or profit. And that is effectively a tax imposed by the faction leader on the population of Somalia, an inflation tax, or hidden tax. For example, if after the introduction of the new money the exchange rate depreciates from 1 US$ = SoSh. 8,000 to 1US$ = So.Sh. 11,000, the difference (So.Sh. 3000) is an inflation tax extracted by the faction leader from the population, especially from the poor who cannot protect themselves.

One way to protect the public from the inflation tax, which is generated by the faction leaders, is to operate in US dollars even for small transactions. Already the Somali economy is widely dollarized. It is a matter of importing lower denomination dollar bills & coins and carrying all transaction in dollars.

One may find the printing of money by a faction leader scandalous and fraudulent. Actually, there is no difference between when the previous government issued money and now that a faction leader prints it. It was fraudulent then, as it is fraudulent now. The only difference is this. Then, some bureaucratic formalities were performed. For example, the notes were deposited at the Central bank, vouchers were prepared, cheques were drawn, signatures were obtained and money was withdrawn from the banks anyway; whereas now the notes are put in a warehouse and distributed right away without any paperwork. The point I would like to make is this. If money is printed at will without any constraint and accountability, it generates extreme inflation and robs the people of their livelihood. It does not matter who prints the notes, a government (national, regional, and local), a faction, a warlord, or a businessman, the effect is always the same: hyperinflation and economic devastation. And that is why there is a need for a system that constrains the ability of any government, faction, or group to print money at will and thereby create inflation.

To sum up:

1. Never give cash to any government, whether regional, local or national. Governments must not depend on foreign aid for their day to day operations. Instead, they should build political consensus, mobilize domestic resources and administer public funds in an efficient, accountable and transparent way. Giving cash to a government would amount to funding the civil war in Somalia.
2. External aid should be targeted to social and economic projects/initiatives based on the needs and priorities of the community. Also, aid should be transparent and accountable to the community.
3. To avoid financial crisis, the government should not own or control financial institutions. Its role should be limited to regulatory functions.
4. Do not re-establish the central bank. Instead introduce a currency board system. The currency board is proposed because it stops the politicization of monetary creation, limits the scope for corruption and provides financial stability. The currency board should be established in partnership with international financial organizations and the Somali private sector.
5. Do not rush to issue new currency. Use the US dollar for the time being until the currency board is established.