guest column:John Legat
Funds held in the banking system at RBZ, the interbank market or in cash notes totalled $ 14,8 billion.
Some $7,4 billion was held in FCA accounts.
The remainder of the assets of the banking sector were held in contingent assets, non-financial assets and other assets. In theory then, the banks could reduce their liquidity to lend more to the private sector or buy more government securities.
Threat of bank failure
The reality is different, however. First, the bulk of bank deposits are demand deposits. This explains the large amount held in the banking system to cover customers’ use of swipe cards and mobile money. Second and more concerning is the level of bank capital and reserves which stood at $3,9 billion or just US$257 million.
This compares with “other liabilities” that have grown rapidly to $4,6 billion (US$300 million), which we have to assume are foreign exchange linked liabilities given their rapid rise since February 2019 when they represented 31% of bank capital.
This is another scary number that we would like to look into in greater detail as it might be highlighting the possibility of a bank or banks failing. Put another way, banks need to maintain very high liquidity levels and restrain from lending medium and long term either to government or the private sector.
We noticed this at the end of last year when a number of the listed companies we speak to highlighted the difficulty of obtaining loans of any meaningful amount from their banks.
No lending capacity
Further in our last Notes we made mention of the fact that bank balance sheets were falling rapidly in real terms as compared with their client base as a result of bank assets largely being held in Zimdollar denominated assets, whilst their clients’ revenues and profits could move more in line with inflation. Put simply, banking sector borrowers have become far greater in balance sheet terms than the banks themselves.
This in turn has forced the private sector and government to turn to the pension funds and the insurance sector for liquidity. As we have highlighted above, these two sectors have very little liquidity and it is entirely held in $ denominated assets. The private sector’s needs though are based on the US$ rather than the Zimdollar.
Farmers have no source of funding as liquidity bites
For example, to plant and grow a hectare of maize is estimated to cost around US$800 for dry land or rain reliant maize which covers mainly diesel, fertiliser, spare parts, among others. All of which are US dollar denominated.
So a crop of one million tonnes, assuming an average yield of say 4,5 tonnes per hectare, would require say US$180 million which, at the interbank rate at the end September, would have equated to $2,7 billion. At the parallel rate of $19 at that time, this number would rise to $3,4 billion and at today’s rate of $24 would imply a need for $4,3 billion.
For large commercial farmers with access to irrigation on the other hand, the cost per hectare would rise to US$1650 per tonne but the yield will rise to maybe 8 tonnes or more per hectare. In reality, Zimbabwe relies on both dry and irrigated land but the amounts involved provide a good illustration that can be compared to the current size of the domestic capital markets.
Anecdotally, we saw this at the end of 2019 as we were approached by a number of agricultural commodity consumers seeking capital to provide farmers for the 2019/2020 planting season, capital that they would normally obtain from the banks. Sadly the pension and insurance industry could not fill those shoes and as such we assume that the number of hectares planted was substantially down on the previous year.
We were very interested to see CBZ Bank last week offering a $500 million bond together with a US$50 million bond in order to raise a total amount of US$80 million at current interbank rates.
These funds would be used for the current agricultural season, 2019/2020, specifically to grow maize (170 000 hectares) and soya (30 000 hectares). The offer closed last Friday on January 10. This strikes us as being rather late as we understood planting needed to take place by the end November in time for the rains, which have yet to materialise in any consistent way.
We note, however, in the risk clause within the term-sheet that should farmers not be able to supply the products to the Grain Marketing Board for whatever reason, government will step in and supply the necessary amount of Zimdollar to allow for the conversion by the RBZ to cover the US$50 million repayments together with interest at 9,5% in USD terms.
That equates to an unlimited liability in the Zimdollar. The same is true for the local $ bond, with the government guaranteeing the repayment plus an 18% coupon all in $.
There appears to be no risk to CBZ. Given the lateness in the placement of these two bonds from an agricultural perspective and the likelihood of drought, the default risk must surely be high and could therefore prove expensive for government in 270 days’ time which is the maturity date of the two bonds.
That of course assumes that both bonds are subscribed for which given the liquidity numbers we have outlined in these Notes, suggests that this will be a tall order. The Ministry of Finance must be hoping as much!
Starting the printing press
This brings us back to a point that we made in our last Notes published in October where we surmised that “the RBZ has become the lender of ‘first resort’” given the constraints of the domestic capital markets.
We explained that if government was unable to fund itself through taxation and the issuance of Treasury Bills, then one of the few options would be to print money thereby undermining the currency by boosting reserve money.
This of course happened in August 2019 as we highlighted in our October Notes and resulted in the currency halving on the black market in a matter of weeks. That action by the RBZ has also put at risk the IMF’s Staff Monitored Programme (SMP).
Returning to the domestic capital markets and specifically prescribed assets (‘PAs’), IPEC is encouraging the insurance industry as a whole to move to 15% of assets in PAs. That would require investing an extra 2% or $216m as at September 2019, the equivalent of US$14m at the time.
For the pension fund industry, the IPEC level stated in their quarterly report is 10% (until December 2019) implying a further $230m or US$15m. Although these could be funded out of money market assets, in reality this could not be the case as liquidity is required to pay pensions, insurance claims and run the various businesses.
In the overall scheme of the economy US$29m (at September 2019 rates) does not fund very much even if these sectors coughed up those funds.
IPEC or government could force the insurance/pension sectors to sell down their property and equity assets but in reality that would be very difficult indeed; outside of strategic shareholders local pension and insurance funds are the largest owners of domestic property and equity which implies that foreign investors would be required to purchase these assets from the local institutions. This seems highly unlikely as foreign investors remain net sellers of the Zimbabwe Stock Exchange (ZSE).
Further, as IPEC states in its report, equity and property have proved to be the best performers of local assets even if they haven’t kept pace with the decline in the local currency.
Local debt assets have lost significant value in real terms by contrast. Herein lies the dilemma for pension fund trustees.
On the one hand their fiduciary duty to their stakeholders (employees and pensioners) is to protect the real value of the pension funds under their supervision as best they can.
If they then knowingly buy an asset that will likely lose real value — if not all of it compared to other assets such as property and equity which both have proven to be excellent assets to hold in the event of the demise of the Zimdollar (eg 2009), then they risk being sued for negligence by those stakeholders and maybe their unions. Under the new Company’s Act passed in the latter half of 2019, that would mean being sued in their personal capacity.
On the other hand IPEC may fine the pension fund for not meeting the targets.
For now IPEC is giving trustees the time to attempt to comply with their targets all of which would delay implementation. In a hyperinflationary environment, the longer this implementation takes the better for the stakeholders as value would be preserved to some extent.
Most of the prescribed assets on the market are debt orientated and denominated in $. In the event of the demise in the $ at any point, these assets would cease to exist — and become valueless – as occurred in 2009. We have found few such debt instruments that have a clause that protects investors should such an event occur, by for example an immediate conversion to US$ or into a related equity instrument.
We have seen one such instrument in the making but it is not a prescribed asset. It is even harder to find an equity-related prescribed asset and those that exist may not make economic sense to the investor.
The search for US$
As stated in our previous Notes during 2019, we have looked at a number of private equity investments as alternatives to equities and property.
Similar to agriculture though, the difficulty is that all of these projects usually have some need for US$ or the Zimdollar capital requirements are linked to the US$. That implies an unlimited liability for $ investors should the Zimdollar continue to decline.
Take for example, a solar project of which there have been a number approved in recent months. An US$10 million investment either in debt or equity (usually a mix) equates to $170 million at today’s interbank rate or more appropriately $240 million at the black market rate.
That might provide 10 megawatts of power. Since the equipment has to be imported, the solar company may well have US dollar debt on its balance sheet which would need to be funded and eventually repaid.
But Zesa can only pay in Zimdollar even if the tariff paid to the solar company is in some way linked to the US dollar. The risks therefore remain extremely high. As illustrated above, the pension and insurance industry do not have the free funds to invest in such a project. The project may be scaled back into smaller bundles at which point the economics of power generation start to fall away.
A time to sell or buy?
Meanwhile, as highlighted in our October Notes, the valuations of listed equities in US dollar terms remain extremely low and cheaper arguably as compared with the latter days of the Zimbabwe dollar in 2008. That of course is not surprising; foreign investors have been net sellers of equities over the past twelve months and domestic investors have had little surplus money to buy more.
Valuations of any asset around the World tend to fall when few want to buy whilst they rise to very high levels when investors refuse to sell as prices rise, sometimes to astronomical levels as we have seen on Wall Street in the recent past. The best time to buy an asset is therefore when nobody else wants it, or indeed is able to buy it and that is usually when assets can be bought at a huge discount to their intrinsic or real value.
Equally, the best time to sell is when there are no sellers despite rising valuations.
In this regard we have been asked by a number of our pension fund clients whether now is not a good time to wind up their pension funds as they have lost so much real value since 2016 (US dollar terms). There seems little point they argue in making contributions if they will lose real value, better to spend that money now.
The answer of course is that now is very much not the time to be selling undervalued assets and indeed it is the best time to be buying into such low valuations by continuing to make contributions to their pensions.
Recent history has shown that to be the case when valuations in US$ terms rose exponentially between 2008 and 2013 as the economy recovered. We have no idea when this may occur again but as with 2008, the current economic situation is unsustainable ultimately. Something will have to give.
If what “gives” leads to stability in Zimbabwe’s monetary foundations as occurred in 2009, then the prospects for the domestic pension and insurance industries will be excellent so long as they enter that period with solid or real assets such as the ones they hold today. In other words, valuable stakes in Zimbabwe’s finest companies and secure property assets.
The International Monetary Fund team was in Harare in early December to continue negotiations with regard the SMP and the Article IV Report, the latter is expected to be published in February 2020. This will give us an idea of how the IMF is thinking and whether indeed the SMP will be extended or cancelled.
With inflation running at 521% per annum (December 2019), the economic numbers that government, the IMF and economists are dealing with are fairly meaningless. This was apparent in the national budget where the numbers both in real and nominal terms bore little resemblance to any prior budgeted figures.
As we write, the rains have been worryingly erratic. Early warnings back in September suggested above or normal rains prior to January with below average for the rest of the season.
Rains prior to January have been below normal with long periods of no rain and if there is little change to that between now and the end of the rains in April, agriculture will suffer dramatically. Dams are already below 50% whilst the water table has not recovered implying that boreholes will likely struggle through 2020.
This would cause a contraction in the agricultural sector with knock-on effects across the economy. The World Food Programme has already issued an alert to the international community to raise funds for Zimbabwe in the likely event of a severe drought. Even if we receive food aid, the logistics of bringing that food in will be enormous not least in terms of the number of trucks required to ship it in and of course the fuel to drive those trucks.
Low dam levels suggest that electricity from hydro-power plants will remain constrained. Without external assistance, 18 hour power cuts are likely to persist well into 2020 with the consequent strain that this will put on the industrial and farming sectors. With more foreign exchange directed to food imports, the ability to source petrol and diesel will also be tough and hence we expect shortages to continue during 2020. A weaker economy is, therefore, more likely than a stronger one.
The prospects for Zimbabwe in December 2008 looked bleak and uncertain. Industry was devastated after years of neglect and under investment.
The domestic savings industry was in a far worse state than it is now but thanks to the ZSE it was at least invested in non-monetary assets. The banking sector could not lend back then due to the second highest hyperinflation the World had ever seen.
Real disposable incomes had been destroyed with a large part of the population on the poverty line. But then in 2009, something “gave”, and the country dollarised in its entirety providing the economy with a stable monetary foundation from which to grow. It grew rapidly from then on.
We knew back then that the status quo was unstainable and that something would have to “give” but it was hard to predict how it would end. When it did end, asset values grew rapidly in US dollar terms enabling the domestic capital markets to once again provide capital to those that needed it.