TAFARA MTUTU ON the May 7, 2022, President Emmerson Mnangagwa, flanked by the Reserve Bank of Zimbabwe governor John Mangudya and Finance minister Mthuli Ncube, delivered a set of measures with the purpose of (i) restoring confidence, (ii) preserving value, and (iii) restoring macro-economic stability in the country.
These measures were necessitated by the strong depreciation of the local currency on the parallel market, a sustained rally on the Zimbabwe Stock Exchange, and a virtual standstill in the public transportation system in recent weeks.
Key highlights of the President’s address are given below:
Compensate the banked population that had foreign currency balances in their accounts before the end of January 2019;
Clear the current auction system backlog and reduce the settlement period of allocated funds to 14 days;
Increase the transfer limit of the willing-buyer-willing-seller transactions from US$1 000 to US$5 000;
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Allow payment of duty, royalties, and taxes in Zimbabwean dollar (Zimdollar);
Further tighten money supply by reducing quarterly money supply growth to 0%;
An IMTT tax of 4% applicable to foreign currency transaction except for willing-buyer-willing-seller transactions;
An increase in foreign currency withdrawal charges from US5c to 2%;
Settlement of foreign currency-denominated tax obligations in ZW$ at the official interbank rate;
Conversion of export proceeds at the willing-buyer-willing-seller exchange rate;
Suspension of lending activities until further notice; and
An increase in the Capital Gains Tax (CGT) for investments held for less than 270 days from 20% to 40%.
We maintain that the government still has a long road ahead before they can garner a vote of confidence by the market. We note that the framework for compensating holders of United States dollar (USD) balances prior to January 2019 is not yet in place, as is the framework to compensate the insurance sector’s policyholders for value lost in 2009 when the economy dollarised.
Talks of improving the foreign currency auction system’s efficiency are all too familiar and this song has been played before.
We observe a perpetual cycle of no backlog preceding another period of delayed settlements after a few weeks, even considering the increase of foreign currency inflows in the country compared to last year.
The changes in the willing-buyer-willing-seller transactions limits will likely continue to be increased over time to support the authorities’ efforts to instil confidence in the official rate by improving the flow of foreign currency in the formal system.
We assert that this complements the measures relating to foreign currency balances with the intent of channelling foreign currency movements — from international transfers, transactions other than willing-buyer-willing-seller transactions, and withdrawals on ATMs — to willing-buyer-willing-seller transactions which have lower costs and add more foreign currency flows in the formal market.
The 2% withdrawal charge and 4% IMTT of foreign currency transactions (except on willing-buyer-willing-seller transactions) make liquidation of nostro balances with banks the least expensive avenue for using such balances and further drives supply of foreign currency at the official currency rate.
The payment of statutory obligations in Zimdollar at the auction rate is envisaged to create demand for the local currency both on the formal and parallel markets, and this has been complemented with the heavy stance on the 0% quarterly money supply growth which will limit local money supply.
Using the simple laws of supply and demand, an anticipated increase in currency demand together with limited supply will theoretically lead to strengthening in the value of the currency, which should counteract the recent depreciation of the Zimdollar on both the formal and parallel markets.
The suspension of lending activities will severely affect the productive sector, particularly businesses that regularly need credit lines to close working capital gaps between production and sales like Seed Co Limited, Padenga Holdings and Dairibord Limited.
Although banks could be affected by the suspension, the sector generates sufficient cash flows though non-funded income to remain afloat.
However, a lengthy suspension could warrant a haircut on the country’s economic growth expectations for 2021 given the pivotal role of the sector’s lending activities.
We anticipate the higher CGT tax to reduce short-term speculative investments and reduce daily market turnover on the Zimbabwe Stock Exchange, while a liquidity drain on the exchange will cascade from the anticipated higher demand for Zimdollar in the short-term.
From a fundamental perspective, businesses that extensively rely on credit lines, like seasonal businesses, will likely experience constraints in their capacity utilisation, and this could affect valuations of such companies.
The suspension of lending activities will affect interest income for banks, but we note that the banking sector largely derives its revenue from non-interest income.
Based on latest financial reports, CBZ Holdings’ net interest income accounts for 17% of total income, ZB Financial Holdings 19%, First Capital Bank 33%, NMB Holdings 38%, and FBC Holdings 51%.
The remainder comes from other streams of income such as fees, commissions, property sales, insurance and fair value gains. However, given that some of these banks’ revenue comes from relatively illiquid sources, the suspension of lending activities could affect the cash generating ability of the banks, with ripple effects on their ability to pay dividends at current pay-out ratios.
The overall impact of these measures will likely slow down the depreciation of the local currency, as these measures collectively drive demand for Zimdollar, albeit to the detriment of the country’s growth potential.
We also anticipate a slowdown in stock market activity in line with the containment measures to control currency depreciation in the short-term.
However, these measures will likely be nullified by the unintended allure of foreign currency in the parallel market, which could begin trading at an added premium because of its relatively lower cost.
- Mtutu is a research analyst at Morgan & Co. — tafara@morganzim.com or +263 774 795 854