Markets shall not fail forever

The demise of some of the most revered global banks such as Lehman Brothers in 2008 has taught many investors around the world unforgettable lessons. The contagion touched nerves around the global markets in many angles; from the collapse of the commodity prices, crushing stock markets and the pains of discovering seasoned and polished fraudsters running ponzi schemes such as Madoff who had thrived under the veiled tranquility of excess global liquidity and unimaginable poor regulation.

Lessons have been learnt, and the syllabus on investment markets will forever have core topics in explaining why ‘markets don’t roll on good times forever’. The commodity prices recovering from their floors, coupled with the optimism from the green shoots seen in the recovering global stock markets, and the sight of big global banks returning to making profit means therefore that men shall not allow markets to fail forever; forget what they preach in calm weather. The big hand of politics will always move to tamper with the capitalism concept of creative destruction.

Of course investors learn new lessons every day, but the biggest lesson learnt during the last 50 years is that governments and central banks shall always keep printing money, at times under the guise of ‘quantitative easing’ to rescue failing markets. The text-book theories and please-the-gallery guidelines about policy makers not intervening in free markets to guard against moral hazard shall, as it has been proven at a grand scale in the big world economies, always be selectively used, whilst they will be discarded on the basis of ‘this time it’s different’ pretext.

Didn’t the Bank of England warn against bailing struggling banks in September 2007 after the European Central Bank, the US Federal Reserve and the Bank of Japan had started opening valves of liquidity in August of 2007 to ease the market crunch and save banks from collapsing? Yes it did, reading from the same verses it thought were from the common banking bible agreed ages ago by everyone, including the IMF. Albeit the verses being in bold print, the moral guidance was discarded in mass. Everyone, including the IMF, joined the new chorus, trumpeting the cause for decisive market intervention to stop the markets from collapsing.

Investors need to understand that stock markets, being the barometers of economic and political confidence, shall always be protected to ensure lavish perpetual flow of credit in economies during times of severe economic stress. In such times, interest rates will therefore always be slashed to near zero levels to ensure that those with cash will constantly feel stupid in keeping the cash in the banks for safety reasons. Instead, they will always be compelled to invest it in any way to at least earn some return, in the process reverting to the same collapsed stock markets and pushing them up, and giving the false confidence that recovery would have dawned.

The banks on the other hand, in seeing the stock markets showing signs of life, will start letting credit flow in the economy once again, more so since the alternative return from risk free-assets would have been carefully managed to repulse them. Is it not the reason why the 3-month LIBOR is at 0.27% per annum, whilst the 10-year US government bonds are at only 3.34%? Yes it is, to chase banks from keeping liquid safe assets, but instead invest in the economy and let credit flow continue to give life to the markets, and of course give the impression of good policy.

The lessons are therefore clear. Opinions, no matter how long held, don’t stay constant forever. They will always change and drift to reflect the fundamentals of survival on the ground. A few years ago Private Equity funds wouldn’t gamble with African markets because of the views, mistaken at times, that the African markets drift very randomly due to poor fiscal discipline, civil wars, poor infrastructure, low incomes and so on. Today, don’t the same aspects of poor infrastructure, low but rising incomes and inefficient markets create the huge appetite for PE firms targeting internal rates of return of above 25% in the short term in Africa, far better than the near zero bond yields obtainable today in Europe, Japan and the USA?

Whilst the syllabus on investment markets will forever have core topics in explaining why ‘markets don’t roll on good times forever’, it will have a mandatory conclusion on why ‘market shall not fail forever as long as men live’. So where does this leave the investor? The conclusion is difficult, but it’s clear that policy makers cannot be trusted to keep long held traditional opinions, whilst the ‘too big to fail’ political mentality will always reward and insulate excessive risk taking behavior by capitalists and their managers on obscene performance-based reward systems. In the end therefore, investors will be always be insulated from market failure, whilst volatility, although sometimes getting to extremes, will always smoothen in the long run in a defined positive trend.

Working Capital Challenges Haunting Zimbabwean Producers

Talking to many business owners today, the major impediment in their way is the lack of working capital and long term loans to re-structure their balance sheets after a decade of negative physical capital formation. That granted, they see a bright future where productive capacity utilization levels will increase. Notwithstanding the current predictability of the broad pricing mechanism, many fail to understand why the domestic debt markets have remained tight for those seeking transformative loans. Isn’t it so strange that easy bank overdraft facilities used to be largely one year during the chaotic hyper-inflationary environment fraught with fever-pitch uncertainty, yet with the current stability, many borrowing corporates would be lucky to be extended an overdraft facility beyond 3 months today?

It appears strange indeed! However, looking deeper will reveal much bigger sectoral challenges in the adjustment phase of the economy. Inasmuch as there is predictability in general pricing, with forecasts not as wild and wide as before, the economy-wide liquidity has remained tight, forcing the banks to cling to deposits cautiously. The absence of risk-free liquid assets which banks can hold for trading purposes has compounded the problem further, pushing the banks to manage potential liquidity risks through managing the duration of the loans.

Which bank might have cared to manage liquidity during the hay days of excessive government spending in 2008? There is an about turn, and sober realities of the steady normal economy are bringing about change in the way business is done. Dollarisation and the accompanying cash budget have brought crippling fiscal discipline to government behavior. The government has lost the fiscal leverage to print money, and cannot be the source of liquidity glut that intoxicated the markets of yester-year. This is therefore a bigger challenge to the banks, with each having to keep liquidity close to its chest, more so when the ‘lender of last resort’ function of the central bank is almost non-existent today.

The speculative days of yester-year associated with easy wealth are gone. The deep and steady currents in the sea of economic activities gravitating towards normalcy can result in excessive bad loans on bank balance sheet from borrowers misjudging the market dynamics. Therefore prudent restraint on credit creation being exercised by the banks is normal, more so when the world is just coming out of a mess created by reckless banks whose appetite for lending was foolish.

Considering other challenges facing the financial markets and the economy as a whole, it is therefore not surprising to find that the average cost of capital is quite high in Zimbabwe today. Annualised costs of borrowing are rocketing above 80% per annum in extreme cases. In a market where price controls and other experimental administrative policies have proved disastrous, regulating the cost and duration of debt instruments today outside the ordinary moral suasion will not work, and therefore the only feasible and sustainable policy framework would be attracting lines of credit at both government and private sector levels to thaw the market. The market rigidities in Zimbabwe, as in Zambia, Kenya and Tanzania, are largely to blame for high cost of debt. In Zambia, notwithstanding the stable inflation and an outlook that is not as gloomy, the lending rates remain so high around 30% per annum. The fact that the government securities to loans ratio for the banks stand at 41% points to more worries about credit risks in the Zambian economy. Attaining efficiency in Zambia’s monetary policy transmission mechanism has proven difficult, with the disparity between the annual risk-free rate of 16% and the lending rates at 30% pointing more towards the challenges of limited liquidity and shallow dept in the economy where bank deposits are only 28% of GDP. The politicians in Zambia have started on the moral suasion route, with the government pleading with the banks to reduce the high lending rates that are viewed to be hindering the rate of economic growth.

The policy challenge associated with poor transmission of monetary policy to influence real activities in the economy continues to haunt many countries in Africa today. Tanzania’s bank lending rates above 20% per annum versus the 8% yield on risk-free government TBs reveal similar policy challenges in an economy where bank deposits are only 44% of GDP. The absence of a secondary market for credit instruments will likely continue to strengthen the discord. Far afield in Kenya, the discord is quite exciting. The one year TB rates, at 8.4%, are not in sync with the reality on the ground, and the banks have decided to ignore the optimism in government forecasts by lending above 20% in an economy where the post election violence and drought have keep inflation high, currently standing around 18%. The current El-Nino rains pounding Kenya should likely bring the banks and the policy makers to the same optimism levels on the future of inflation (whose basket is largely food-driven), but still it would be naïve for banks to reduce their lending rates yet at below inflation rate. It is no wonder the big players in the debt markets in Kenya are plying the bond route, with the recent huge long-term bond issuances by Kengen and Safaricom pegged around 12%.

Zimbabwean corporates are therefore not outliers on the continent. Being buffeted already by weak domestic demand and power challenges, Zimbabwean companies will find it difficult to strike the right competitive footing against South African producers who, amid all the other advantages, can interrogate their debt markets at reasonable costs.