Big deals, big mistakes

The year 2011 has been a year of big deals. One of the biggest deals, the Essar deal, remains in controversy to this date. Having gotten 54% of Zisco in a special bargain, well above the 49% shareholding that is normally reserved for foreigners, Essar believes it can get more. There are reports of its planned iron ore slurry pipeline to be built from Chivhu and Kwekwe all the way to Beira. Why would Essar want to pump unprocessed ore out of Zimbabwe at a time players in the chrome industry are being forced to add value? How much will the country lose in terms of VAT, income tax, jobs and so on if iron ore is going to be processed outside Zimbabwe?

How does one put market value to unprocessed ore being pumped out of Zimbabwe for taxation purposes and do we have capacity to deal with transfer pricing issues that could potentially prejudice the country of billions of dollars? Does it ever make sense that big mining companies do not pay that much in corporate tax in the country they extracts the resource, whilst the tax is paid elsewhere? In the US, GlaxoSmithKline PLC, a UK drug maker, settled $3.4 billion for its transfer pricing sins, and the US government is always taking to court suspects of prejudicial transfer pricing. Zimbabwe could do much more for its minerals that are exported with very low values. If the values of the ore reserves of Zisco are in excess of $50 billion, why therefore would Essar get 54% in the first place as a special case in violation of the indigenisation laws? There are just but many questions on the Essar deal that remain unclear and indeed the deal is big, with big mistakes as well on part of the Zimbabwe government.

Steal from me and I will fix you!

Having well understood and appreciated the contribution of the diamond revenue in transforming the Zimbabwean economy, Minister of Finance made two important decisions in the last budget. The first was to acknowledge that indeed the diamond revenue in Zimbabwe, just like in Namibia and Botswana, is very critical in determining scope and direction of GDP via the government revenue route. He revised the revenue estimates upwards by $600 million to $4bn. If diamonds bring $600 into the fiscus, what is the government getting directly from gold and platinum whose combined exports are estimated over $1.6 billion annually?

Hiking royalties, according to Hon Biti, could bring the desired cash into government coffers since the government has no notable shareholding in the mining of these two key minerals where not much accrues to the government as compensation for the depletion of the natural resources other than the obvious PAYE and corporate tax. He hiked royalties from Gold and Platinum to 7% and 10% respectively as if saying ‘steal from me and I will fix you’. In Zambia, copper exports are expected to top $8.4 billion this year, but the mining sector contributes a paltry 11% to GDP. Worse still, bank deposits remain below $5 billion whilst cost of credit has remains very high above 30% per annum on the back of a volatile exchange rate.

These factors put Zambia in a difficult scenario of failing to finance infrastructure projects to develop the country yet it will export copper worth over $20 billion in the next 4 years. The fact that the copper exports proceeds remain offshore is the major curse of Zambia, and indeed it will remain poor a country notwithstanding the huge resource endowments in copper. Zimbabwe and Zambia may need to borrow a leaf from Austria. In Australia, 85% of the mining industry is foreign owned. To compensate the Australian for the depletion of resources, the Australian government imposed new taxation levels that, in effect would take the cumulative taxation levels to as high as 57%, making Australia miners the highest taxed in the world. Surplus profit will be charged at 30% beginning January 2012. That is expected to add an additional A$4bn every year, which money will go towards infrastructure projects and pension.

The Chamber of Mines in Zimbabwe has a different idea. It opposes the increase in royalties and believes the mining sector is contributing more to the economy through investment in health, education and housing. That fact is not deniable, but does the Chamber of Mines believe that building toilets and schools in the remote areas for their employees’ benefit is good enough to off-set the royalties? If a big mining company sets up operations in the bush and builds a road to get there so that they can extract the resources, and equally builds a clinic so that their sick and injured workers get attended to as per the law, would one honestly call that ‘significant’ in contributing to the development of the economy?

That a very sick argument, and indeed the President of the Chamber of Mines, Mr Chitando needs to understand that royalties address the wider spectrum in the distribution of national income from key resource endowments as opposed to localised benefits to a few people. The government will be receiving at least $100 million each year from the recent hike in royalties from Gold and Platimun, and surely the mining sector, on its own volition through building classroom blocks, toilets and clinics, cannot be expending as much annually for the wider benefit of the economy. Indeed the Minister of Finance was spot on.

Mathematics, a difficult subject after all

The last person you expect to get numbers wrong is the accountant, moreso the Ministry of Finance lest other ministries are allocated disproportionately higher votes in error. The economy is growing, no doubt about it. Economic growth is estimated at 8.1%, 9.3% and 9.4% for 2010, 2011 and 2012 respectively, so the official position stands. GDP tops $8.3 billion, $10.1 billion and 11.9 billion for 2010, 2011 and 2012 respectively. These figures from the budget do not tally at all, so will all the statistics that use GDP as the base reference. The mathematics is very bad, even if the nominal GDP figures are deflated using the average inflation. The ordinary person does not need to know the implicit GDP price deflator that is used to arrive at the GDP figures, but the bottom line remains that the figure as published in the budget are somewhat not correct unless what we refer to nominal GDP is probably GDP at purchasing power parity.

Nominal GDP growth from $8.3 bn to $10.1 bn is 22%. What is the figure of the real GDP in billions that then that gives us the official growth position as stated of 8.1%? Taking the 2009 GDP estimate to be correct, would it not be the correct position to say our GDP as a country is $7billion for 2011, not the $10.1 billion we are getting from the Ministry of Finance? Mathematics has always been a very difficult subject since the beginning of time, and indeed when it comes to national statistics, more attention needs to be given to such so that planning becomes much easier for everyone.

BARBARIANS AT THE GATE!!

The year is coming to a close and most things are indeed counting down to 31 December, from financial year ends to calendars and so on. But in the business world, so much remains unclear and unresolved. A huge number of big companies in Zimbabwe still suffer from high gearing levels, and there is no indication that the cost of borrowing will climb down significantly in the new year. The debt burden will most likely increase and indeed worsen for some corporates whose business models have not been generating sufficient cash to service the big loans sitting on their balance sheets. The flow of credit has significantly improved in the economy, but that has not translated to ameliorated risks in the economy.

Banks were sitting on $1.6 billion worth of loans in January and that has increased significantly to about $2.7 billion currently. A casual analysis of these statistics will indeed conclude that more credit has been flowing into the economy and that should have seen a massive decrease in cost of credit and ameliorating wider economic risks. But alas, the cost of credit has remained pricey, in extremes of 60% per annum whilst economy-wide risks have been amplifying as big companies such as RioZim struggle to remain afloat, whilst some of the flag-bearers of yester-year such as African Sun continue to post huge losses. Therefore a closer analysis of the huge piles of debts sitting on corporate balance sheets and the obtaining high cost of credit will reveal that indeed the build-up in the quantum of loans to $2.7 billion is, to some significant extent, a result of ‘interest’ cost build up other than the real flows of fresh money into the credit markets.

The stock market, which to some extent is a market that measures the pulse of the economy, has concluded already this year that earnings are poor and there is no need for optimism. From a replacement cost valuation perspective, most of the companies on the Zimbabwe stock exchange will appear to be trading at a huge discount. African Sun for example, with all its beautiful hotels constructed by brick and mortar and the ever smiling front office personnel, cannot be surely valued at $7 million by the market! That is not enough to build one 5-star hotel, moreso for a hotel group with some good brand and unquestionable goodwill? But a closer analysis of its liabilities and net cash-flows tells a completely different story about its ability to generate positive earnings. And in the ensuing guesswork, the market cannot be faulted for valuing African Sun at just $7 million, a hotel group that has posted cumulative losses of $17.6 million since 2009 and with no clear sign of when it will return to profitability.

Indeed that adjustment mechanism to the normal environment has been very difficult for African Sun whose balance sheet, like those of many of big corporates in Zimbabwe, continue to struggle with high costs of funding and stubborn operating costs. The high cost of funding and runaway operating costs are indeed the barbarians manning the gates to profitability for most companies in Zimbabwe.

Low inflation, a misleading achievement

Although inflation has averaged less than 5% per annum, and will likely remain subdued in the coming year, the challenges pertaining to operating costs increasing much faster than revenue for the majority of corporates remain the biggest headache in running businesses in Zimbabwe. Dollarisation has brought sanity in the consumer goods market to the satisfaction of policy makers, but it has not safeguarded the real costs of doing business, the real dilemma facing companies today in striking the balance to increase revenue whilst remaining profitable. The real costs of doing business have been ballooning, from labour to energy costs. Gone are the days in 2008 and before when real wages averaged $8 per month whilst energy and all other costs were indirectly subsidised by the government through the excessive printing of money to cover the huge budget deficits.

The ever increasing minimum wages and the very difficult labour laws pertaining to retrenchments means that companies will continue to carry excess staff at a time capacity utilisation and productivity levels do not warrant such staff numbers. Funding options available to undertake retrenchments remain very narrow and dangerous, more so when the credit markets are tight and corporate profitability still very low. Even parastatals such as NRZ and Air Zimbabwe have hit very difficult times being saddled with excessive staff levels that are not doing anything but still getting paid.

The airline industry is a troubled one globally, with American Airlines, one of the biggest in the world, having filed for bankruptcy two weeks ago to seek protection from its own employees and creditors. All network carriers in the US have been hopping in and out of chapter 11 bankruptcy to remain afloat. Air Zimbabwe has over $1,300 employees manning just 5 planes, half of which are rarely up and running always. Filing for bankruptcy could indeed be the only way out for Air Zimbabwe so that it starts on a good plate unless the government and new technical partners marshal massive resources for its bailout.

With elections looming and civil servants not having been accommodated for a pay-rise in next year’s budget, the complete resuscitation of the national airline may find sympathisers, but the money may not just be available. Evaluating all these huge operational challenges and inefficiencies bedevilling companies reveal a sad picture that indeed inflation in Zimbabwe could be among the lowest in Africa, coupled with prudent fiscal policies and very stable exchange rate regime, but still running profitable companies remains the biggest challenge in this country.