Banking sector stable but troubled

Times are changing fast for the broader banking sector, and indeed the massive retrenchments that are happening in the sector send a strong message that all is not well and indeed, the rationalization is long overdue. Not so long ago the flurry of the Zim-dollar transactions associated with excessive liquidity saw banks going on a massive recruitment drive to fill-up their various divisions whose fortunes had ballooned. The ASPEF facilities created huge agri-business divisions; whist the high velocity of currency circulation saw the settlements departments getting bigger at more or less the same rate of inflation, jokingly. The RTGS transactions associated with the parallel market transactions, popularly known as ‘burning’, made this division one of the busiest in every bank. On the other hand, the Treasury functions, whose fortunes blossomed well during the ‘asset-management’ hay-days of between 2000 -2004 when ‘dealers’ were golden, remained very relevant and vibrant as the liquidity swings in the market during the hyper-inflation era pinned the daily survival of banks on the ability of their treasury teams to close deals in the market and balance their central clearing positions.

All these are excesses of the past that are now haunting the banking sector’s operational efficiency models. The Agri-business divisions are now haunted departments where lending to agriculture has been made very difficult not only by the current high cost of credit, but equally by the very short-term nature of loans that cannot afford the broader agricultural sectors to service interest due to the cyclicality of the cash flows. The death of the Zim-dollar has equally brought a near-death to the once hectic settlements departments as the volumes of transactions have drastically come down as households in the economy have lost the ‘burning’ magic of generating wealth, nominal or otherwise, out of thin air. The low loan to deposit ratio of less than 50% says a lot about reduced activities in the corporate banking departments, whilst, on sad note, the death of the Zim-dollar equally pronounced hardship sentences on many banks’ rural branches around the country whose depositors were left clutching only to their account numbers but with zero balances.

The massive retrenchments and branch closures happening in the sector are part of the broader rationalization programme, but more would be needed to preserve profitability considering that the cost to income ratio averaging above 120% is unsustainable. Zimbabwe has had a reasonable, but equally irrational staff retention policy of offering company cars, cell-phones etc to employees over the past decade – a practice that doesn’t make sense on corporate balance sheets as long as there are no economy-wide implicit subsidies out of generally high inflation. Considering the need to contain costs, this unfortunate policy should be heading towards extinction within the banking sector by year-end, and indeed some banks have already started off-loading the mountainous fleets of vehicles to employees. The use of US$ in the economy requires some measure of sanity in the broader decision making framework, and those corporates that continue to ride on the exuberant mentality of an inflationary environment may not live longer to correct their mistakes. Cleaning bank balance sheets would entail equally closing some non-profitable branches opened at the height of hyper-inflation, whilst keeping a very close eye on the quality of the loan book should be the most important risk consideration on any bank balance sheet going forward.

The net interest margins prevailing in the banking sector, generally above 71% for the top 10 commercial banks, are very healthy, but considering the very low loan-to-deposit ratios averaging 49%, and indeed the quantum of total deposits, it wouldn’t surprise why banks such as Barclays would generate $15 more from non-funded income for every $1 generated from net interest income. The message is clear: survival is still difficult in the broader banking circles, and by year end, many more drastic decisions would have been taken by various banks to clean balance sheets of excesses and realign with the stable, but very precarious trading environment. Unlike the ZW$ era where losses were never real, the US$ environment has real losses that would dent banks’ capital positions, and as such more consideration need to be paid to the bottom line than never before.

What does the future hold for the banking sector? The sector, as the rest of the economy, has huge potential, especially considering that the existing asset classes in the banking sector are so narrow and there is huge scope for market deepening. The existing low loan-to-deposit ratio says a lot about excess savings that exist in the economy and having huge potential to create value for the banking sector when perception and risk profiles improve later on. For lack of information and exposure, many would attribute the current liquidity crunch in the market to ‘insufficient’ deposits. With deposits now around $1.7 billion from as little as $400 million in April of 2009, that argument should be falling away, and indeed the current credit crunch has everything to do with market perception and risk profiles and very little to do with insufficient deposits except for the very small banks. Hence from a broader perspective, the banks have capacity to lend, but the issue of risk is holding back the flow of credit. Therefore once the market risk profile eases, more credit will be flowing and indeed more revenue will be generated on bank balance sheets. Looking across at Zambia and Tanzania with deposits to GDP ratios of around 15% and 28% respectively puts Zimbabwe’s 46% at an enviable position, but the pronounced economy-wide risk issues are holding back the flow of credit, creating the current crunch.

The commercial banking model remains the better of all the available models due to its ability to levy charges on the many transactions and accounts every bank would be having. Although the commercial banks with wide networks have better revenue models from ledger fees and commission income, the fact that about 50% of the global deposits are concentrated in three bank, i.e CBZ, Stanbic and Standard Chartered means equally that the bulk of the remaining banks are fighting for a smaller piece of the cake, and therefore more leaner and efficient operating structures will be driving force in the banks going forward. Equally, when faced with survival challenges, it is expected that innovation will quickly come to the fore, meaning that products such as consumer loans, asset finance scheme, etc will be coming back into the market quickly to broaden the income base of the banks. However the pace of economic recovery will have the final say on the products the banking sector will be able to create and sell efficiently.

Invest wisely or lose it

In psychology, they tell you that one’s behavior is influenced, to some extent, by the upbringing. Seven years of high inflation is a long time to sow stubborn habits in investors, and surely Zimbabwean stock market punters had become so much used to uneventful miracles that would see portfolios tripling or quadrupling on a daily basis in response hyperinflation that saw inflation hitting around 500 billion percent in late 2008, according to estimates. Of course Zimbabwe is now a totally different place but one thing has come to worry investors. For once stock market punters understand they can lose money on the Zimbabwe stock exchange. And many more will continue to lose money.

The phenomenon is not surprising in stable economies. In the 10 years since January 01 2000, the S&P 500 lost 2.7%, whilst the FTSE 100 has lost 2.4% before even factoring inflation. Let’s get closer to home. In the three years from 01 January 2007 to 31 December 2009, the Johannesburg Stock Exchange’s All Shares Index (ASI) gained 10.3%. Considering that cumulative inflation in South Africa was 27.4% over the same period, it is quite clear that the ASI has lost 14%. A person who invested 100 loaves of bread on the JSE in 2007 was only left with 86 loaves by end of 2009 when adjusted to inflation. Inflation eroded the other 14 loaves. The Lusaka Stock Exchange in Zambia (LuSE) has performed much better over the same period. A 100 loaves invested on 01 January 2007 on the LuSE were 109 by 31 December 2009. Although cumulative inflation was quite high at 39.5% over the three years in Zambia, investors on the LuSE emerged rare winners on the back of robust economic growth.

The dollarized trades on the Zimbabwe Stock Exchange (ZSE) since 19 February 2009 have obviously created distortions in terms of evaluating the real returns on the ZSE over a long period, but a glimpse on the year-to-date trading on the ZSE confirms that indeed investors can lose money on the stock market in Zimbabwe, which is so different from the last 4 years where the ZSE was always defying the law of gravity. Year to date, the Zimbabwe Stock Exchange has lost about 9.53%, whilst the some counters such as Fidelity Life have lost as much as 50%! Now it’s dawning on investors in Zimbabwe that a normal economy has some defined order where rewards and losses are more or less evenly distributed, and the choices that one make today will only reward them in the future more on the basis of sound judgment. And sadly, speculation will play vital role, but not usually rewarding.

Investors on the Zimbabwe Stock Exchange therefore need to sober and invest in companies with solid fundamentals. Some of the listed companies, without access to long term reasonably priced capital and strategic re-focusing will continue to reel under so much pressure for a very long time and it should not surprise anyone to realize that some companies will not declare dividends in the next 5 years. Some companies’ share prices are trading below their net asset values per share (NAV), with the likes of ZECO trading at 89% discount. In order to create and indeed crystallize value over the long term, investors should focus on the value the companies are likely to create in the future in line with various fundamental considerations. Let us consider an example. FBCH, the banking group, is trading at around 25% of its NAV. Theoretically, the fair value of FBCH would be around 14 cents per share and not the current 3.4 cents trading price and the differential would ordinarily be the ‘opportunity’ for punters to benefit on the upside. Unfortunately, as the market has come to a consensus, the share price of FBCH doesn’t need to be at 14 cents. Investors are not seeing reason, and indeed the market is collectively saying that the fundamentals associated with the future of the banking group have nothing to justify a share price of 14 cents today unless there are clearer fundamental changes on the likely future earnings of the group. Considering the need to capitalize its building society arm, and indeed the latent sustainable demand for housing, its market share and the general liquidity crunch, the banking sector is not at its best footing to convince the market to award FBCH favorable optimism today.

The same goes for the likes of NMB, ABCH and ZBFH that are trading far below their NAVs. Collectively, the Zimbabwe Stock Exchange will rise in line with general increases in the liquidity levels in the economy as what has been happening since dollarisation, and most of the share prices will gravitate towards their ‘fair’ value levels. But specifically, the returns that individual investors will get will be a function of sound judgment and investing in companies with better prospects, and to some extent, luck. I am a strong believer in luck, but luck only benefits those that are prepared. And as the law of attraction goes, luck meets those that anticipate it and indeed investors can put themselves in the path of luck through their actions and choices of companies they pick to invest in. The point remains therefore that yes, money can be lost on the stock market. Many will continue losing! Willdale share price has tumbled by about 60% since January 2010! That is so much loss in US$. I wouldn’t want to speculate and lose $60 for every $100 I would have invested in Willdale in such a short time. That’s a huge bundle, and I guess no one would want that.

And investing on the stock market in a stable economy is the much more difficult than investing during the hyper-inflation period where everyone has sure upside nominal benefits. Equally, as there would be losers, some will be benefiting and winning, and Zimplow has gone up 74% year to date! Ofcourse focusing entirely on the short term is a wrong approach to evaluating returns on the stock market considering the long term nature of stock market investments. But the figures from the S&P and FTSE over the last 10 years equally show that the short-term sometimes expounds to long term and the facts remain strong, and indeed stuck in the tradition of making losses! And therefore cutting your losses in the short term improves overall returns on the long term.

On the other side, the fixed income market, which became so active during the birth and boom of asset management companies in early 2000 on the back of rising inflation, has become so depressed largely due to the poor vision of the government in ignoring the importance of setting a risk-free rate in the economy. Generally, deposit interest rates are very low, mostly below 2% per annum and considering that inflation can close the year above 8.7%, investors on the money market are likely to lose money to inflation this year in Zimbabwe. Many Zimbabwean corporates are facing challenges in raising capital, and many right issues have been disastrous for sitting shareholders. Yet it remains mysterious why some of the seemingly ‘solid’ corporates are not interrogating the markets directly by issuing commercial paper in a market where those with excess cash feel cheated by the prevailing deposit interest rates.

Years of hyper-inflation, which should have hardened company strategists and made them more innovative seem to have, on the sad contrary, killed the real innovative genes of some company leaders in Zimbabwe. Accessing debt directly in the market will most likely reduce the current high cost of capital obtaining in the mainstream credit markets for corporates. And equally important would be the better rewards that will go directly to those with excess cash that have little choice as they are stuck in low-deposit interest rate environment. And it only needs companies with good vision to take the step of faith and attempt to change the current circumstances by interrogating the debt markets directly. What does this mean therefore? Does it suggest that we have incompetent CEOs running some of these big companies in Zimbabwe? The answer is a BIG yes, and some are not only incompetent, but are very foolish and continue to sit waiting for fortune to visit them. And its high time activist shareholders take their CEOs to task.

The stock and money markets in Zimbabwe are very tricky in 2010, and hope lies in improved economy-wide liquidity that will likely push the general asset price levels high to benefit the stock market punters, whilst the money market investors’ returns will improve due to reduced risk and predictability.

MONEY MARKETS RUNING WILD AND WIDE

Significant quantitative easing and a long dovish stance have kept interest rates in the major world markets close to zero for over a year. And since January 22 2008 when the US Fed Reserve made a significant rate cut in response to the liquidity crisis, key policy interest rates have hovered near zero for so long, much to the chagrin of bondholders in major markets such as the Euro-Zone, Japan and USA. Africa is however different place. Notwithstanding the crisis and a lull in ‘global’ interest rates, most sections of the African money markets remain uncorrelated with global events, and rightfully so.

Places such as Zambia and Zimbabwe have continued, as before, to reel under high real interests rates for the borrowers. Notwithstanding other countries such as Tanzania and Zambia slashing the policy rates from the highs of 2008 to encourage affordable flow of credit into their economies, the poor transmission mechanism of monetary has inhibited the benefits to the real economy serve for the respective governments reducing the costs of debt servicing. Zimbabwe, having run on a dollarized economy for over a year now, continues to experience one of the highest costs of credit in the world, and the absence of key policy interest rates and lender of last resort functionality has kept the market on a craze-wave in the determination of the interest rate levels.

Borrowing rates in Zimbabwe are varying from as low as 20% to as high as 40% per annum in the mainstream banking, whilst the secondary financial markets’ cost of capital range from anything above 150% per annum on annualised basis. These distortions, largely a function of the liquidity constraints and uncertainty, lend much of their roots equally to the absence of the ‘risk-free’ rate in the market to gauge the extent to which the economic players can price their various risks from the reference ‘anchor’.

Saddled with a huge debt of about $5.7 billion, thus about $100% of GDP, Zimbabwe is not in a desirable position to keep plunging into fresh debt arrangements considering fragility of government finances. That said however, it remains puzzling how Zimbabwe policy makers still remain silent on giving the financial markets pricing guidelines more than a year after adopting the multiple-currency system. The prevailing multiple currency system in Zimbabwe is creating ambiguities on the near-efficient ‘reference price’ for financial assets. Would Zimbabwe need to use the US bond yields at 0.42% for the one year risk-free rate? Since Zimbabwe is so close to SA and has so many Rands in its economy, would using SA’s repo rate at 6% be a sensible idea?

There are so many questions on the ‘risk-free’ rate in Zimbabwe as there are equally so many divergent answers. Policy makers need to understand that markets cannot be left to wonder and wander for so long because of the many distortions and economic costs this bring about in the wider economy. Zimbabwe’s inflation, unemployment, income levels and other key dynamics are so different from the countries whose currencies it has adopted, and therefore to have a reference to South Africa, US, UK or Australia’s reference pricing is not only a blind move, but a costly one too. For a country struggling with high unemployment estimated above 60% and worrying under-employment levels, the road to stabilization becomes long and costly too.

Notwithstanding its current debt challenges, the Zimbabwean government has to step in and set the ‘risk-free’ rate in line with the macro-economic dynamics of the country. The government therefore has to start issuing TBs and Bonds to give the market direction. Today municipalities, corporates and many other players in Zimbabwe wishing to interrogate the domestic debt market efficiently through issuing bonds to revamp their structural challenges are faced with the burdensome challenge of not knowing the ‘anchor’ risk-free rate. The borrowers are not willing to get into long-term debt arrangement for fear of locking themselves expensively on the long-end if consideration is given to the current high interest rates. The fear of making mistakes is compounded by that fact that no long-term reference pricing exists in the market, and considering the fresh history of the hyper-inflationary environment, the decision making process finds peace in going for short term debt arrangements, or, not at all! Yet, ironically, most corporates in Zimbabwe require reasonably-priced long-term capital to breathe life into the balance sheets that have been severely weakened by years of hyper-inflation.

The banks on the other hand are lending largely on the short-end, up to 3 months, in line with the same mentality of not knowing what the future holds. For the banks, the fear of the future is compounded more by the economy-wide liquidity constraints, the absence of lender of last resort, non-existence of liquid ‘risk-free’ assets and the dearth of a secondary market for credit securities. The secondary market is always a very vital window in generating liquidity on bank balance sheets in times of liquidity challenges. How do banks therefore effectively trade credit instruments on the secondary market without perfect knowledge of the policy risk-free rate? It would therefore be so unreasonable to trivialize the importance of the ‘risk-free rate’ in an economy that has a long history of policy uncertainty. And without the policy rate, any long-term pricing is left to speculation and as with the current case in Zimbabwe, the borrowers, and hence the wider economy, suffer from lack of reasonably priced short and long-term capital.

As companies continue to reel under serious capitalization challenges, and with banks’ loan-to deposit still below the desirable levels, the policy makers need to understand that equally the government revenue, which is itself a function of the scale of economic activities, would continue to remain depressed. Zimbabwe expects only about $1.4 billion revenue in 2010, and saddled with $1.7 billion of recurrent expenditure (117% of revenue), the helping hand of the donors has been over-estimated in the current fiscal year. This therefore requires structural and pragmatic solutions for the Zimbabwean economy, and totally missing the importance of a well-functional financial system with appropriate policy instruments to manage pricing expectations is retrogressive.

Free markets are generally thought to be efficient, but the recent global financial challenges have left huge holes on the validity of such assertions. Expecting therefore pricing efficiency on the money market in Zimbabwe without some policy benchmarks to guide expectations is putting too much faith in the power of markets to allocate resources efficiently. The effectiveness of monetary policy in some African economies continues to be debatable. As with Zimbabwe’s history, and with what has been happening in Zambia, Tanzania, Kenya etc, there definitely could be a dislocation in the efficiency of the monetary policy in influencing the real interest rates in the economy, but it is still much better to have a measure of the variance than not to have one at all. Zimbabwean policy makers should therefore never under-estimate the psychological power of the policy rate in influencing the decision making process and flow of money in the economy.

With the South Africa Rand expected to remain strong in the next 6 six months or so on the back of significant carry trade transactions on the back of very lucrative interest rate differentials between the Euro-Zone & USA, some curious eyes in Zimbabwe begin to wonder why Zimbabwe, with much higher interest rates than the 6% obtainable in SA, is not attracting so much, if at all, in terms of foreign portfolio investment inflows. SA has attracted over $2 billion of foreign portfolio investment inflows this year alone into bonds as foreign investors enjoy the ‘sunny’ interest rates. Why wouldn’t an investor in UK or Germany borrow at their current rates of around 1% per annum and invest in 20% yields obtaining on the Zimbabwean market? The key consideration for most investors would be around the sustainability of the obtaining yields in Zimbabwe. When one digs deeper to evaluate the extent of the credit spreads and realizes that in fact there is no reference risk-free rate in the economy, the conclusion that such yields are unsustainable and therefore a house of cards is difficult to argue with. On the other hand, the short-term nature of the investment assets in the market hastily confirms this fear, and as such attracting meaningful carry-trade related foreign portfolio investments into Zimbabwe becomes a pipe-dream.

The Zimbabwe policy makers therefore need to consider seriously that inasmuch as they wouldn’t want to plunge into unnecessary debt arrangements because of the current debt burden, the costs of an inefficient money market pricing system in not a better choice either. Many key fiscal requirements of capital nature require funding in Zimbabwe today to stimulate growth. Therefore raising debt in the market with the twin objectives of funding activities with larger multiplier effects on employment creation and on the other hand giving the financial markets risk-free benchmarks could be the one of the best policy option that policy makers can take in addressing an array of challenges with one stroke of action. Equally important would be the adequate capitalization of the RBZ to allow it to carry out the functions of ‘lender of last resort’ to calm the nerves on the interbank market.

Fiscal policy dilemma runs deep in Zimbabwe

Maintaining the growth momentum in the economic stabilization phase is a very crucial element in creating both private and public sector confidence, especially when coming out of a 10-year recession. And the ability of Zimbabwean policy makers to keep delivering the growth promise will depend on their choices of sustainable policies. Worldwide, governments have varying history of making good and bad decisions, but what always makes the positive difference at the end of the day is the consistence in making more good decisions and reducing the incidences, and indeed implementation of bad decisions for a long time. The price slashes of yester-year, wholesale economy-wide subsidies and exchange control regulations are some of the bad economic decisions by the Zimbabwe government that were implemented and believed in for a long time, and the results of such policies have left a huge dent on the economic landscape.

The time has come again for the Zimbabwe government to make hard, but corrective decisions. There is need to implement drastic civil service reforms to unlock the obtaining scarce financial resources towards more productive sectors of the economy ahead of the wasteful consumptive expenditure gobbling 70% of domestic revenue. After having placed too much, and indeed questionable faith on the influence of donors on funding the 2010 budget, realities of donors not playing ball have come to poke holes in the optimism of the stabilization process. Having received only about $3 million of the anticipated $810 donor support by end of March, the Zimbabwean government has little option but to re-write the 2010 budget during the half-year review and institute a serious civil service reform.

Donor challenges are not uncommon at all in Africa. Mozambique has seen challenges after donors threatened to withhold $472 million in the 2010 budgetary support, while Malawi had to plead with the IMF for it to negotiate with donors to release $545 million they were withholding in budgetary support. Malawi is one of the highest per capita aid receipts in Africa with donors supporting 40% of its budget for about 14 million people. Zambia was equally left in the limbo when donors threatened to suspend $600 million in donor funds for the 2010 budget over allegations of public sector corruption, and the government had to dig in by making budgetary cuts. Tanzania, having had a fair challenge with some donors in the past, has about $831 million donor funding for the 2009/2010 budget, constituting about 12% of its budget from about 14 major donor countries.

These figures show that donors still play a very crucial role in providing development finance in many African countries, but it is important to note equally that getting significant donor funds is not always easy and understanding their behavior is vital for Zimbabwe when making budgetary consideration on such funds. There are so many conditions that donors attach to their bags of cash. Failure to meet such conditions invites threats, the many threats that always create uneasiness and headaches when Finance Ministers in Africa prepare their national budgets with begging bowls in hand.

Unfortunately the Zimbabwean government has little room to tweak the revenue side to meet the original budgetary expectations now that donors have not come in as anticipated. Domestic borrowing, though inexistent but very crucial at the moment, will be lucky to raise over $300 million considering low deposit levels in the banking sector below $1.5 billion and risk aversion. Very few options therefore remain at hand for the Zimbabwean government in raising the revenue levels from the projected $1.4 billion for the 2010 fiscal year. The privatization route, a process that cannot be hastened considering the deplorable nature of some of the key targets, is nothing to write home about, although it would still be crucial to stop fiscal bleeding through subsidies to inefficient Parastatals that have long ceased to be valuable by any measure of economic logic.

The government, being the largest employer and capping salaries at less than $300 per month, has spelt gloom on the private sector wages expectations. Vibrant domestic demand is what will pull the Zimbabwean economy back on track as that will provide a strong market for domestic producers, whilst the secondary effect on government revenue would be quite significant. Inasmuch as the current weak government finances diminishes the rate of economic recovery, more can still be done to create an efficient public finance management program that will spur growth faster than the current rate of growth. The current government wage-bill at 70% of the domestic revenues is unsustainable and reveals deep-seated inefficiencies in the government decision making processes and prioritizations. The Zimbabwean economy has shrunk by over 40% since 1999, whilst the civil service figures have hovered around the same levels over the same period.

The priority of the government therefore should be to have a credible and effective civil service reform that reduces the number of civil servants by almost half, an exercise that will unlock at least $200 million annually toward capital expenditure, which in itself will self-correct the situation over time by creating more employment opportunities. Although this is a politically sensitive issue especially ahead of elections that can be held anytime from 2011, the Zimbabwe Unity government should understand that making this decision collectively now could be the best option for the party that will eventually win the elections. The winning party will begin on more efficient government structures and will most likely be able to deliver pre-election promises than having to start cleaning up the mess from day one in office. For a country whose average civil service salaries had plummeted to less than $10 per month in 2008, the current civil service salary levels today around $200 per month are a major milestone although more needs to be done to bring cascading salary scales that will allow the public service to attract efficient labour into its structures. But are the policy makers ready to make that decision that can ruffle the very political votes they need to remain in office? That is the biggest dilemma. Either they keep the unsustainable civil service without any reform, in the process burdening the economic recovery process, or they reform, face the militant labor unions but eventually deliver the promise. The government ought to have learnt from the past mistakes of unsustainable policies for short-term gains, and this time around history should be the best teacher.

Zimbabwe has suffered massive brain drain on the back of deteriorating economic conditions, and attracting good engineers, administrators, scientists, economists, IT specialists etc back into the civil service today is the most difficult thing to imagine considering the poor working conditions and gloom prospects. The average salary in South Africa is about R 16,500 per month ($2,200) compared to the average wage in Zimbabwe below $500. Considering that the average wage in Zimbabwe was $1,546 in 1990, more needs to be done in aligning government priorities towards sustainable growth, and it starts with its budgetary priorities. Therefore the government, in the quest for sustainable fiscal expenditure and efficient service delivery through proper skills retention and attraction, has very little choice but to implement a drastic civil service reform at the earliest possible to minimize economic losses and sustain growth that will create more employment opportunities and help fight poverty in a broader perspective.

Its all about credit after all

The Reserve Bank of Zimbabwe monetary policy statement (Jan 2010) instills a somewhat cautious optimism on the pace of economic recovery. There have always been worries and talk about Zimbabwean banks not doing enough to let credit flow into the economy, more or less the same worries that gripped the world after global banks suddenly slowed on lending after the sub-prime mortgage market crisis –induced recession. Governments around the rich world responded through ‘quantitative easing’, flooding the markets with liquidity to ease banks’ worries of liquidity crunch. The IMF still worries today that hastened withdrawal of this fiscal support to the markets could jeopardize the global recovery process.

Of interest therefore to Zimbabwe is the rate of credit creation in the economy, and in particular, the ability of banks to generate loans from the deposits at hand, measured by the loan-to-deposit ratio. Total bank deposits are currently sitting at about $1.3 billion, with the loan-to-deposit ratio at 49%. The general perception in the economy is that the banks are taking a very cautious approach towards lending and they should instead let credit flow more freely into the thirsty economy. Understanding the behavior of the banks would be very important in creating and stimulating the right policies that will support the commendable economic recovery process the country is currently enjoying. What exactly is the position of regional countries on the ability of banks to create loan on their balance sheets, and are Zimbabwean banks so much off the mark? Let us look across Africa and see if we can draw any important lessons on this important aspect.

Across the Limpopo, South Africa (SA) sits on about $321 billion in deposits, with loans at $306 billion, thus giving one of the highest loan-to-deposit ratios in Sub-Saharan Africa at 95%. The structured finance market, which doesn’t exist in Zimbabwe, is active in SA. Globally, securitization has brought about the ability of banks to increase liquidity and spread risk, implying more loans can be generated on bank balance sheet. For now let us pay a blind eye to some of the challenges of securitization that emerged from the sub-prime mortgage market crisis where greedy originators tricked the markets, and indeed successfully.

Securitization is dead in the Zimbabwean markets, which means therefore that banks have to keep a closer eye on both liquidity and credit risks as assets sit permanently on their balance sheets until they mature. Looking at it closely reveals that in fact there aren’t any meaningful assets to securitize because the asset classes in the market are too narrow. Impliedly, it would be therefore dangerous for banks to have high loan-to-deposit ratios because they cannot repackage and sell these on the secondary market to generate liquidity and spread risk. Expecting Zimbabwean banks to quickly follow the SA model and shore up the loan-to-deposit ratio to around 90% or thereabout may be expecting too much. Although this high loan to deposit ratio existing in SA hit the banks hard during 2009 when by June 2009 impairments had reached $18.5 billion due to slowdown in economic activities, the SA banks continue to create more value in loans ahead of the traditional liquid assets, with the liquid asset ratio at only 5%. A rather efficient loan distribution mechanism exists in the SA economy where private households account for the greatest chunk of credit, taking up 38% of the total loans. The manufacturing, mining and agriculture sectors take up only 4%, 3% and 1.5% of total loans.

Across the Zambezi, Zambia’s deposits stood at only $3.1 billion in October 2009, with a loan to deposit ratio of only 57%. Although having witnessed strong GDP growth of above 5% for the 6 years to 2008, the depth of the financial markets remain very shallow in Zambia, just like Zimbabwe’s. The shallow markets have constantly resulted in the poor transmission of monetary policy in influencing real economic activities on the ground. Resultantly, Zambia’s borrowing rates have remained very high and prohibitive. The excessive credit spreads reveal huge underlying inefficiencies in the market borne out of inherent high credit risk in an economy whose fortunes correlate strongly with the swings in copper prices.

It is important to note that key developments have taken place in the Zambian market, which overall is good for the development of the credit markets. The central bank’s aggressive liquidity sterilization exercise that responded to the influx of donor funds and high copper prices then in the 2004 -2008 period in order to tame inflation has moderated. Subsequently, the yields on government paper have come done significantly from about 18% in December 2008 to about 9% currently. This has somewhat reduced the past overbearing influence of the government crowding out private sector borrowers, and the loan-to-deposit ratio should therefore be expected rise from the current levels, whilst the liquid asset portfolio, which makes up 19% of total assets, should be coming off as banks should now be pursuing the lucrative credit markets.

However when evaluated against its GDP, Zambia’s deposits to GDP at only 20% reveal a huge challenge in the ability of the local financial institutions to influence growth at the house-hold level, and that explains why consumer credit in Zambia from micro-finance companies is among the highest in the world at around 10%-15% per month, whilst credit from mainstream banking at around 25% is high considering the inflation and yield curve dynamics in the economy. The important lesson we are drawing from Zambia is that the current economic stability in Zimbabwe may not necessarily imply reduced cost of credit and efficient market pricing mechanism. A lot of work still needs to be done at the policy level to avoid market failure, and that starts with the need to understand the importance of a secondary market.

When one then compares Zimbabwe to South Africa, Zambia, Tanzania, Kenya etc, there is definitely an anomaly on the low loan-to-deposit ratio that is peculiar to Zimbabwe. Kenya, with about $12 billion deposits on a $35 billion GDP, has a loan to deposit ratio similar to Tanzania at around 68%. The issues affecting the flow of credit can therefore be summarized as follows: First, credit risk is still very pronounced in Zimbabwe at the moment, and banks wouldn’t want to buy into economy-wide risks that much yet. Banks would argue that quality borrowers are very few, and because of the depressed markets, the securities being offered by most of the borrowers would be so difficult to turn into cash when push comes to shove.

With the banking sector now having to contend with tough capital requirements, rising impairments out of exuberant lending may claim scalps in the boardroom. Only foolish shareholders would subsidize management inefficiencies and imprudence manifesting in high loan loss ratios. Second comes the absence of a risk-free liquid asset portfolio in the Zimbabwean financial market, and that ties up well with the nonexistence of ‘lender of last resort’ functionality due to poor capitalization of the central bank. This compels the banks to keep more of the cash close to the chest. Third, we have the deficiency of a strong market pricing discovery system due to the absence of a yield curve and the defunct secondary market for credit securities. This puts a lot of risk on loans, more so when trying to generate liquidity on bank balance sheets in times of need.

Lastly, the country risk, on the back of huge debt level, is still very high and the international banks’ country exposure limits remain low. This means that some of the big banks in Zimbabwe that are foreign owned will not be flexible enough to tweak their asset allocation as they will be guided by their respective global risk frameworks that will be minimizing exposure to some assets in Zimbabwe, regardless of whether the deposits are from Zimbabwe or not. And because the international banks command huge deposits, their overall lending policy tend to influence significantly the overall asset allocation in the banking sector.

These are some of the key policy issues that would need to be addressed in order to see a marked improvement in the flow of credit into the economy, more so credit to individuals that seem to be the last priority. Individuals, exhibiting pronounced instability due to fragile disposable incomes emanating from low but growing average salaries around $300 per month, have a small share of the market loans at only 5% in Zimbabwe. Although the sustainability of the transformative effect of household debt on economic growth has come into serious question globally considering the recent intoxication of American households with excessive debt that plunged them, and indeed the whole world, into the sub-prime mortgage crisis, the Zimbabwean recovery process will be without doubt much faster if households can miraculously bring forward future consumption via credit. The secondary effect through rising employment creation for the domestic producers and service providers will in turn bolster the current fragile fiscal revenue and begin to mold a sustainable growth path for the economy.

LIQUIDTY CRUNCH DRIVING COST OF CAPITAL TO CRAZY HEIGHTS IN ZIMBABWE

The liquidity crunch that came with the adoption of the multiple currencies in 2008 has lasted for over a year now, and there aren’t signs that the crunch will thaw any sooner. Although bank deposits have grown by over 500% since then to over $1.2 billion today, the demand for credit has continued to rise. As expected, a steep scarcity premium had been borne out of the crunch, and those controlling the levers of liquidity are benefiting from the lucrative returns on cash. The huge and unsustainable debt overhang gagging the Central government at $5.7 billion exacerbates the liquidity crunch as the flow of offshore lines of credit is repulsed on the back of high potential country risk. The aftermath of the global liquidity crunch continue to haunt capital flows to perceived high risk destinations, and amid tradition and history clear on the high risks associated with countries saddled with high debt, attracting significant lines of credit is a big hurdle that Zimbabwe faces today.

The liquidity crunch in the Zimbabwe’s money markets has seen the ‘cash’ investment asset portfolio taking a leading position in the investment models of many pension funds and Fund Managers in town, taking away the glitter from the Zimbabwe Stock Exchange. With cash portfolios yielding between 27% and 43% on annualised basis because of the scarcity, most portfolios are being re-constructed to mirror these market fundamentals. The issue of the sustainability of these returns over the long term is what might be the sticky point, but the basic fundamentals of the risk-reward trade-off will continue to see more flows into the cash portfolios as long as yields are above 20%, more so in a country that is having negative inflation in real US$ terms.

Although it’s a boon for those with cash, the liquidity crunch has wider negative effects for the economy. It’s not very uncommon to find money being lent at between 3% and 5% flat per month in Zimbabwe today, and when compounded, the effective annual cost of borrowing for the majority of companies that badly need working capital is between 43% and 80% respectively. Worse still, lending rates around 10% flat per month are existing in the market for others, and the effective annual compounded cost of credit at 214% makes distorts the market further. The few lucky established companies that are accessing credit around 20% are getting it at favorable cost. This high cost of credit is inhibiting credit creation, and with the stiff competition coming from global producers, Zimbabwean companies are now faced with serious competitiveness challenges. With the average loan tenor around 90-days, the credit cycle is so short to allow corporate to restructure their balance sheets.

Long term debt is what most companies in Zimbabwe need today. Manufacturers need to re-tool, refurbish and revamp most of the production processes in order to compete with low cost producers in the region and Asia. The construction and real estate industries need reasonably priced long term debt, (with tenor of at least one year), to begin where they left. The mining industry is choking with lack of equipment, and requires concessionary funding, more so for indigenous small scale miners who cannot interrogate the offshore markets for funding. The sad reality is that the money within the borders of Zimbabwe around $1.5 billion is too little to meet the demands, and worse still, all these sectors of the economy require long term funding which is not available.

The secondary market for marketable credit securities has long dried, and with the RBZ incapacitated to play the effective role of the lender of last resort, it would only take a foolish bank to disregard inherent potential liquidity risks and plunge into generating disproportionate long-term assets on its balance sheet on the back of volatile deposits. Banking regulations state that a bank cannot lend more than 25% of its capital to a single entity, and considering the existing capital bases of banks in the market, few banks can lend over $2 million to a single entity. The last press release from the RBZ in October of 2009 showed 15 banks having capital less than $10 million, and only three of the 26 banks having capital in excess of $20 million. The property market is very depressed in Zimbabwe, and being prudent requires one to net off some significant part of ‘investment properties’ on bank capital balances in evaluating the exact real risk that a bank can stomach on its balance sheet without running into serious liquidity challenges. This compounds the challenges some banks face today in evaluating the extent and magnitude of risk they can take on their balance sheets since part of their capital bases cannot be easily manipulated to be the ‘last line of defense against losses’ in a market that has no liquidity. These aspects continue to stifle the creation of long term loans in the market on the back of volatile deposits.

The goodwill associated with listed companies has not been so helpfully either in allowing them easy access to credit. Most of the listed companies on the ZSE are in dire need of capital, and the inability of the banks to underwrite the rights-issues means that the SMEs and other non-listed companies are crowded out of the market, and have to bear the brunt of the most expensive money being offered in the market because of their perceived risk. Let’s take an example in the market. One local bank was the underwriter in the recent $10 million Africa Sun’s right issue, and about $3 million was not subscribed to, which automatically had to be taken up by the underwriters. Taking this said bank’s capital figure of about $541 766 as of 31 October 2009, it implies a huge solvency risk on part of the bank in underwriting such a transaction. An underwriter in such a case would need strong off-takers to relieve the pressure. This reality will continue to see banks taking a very cautious approach towards underwriting right-issues for listed companies. Resultantly, the pressure will continue to pile on the little credit that is available in the market, and because they can easily offer their near-liquid shares as security, the listed companies will continue to get favorable cost of capital ahead of non-listed companies.

The challenges of credit availability continue to drag the recovery process, and the key policy issues should therefore be centering on developing the financial services sector to ease gridlocks and make credit flow freely and abundantly in the market. One important aspect that is lacking in the market is a yield curve. The central government, through the RBZ, should come into the market and define the yield curve. The last paper that had government guarantee in the market, being the GMB bill, had effective compounded yield of around 24%. Is 24% the yardstick for the floor risk-free rate in Zimbabwe or these bids were accepted because those with cash today are kings who are pulling strings? The government solvency is currently compromised by the existing debt of $5.7 billion, and it wouldn’t be too wise to plunge into fresh debt arrangements. But the financial markets need direction in pricing debt instruments, and we cannot run without a defined yield curve for long lets we prolong the current pricing allocative inefficiencies that will continue to distort the credit markets. We have adopted a multiple currency system, and there are huge variances between the yield curves in the USA and South Africa (SA) because of inflation differentials, different balance of payments benchmarks etc. It would be difficult for Zimbabwe to adopt the yield curves in the USA or SA without paying due attention to our unique dynamics on producer and consumer inflation, perceived country risk and stock of capital. Leaving the markets to roam wide and wild without risk-free benchmarks is not an efficient option.

Policy makers therefore need to guide expectations in the pricing of financial assets, which in turn may cascade to influence the real activities in the economy. Of course the concern that will come to mind quickly centers on the extent to which Zimbabwe can influence the efficiency of the transmission mechanism of monetary policy when using largely the US$ as medium of exchange, whose issuance we are not in control of. But the fact remains the markets are roaming wide and wild, and we need a strong and continuous point of reference for evaluating investment decisions. Considering the importance and centrality of credit creation towards faster recovery, we need to get things right. Therefore addressing the debt challenges, the yield curve and perceived country risk profile should become priorities in order to unlock other gridlocks relating to capital flows and pricing for 2010.

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.

Dollarisation challenges and fortunes for the property market

The property market in Zimbabwe, which had become a refuge for investors during the hyper-inflation episode, has started off on a low, but assuring note after the dollarisation. The rental yields, themselves a function of the income levels and the pace of economic activity, have improved to around 7%, 6.2% and 5.3% in the middle density, high density and low density segments respectively. Considering building costs averaging about $1200 per square meter of office space in Harare, commercial property returns, in particular prime office rental yields, have improved significantly to around 6% in real terms from as low as 0.5% during the 2007-2008. Whilst property owners are now better off compared to their deplorable status of the past decade, the snail pace of income growth will continue to put off significant flows of commercial property investment from international investors as other destinations of real estate capital such as Angola, Zambia, Uganda, Tanzania and SA continue to offer sustainably high returns. Prime office space monthly rentals per square in Sandton, Kampala, Dar es Salaam and Lusaka hover around $13, $15, $17 and $20 respectively; whilst in Luanda any figure under the sun can be charged.

The major players in the property market in Africa, in particular private equity funds, are targeting investment destinations offering internal rates of return above 20%. Considering the current and projected slow growth of Zimbabwean incomes and the absence of a clear and tenable exit market, the majority of international players sitting on hot capital are not putting Zimbabwe on their radar for property investments. This will, on the positive, give indigenous players enough time to take first move advantage positions in the property market and become the torch bearers for tomorrow.

The future of the property market is likely to exhibit improving yields borne out of the bullish projections of GDP that is expected to hit only $6 billion by 2013 according to IMF projections which I believe are too cautious as the country has the potential to grow much faster than that. The increasing disposable incomes which have seen average civil servant wages increasing from as low a $6 per month in 2008 to just below $200 presently, a strengthening banking sector, fiscal discipline and recovering global commodity prices are all vital elements that will contribute towards the property returns firming, edging towards regional parity.

Dollarisation has brought many interesting dynamics to the property market, and it will not be as easy as it has been for the many players who built huge property portfolios over the last 15% whilst benefiting from rising inflation. Anyone who bought a property in ZW$ from bank financing over the last 4 years got it effectively at less than 5% its real value, whilst those that got mortgage financing in 2008 got their property at less than 1% of the real values due to miraculous benefits and healing effects of hyperinflation. Most ZW$ borrowing costs, which became as lucrative as minus 0.99% in 2008, benefited anyone who cared to borrow, from beneficiaries of ASPEF and BACOSSI, to those who got loans to finance or refurbish their property portfolios. I remember presenting to more than 15 ‘big’ corporates and some listed entities during 2007-8 in their strategic meetings, and my key message was always consistent – urging them to borrow as much as their balance sheets could stomach and spend on their wish lists as long as someone would accept their ZW$. Some took the advice and made miraculous changes on their balance sheets, but as time went by, no one serious accepted ZW$ anymore as medium of transaction and eventually the death of the currency closed this exciting chapter in Zimbabwe’s history where a transformative credit binge made borrowers excessively wealthy whilst the lenders, (banks and ordinary people with savings in banks which they couldn’t access because of the cash crisis) were condemned into extremities of poverty.

The dollarisation has now brought about a sobering normalcy, whereby debt is real until it’s fully paid, and there won’t be implicit discounts associated with excessive inflation anymore. The predictability of future incomes and costs imply therefore that the mortgage market reincarnation will come sooner, whilst construction projects that had stalled will be rejuvenated and more importantly, new developments will come on stream. The only question that remains vague however is the ‘when’ bit, as the rate of growth of the GDP, expected around 6 - 7% per annum for the next 4 years, will not be able to rejuvenate the mortgage market to desired levels as the majority of the working class may continue to fall outside the bracket that would be able to afford mortgages for much longer. To access a 12-year Msasa Park mortgage of $50,000 at 10% assuming a loan to value payout of 80%, one would need to be earning a gross monthly salary of around $4000 to qualify. Considering the income levels of the assumed middle class in Zimbabwe, and the projected growth rate of incomes, it will be 2014 when individuals earning around $600 per month today and growing at an average of 40% per annum will be able to afford mortgages for Msasa Park houses. Considering that Zimbabwean incomes missed the miraculous global commodity boom of the last 5 years that transformed the economies of Zambia, Angola, SA and many commodity rich nations in the world, the feat will not be easy, more so now when facing a foul global capital market.

Amid the good prospects of the property market in Zimbabwe, there is absolute confusion in valuation of property portfolios after the dollarisation. In it June 2009 results, Pearl Properties states $230 million as the gross replacement value for its property portfolio offering 117 000 square meters of letable space. This translates to ‘market value’ per square meter at $1981, compared to its current market capitalization per square meter at $254. Mistakenly, one can view Pearl Properties to be trading at a huge discount with an upside potential of 7.5x and consider it a hot ‘buy’. How does Pearl justify building costs at around $2000 per square meter for its property portfolio, more so for Zimbabwe’s climatic conditions that do not require elaborate costly air conditioning as one would find in the MENA region and Parts of East Africa? Although Pearl is trading at some potential discount considering the potential of improving rentals in the market in line with growing Zimbabwean incomes, the market is however not so blind, and has been completely ignoring such lurid gestures of its in-house valuation. It is no wonder Pearl’s market cap remains around $31 million, far from the showy $230 million tag!

It’s not only Pearl Properties that seem to lie underneath a misleading veil of imaginary wealth. Pearl is not alone in the squanddery. The Zimbabwean banking sector is a close cousin of Pearl Properties after it prudently piled its capital into ‘investment properties’ and now seems to suffer the same fate of appearing exaggeratedly rich yet being poor to change its fortunes. Although it was an excellent strategy by Zimbabwean banks during the hyper-inflation environment that decimated all capital in liquid and near-liquid assets (denominated in the now defunct ZW$), the banks today are sitting on low loan-to-deposit ratios due to many reasons, one of them being that the greater part of their capital portions in properties cannot easily absorb risk since its illiquid, and therefore cannot practically act as the ‘last line of defense’ as may be desirable. Unlike European banks that ran on very high loan-to-deposit ratios and later collapsed as the sub-prime mortgage market crisis took its toll, most of the Zimbabwean banks are showing excessive prudence in understanding the limitations of 'investment properties' miracles on their balance sheet by running on low loan-to-deposit ratios.

Hands-off the banking sector

The dust never seems to settle in the banking sector in Zimbabwe, one sector that has been accused of any possible act of sabotage under the sun in Zimbabwe. In 2006-8, the accusations of fuelling the foreign exchange parallel market, creating artificial cash shortages, turning the stock market into a casino and others too many to mention kept the blame game in motion as hyperinflation saw prices of goods doubling on a daily basis. Not all of the accusations were without basis however as a few lousy banks were caught pants down as the Reserve Bank took further steps to prove some of the allegations. However, objective evaluation of the wider accusations always led one to more bigger challenges in the economy beyond the scope of banking, to which banks responded by engaging in ‘depression-bursting techniques’ to stay afloat just like any rational economic player in the economy who has survived to date.

Now the accusations have surfaced, aimed at big banks accused of stashing away cash instead of lending to the needy economy that is running on very thin working capital base relative to the needs of the industry. These accusations, considering the income challenges that the banks are facing in Zimbabwe today and coupled with lack of alternative assets in the market, seem to be largely bizarre. Reading through the accusations, there is one conclusion one can make; only banks with brainless credit risk policies will be found sitting on disproportionate large amounts of non-interest earning cash, whilst only stupid banks will lend every coin they have on their balance sheets and collapse tomorrow. That closes the analysis.

Without any other interest earning asset portfolio existing other than the loans and advances today in Zimbabwe’s banking sphere, and with banks facing huge operational costs and adjustment challenges, any bank with sizeable deposits is in a better shape to meet obligations to staff, shareholders and clients through creating assets on the balance sheet via loans and advances. It therefore would be bizarre to find a bank sitting on excessive cash balances. Doing so would be too is too risk averse and such banks don’t deserve a place in the market. The other balancing side of the coin however gives better insight to policy makers and interest groups that may want to blame the banks for not lending every coin of their deposit. And that is the issue of liquidity. Traditionally, the RBZ acted as the lender of last resort whereby banks in short positions would get accommodated, whilst at the same time the interbank market has always been active with TBs being used to secure such transactions. Today there is virtually no accommodation from the RBZ for banks in need of liquidity because the central bank itself has no sufficient buffers of currencies, whilst on the same note the interbank market is sticky as few bankers’ acceptances are acceptable as security amongst banks. The listed companies, whose shareholders cannot respond to right issues as they have equally been decimated by a decade long hyper-inflation, have swooped on the credit markets, suffocating the smaller unlisted companies since their bankers’ acceptances are deemed liquid to some extent.

The market is therefore very illiquid, and those in the know understand the disastrous impact of running a bank with a very high loan-to-deposit ratio in a market that is as illiquid as Zimbabwe’s. That bank may not live long to be recognised as a bank that made the difference. True, the economy needs to resuscitate production, but the deposits in the banking sector at around $500 million in May 2009 are too thin to meet the needs of the thirsty economy. As long as Fidelity Printers is not printing US$ and with the RBZ having to rely on legitimate built-up of reserves, it will take a long time for the RBZ to accumulate sufficient foreign currency buffers to oil operations of the interbank market. And as long as the interbank market is not efficient, whilst the accommodation policy of the RBZ is dead, the banks have therefore every right to maintain huge liquidity buffers. Unfortunately because of the market dynamics, this liquidity portfolio will be in the form of cash. Considering the painful adjustment mechanism companies are going through, bad loans are now a potential threat in the banking sector that had gone for the last 5 successive years with the lowest loan loss ratio in the world due to inflation that kept borrowing the most lucrative thing. Banks therefore have to balance the liquidity issue and solvency needs, more so now they need to boost capital levels to the new requirements around $12 million after losing all the capital to inflation.

With this complete picture in mind, the banking sector in Zimbabwe is treading on one of the most difficult paths in its history, and criticism that does not take into account the intricacies of these liquidity dynamics will largely miss the point. Instead, the government should scrutinise itself and evaluate what it has done to assist in credit creation. Instead, the issue of reducing the statutory reserves to zero should be a key priority in a market that is sitting on arguably the lowest deposit base in Africa relative to its capacity.

Elsewhere, the challenges are more or less the same. The huge disparity between the lending rates and repo rates in Tanzania and South Africa have been misconstrued by some policy makers as inhibiting the interest rate pass through, hence undermining the efficiency of monetary policy to influence real economic activities. In Tanzania, with the banking sector sitting on total deposits of about $5 billion and $6.1 billion in assets, the big banks have about 50% of balance sheets in loans and advances and a sizeable 16% in government securities. What has attracted attention is the average annualised cost of borrowing of about 20% per annum compared to mild annual inflation running at 11.3% year-on year ( May). The sector has been accused of reaping off borrowers and therefore inhibiting credit extension mainly to the small companies that are in the growth phase. The call to reduce interest rates in Tanzania would be very difficult for banks that would likely see more bad loans as the economy feels strains of collapsed global prices of cotton, Tanzanite and the negative impacts of slowing tourism activities. The government securities, in particular the one year TBs, aren’t attractive anymore for the banks considering the yields have been coming down sharply over the last 10 months, from as high as 18% in October 2007 to the current yields averaging 11%, closely matching inflation that has been coming down in line with commodity prices cooling off.

In SA, the debate sparked by Tito Mboweni with the big banks seems to reinforce the general notion in many African counties that the banks are insensitive to needs of the wider economy, and will go an extra mile in maximising profit. As SA’s Reserve Bank has been hastening the cuts in repo rate to make credit more available in the recession-hit economy, the banks have not been reducing their lending rates at the same pace, attracting attention of the central bank. The efficiency of monetary policy is very important in SA, Africa’s biggest economy with total assets in the banking sector at around $300 billion. With one of the highest loan to GDP ratio on the continent at 78%, the transmission mechanism of monetary policy would need to be more efficient to allow policy makers to manage wider macroeconomic risks and shocks in the quest of maintaining sustainable inflation and unemployment levels. The decision on 25 June by the SA’s Reserve Bank to keep the repo rate unchanged at 7.5% brought even more special interest groups such as Cosatu in condemning the high interest rates, this time the anger being directed at the Reserve Bank for failing to stimulate the economy.

Whilst many African economies are still far from accommodating consumer loans on banks’ balance sheets, SA runs deeper, with home loans and mortgages to total assets at about 31%. This ratio is not significantly different from zero for banks in Tanzania, Zimbabwe, Angola, Mozambique and Zambia, making the interest rate debate in these economies less emotional. Combined with household debt at about 75% of disposable income, the interest rate factor becomes an important issue in SA’s macro-economic framework. In most of the debates around bank interest rates however, many fail to understand the link between the central banks’ provision of liquidity to the banks and the determination of the lending rates based on the repo rate. As long as banks are not borrowing from the central banks to manage their short positions, it will always be difficult for the lending rates to be very responsive to the policy rates. And in such instances, moral suasion would need to do the trick

Green shoots emerging on Zimbabwe’s economic landscape

The major economic indicators point to a brighter future ahead for Zimbabwe, although the major debate would be on how bright things are going to be. GDP growth rate, having contracted by another 14% in 2008, is set rise this year on the back of tangible reforms. The disastrous impact of excessive money printing, illogical price controls and fixed exchange rate that characterized the foundations of the chaotic policy making framework of yesteryear have silently been replaced by silent and steadfast dollarized economy that is self-regulating, in the process taking away the rent-seeking behavior that emanated from seignorage revenue.

The stock market, in itself a barometer of confidence in an economy that has no other known measures of business confidence, has been bullish of late. This bullish trend, although nothing when compared to the mad bulls that characterized 2007 and 2008 on the back of excessive broad money supply growth from a currency that has since died a natural death, is a believable measure of confidence. Between 2004 and early 2009, the Zimbabwe Stock exchange surged and contracted on the whims of market liquidity conditions. These excessive liquidity conditions emanated from surplus positions on the money market from the so called ‘sanctions bursting activities’, ASPEF, BACOSSI facilities and other laxative sterilization strategies of the RBZ that drove the stock market to new records daily, which records were meaningless when converted to real value creation.

That era has passed, and with little doubt, the government and RBZ have little influence in determining the direction of the ZSE on a daily basis as before. Liquidity conditions today definitely play a major role as before, with more flows into the economy translating into share prices gravitating towards their realistic values. The major difference however is that today’s liquidity inflows are emanating from real economic activities compared to irrational explosion of monetary exuberance of the past. All major sources of liquidity inflows into the economy are showing a positive trajectory, from donor funds via exports to external lines of credit flowing in. These are the sources of liquidity that will be more important in oiling the operations of the stock market from the primary trading perspective, whilst constructive impact of these flows on the real economy through increasing productive capacity and bolstering purchasing power reinforces the secondary value perception of listed companies.

Zimbabwe’s productive capacity remains very low below 20% in many extractive and manufacturing industries, whilst the savings rate that has fallen into negative territory due to a decade of hyperinflation is not making the comeback on the real demand side any easier. As the world today warily looks for signs of ‘green shoots’ in the global economy that might signal the beginning of the end to the recession, the return of the majority of the Zimbabwean civil service to work, albeit on $100 per month, is in itself a sign of the first green shoots in the economy that need constant watering until the new plants develop deep roots to weather the dry winters of tomorrow on their own. Notwithstanding the unemployment rate still very high above 80% , whilst the average monthly wages that have improved slightly to around $100 from its lowest of about $40 in 2008, the turning wheels of change in the economy that are seeing pricing predictability are encouraging signs of a positive future. Embracing these positive developments, the industrial index is up 144% from 16 March, whilst the mining index has jumped by a staggering 242% over the same period.

The temptations of fiscal indiscipline that drove budget deficits to above 80% and 100% of GDP in 2007 and 2008 respectively (taking into account unbudgeted RBZ quasi-fiscal activities) and swept the foundations of the economy into a big mess are now in the rear-mirror as the central government cannot print USD and would have to rely on cash budgeting going forward. Bilateral and Multi-lateral support will be low and slower due to the challenges in the global economy, but the official flows that are now reported above US$1 billion are positive signs of part of the global players acknowledging the existence of potential and the need to alleviate suffering in a nation with a bright future.

Notwithstanding the positive signs of progress emanating from dollarisation, arbitrage opportunities continue to present themselves in one form or the other, in the process reflecting the deep scarcity of capital to kick-start the recovery process. Reflecting the huge scarcity of cash for working capital purposes, the cost of borrowing on the USD has risen to as high as 79.5% annualised as lending is now done between 2% to anything up to 5% flat on 30-day cycles. This is far pricey compared to the dollar base rate in African around 10% per annum. Whatever happens however, the banks in Zimbabwe today are not losing capital in buying Treasury Bills (TBs) as they have done over the last decade, and Kenyan banks buying the negative yielding TBs from the Central Bank of Kenya may need to learn from the tragedy of Zimbabwean banks before it is too late. As capital positions of banks strengthen gradually, whilst more inflows from abroad bolster their lending capacity, the cost of capital will surely begin to soften and bring relief to many Zimbabwean producers who are battling with competitiveness against producers in South Africa who are now enjoying favorable borrowing costs and more abundant working capital. The recovery of the Zimbabwean economy without sufficient capital, skills, and favorable commodity prices, will take 5 years and longer, but the positive side is that the recovery has started and what is key is to manage the process and not let loose.

Mining Counters Trading at attractive Discounts on the Zimbabwe Stock Exchange

The series of sectoral analysis on the Zimbabwe Stock Exchange continues. Today's focus shifts to the mining counters. Globally, mines are cutting on production and exploration due to plummeting commodity prices. With the exception of gold and to some extent uranium, the global mining landscape is a sad story. From the miners of rare Tanzanite in Tanzania, to the glitter of diamonds at Debswana in Botswana, the sad news of production cuts and layoffs continue to dominate the landscape. Commodity rich Africa is facing a challenge that is set to slow down and in some instances, reverse the strong growth that had characterized the last five years. Zambia, whose economic prospects swing with in tandem with the international copper prices, has been hit very hard. And since October 20 last year, life has never been the same for Zambian economy.

Copper prices have collapsed by more than 50% from the July 2008 peak of $8940 per tonne. With two thirds of Zambia’s export earnings coming from copper, the exchange rate has responded and collapsed by about 48% to the current $1/KW5592 over the same period. The Lusaka Stock Exchange (LuSE) which had benefited from huge liquidity inflows from largely the exports that sustained a sharply appreciating exchange rate (whilst the local inflation pushed the kwacha share prices upwards) attracted huge attention in 2007 when it bagged a whopping 108% return in US$ terms. It joined the Shanghai Stock Exchange among the league of the best stock markets in 2007. Its a pity today that all who bet on the Kwacha and the LuSE since October 2008 have lost out as the gold train derails. The only benefit coming from the crushing copper prices in Zambia has been less power cuts. The mining sector that used to consume about 49% of the internal generation is cooling off, leaving enough capacity in the national grid to feed other industries and users that would ordinarily suffer when the copper fundamentals are solid. At least Zambia can afford to export to Zimbabwe, thanks to the global crisis.

Angola, whose GDP growth rate rocketed past the 15% mark in 2007 and 2008, joins its league of oil and diamond commodity-rich African countries that have seen fortunes getting darker by the day. It would have to painfully scale down ambitious infrastructure and other social programs as the major sources of revenue have hit a bad patch. Having promised many deliverables in the run-up to the elections, the President of Angola sees the need to kick start an awareness program to educate the citizens of ‘the seriousness of the situation’, of course to manage expectations. Its preparation to host the 2010 Africa Cup of Nations soccer tournament has not come at the right time in its history. There is however a silver lining. Due to the shallow financial markets and the absence of mortgage financing, the property market in Angola, just like the Tanzanian one, has kept its glitter.

Zimbabwe mines missed the global commodity rally of the last five years because of administrative pricing and implicit taxation on the back of many schemes by policy makers that negatively exploited the sector. With that, they missed the biggest opportunity in a century to beef up the physical capital and strengthen their financial reserves. The threat and confusion regarding indigenization scared off potential exploration in other areas, whilst power challenges and the associated illogically exchange rate regime left big scars on the mining landscapes that are much more visible than the dump sites the mines created! Today the exchange rate issue could be over, but without a sustainable price and with no capital to de-water and retool, many of the mines will remain closed. The Mhangura and Inyati copper mines missed a lifetime opportunity when copper prices buoyed exploration and production in Zambia’s copper belt and the rest of the world. Zimbabwe’s copper production has sustained a sharp decrease from as high as 27 000 tonnes in 1980 to as low as 2500 tonnes in 2005, and sadly it will not recover now the prices have slumped and the lines of credit have dried.

For its huge coal reserves, massive operational infrastructure, coking ovens and thermal electricity generation coal in the face of the regional power shortages, Hwange continues to fail to impress investors on the Zimbabwe Stock Exchange and has traded around $25 million market cap for some time. But it’s definitely a good buying opportunity.

The glitter of Rio Zim remains to shine only on Renco mine as Murowa Diamonds stares into the eyes of waning global affection for diamonds. The dollarisation and subsequent policy changes that saw the abolition of the RBZ surrender requirements will put RioZim gold production in favorable light, but its nickel and diamond fundamentals remain challenged. The overall future for the company is much better notwithstanding the challenges. The portfolio comprising coal, metals, gold and diamonds is diversified enough to allow RioZim to inject more capital into higher yielding activities and create value for shareholders in the long term. The sentiment driven gold price, which continues to be buoyed by negative global prospects, will put RioZim gold mining activities in better shape. And should it meet at least its 2007 gold production of about 645kgs, RionZim would be a step stronger in turning strong positive cash flows at a time the banks are not easily loosening the funding towards working capital and other capital projects in the mining sector. Whatever prospects of gold and coal one can look at with the current market cap of Rio Zim around $24 million, it doesn’t need much analysis to see the value that many will scramble for sooner. The fortunes of Falgold follow more or less the same trends.