LIQUIDITY, LIQUIDITY – WHAT A CRUNCH!

The happenings on the economic front in Zimbabwe are reminiscent of horror movie scenes. Every other policy or public official announcement on key aspects, save for inflation figures, points towards more disaster. The government revenue collection figures are very disappointing and having been missing its revenue targets by about $30 million every month this year, the government is fast running broke. On the back of unemployable expenditure reduction and switching alternatives to manage our huge appetite for imports, the trade figures show that the negative balance of payment position is shooting through the roof and unless the figures are incorrect, and indeed they could be, managing liquidity and creating jobs will remain problematic for a long time.  

Statistics from the banks are revealing household indebtedness that is rising at alarming pace! And worse, even nature doesn’t seem to sympathise as below average rainfall is forecast for the 2-012/2013 agricultural season. The biggest of all, the liquidity crunch, does not seem to be ameliorating and has reached worrying levels. It is now being blamed for everything wrong in the economy, just like the shortage of foreign currency, price controls and high inflation were the scapegoats for everything wrong prior to dollarisation in 2009. If Zimbabweans were like the Greek that have taken full time jobs in street strikes and demonstration against austerity measures being undertaken by its government, by now we would have been fed up of demonstrations against the liquidity crunch. 

Save for a few giants in mining such as the diamond, platinum and gold mines, and a handful of companies focusing on fast moving consumer goods and services such as Delta, Innscor and Econet and a few isolated others, the liquidity crunch has had its fair share in battering the economy into bad shape and signs of worse things to come are there for everyone to see. The mid-year results from the banking sector, which are generally the barometer to gauge the healthy state of the economy, are far less impressive and reveal a troubled economy underneath that needs more collective efforts from policy makers and politicians than before to steer it into the right direction.

But sustaining the argument that the liquidity crunch is the cause of most the challenges facing the economy is very flawed, at least from a fundamental perspective. Rather, it is important to note that the liquidity crunch is a product of largely bad decisions by economic agents that have been draining away the massive liquidity flowing into the economy since dollarisation.  There is abundant evidence to prove that the overall nominal liquidity position in the economy has been improving significantly since dollarisation and the structural economy-wide rigidities that make the liquidity untenable needs more of policy coherence and meeting of minds among the policy makers and politicians than focusing solely on liquidity as if it’s the most important economic variable.

The growth in broad monetary aggregates, a good proxy in measuring the general liquidity position, has been impressive since dollarisation in 2009. Banking deposits, which stood at $475 million in April 2009, leapt to a billion dollars six month later in October of the same year. By December of 2010, deposits stood at $2.5 billion and presently there are estimated around $4 billion. An informed conclusion would therefore concede that broad money supply, and indeed private sector credit expansion,  have been skyrocketing at a break-neck speed.  

Another indicator that can shed more light on the directional aspect of the economy-wide liquidity position is the cost and structure of credit in our market. In line with the massive growth in the quantum of liquidity in Zimbabwe since 2009 and rising loan-to deposit ratios, the cost of credit has been coming down sharply, from the highs of over 100% per annum just after dollarisation to the current rates of around 25% per annum. Equally, from a structure perspective, the tenors of credit facilities being offered in the mainstream financial services sector has improved markedly from just 3 months, which was the norm in 2000-2010, to around 1 year in best case scenarios presently, and indeed much better for mortgages finance. All these aspects clearly buttress the notion that the liquidity position in the economy, by and large, has been improving markedly.

On the other hand, evaluating the behavioural aspects of the lenders and borrowers can equally give a good picture on the status and transition of the economy’s overall liquidity position. An economy that is enjoying considerable amounts of fair and easy flowing liquidity is usually characterised of banks lending expansively, whilst borrowers, because of the existence of easy credit, pile up loans quickly and unreasonably. The US sub-prime mortgage market crisis of 2008 has its root problems from this phenomenon. It is much easier to draw a casual link of similar nature in Zimbabwe.

The increasing monetary aggregates since 2009 tempted and indeed misled both lenders and borrowers that the ‘good times would roll forever’. The resultant increasing bank loan-to-deposit ratios, which leapt from 33% in April 2009 to a peak of 87% in December 2011, provide evidence of the lending over-drive by lenders and on the other side, the speedy gearing or indebtedness on part of the borrowers. This reason behind this is quite easy to comprehend though. The abrupt dollarisation of the economy in February of 2009 wiped all the working capital of domestic companies and the need to borrow became so urgent and the only way to survive was through borrowing not only to produce, but equally to pay wages and salaries as the companies had lost everything to inflation, save for physical capital. Yes, the massive gearing of balance sheets by companies was for a noble cause since the dollarisation, without international support, created havoc and indeed the banks need to be applauded for having been lending generously. But, still, not sufficient restraint was employed by the borrowers and lenders.

Therefore the liquidity crunch which has been building up in the economy is in actual fact, emanating from the reality that the many borrowers have lost money on their balance sheets and cannot repay the banks to enable continuos flow of credit in the economy. The problem, as has been explained before, is easily traced to the avalanche of liquidity flowing through the economy since 2009 which, unfortunately, intoxicated weak business models via loans they accessed from banks. The swelling liquidity rivers of life that borrowers jostled to drink from have unfortunately turned to become the same rivers that devour most of those that recklessly drank from them. And the messengers of court and deputy sheriff, who are the undertakers and executors of estates of those that get intoxicated by drinking from these assumed rivers of life, have been very busy. Indeed if these were a business to be listed, the share prices and certainly the dividend payouts would not disappoint for the next three years or so!

Policy makers have attempted to intervene in the crisis. There has been talk of ZETREF and DIMAF funds to improve liquidity and revive financially distressed companies. Inasmuch as it is a good policy to ease pressure off the balance sheets of these distressed companies by pumping cheap and long term money into these weak balance sheets, the fact that the funds are targeting financially distressed companies means that the money is most likely to be lost. One of the most plausible consequences of this intervention is that the companies that will access these loans will simply re-finance their existing loans and at the best case, remain in their current situation awaiting bankruptcy. And for a broke government that is battling to balance key emotive day-to-day survival priorities with such economic interventions, the execution of such decisions will be slow and very painful, if at all they live to be executed.

The foregoing analysis clearly points out that the fundamentals of our economy are quite bad and it is difficult to ascertain the amounts of liquidity that would need to be pumped into this economy until it starts to tick sustainably. Most of the business models that companies are running on are beyond their sale-by date and no matter how much money is pumped into their balance sheets, they will continue to struggle. Given these many liquidity-sapping corporate dinosaurs that litter the economic landscape and the fact that Zimbabwe is dollarised and has no capacity to quantitatively ease the markets, the liquidity crunch is definitely going to stay for another long, long season.

Elsewhere, quantitative easing seems to be the only consensus in stimulating growth that has become very elusive. US Fed announced on Thursday last week that, in the name, letter and spirit of quantitative easing, would start pumping $40 billion monthly in the economy buying mortgage backed securities for an indefinite period until it starts witnessing improvements in the labour market. And interest rates would be kept low until mid 2015! 

SETTING UP OF SMEs STOCK EXCHANGE CRITICAL

The establishment of an SME Stock Exchange has been a subject of debate for a very long time. The policy makers, as usual, have paid little attention to it, rather preferring not to be seized by ‘small issues’.

Evaluating the path the economy has taken since 2009 provides a fresh understanding of why the Ministry for Small to Medium Enterprises and SME business associations such as ZNCC need to devote much attention towards creating market-based funding solutions for SMEs. And equally important would be the need for policy makers to understand that SMEs are not only the market stalls at Mupedzanhamo, Siyaso, grinding mills or other small groceries,  clothing and cellphone shops operating across the country. Yes, this segment is important as it captures the “S” part of the SMEs and provides employment and convenient service to the economy which the big corporates can never match. But the “M” segment equally needs an enabling platform to raise capital as this sector has capacity to generate exports and sustain vibrant labour force.

A closer look at the happenings on the Zimbabwe Stock Exchange, the capital raising market for the big guns in town, shows that indeed much more needs to be done for the SMEs in a market where even the big corporates are struggling. Raising fresh equity has been a nightmare for the ZSE listed companies. About 15% of the ZSE listed companies embarked on rights issues since dollarisation, and save for OK Zimbabwe’s and one or two others, most of them were not successful as anticipated. Some planned right issues for CFI and Steelnet for example, could not even take off as shareholders understood, albeit lately after having shown intention to do so, that they had no money to follow their rights. A poorly subscribed African Sun’s $10 million right issue left some underwriting bank in serious trouble as it found itself with a commitment it could not fund.

The answer behind the poor subscription of the rights issues is found in our history. Current local shareholders of companies in Zimbabwe had their savings and part of capital wiped out when the economy dollarised in 2009. One can surely not fault them for failing to inject fresh equity into most struggling companies. Amid the hyperinflation, it was almost impossible for corporates to have savings in foreign currency. The many exchange control regulations that existed then made it almost a criminal office to have savings in foreign currency. One’s holding of foreign currency could not escape criminal charges relating to externalisation, illegal possession, failure to acquit export earnings or simply accusations of economic sabotage. Hence all honest Zimbabwe businesses and shareholders lost significant portions of their capital to inflation. The need to recapitalise came immediately after dollarisation and expecting existing local shareholders to inject fresh capital into their struggling businesses is a very tough call. They simply do not have the money because the operating environment and dollarisation made it mathematically impossible to defend not only capital positions, but more importantly, cashflows.

The debt route became the most obvious way towards funding businesses and indeed today we see most companies struggling with debt acquired post dollarisation. At least the listed companies have distinct advantages over the unlisted ones in accessing credit. To some extent lenders accept the shares of listed companies as collateral and until lately, the basic belief, among lenders was that listed companies are blue chip and could even be lent money without collateral. Most of the credit in the market was therefore flowing towards listed companies at the expense of SMEs. Most SMEs therefore find themselves on the peripheries of the credit markets where high cost of debt, stringent collateral demands and very short tenors are the rules of the game that have been affecting their ability to grow businesses beyond hand-to-mouth.

Belatedly, the deteriorating balance sheets of listed companies that have resultantly exposed most lenders in the market has changed market perception about the bankability of the SME sector. Most lenders have burnt their fingers on lending to listed companies, more so when they held the shares as collateral.  CAPs, Steelnet, Rio Zim among others, are clear examples of listed companies that have taught lenders the basics of lending. These lessons have opened up opportunities for SMEs as most banks are now focusing on SMEs as a more attractive and manageable asset segment.

Notwithstanding the shift in focus from the lenders to target more of SMEs, the debt route is not the most optimal funding solution for SMEs. Equally important to note is that the stringent collateral requirements imposed by the lenders means that some SMEs with good business models will fail to take off as they fail to access credit. For example, raising $100,000 is extremely difficult for a small or medium sized company in Zimbabwe. With lenders on average requiring collateral twice as much as the value of the loan, this level of borrowing requires immovable assets in excess of $200,000. This figure is not small for what would be called SMEs in Zimbabwe and therefore most of the SMEs, no matter how good their business models are, still fail to access credit in the market. For the few lucky ones having the collateral, the loan tenor is usually shorter than desirable as most credit facilities are at best 6 months.

The working capital cycles therefore become seriously compromised and most SMEs in manufacturing and sourcing inputs from as far as China will find it almost impossible to repay their loans on time. It is therefore not surprising that, notwithstanding the lenders seeking stable asset classes in lending to SMEs, foreclosures rates on SMEs are increasing at an disturbing rate. Almost every other day one reads from the local newspapers sizeable numbers of properties going under the hammer as the Deputy Sheriff auctions properties for those who would have failed to repay their loans with lenders.

The SME model is therefore under threat. A platform in the form of an SME Stock Exchange has to be created where strong SME models can tap into the market and raise capital. From a logical perspective, investors with surplus cash would most likely create value when investing in smaller and efficiently run companies than most of the ZSE listed companies that have big inefficient and rigid operational structures that are no longer relevant in this environment. The market has sufficient capacity and depth to support an SME Stock Exchange, with the big pension funds such as NSSA needing rather to focus on supporting IPOs of small efficient companies than keep sinking money in right issues of dead listed companies that will not resurrect.  Some few honest listed companies have been honourable enough to say the truth about how difficult the operating environment has become and discontinuing operations. 

Chemco, notwithstanding the parent company having reasonable access to funding, is closing some of its manufacturing business units because they cannot produce at competitive prices. It will instead start ‘trading’, buying from low cost producers abroad and selling locally. Apex has shed some of its foundries amid viability concerns. Other stubborn listed companies unwilling to face reality and cut losses short much earlier struggle on until the day they will most likely collapse, but in spectacular fashion. When listed companies with relatively easy access to debt are finding it tough, the writing is therefore clearer on the wall that the SMEs are likely to struggle much more.

The policy makers, for being what they are, will never champion the formation of the SME stock Exchange. Such associations as the ZNCC have to seize call and lobby aggressively with the relevant ministries to ensure that the setting up of a secondary bourse comes to being a reality. Of course it remains fact that merely raising fresh capital from the stock market is not what will make SMEs vibrant. A host of all other challenges such as poor public infrastructure, weak domestic market, power challenges and inefficient supply chains, among others, will continue to pose challenges on the competitiveness of the SME models. But nevertheless, an efficient platform has to be in place for SMEs with viable models to tap in to the capital markets and expand their businesses. And it is the creation of a secondary bourse will achieve that for a sector that feels neglected. 

Soft Infrastructure Critical For Success of Small Scale Miners

Harare Shamva road is largely a quiet road when compared to other busy inter-town highway. Those that drive down the road will, with no doubt, enjoy the pothole free highway. Driving with a relaxed mind, one has good chances to marvel at some beautiful hills and pollution-free man-made small dams that adorn the snaking road.  

About 80km from Harare towards Shamva, there is some activity to the right side of the road where Shamva gold mine has been operating for many years.  Just across Shamva gold mine, about 4 km away in a very bad dusty road, lies the famous Tafuna Hills. From the main road, Tafuna Hills looks serene and just like other ordinary hills in the area.  The very steep slopes and ordinary looks would, under normal circumstances, not entice a person driving down the highway to cast a second glance. Rather, the collapsed Shamva gold mine shaft that is visible from a distance may be a more intriguing attraction.

Tafuna Hills however offers much more than what meets the eye from a distance. A snaky and gullied dust road from the highway takes one to the foot of these hills and, all of a sudden, there are signs of concentrated human settlements, including shacks.  A further drive up the hills would herald the start of small scale gold mining activities. The many small scale miners that form part of the envied Tafuna Hills mining community have one thing in common – good ore yields around 8 grams per tonne and lack of mining equipment. The latter is a big problem.

The small scale miners, working in groups popularly known as syndicates, use hammer and chisel to dig into earth in pursuit of lucrative gold reefs, largely known as ‘bandi’. Very few have capacity to hire or buy compressors to drill and blast the very hard blue stones that characterise the area. Equally, an even fewer number has slurry pumps to pump out water from the shafts as they encounter more underground water the deeper they go. With this very manual and painful way of extracting gold ore from underground, many of these small scale miners end up hauling out, at best 4 tonnes of gold ore per week. The average weekly earnings therefore converge around $180 per week for most of the syndicate partners. Considering the very low alternative returns from other rural activities such as farming, this reward for labour is very high and addictive that it keeps attracting the small scale miners to shed sweat in the unsafe underground work environments. This tale is common for most small scale gold miners across the country. 

Small scale gold miners, whose definition expands to capture as well these non-mechanised producers, contribute about 50% of the total gold production in Zimbabwe. Zimbabwe gold exports rose to $627 million in 2011 and may surpass the $900 million mark in 2012. The sector is therefore very crucial after diamond and platinum mining and the government needs to do much more for the small scale gold mining sector to transform its image and improve output. A number of small scale gold mining associations have been regularly calling on the government to come up with schemes that provide funding and equipment to the small scale miners. 

The government has a history of bailing out big corporates and farmers by giving concessionary credit facilities and equipment. The small scale miners believe they deserve the same treatment because of their unquestionable contribution to GDP and exports.  These calls are genuine and seek to address the inconsistencies on part of the government market interventionist policies. But a more objective assessment of the small scale mining industry reveals that they do not need active government assistance in terms of cash hand-outs and equipment. Rather, the small scale miners need to lobby the government, through the Ministry of Mines and Mining Development, to establish efficient soft infrastructure that allows the private sector financiers to find reason to finance the rather lucrative sector. 

The mining registers at the Ministry of mines are not easily verifiable and involve huge hassles in ascertaining ownership. It takes a lot of time to establish who owns what claims, and equally, the claims are not easily transferable. The Ministry of Mines and Mining Development needs a very efficient mining register system that allows easy cross-referencing,  traceability and transferability of ownership. The absence of this soft infrastructure at the Ministry of Mines has been a major source of conflict in many mining transactions and leaves the system subject to manipulation. The Zisco-Essar deal is one such deal that has been subjected to controversy and the root cause can be easily linked to absence of efficient soft infrastructure that allows easy verification. The recent Kwekwe gold rush that grabbed headlines got more exciting not only because of the easy find, but because a number of people had ‘genuine’ certificates proving legitimate ownership of the said gold claims. 

The Zimbabwe Government and ACR disputes over diamond claims in Chiyadzwa can as well be easily linked to inadequate information systems at the Ministry of Mines. And there are many other disputes revolving around ownership of claims that emanate from the inefficient soft infrastructure that exists at the Ministry of Mines and Mining Development. 

Private sector financing mechanism thrives mainly when the underlying collateral is marketable and not easily susceptible to disputes over ownership. The inability of the small scale miners to attract private sector funding is, to a large extent, a result of their inability to prove undisputed ownership of their claims. Zimbabwe has a thriving small scale mining sector and there is no reason why the mainstream lenders should shun this for other sectors of the economy whose prospects may not be even as bright as those of the small scale mining industry. 

The government recently hiked the mining registration and renewal fees to deter speculative holding of claims by individuals and corporates who, according to the government, are disrupting the intertemporal distribution of natural resources wealth. The overall objective is right, but the government has to equally consider sanitising the soft infrastructure aspects relating to ownership verification and transferability of mining claims so that the private sector finance mechanism can easily find small scale miners a good market for lending. 

The local banking sector, sitting just around $3.3 billion deposits and riding on a precarious loan to deposit ratio of around 81%, has no meaningful capacity to finance big mining transactions off the domestic balance sheets. The big mining projects have always been and will, for some time, continue to rely on offshore financing arrangements to fund their requirements. The small scale miners are very much localised in nature and have not capacity to attract off-shore funding and therefore would need to rely on the local banking institution for funding. Expectations by some of the small scale miners associations that the government should provide sustainable funding and equipment purchase schemes for their members are justified, but far fetched. 

Yes, the government has done that before but the scale, reach and success remains very limited relative to the demands of the small scale mining industry. Working towards attracting domestic financiers to finance small scale miners should be the utmost priority for the government and small scale miners associations in search for a sustainable funding solution. And invariably the issue of soft infrastructure becomes the most important aspect that needs to be addressed by the government, without which the small scale miners will remain largely without access to finance.

Small is beautiful after all!

Zimbabwe’s big corporates have hit hard times. Profits are hard to come by, a clear sign that the high gearing levels will persist much longer than desirable. About 36 percent of the listed companies made losses last year, and this year there is no evidence that the situation is going to be much better. In any case, the outlook for this year is much worse than was much anticipated. Cumulative corporate losses have surpassed $710 million since 2009, a frightening figure considering the very low GDP of about $7 billion and the fact that these losses came from companies that contribute less than 10 % to GDP. This revelation should be a clear sign to policy makers that the growth path of this country cannot be pinned on the big corporates alone.  The German and Chinese growth models are now an envy of most countries the world over, and the Zimbabwe government, coming from hyper-inflation, needs to consider the Ministry of Small to Medium Scale Enterprises as the pivot from which sustainable long term growth of economy will emanate from.

A recent report from China reveals that 90% of the private sector businesses that contribute 70% of employment are family owned enterprises. They further contribute 60% to GDP growth and about 50% to tax revenues. The German Mittelstand industrial model, based on small SMES, have provided anchor to the German economic model and today German is one of the strongest economies in the troubled Eurozone. The case for the small companies to champion growth is easy to follow. The SMEs are more efficient in terms of operational structures and can produce, with minimal equipment, goods at lower per unit costs than the big behemoths. 

This past week I visited over 10 SMEs in Chinese light and heavy duty equipment manufacturing companies in the Shanghai and Haining industrial areas in China. I have come to understand the most important dynamic that is at the centre of successful SMEs – thus the ability and flexibility to operate efficiently with minimal multi-skilled labour force and of course optimal investment in equipment. Eight of these companies, with sales averaging around $60,000 per month each, are all export oriented and have never supplied their domestic market notwithstanding operating in very humble premises and committed multi-skilled labour force.

Because of the fierce competition that exists within China itself, most companies thrive to provide goods and services at the most competitive price in order to remain in business. China, which exported good worth $365 billion to the USA in 2010, attributes its success, to a large extent, on the resilient small companies that have not only managed to have an influential depressive role on the national wage rate, but have equally provided the most competition to the big established companies in China. This is the competition that has seen Chinese companies reaching out to the global market for survival and China has since surpassed Germany as the world largest exporter. For the first quarter of 2012, Chinese exports of goods stood at $430 billion.  

Coming back to our domestic investment markets, it is the end of the first quarter and about 46 out of the 76 companies listed on the Zimbabwe stock exchange are trading below their 01 January 2012 prices. Considering that about 36% of the companies listed on the Zimbabwe stock exchange made losses as of 31 December 2011, it therefore becomes comprehensible why the market sentiment is very negative about the prospects of the Zimbabwe Stock Exchange in generating value for investors. There are, of-course, pockets of optimism in the economy but generally when more than a third of listed companies fail to generate positive earnings in an economy that is bullish about recovery, then it is a good cause for concern for investors. 

Notwithstanding that most of the companies are trading below their historical P/E ratios and at about a third of the average P/E ratios of their regional counterparts, the bearish trends are expected to characterise the Zimbabwe Stock Market for the greater part of 2012. The current government of national unity in Zimbabwe has differed over a number of key policy aspects, with the discord growing louder as the talk of elections this year gets momentum. The stock market is the most timid of all investment markets. Its fortunes swing on the extremes of the information continuum. It has the most efficient and equally as well, the most irrational way of transmitting information into pricing of stocks. 

The bickering policy makers in the government of national unity have been sending conflicting signals over the management of the economy. With the talk of elections gathering momentum, the differences are going to be getting sharper and to some extent, will be deliberately over-exaggerated as policy makers wear their political hats and toe party lines religiously in order to retain their ministerial and more importantly, party positions. The Zimbabwe stock market performance for 2012 becomes more sentiment driven under such circumstances and will therefore most likely remain bearish.

The money market average yields during the first quarter of the year, around 15% per annum, are most likely to remain attractive for the greater part of the year. From the market data coming through, banks are most likely to be more liquid this year than they were in 2011 considering that banks controlling about 34% of the loanable funds in the market have indicated that they are engaging in massive slowdown in lending. This move should, under normal circumstances, leave more liquid assets on bank balance sheets and may reduce the banks’ appetite to engage in aggressive funding of short positions that had been keeping the money market in Zimbabwe very lucrative for the past two years as banks competed for scarce liquidity. Notwithstanding the above that points to more liquidity likely to accumulate in the market, the money market is forecast to generally remain in deficit, which deficit, when compared to the aggregate demands of industry, will likely sustain yields of above 10% per annum for investors on the money market. 

Mining and national emotions - the difficulty of separating the two

The extractive industry has become very emotive the world over. It has becomes  so to the extent that even the first world economies such as Australia that would naturally be mistaken to have soft and liberal investment regulations and taxation have taken aggressive steps towards claiming a larger share of from the extractive industry. On 19 March, the Australian Parliament, amid protests from the big mining companies, passed a mineral resource rent tax that will hit hard on coal and iron ore miners, their biggest exports. At 30% of profits, the new taxation laws are expected to rake in $11 billion for the next three years for the Australian government. 

Nigeria, faced with unstable exchange rate at a time its crude oil exports are expected to hut 2.1 million barrels per day starting May, is mooting renegotiating contracts of oil mining companies. The government believes that it is not getting the best value and renegotiating the terms would improve the fiscal revenue for the West African country that is mired in growing conflict over the distribution of oil windfalls.  Ghana, which produced 2.97 million ounces of gold in 2010 and is the second biggest producer of gold in Africa, will this year see its gold miners paying corporate tax at 35% from 25%. An additional 10% tax on windfall profits will be charged. 

Those countries with monopolies on certain commodities have equally joined the fray. Guinea is home to the world’s largest bauxite reserves, and has an estimated 4 billion metric tonnes, which is about half the estimated global reserves. In September 2011, its legislative body approved a new mining code that sees mandatory nationalisation of a 15% shareholding in mining projects, with the government still having an option to buy an additional 20%. The accompanying increases in royalties will see bauxite miners now paying up to $14 per tonne from around $3. 

Zambia, which expects to export copper worth $8 billion in 2012, resolved to double royalties on copper exports to 6%. Julius Malema and his nationalisation anthem may have been discarded from mainstream politics of South Africa, but his scent still pervades the corridors of power, with debates now centering on a proposed 50% windfall tax on super profits, among other proposals such as the 50% capital gains tax on sale of mining claims.  Zimbabwe has stuck its guns on 51% shareholding on all mining activities, with the biggest mining companies such as the mining giant, Zimplats, reported to having complied with the directives. Alluvial diamond mining in Zimbabwe has been solely reserved for the state. The rationale behind these moves by the various countries to gain a bigger share from the exploitation of natural resources is understandable, and to a larger extent, justified. 

The race for global supremacy has, until recently, been championed by technological advancement. Economies that ran ahead the pack with advanced technologies in production of good and services became wealthier and exerted more influence on global order. Commodities, on their own without much value, became very valuable when processed into final consumer and industrial goods. And those countries with advanced technology that could turn commodities into usable consumer and industrial goods enjoyed massive economic growth that transformed societies into what today is referred as the highly industrialised world. That was the industrialisation race. The period spanning between 1990s and 2000s has dramatically changed the shape of global influence as rapid technological advancement and adaptability, combined with the ease of labour mobility have all combined in stealing the competitive advantages of economies such as Japan, the US and Britain, among others, that had run ahead of the pack because of technological advantages. 

Companies in the West and US, have now relocated overseas to position themselves in close proximity to resources and cheap labour. Apple has moved its factory to China in search of cheap labour. Countries endowed with natural resources now understand that they can extract more benefits from whoever is extracting them, and that those companies extracting the resources have little choice but to comply with whatever laws are put in place. This has created a huge opportunity for resource rich countries who now can load huge taxes on mineral exports. The mining companies such as Rio Tint and Xtrata in Australia, Konkola Copper Mines in Zambia,  Gold Fields Limited in Ghana, Zimplats in Zimbabwe, among others, have little choice but to mourn and eventually comply. 

On a related note, Zimbabwe recently mooted plans to compel mining companies to bank locally, and as expected, there are divided opinions. The mining companies are not happy, and they are right.  Coercing mining companies to bank locally may not achieve the desired results on its own. Mining sector requires long term capital that is reasonably priced, especially at a time as now when some mining companies in Zimbabwe missed out on a global commodities boom that ran for seven strong years to 2007.  This was again a time when a global liquidity glut saw easy credit becoming easily available, and indeed the mining industry in Zimbabwe missed both ends due to non-progressive exchange control regulations that disincentivised production. 

Today mining companies need long term capital that is not available locally as bank loans rarely go beyond one year. Moreso, the dollar cost of capital in Zimbabwe is 3 times more expensive compared to the global average. The mining companies therefore desperately need their offshore accounts to secure offshore loans and embark on production. On the other hand, the Zimbabwean government has not been very clear regarding its policy position on the tenure of the multiple currency regime. Long term loans need predictability especially on the currency of settlement. It would be disastrous for mining companies that would have plunged into huge long-term loans to then realise they cannot meet their debt obligations after a currency may affect their ability to get foreign currency on the open market to settle their obligations. It has happened before and the risks recount fresh memories of the serious foreign exchange challenges that this country faced in the five years to 2008. 

But a closer look at all these problems facing the mining sector reflect again the behaviour of economic agents, and indeed policy makers need to start correcting the fundamental policies for a sustainable future.  The banking sector, sitting on only $3.3 billion, is impoverished liquidity wise because the mining companies, among others, have chosen to bank offshore. Zimbabwe mineral exports are in excess of $2 billion annually, and most of it never comes back. The only way to harvest these outflows and create a robust financial market is to compel the mining companies to bank locally. Zambia has a similar challenge. It exports over $6 billion worth of copper annually yet its financial markets sit on only $3.8 billion worth of deposits. And because of this, it has always fought battles with a volatile exchange rate and very high cost of credit above 25% per annum. 

These fundamental challenges need to be addressed in many African countries rich in mineral endowments, and compelling mining companies to bank locally in Zimbabwe is a step in the right direction. The decision however has to balance with other objectives that should ensure that the mining companies retain part of their proceeds to meet external loan obligations since the domestic financial markets, at least for now, remain weak to fund the mining sector

Discounted opportunities on the Zimbabwe Stock Exchange! Really?

The Zimbabwe stock exchange has had a very bad patch lately, very bad indeed. Since the beginning of March, the industrial index has retreated by 4%, whilst the mining index has slipped much more, having lost a whooping 8%. The losses are huge, more so considering the very stable inflation outlook and the good stream of December 2011 results that are coming into the market. Fidelity Life, Dairibord, Pearl Properties and Innscor, among other companies, have posted impressive results that should have ordinarily had lifted the market. But negative sentiments largely emanating from bickering policy makers on key policy aspects continue to cast a big shadow on the future ability of corporates to continuously generate good earnings.

Analysts and investors would generally converge in wide ranging opinions that a handful of the companies on the stock exchange are trading below their net asset values and when evaluated against the tight liquidity conditions in the market and heightened negative sentiments, these opinions could be true. Discounted opportunities can be found here and there, but the general opinion that the market is trading at huge discounts could be, but just faulty.

Pearl Properties, currently trading at a market capitalisation of $41 million is an interesting counter on the stock market! Its December 2011 balance sheet depicts a strong property portfolio of $110 million up from $86 million in December 2010, thanks to some aggressive mark-to-market gains of $20 million. Its net asset value is very strong at about $107 million. The share price, according to these figures, is therefore trading at a huge discount considering that the market values it at $41 million vis-à-vis the net asset value of $107 million. Who would not want to buy $1 by just paying $0.38 on Pearl shares? But a closer look at the income components, especially the fair value adjustment gains, reveals a weak link on the strength of Pearl’s revenue generating model. Yes, the company has done well under the circumstances to achieve an occupancy rate of 78%, but the net income from the core business translates to a P/E ratio of only 10x. The huge asset portfolio of $110 million can therefore only be valued to the extent to which it generates positive net cash flows for stock holders.

Thus, the ‘discounted’ opportunities in Pearl Properties are only on paper as its true ability to generate tangible earnings remains constrained by the state of the economy and quality of the property portfolio. The market valuation of Pearl Properties can therefore be assumed to be fair and reasonable, and the same applies to many other listed companies on the market that, at face value, may appear to be trading at huge discounts.

Whilst investors remain The money market remains the best investment choice in Zimbabwe at the moment, with cumulative yields in excess of 63% since dollarisation in 2009. The persisting liquidity challenges, which to some extent have been compounded by the deteriorating asset quality within the banking sector as noted by the RBZ, continue to sustain the high investment interest rates of around 16% per annum that are obtainable in the market for those with huge parcels of investible funds.

Recent results from listed banking institutions reveal the tight net interest margins that are prevailing in the sector around at 50%, a revelation of the very stiff competition for liquidity among the banks especially at a time the market had been without efficient inter-bank transactions due to the absence of quality paper to use as collateral. These prevailing high money market yields put Zimbabwe’s money market among the best yielding markets in the world in dollar terms. However the ability of the market to continuously attract more offshore funds chasing these high returns remains constrained by policy uncertainty, especially regarding the tenor of the multiple currency system.

Whilst money market investors continue to bask in the glory of good returns, the borrowers have been finding the cost of funding balance sheet very high and unsustainable. Zimbabwe needs continuous fresh capital inflows to fund the recover process of the economy, and indeed the existing high interest rates on the money market should act as good enough an incentive in attracting high risk capital inflows from financial centres around the world where interest rates remain very subdued around 1% per annum. On the contrary, the much desired economic recovery cannot be achieved with the existing high rates of borrowing, especially for industry that is willing to embark on long-term capital projects.

A balance would therefore need to be struck to ensure that the investment interest rates remain attractive to the global investors, whilst at the same time ensuring that the pass-on rates to the borrowers do not over-burden an already fragile economy. A policy framework that is predictable, transparent and consistent would usually provide the anchor upon which the important market variables will converge to create a vibrant efficient market mechanism that promotes growth.

New Mining Fees - Noble Intentions, But...

The recently gazetted mining regulations under statutory instrument 11 of 2012 have instigated constipation. And many miners, mostly the small scale indigenous miners feel the government is misdirected and has abandoned them. They are justified, to some extent. To successfully register an ordinary gold claim measuring 10 hectares, small scale miners would need to part with $500 for the prospecting licence, $20 for the map, $200 for the claim certificate and anything up to $500 for the prospector. The total would be at the minimum, $1,200. For chrome, small scale miners will need to pump at least $2,600 in regulatory fees before registering an ordinary block. Small as the figures may seem, the background of those that get into small scale mining relegates them to a position where they may not be able to venture into mining legally again. Very few new small scale miners will be able to register claims.

By the stroke of a pen, the lives and livelihoods of many small scale miners and their wider communities in Makonde, Mt Darwin, Sanyati, Shamva, Mazoe, Gwanda, among other areas, have drastically changed for the worst.

Not only are the small scale miners going to find the heat unbearable, but the big mining companies as well. The platinum claims application and registration fees have been hiked significantly to $3 million! The diamond sector sees one needing at least $6 million to register claims. A quick scan of Zimbabwe Stock Exchange listed companies' balance sheets reveals that no more than 5 companies (excluding banks) have net cash positions exceeding $6 million. In any case, most corporates are highly geared and cumulative losses since dollarisation in 2009 top $710 million. It is therefore obvious that more than 90% of listed companies on the ZSE cannot raise $6 million in free cash flows and therefore may not participate in the diamond mining even if they had interest to diversify into the same.

Right issues have performed dismally in the past, and local shareholders have no capacity to raise cash to fund their existing businesses. Therefore given the scenario where the new regulations are barriers for even listed companies to take part in alluvial diamond mining in Zimbabwe, the most plausible explanation for those that will undertake and indeed pay the $6 million largely point to cunning indigenous investors that do not mind being fronts and stooges of foreign capital as long as it take them into the lucrative alluvial diamond mining. And life goes on!

The notion that diamond mining is capital intensive is only a myth as far as alluvial diamond mining is concerned. Ordinary people with sticks and shovels could discover alluvial diamonds in Chiadzwa, mine them illegally and make fortunes, of course with little benefit to the wider society of Zimbabweans as a whole! The government can therefore not argue that the hike in fees is to screen investors and afford those with capacity to mine to take part, at least for alluvial diamond mining.

The government has therefore created huge barriers to entry largely across the board in mining and the majority of indigenous people, whose wealth was destroyed by a decade of hyper-inflation, will be at the worst footing to enter into mining. And indeed the whole aspect of indigenisation, according to those feeling left out, becomes a zero sum game. The BEE programme in SA has largely failed in the mining sector as it created a few island billionaires who many believe are indeed fronts and stooges of foreign capital. The indigenisation of the mining sector in Zimbabwe, unfortunately, will get the same tags.

But the government’s overall motive is not at all wrong. The mining sector in Zimbabwe, in particular coal, dolomite, platinum, natural gas and others, are largely in the hands of largely. The nation continues to suffer critical power shortages when many coal concessions have been granted. But again the fact that the exchange control regulations and the restrictive pricing regime of the last decade made it difficult for long-term investors to pump money into large scale projects, especially energy projects, cannot be ignored. Nevertheless it doesn’t take away the fact that the majority of those granted concessions the last few years have not been speedy enough to begin meaningful utilization.

Makonde, for example, is known for good quality gold and most of the mountains in the area have old German gold mines with very deep, dangerous but lucrative shafts that were abandoned around the late 1930’s when German miners responded to the WW2 call up. However most areas around Gambuli extension are in the hands of speculators that pegged huge blocks they are not utilising, denying other serious miners that may be interested in doing meaningful gold mining and contributing to the good of the economy. The annual ground rental fees at the ministry of mines had gotten so low that people did ‘air pegging’, ending up pegging pieces of agricultural lands and dams because the cost was very negligent.

The recent move therefore to hike fees in the mining industry is, to some extent, a step toward the right direction. The government should in fact consider increasing the ground rental fees as these are largely linked to production and would deter investors from being largely speculative by holding on to mining claims they have no capacity to utilise. Had the government not taken the steps to dispossess De-Beers of the Chiyadzwa claims countrywide, up to this day no alluvial diamond mining would be occurring in Manicaland. De-Beers would still be holding onto its EPOs and treasury would not be getting the annual $600 million in budgetary support from ZMDC, the government company that is partnering with private investors in diamond mining.

The annual licence renewal fees for gold miners, be it small scale, at $400 per claim, are not too huge after all to cause massive outcry. A small scale gold miner on 10 hectares and doing mining should honestly afford $400 licence fees per annum, just one third of an ounce or rather 10 grams of gold. Miners doing gold mining and not affording to extract 10 grams of gold per annum to afford them to meet the annual ground rental fees should quit and rather try tobacco farming. Mining, being an extractive industry, is not for the lazy and laid back. Pretenders should therefore leave space for serious miners who have capacity not only to make money for themselves, but create significant employment opportunities and contribute considerable amounts to the fiscus in royalties and corporate tax.

The government stance to put pressure on miners to encourage production should therefore be applauded. Although the government recently hiked royalties on platinum and gold, and has huge interests in diamond mining, all these come to nothing if the overall mining output remains very low. Mining sector in Zimbabwe contributes to about 6% of GDP and 65% of total share of exports. To industrialize and graduate to being a developed country, Zimbabwe needs to harness its mining activities and graduate from most of the hand-to-mouth mining activities scattered around the country. Shamva, Zvishavane, Hwange and Redcliff are all towns that came out of successful mining companies that employed thousands of people and transformed the lives of many more Zimbabwean through direct and indirect linkages to the economy. It is high time therefore that the mining sector is corporatised to set a good foundation for growth and accelerate the status of Zimbabwe to being a developed country.

In general the mining game has changed the world over, with countries such as Guinea, Australia, Zambia, Ghana, Namibia and Zimbabwe all now wanting a bigger share and say in how their resources are exploited. This has come in the form of increasing taxes such as in Australia and Ghana. In Australia, that is expected to rake in an addition $8 billion this year. Others have hiked royalties such as in copper rich Zambia, from 3% to 6% on copper mining, whilst Zimbabwe and Guinea are garnering for shareholding in mines at 51% and 15% respectively. The Zimbabwe government nevertheless needs not be too overzealous to the extent of pushing out indigenous miners and pave way for foreign capital, crooks and mafia in an unjustly way. Although the mining sector earned $4.6 billion in export earnings since 2009 and can do more should many serious players come in, most of the money remains banked off-shore and Zimbabwe continues to suffer liquidity challenges that have slowed economic recovery.

The majority of the policy makers do not understand that the big figures of mining exports do not necessary translate to increase in GDP as the mining sector contributes only a paltry 6% to GDP notwithstanding exporting over $2 billion per annum. A very balanced approach needs to be struck that should see speculators relinquishing their speculative positions to enable serious players to embark on meaningful mining activities whilst at the same time not creating a situation that chases indigenous miners out of mining and paving way for destructive foreign capital made up of crook, thugs and mafia.

ZISCO - ESSAR DEAL A MONUMENTAL MESS

Since August of 2011 when the Zisco-Essar deal was announced in the various media, there have been many conflicting media reports regarding the actual status of the deal. Essar Africa Holdings Limited (EAHL) is reported to have committed an investment of approximately US$705 million into, among other things, relieving ZISCO of its liabilities. This, as reported, forms the basis of the Zisco-Essar deal (the “Transaction”).

Media reports further state that two new entities would be created, the NewZim Steel Private Limited (NZS) and NewZim Minerals Private Limited (NZM). These, we are told, will be owned 40%:60% and 20%:80% by the GoZ and EAHL respectively. This transaction violates the indigenisation laws of the land but however, with good reason, many Zimbabweans would not have bothered much as long as it furthered their interests in a transparent and beneficial manner.

Zimbabwe boasts of abundant mineral resources. We have the second largest reserves of Platinum in the world. Equally, at an estimated 33 billion tonnes, Zimbabwe has arguably the largest iron ore reserves in the world. The government has been progressive in private-public sector partnerships lately. We see the indigenisation of the diamond sector set to bring about $600 million into the government coffers in 2012, an immense benefit to ordinary Zimbabweans coming out of the mineral resources that, if left entirely in private hands, would not be trickling to the benefit of every Zimbabwean. Similar initiatives in the mining of platinum and indeed localisation of the smelting will surely bring immense benefit to Zimbabweans.

Gone are the times when the IMF and World bank wood-winked resource-rich third world countries into giving up their resources almost for nothing to developed countries under the false pretence of being progressive. The crisis in the developed world today confirms beyond doubt that indeed economies that do not produce real goods cannot sustain themselves for a long time. It is getting clearer each day that indeed human beings on earth live on goods and commodities everyday, and the service industry is just there to smoothen the production and availability goods and commodities to ensure the survival of mankind.

As such, every transaction of national importance involving mineral resources should be given proper and due consideration to ensure that the interests of Zimbabweans and indeed the future generations are safeguarded to avoid any potential prejudice. The fact that Zisco has been lying idle for a long time should never be used as an excuse by the government to deprive Zimbabweans of their right to fair disposal of the underlying assets.

Three key aspects are very important about the deal. Firstly, the deal is the biggest disposal ever concluded by the state post independence. Secondly, it was negotiated at a time when the government had full knowledge of the various indigenisation initiatives currently underway in the mining sector. Thirdly, ZISCO assets are largely national assets that serve the very broad interests of Zimbabweans whilst being represented at the shareholding level by the state.

Given the above submissions, the disposal of any government shareholding in ZISCO, more so a majority shareholding, should be systematic and transparent to ensure that the interests of all stakeholders are appropriately safeguarded. A transaction involving the disposal of a significant shareholding in a deal where the underlying assets involve an estimated 33 billion tonnes of iron ore (above $100 billion) surely needs some high level of transparency and accountability. Indeed there should be a deliberate effort by the Minister responsible, Professor Welshman Ncube, to make public all the key elements of the transaction so that Zimbabweans can, with full information, adjudicate if indeed their interests have been safeguarded. Common sense says that it is virtually impossible to get unanimous approval of the deal from all Zimbabweans, and all the same, it would be unreasonable to call for a referendum on the same. But nevertheless, a transparent framework of the bidding process and subsequent disposal of national assets should be made pubic at one point in time. Confidentiality and non-disclosure aspects that generally accompany such similar transactions can surely not be used to deny the public the right to know how national assets are being disposed of, and in whose benefit.

The media has been full of the dark side of ZISCO pertaining to how much it owes foreign banks, local banks, employees, Zimra and so on. Zisco, so it has been painted, and rightfully so, is in trouble and needs to be resuscitated. But one thing has never been made public, and that relates to the assets of ZISCO. The injection from Essar, we read, will assume all the debts of ZISCO in exchange for shareholding, plus some cash injection that takes the total consideration to $705 million. Common sense says that a company cannot be sold on the strength of its liabilities, and as such, the over-emphasis of ZISCO’s liabilities and the subsequent disposal of Government shareholding on that strength raises more questions than answers on the whole transparency and fairness aspects of the deal.

Zimbabweans need to be furnished with at least three independent valuation reports of the iron ore and limestone reserves that are owned by ZISCO directly or otherwise at Ripple Creek, Mwanesi and Buchwa and other related mining claims owned by Zisco. The disposal of any mining assets cannot be done without geological and valuation reports of the ore reserves. Rivesdale Mining Limited, listed on the Australian Stock Exchange, prospected for coal in Mozambique and ascertained 13 billion tonnes of coking coal reserves in Benga and Zambezi. Tata Steel, Rio Tinto PLC and CSN, among others, bid up to $4 billion on the IPO in 2011. These companies bid up to $4 billion for the Mozambican coal reserves because they knew there was 13 billion tonnes of coking coal at stake. What iron ore reserves are we talking about at Zisco? Does it need to be a secret to a few cabinet Ministers when the owners of the assets, Zimbabweans at large who are the ultimate beneficiaries of the government shareholding in Zisco, are in the dark?

Of course without making the assumption that no drillings were done to ascertain the reserves during the Transaction, it is very important that independent valuation reports of the ZISCO mineral reserves and other assets be made public for Zimbabweans to understand the value being given up in ZISCO in return for the cash injection and debt assumption by Essar. That forms the basis upon which a conclusion can be reached on whether the deal was reasonable, fair and transparent. From a casual analysis, Essar, with their massive experience in the steel business, definitely knew what they were buying into by assuming significant shareholding in NewZim Minerals Private Limited and splashing $705 million into the deal. But there are huge doubts on whether indeed the Government of Zimbabwe, on behalf of Zimbabweans, acted on correct information in agreeing to the deal. If it did, then surely it has to be made public.

There are media reports that a 260km long slurry pipeline would be build from Chivhu to Mozambique to pump iron ore. There is potential prejudice to Zimbabweans in terms of loss in Value Added Tax, Corporate Tax and Pay-as-you-earn running into hundreds of millions of dollars every year if this is allowed to be an integral part of the Transaction. Equally, the valuation of unprocessed ore is very subjective and there are potential loopholes that could allow transfer pricing, resulting in Zimbabwe potentially losing billions of dollars. Whilst it is common knowledge that selling unprocessed iron ore to the Chinese is a very lucrative business the world over, many questions therefore arise on whether the Government of Zimbabwe could equally not just have sold part of the iron ore reserves to extinguish debt and later court partners from a point of strength.

Taxation aspects are a big issue in such big mining transactions. The explicit and implicit taxation concessions granted under this Transaction need to be made public as well. Resource rich countries such as Zimbabwe, Zambia, Nigeria and so on continue to lose billions of dollars in potential revenue from unbalanced tax concessions that do not take into account the depletion of the natural resources. Even nations such as Australia, whose markets and business laws are viewed by many as progressive, have lately been reviewing their taxation levels on mineral resources.

A number of media columnists and ordinary Zimbabweans, through the various media houses in Zimbabwe, have questioned the fairness of this deal, but unfortunately no official response has been given. Of course it is not that persons appointed to public office respond to all concerns that are raised in the media, but surely concerns involving 33 billion tonnes of iron ore belonging to Zimbabweans deserve a formal response, failure of which recourse to the courts of law may be the only way to elicit responses on such matters of utmost national importance and prejudice.

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.

ZIMBABWE BANKING SECTOR: GOOD BANKERS BAD DECISIONS

Wisdom has it that losses lie where they fall. But for banks in particular, losses can fall anywhere in the economy but still end up lying on their bank balance sheets! The recent schemes by bankers to convert debt into equity or any such related debt-restructuring schemes at Lobels and Rio-Zim, among other companies, point to a worrying trend in the market for the banks. The period 2004 -2005 can be remembered by many bankers in Zimbabwe as a time when finding good sleep was a rare find because of the liquidity crunch that prevailed. Some six banks went under curatorship during the period and a score of others got relief from the Troubled Bank Fund. With the way big deals have been turning sour for some of the banks recently, one can only but feel pity for a sector that is still to recover fully from the massive capital erosion of the hyper-inflation period.

The idea that Zimbabwe needs progressive banks that are willing to lend and help the economy tick is hard to argue with. Dollarisation that was adopted in February 2009 has surely brought about all the celebrated economic stability in Zimbabwe. But it has equally brought about serious liquidity challenges that have resulted in companies scrambling to get credit. Therefore the banks have a very vital role to lend reasonably and ameliorate the risks in the economy. Unfortunately the process of lending in an economy fraught with a host of downside risks is not easy, and indeed the high loan to deposit ratios of most of the banks around 100% cannot escape the unfortunate plunge into some serious bad debt traps.

The biggest mistake by bankers has been to assume, very erroneously indeed, that we have blue chip companies that can get all the credit they require without providing collateral. That thought process has now come to haunt the banks. Most listed companies have always adorned the 'blue chip’ jacket status. It is very common among bankers to fall for the false perception that listed companies are stable, well run and have predictable earnings and hence can get unsecured credit. Just a look at the sheer number of companies that delist every year on the JSE in South Africa, and the countless numbers that file for bankruptcy in the US should on its own be a good indicator of the challenges companies face even when operating in stable environments.

The fact therefore that inflation has averaged below 4% since 2009 on the back of strong economic growth should not, at any time, be an indicator of stability and predictability on corporate balance sheets. If anything, the fact remains that more companies will file for bankruptcy in the first five years of dollarisation than in the 8 years to 2008 of hyper-inflation. And if the deputy sheriff and the messengers of court were business to be listed, indeed this would be a time when their earnings would always be exceeding market expectations and delivering excellent value.

The dollarisation of the economy has seen a number of ZSE listed companies hitting very hard times, with some companies such as RedStar delisting in a whirlwind of huge debts. Steelnet, a listed company, is now under judicial management and it is hard to believe that, notwithstanding the huge losses it posted in 2010, some lenders indeed saw the ‘blue chip’ light in Steelnet and extended loans to it. Although the losses have finally fallen on Steelnet, they are indeed lying on some banks’ balance sheets today in town. Many other listed companies have come up with synthetic re-capitalisation schemes designed to buy them another day in the market, but the fact that their operating models are no longer viable means that sooner or later they will meet their destiny and close shop.

This reality that some listed companies are just like tuckshops, and at times with worse fundamentals than growth-point butcheries has been very difficult to accept for the banks. And resultantly bankers have piled unsecured credit onto the balance sheets of such listed companies. More than 60% of listed companies in Zimbabwe are in dire debt situations. It is normal to find high gearing ratios for companies in Zimbabwe since they are re-building their balance sheets that have been eroded by inflation. However considering the shallow debt markets and intense global competition, it has been indeed very difficult for some of the companies to remain efficient and competitive.

At a time the US government has seen its credit ratings being downgraded, with the Euro-zone joining the sovereign debt crisis band members, the only logical thing for banks is to understand that things are changing always. What was fact yesterday can be a fallacy today and equally, what is fact today can be fallacy tomorrow. Therefore one of the safe ways to safeguard capital positions is never to lend unsecured, nomatter how "blue-chip" a company may sound and look. It would be a very wrong perception to conclude that there are no blue-chip companies listed on the ZSE. The fundamentals of some listed of companies such as Econet, SeedCo, Innscor etc are not in doubt.

But equally these same companies can never be expected to remain solid especially should their engage in massive debt-build up just because debt is favouring them in the market. And for lack of a credit reference bureau, most banks end up pilling debt on the same companies not knowing how much other banks would have plunged in. And as it is turning out, the big borrowers only disclose their true indebtedness to the market when they start defaulting, and only at such times do the banks begin to realise how deep and how many of them would have plunged. The situation can be likened to the joke that talks of 10 brothers and cousins all courting one woman. They are all invited to the woman's house one evening and each told to undress, be quiet and given a chair to sit on and wait patiently in a dark room for their time to meet the woman, only for the light to be switched on and all the 10 seeing glaring at each other and sharing the embarrassment.

The coming together of the banks in rescuing some of the big giants such as RioZim and Lobels is not at all a bad initiative. The economy needs big companies that can be able employ large numbers and contribute significantly to GDP, and indeed the profiles of some of these companies fit into this category. Equally, the banks need to do these restructuring schemes with the big companies that owe them money especially if they are not adequately secured since they are riding on tight capital positions that cannot take huge write-offs lest they cease to be compliant with the capital regulations. But there are indeed better ways in which banks can contribute to the economy without necessarily having made decisions that come back to haunt them.

Unfortunately most of the losses in the economy end up sitting on bank balance sheets, especially when they lend unsecured. Even with collateral, sometimes the markets just cease and still the losses end up sitting with the banks. The 2007-2008 global financial crisis even haunted the banks that had mortgage securities when the values of the same securities plunged. Even in Greece, the banks are no longer safe not because they lend to the private sectors, but because they are sitting on sovereign bonds that the Greek government may default on. Sounding like a zero-sum game, lending is indeed a difficult process and safeguarding capital can be the most difficult job for bankers especially in a market as tough as Zimbabwe’s.

In hindsight, its easy to see how the banks make bad decisions, and bankers always take the blame when they make wrong lending decisions. The blame will never be on the borrower because the banks are always assumed to make good judgement before they lend. An objective analysis however reveals that some of the big corporates in Zimbabwe are engaging in acts of reckless over-trading on their balance sheets by pilling up creditors and debts without proper disclosure. At a time the Zimbabwean economy is enjoying strong GDP growth and very stable inflation, it is easy for the banks to under-estimate the underlying risks in the economy. And surely the biggest embarrassment would be for any other bank in the market today to follow the footsteps of Renaissance Bank and collapse due to a culmination of bad judgments.

Crossing the Grumeti River, The Bankruptcy Test

Every June, for those with a huge passion for wildlife, is a beautiful time to watch the world’s biggest wildlife migration in Serengeti, Tanzania. There would be so much excitement among the animals, especially the 1.3 million Wildebeest, the 400,000 Gazelles and over 50,000 zebras, among the over 2 million herbivores that endure the 250 km journey. The Masai Mara, in South-Western Kenya, would be the coveted destination as the search for pastures will be generating the excitement and hope. But with the promised land so far with many dangers and pitfalls, not all will make it. The lions, leopards, cheetahs, hyenas and other predators wait for their turns as easy prey come along. The long hunting nights will be over, at least for a while. And indeed the Grumeti river crossing is the pinnacle of all. It will be beginning of the Crocodile Meat Festival. Crocodiles need not ambush the prey, but they just wait as prey comes trampling on them as the hordes of animals cross the Grumeti river, indeed the beginning of the festival.

The Great animal migration in Tanzania to Kenya and vice versa, the endless pilgrimage in water and pastures, reminisces the current journey Zimbabwe companies are taking from the hyper-inflation environment into the dollarized era. The folk-stories at Renaissance Bank, the travails of Lobels Bakeries, the humbling of Rio Zim, the troubles of Steelnet and the jetlegs at Air Zimbabwe, among many struggling companies, mirror the dangers of crossing the Grumeti river. The 5 years to 2008 that was characterized by high inflation created, unfortunately, a very poor breed of management among some corporates in Zimbabwe.

Institutional recklessness, which indeed was an important element for one to survive during high inflation, has unfortunately been carried over to the dollarized environment. And its claiming scalps! The many rivers of inflation that criss-crossed the Zimbabwe business environment, the blessed rivers of life then, would absolve all who cared to get baptism! And all bad decisions and debts would be washed away with the current! The government and all who borrowed in local currency before February 2009 were forgiven when the economy dollarized. They are all free today of their past ZW$ obligation, and the great migration, among pomp and fun-fare, started towards dollarisation. The promised land of dollarisation had adverts showing highways devoid of price control, exchange control regulation and with free access to foreign exchange! And indeed it was a good journey into the promised land.

Unfortunately crossing the Grumeti river has never been easy. Surviving a biting liquidity crunch has not been easy for AIG, Lehman Brothers, UBS, Northern Rock and many other EU and American companies. Governments in the EU and US fell over each other pumping billions of dollars to ease the crunch and save their economies. It therefore clear how much bleeding and disaster it is for Zimbabwean companies in taking debt dosages with interest rates above 20%,and at times over 35% per annum.

Crocodiles of bankruptcy now patrol these same debt rivers that once had the waters of salvation during hey days of inflation when borrowing was fashionable. Today all that carelessly go for a dip are mauled. Red Star, PG Industries, Steelnet, Lobels, Rio Zim, to name but a few giants, have not escaped the jaws of the debt crocodiles. The burden of interest cost on debt has compromised the strength of their cash flows. Many such troubled companies as Rio Zim may have solace and excitement in putting press statements about how conscious they are about their gearing position. But press statements, for what they are, are just statements. They don't change poor operating models and soon, corporate egos that could swim during inflation will find buoyancy the most difficult thing to maintain in the still waters of dollarisation that, unbeknown to those attempting to cross the Grumeti River, has huge undercurrents and crocodiles that will sweep them away.

Unfortunately the banking sector has no capacity to carry the excesses of sick companies, neither do creditors. Bankers are grappling with their own problems with regards non-performing loan, reported last recently above 30% of loan books. These are bad decision coming back to haunt otherwise good intentions by bankers that, in retrospect, were recklessly implemented. But as always, bankers get blamed for all bad debts, whilst the borrowers get very little remorse. When a debt goes bad, it’s the banker that made a bad decision, not the borrower! And indeed many borrowers in Zimbabwe still court the hyper-inflation mentality of yester-year where they borrow recklessly with no intention or repaying back the money. This is over-trading with criminal connotations! And indeed the recent press reports by some policy makers making gestures that seem to condone the behaviour that encourages borrowers not to repay their debts is very regrettable.

The market mechanism is very clear in dealing with the weak and inefficient. Even the natural animal habitat has a very efficient way of regulating the numbers, including that all human beings die at some stage. We can’t live forever, save for our souls. Its time therefore that policy makers and entrepreneurs contend with the possibilities and indeed realities of companies going under, no-matter how big. But bankers will always be at the centre of most storms in crises because the notion, an erroneous one, will always exist that they have to give everyone money. And considering the small balance sheets and tight capital positions with most banks in Zimbabwe, bankers are better off shunning big deals. It’s very unfortunate that the big companies need big monies to restructure, but when they collapse, they go down with the banks that would have stepped in to assist. And indeed the market and jury will be right to pass a verdict condemning the banker for having lacked prudence and oversight.

But that is however not the desirable path for Zimbabwe that has unemployment rate above 60% and desperately needing a vibrant middle class to pull the economy up. Although Italy and Germany would have economies centered on small companies, Zimbabwe desperately needs a handful of big companies that make a huge difference in employment number. Unfortunately globalization has come and its there to stay. A chat with Republicans in America will reveal how much they don't like the Chinese for having stolen millions of American jobs by providing cheap goods that have driven hundreds of big US companies out of business. Many companies such global brands as Motorola, BMW, Apple, Nokia etc now outsource and at times set up plants in low-cost production zones around the world. Terry Gou’s Hon Hai company, the biggest contract manufacturer of electronics in the world with its biggest plant in Shenzhen, China, exports over $50 billion worth of goods to such companies as Apple, Nokia, Sony, Dell and a host of others. The competitive issue therefore nowadays is not really about cost and availability of capital alone as many in Zimbabwe companies believe. It’s much broader, encompassing supply chain efficiencies, productivity, technology, labour and everything that affects the final total cost and quality of products. Why would a men's suit cost $20 retail in China and yet a poor quality one cost $90 in Express Stores? A tie would cost $0.30 in China whilst getting one locally in Enbee for a school kid is around $5! Don't we export the cotton to China? Would the huge price differential be explained by the high cost of capital alone?

Definitely capital is important to set up the machinery and secure all important production elements, but there is much more that needs to gel with capital availability to make a producer very competitive, the very reason why even countries with cheap and available capital such as the US have been seeing companies relocating to China and other low cost countries. And the problems confronting Zimbabwean companies seem to be converging in huge numbers: inefficient and expensive labour, poor infrastructure, energy challenges, weak domestic market and of course lack of capital. Indeed the road towards bankruptcy is still very wide, and many more companies, inasmuch as it hurts, are taking their steps towards their destiny. It’s a way the market operates, and as others close, new ones get born. The major temptation that is hastening the whole bankruptcy dilemma is overtrading – thus borrowing more than what the balance sheet can sustain and accruing creditors at a very fast rate with only but hope that probably a miracle will happen to correct the situation. And unfortunately miracles of such nature have since gone with inflation.