The Zimbabwe crisis: the deeper underlying problems

The Zimbabwe crisis: the deeper underlying problems

By Charles Robertson, (The Source) – Not paying the worker is a short-term solution to the problem of cash shortages. Wage arrears are now rising. But while pay to the police and army remains a priority which helps give this policy more longevity because violence can be unleashed on those demanding to be paid, strikes and unrest this month suggest it cannot be maintained for long.

Ideas to address the challenges

Not allowing exporters to keep the dollars they earn is another short-term solution. We heard that in the past three months some commodity producers have been unable to take dollars out of the country. This gives the government room to pay key workers or ensure there is cash for vital imports of fuel (or others, such as ammunition). But this is not economically viable in the longer term because businesses will eventually stop producing commodities.

The government has also banned certain imports to help save dollars – similar to Nigeria. In Zimbabwe these include baked beans, peanut butter, canned fruits and jams. But there appear to be no restrictions on ministers using parastatal revenues to purchase cars costing $300,000.

Aside from arrears, non-payment to exporters and import controls, the government does have one rational solution to the problem. It is seeking out a lender of last resort.

Zimbabwe suspended payments to international financial institutions (IFIs) years ago, but now it needs dollars and they might provide them – or theoretically open the way for Zimbabwe to borrow from the private sector. It intends to borrow dollars from Afreximbank to clear arrears owed to the African Development Bank. It plans to take a long-term bilateral loan to repay the World Bank, and it hopes to use Special Drawing Right holdings to clear arrears to the IMF. The finance minister seemed confident at the London conference that arrears could be paid by October which could see dollars flow to the country by the end of the year.

Another idea, due to take effect in October, is to inject liquidity into the system by issuing bond notes, backed by $200 million from Afreximbank. They will be given, with a 5% bonus, to exporters. So if an exporter sells $10 million of goods, then the Zimbabwean government will give $500,000 of these bond notes to the exporter. This sounds like an inducement to the exporter to accept the new notes. We however see little advantage to this, over the more straightforward idea of just giving the dollars to the exporter.

Many assume that this is just a precursor to the government printing unbacked notes in the future. The finance minister stated that Zimbabwe is not ready to reintroduce the Zimbabwe dollar to the economy until foreign exchange reserves are equivalent to 6 or 12 months of import cover and until the twin (budget and current account) deficits are addressed. This could be semantics. After all the new bond notes are not going to called Zimbabwean dollars.

The authorities are also trying to encourage the country to use the rand (and other currencies). One person pointed out that a packet of cornflakes is half the price in Johannesburg compared with Harare (and this is not just due to transportation costs). This was a problem already evident two years ago. But shopkeepers could change the currency to rand today, and prices would still be twice as high as Johannesburg; it is price and wage cuts that need to be enacted, not a change in the currency in which prices are displayed.

Deeper underlying problems

The most significant problem for Zimbabwe is the lack of savings in the country, and the lack of confidence in the future. Hyperinflation always wipes out personal savings, unless investors are canny enough to have gold, property, equities or ideally foreign currency, and Zimbabweans saw their savings destroyed less than a decade ago. As noted above the government has no savings either. Over 2012-2017, the IMF estimates that Zimbabwe gross national savings will have averaged -6% of GDP, one of only six countries with negative savings over the period, and the worst in the world.

These are going to very long-term challenges for Zimbabwe, whatever happens in the short-term. But problems in the short-term could be overcome, if the country attracted foreign capital. This is what encouraged the visit of the finance minister and the reserve bank governor to London last week. Six things could make this happen, but some are likely to take years.

First, commodity prices could soar. Gold prices are already up 29% YtD. A rise in platinum, diamond and tobacco prices would go a long way to helping Zimbabwe boost exports. To attract more foreign capital above this would require the input of foreign investment into the relevant mines and farms. High commodity prices might tempt them, but there is an obstacle which would need to be addressed, which is our second point.

Second, the government could change the indigenisation law. As we have pointed out to governing ZANU-PF officials on a previous visit to Harare, Zimbabwe won the freedom to make the legislation it wants since liberating itself in 1980. But the private sector also has the freedom to ignore Zimbabwe and choose instead to invest in SA, Kazakhstan, Russia, Australia or any other mineral producing nation which might allow majority ownership of mines and farms. There is reportedly more foreign interest in manufacturing, where investors can have majority ownership if they use credits (e.g. by investing in education).

We heard from Professor Stephen Chan at the African Confidential conference, that China is particularly bitter that Zimbabwe has “chosen to bite the hand that feeds it” by taking majority ownership of mines that Chinese companies had developed. In the past, China might have been the lender of last resort to Zimbabwe, but not now.

The government is pushing legislation that will enable 99-year land leases that would allow land to be used as collateral and re-establish a land market. We have not yet met a foreign investor ready to invest in Zimbabwean agriculture.

Third, Zimbabwe could improve its woeful Ease Of Doing Business score. At 155th out of 189 countries, this is a particularly unfriendly country for businesses. It is 182nd out of 189 when we look at the sub-component of starting a new business. These are not the sort of ranks which tend to attract in FDI or encourage domestic entrepreneurs.

Zimbabwe fell two places in the rankings in the latest survey. However, the actual score rose by one point (out of 100). Zimbabwe did get slightly easier to do business in during 2015, but other countries did more than Zimbabwe. There is an assurance to do more in the future. If Zimbabwe deters FDI because of its laws and its poor EODB score, another option is to look for portfolio flows.

Many countries prefer sticky FDI to portfolio money, but portfolio money can at least buy companies that already survive within the difficult business environment. But this would require not just the prospect of GDP growth, credit rating upgrades (or at least a credit rating), bank lending growth, but perhaps also improvements on corruption.

Fourth though, Zimbabwe’s corruption perceptions index rank is a problematic 150th out of 167 countries. This hurts equity investors, not because they are necessarily the most moral of all capitalists (although of course we think our clients are highly moral). Rather, it is because equity investors can end up relying on a local court system, and corrupt countries rarely have a good judicial system.

The World Justice Project shows that among the DM, EM, FM, and beyond frontier countries we cover, only Venezuela has a worse ranked judicial system. Meanwhile only Myanmar and Bangladesh have a more unfriendly rank in the EODB judicial sub-component scores.

Fifth, we might see political change. Foreign investors often welcome a change of leader. The biggest overweight for global emerging market (GEM) investors is India, since a positively received change of leader in 2014, while Argentina has seen a 50% rally in MSCI Argentina since markets began pricing in the new president’s victory in late 2015 elections.

Zimbabwe has not had a change of leader since most of the population was born. Former finance minister Tendai Biti said on 5 July that planning for the succession in Zimbabwe is now the only game in town.

Some believe the next president is likely to be vice-president Emmerson Mnangagwa, who is said to be pro-business. Opposition figures might come to the fore if there is a more unplanned transition; in any year, there is a 2-5% chance of falling incomes triggering a dramatic political change as we explained in our report, Revolutionary nature of growth, published on 22 June 2011.

Sixth, and as noted above, the government might succeed in winning IFI support and even consider a HIPC debt-write off deal, which could in theory pave the way for capital inflows. The IFC is expected to prepare proposals for possible investments in Zimbabwe. We are not certain that the IMF itself would consider lending to Zimbabwe (the US does not back this), but the IMF’s latest review on Zimbabwe, published in May 2016, confirms that Zimbabwe has been adhering to promises made under a Staff Monitoring Programme, and says this “would serve them well should they request an eventual financing arrangement with the Fund”.

It recommends a significant reduction in the wage bill, while noting the government intends to keep the total wage bill constant in nominal terms through to 2019 (the government intends to cut wage costs from 66% of expenditure in 2016 to 50% in 2019, by cutting numbers of employees). Any deal with the IMF would enable the government to blame the IFIs for imposing hardship on Zimbabwe.

Possible conclusions

The IMF is pretty bullish on 2017 growth, assuming that a bounce-back from El Nino will let GDP rise by over 5% producing real per capita GDP growth for the first time since 2014. They have an alternative benign scenario of 9.5% growth in 2017 and another 9% in 2018.

We are not publishing forecasts that differ from this, but a similar currency experience to Greece and Cyprus suggest investors should be more pessimistic. Cyprus saw GDP shrink 2% in 2012, 6% in 2013 and 2% in 2014. Greece saw a 0% change in GDP in 2015 when capital controls were being imposed, but this was after big GDP declines in previous years.

Rising gold prices will help Zimbabwe, but to achieve significant private capital inflow from abroad, we suspect the country will have to reconsider its indigenisation law, or make dramatic improvements on the ease of doing business and corruption. A significant political change could make a big positive difference.

Lastly, improving relations with the IFIs might help too.

In the meantime, we suspect there are opportunities that would produce strong returns for long-term investors, if any of the above reforms happen. For the vast majority of investors in publicly listed equities, we suspect Egypt and Nigeria will prove more interesting once both have fully resolved their exchange rate challenges.

Zimbabwe has introduced a priority list for those seeking to import goods to Zimbabwe. It is similar to something we have seen for Egypt – which also prioritises food (iii), and export-generating investment imports. It is notable that payments for foreign education are a low priority – this has been a controversial issue in Nigeria too. Nigeria also has a list of goods for which the CBN will not provide foreign exchange.

This is the second of the two part series. Charles Robertson is Renaissance Capital’s Global Chief Economist and head of its macro-strategy unit.