By Charles Robertson, (The Source) – How can you have a currency crisis, when you don’t have a currency? A few years ago, after the hyperinflationary meltdown in 2008, Zimbabwe was in strong recovery mode. GDP doubled by 2012, on the back of rebounding commodity prices, a surge in wages and consumption of imported goods. Since then foreign capital inflows have dried up and exports have fallen. Consumer prices have fallen just 6% from their peak even as neighbouring South Africa has seen a 40% currency depreciation.
The lack of downward wage adjustment in Zimbabwe has maintained excessive import demand which has now used up most of the foreign currency in the country. Dollar deposits in the banking system have become theoretical, a little like euro deposits did in the recent liquidity squeezes in Greece and Cyprus. The government might put money into employee bank accounts, but there is no cash to withdraw from the bank account. Zimbabwe is bust. Again.
The government’s responses range from unsustainable to sensible
The government is trying a variety of approaches to deal with this problem. It has stopped paying wages in full, but this has triggered a strike. It has banned the import of some consumer items, which has added to protests. It appears to be restricting the repatriation of export earnings; this is not a sustainable policy choice. The government is pushing forward a 99-year land lease law to encourage investment in agriculture, but we have not seen evidence that this will attract cash inflows.
The authorities are trying to encourage locals to price in rand, but coming after five years of rand deprecation, this will still require deep price cuts to improve the current account. Zimbabwe is borrowing $200 million to back new ‘bond notes’ due for release into the system in October, which many fear will lead to unbacked currency issuance in the future. Of all the measures, the most high profile is the aim to borrow money to clear arrears to the IMF, World Bank and African Development Bank, with the aim of encouraging private capital inflows by end-2016.
The underlying problem
The underlying problem is that hyperinflation wiped out private sector savings, and the government failed to grow its own savings during the boom-time. It is reliant on export values to pick up (gold is up 27% YtD, but all exports need to rise 100% to close the trade deficit) or foreign capital to improve liquidity. We see the indigenisation law deterring foreign investment in mining; related to this, China believes Zimbabwe has bitten the hand that feeds it and is unlikely to provide significant new funding.
Zimbabwe fell two places last year in the Ease of Doing Business (EODB) rank to 155/189 which deters foreign direct investors (FDI) and is 150/167 in Transparency International’s corruption ranking which deters equity investors; while its legal score is only higher than Myanmar, Bangladesh and Venezuela. We think changing the indigenisation law, or improving corruption, EODB and legal scores, would help provide capital inflows. Significant political change could also trigger inflows. Debt forgiveness and a possible IMF financing arrangement are other options.
Most of the above measures are a wish-list. In the near term, the reserve bank governor says a 20% internal devaluation is required, which we see as the optimistic end of a 20-40% spectrum. This will be very harsh on the population and implies a deep fall in GDP. The IMF is far more optimistic with its 1.4% growth forecast for 2016 and 5-10% rebound in 2017.
Agriculture should help in 2017 but problems to intensify
Zimbabwe is not alone in suffering from lower commodity prices. But its poor business environment contrasts with Kenya, and it does not have the relative luxury (that Nigeria and Egypt have) of softening the pain through devaluation. There probably are very interesting opportunities for long-term (private equity?) investors with a very high-risk appetite, but for now, we expect problems to intensify. The positives are the post-El Nino rebound, the likely clearance of external debt arrears, and rising gold prices.
What to like about Zimbabwe?
Aside from the many great Zimbabweans we know, there are four clear positives about the country.
First, the UN estimates the working age population will rise by 15% every five years which means that annual growth should be at least 3% a year, just to keep pace with this population growth. If we assume the average EM/FM country grows at an underlying 2-3%, then base GDP growth in Zimbabwe should be 5-6%. The finance minister (who I shared a panel with on 5 July in London at Africa Confidential’s Zimbabwe 2016 Conference) stated that at least 5%, and up to 10%, is the target Zimbabwe seeks. We agree.
Second, education is broad enough for Zimbabwe to be able to escape poverty. We estimate countries need to educate 25-30% of their secondary school age (11-17) children to be able to escape poverty within 20 years. Zimbabwe in 2012 educated 46%, well over this threshold. At Africa Confidential’s conference, there was plenty of anecdotal evidence that human capital is plentiful.
Third, Zimbabwe has a functioning equity market. It may be self-serving to suggest this, but we think the positive moves seen recently in Nigeria are because the government is financially savvy and hears investors (equity and direct investors, local and foreign). By contrast, in Angola with no equity market, we are seeing little progress on reforms. Like Nigeria, the Zimbabwean government will also hear financial market criticism of policy mistakes, although it may not choose to listen to it.
Fourth, Zimbabwe has been offering currency stability to dollar-based investors, in contrast to the slump in currency value in neighbouring South Africa, or Nigeria or Zambia, to name just a few other equity markets across the continent.
Against these positives, we must point out the following: while GDP “should” be rising 6-7%, GDP growth has not even been keeping pace with 3% population growth. In 2015 we estimate per capita GDP among the working age population fell by 2%. In 2016, the IMF expects GDP to rise by 1.4%, roughly in line with our expectations for Nigeria, but half the rate of the working age population increase.
The quality of human capital is far higher than neighbouring Mozambique for example, but much of it has left Zimbabwe. The stock market is sending a very negative message, with MSCI Zimbabwe halving since 2013 (the broader market includes dual-listed stocks which makes this less useful). Lastly, while Zimbabwe was offering a liberal currency regime, today that is no longer the case, with controls being imposed in a similar manner to Nigeria.
What has gone wrong?
Zimbabwe – like many countries in Africa – has been hit by the fall in commodity prices. The value of precious metal exports (primarily gold, but also platinum and diamonds) fell from $1,4bn in 2012 (37% of exports) to below $1bn in 2013 and remained there through to 2015 (31% of exports).
El Nino has exacerbated the problem. The IMF says Zimbabwe is experiencing the worst drought since 1991-1992, and it expects agricultural output to fall 10% in 2015-2016. Zimbabwe appears to have been hit harder than neighbouring Zambia, which took in Zimbabwean farmers after Zimbabwean land reforms, and has reportedly seen an increase in its corn crop this year.
What is interesting, though, is what has not happened in response to the fall in export revenues. We have not seen a 40% fall in prices and wages.
When the Zimbabwean currency was withdrawn in 2009 after hyperinflation, the authorities chose to follow the example of Ecuador, Panama, El Salvador and Kosovo, and instead use foreign currency. They might have chosen to use minimal gold reserves to support a currency board system, but they instead chose this purer form of monetary regime.
Adopting someone else’s currency can be pretty brutal in the face of a negative economic shock. It is similar to the gold standard. If exports shrink faster than imports, then the trade (and current account) deficit will cause a flow of foreign currency out of the country to cover that trade deficit. As the quantity of dollars shrinks, prices and wages must necessarily fall. This will then limit demand for imports and can also help out on the export side. Admittedly, it doesn’t work quite so well if you are selling commodities whose price is determined globally (it is not your actions which can boost export volumes), but if your wages fall enough so that you become a cheaper supplier, you can win market share from other more expensive countries.
Zimbabwe’s largest trade partner is South Africa, which coincidentally exports many similar products. To maintain competitiveness with SA, which has seen the rand weaken from around ZAR7-8/$ in 2009-2011 to ZAR15/$ now, wages would need to have fallen in Zimbabwe by around 40%. But we have seen nothing of the sort. Consumer price deflation was only around 1% in 2014 and just 2% in 2015. The latest figure for May 2016 was still deflation of just 1.7%.
The CPI is down just 6% from its peak at the end of 2012, not the 40% which comparison with SA suggests is needed. A monetary regime like this needs a great deal of wage flexibility, which Zimbabwe does not have. The only exception we are aware of is the listed company Econet, which has announced the unprecedented decision to cut wages by 20% and would appear to be ahead of other companies in the country.
The Reserve Bank of Zimbabwe governor, John Mangudya, says an internal devaluation (ie price deflation) of 20% is needed. That looks optimistic today, but would be right if you assume the rand will rally back to a long-term fair value of ZAR11/$. We do not think it will.
To be fair to Zimbabwe, most (all?) countries cannot bear to see wages drop 40%, which is why countries tend to have their own currencies, which can be devalued without the population noticing they are much poorer. Even in the supposedly well-educated and financially literate UK, the pro-Brexit media was excited recently when the stock market rose in sterling back to pre-referendum levels; only at the end of the article was there any mention of the pound having lost more than 10% of its value in dollar terms.
If wage flexibility is insufficient, the government can compensate for external shocks by spending its own savings. Russia and the Gulf countries have been spending their savings to soften the shock of low oil prices (Russia devalued as well, to further soften the pain and unemployment stayed in a 5-6% range as a result).
Yet Zimbabwe did not build up a store of savings, even during 2009-2012, when the economy doubled in dollar terms to $12bn. The budget showed only one year of surplus, at just 0.7% of GDP in 2010, despite real growth of 10% annually for four years (inflation accounted for the faster rise in nominal GDP).
So Zimbabwe has entered the low commodity price era, with inadequate wage flexibility and virtually no government savings. As wages have remained too high, imports too have remained too high. As a consequence, Zimbabwe keeps running a current account deficit and the supply of physical dollars in the economy has continued to shrink.
Where it gets complicated is when we consider the role of cash vs virtual money. Around the world, to the great distress of gold bugs, money is no longer backed by anything physical like gold. Moreover, in the UK, physical money supply is a tiny proportion of the value of deposits in the banking system, let alone the value of all sterling-denominated assets in bonds and equities. In theory, the Bank of England can however print notes to meet demand for physical money, but Zimbabwe cannot print US dollars.
Today, the billions of dollars that are theoretically in the Zimbabwean banking system cannot be turned into actual physical dollars, as the country has largely run out of dollars. So when the government pays its workers, let’s say $400 for a month’s work, and wirelessly transfers that into the bank account of that worker, the worker is unable to convert the $400 into actual cash. As a result, we now read reports that a cash dollar is worth more than a virtual dollar in the bank account.
It reminds us of the recent Greek and Cypriot crises, where capital controls meant that the value of euros in their bank accounts was (to an economist) worth less than the value of euros in bank accounts in France or Germany for example. The crucial difference of course, is that the ECB was prepared to ferry euro notes and coins to these countries – it was the lender of last resort that Zimbabwe does not have. The end result in Zimbabwe is few will want to put any physical cash they do have into the banks.
Meanwhile banks are left to buy the booming stock of domestic government debt. This has risen from $1.1bn in 2012 (9% of GDP) to $1.7bn in 2014 and $2.0bn (14% of GDP) in 2015.
This is the first of a two part series. Charles Robertson is Renaissance Capital’s Global Chief Economist and head of it’s macro-strategy unit.