Zimbabwe's Black Market And the Myth of a Fully Dollarized Economy 2
HARAR, ETHIOPIA - MARCH 27,2014 - Harar known to its inhabitants as Gey, is a walled city in eastern Ethiopia.Founded in the 7th century by Arab immigrants, it was chosen as the capital of the Adal Sultanate from 1554 to 1557.

The accepted rule by all those investing in Zimbabwe is that it is a fully dollarized economy and does not have a local currency. This myth has held the financial system together and prevented a national panic attack. However, today the imbalances are too wide for the private sector and investors to ignore the reality of a second currency.

Whilst dollarization did look like the long-term solution to hyperinflation in April 2009, it was actually not supposed to be about the sole use of the US dollar as a legal tender, but rather, about the adoption of a multi-currency regime. However, when the government made it clear that it would conduct all of its transactions in US dollars, the private sector quickly followed suit. As a consequence of this, Zimbabwe is now priced in US dollars, but effectively funded in South African rand (its main trading partner). This mismatch between pricing and funding has been the fundamental flaw in the dollarization process.

When Zimbabwe dollarized, all assets were re-valued in US dollars, but since then more US dollars have been exported out of Zimbabwe than have come in. This has significantly reduced US dollar liquidity in the country and forced the government to increase leverage. A vicious cycle of debt has been built around Zimbabwe. On best estimates, Zimbabwe has US$10 billion of debt compared with GDP that is expected to reach US$14.4 billion in 2016 (as per the IMF).

Rebirth of a local currency

Along with the myth that there is no local currency, another is that the Government of Zimbabwe cannot print money. To explain why these are myths, we have tracked the historical trend in ‘hard cash’ (i.e. cash that is immediately available to the banks in either notes and coins, or in their nostro accounts abroad) and compared this to system deposits.

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The absolute level of ‘hard cash’ in Zimbabwe has fallen from US$582 million in 2009 to US$269 million at April 2016. Whilst the absolute fall in ‘hard cash’ over the years is concerning, what is really alarming is the trend in the ratio of ‘hard cash’ to deposits, which has fallen from 49% in 2009 to 6% at April 2016. This is because, while the level of ‘hard cash’ in the system has been declining, the total pool of deposits has been growing. Since 2009, total system deposits have increased from US$1,191 million to US$4,275 million.

Where have the deposits gone?

When you look at the trends in system liquidity, the first question you ask is, what happened to the deposits? The logical trend would have been for system cash balances to grow in line with deposits.

The reason why this did not happen, in our opinion, is because of the use of two types of US dollars in Zimbabwe. The first and most preferred US dollar in Zimbabwe is the physical paper dollar. This dollar is 1-for-1 with the US dollar anywhere in the world. The second US dollar in Zimbabwe is the one that sits on the RTGS, or real-time gross settlement. The RTGS is Zimbabwe’s national payment system. Settlement in “real time” means a payment transaction is not subjected to any waiting period. The transactions are settled as soon as they are processed. “Gross settlement” means the transaction is settled on a one-to-one basis (between the banks) without bundling or netting with any other transaction. Once processed, payments are final and irrevocable. So, when we say the second US dollar is on the RTGS, we are effectively saying that it is floating in the banking system.

How much of the RTGS is cash funded?

How much of the local currency is backed by hard cash? The truth is no banker in Harare was able to tell us with any conviction. However, what all the bankers agreed on is that, for the banking system to run smoothly and all cash demands met, the total hard cash needed in the system was equivalent to 20% of deposits. On this basis, the total ‘hard cash’ in the system that Zimbabwe needs as of today is US$855 million.

Why hasn’t the system collapsed?

With such a large shortfall in ‘hard cash,’ the first question we asked is, “why hasn’t the banking system collapsed already?” The answer to this question is a rebuttal of the myth that the Government of Zimbabwe cannot print money.

The total value of government securities held by the banking system has increased from zero in 2009 to US$1,198 million in April 2016. As a percentage of deposits, government securities have increased from 0% in 2009 to 28% at April 2016. Notably, the banks first began putting these securities on their balance sheets in 2012, which was the same year the ratio of ‘hard cash’-to-deposits fell below 20% for the first time. This was therefore the first year the Government of Zimbabwe started printing money.

As the principal and interest payments on these government securities are settled on the RTGS, it is clear that the government has been using the issuance of this debt to effectively print money. This money printed and placed in the RTGS has helped keep the Reserve Bank of Zimbabwe liquid in local US dollars. This has been done by looking at the trend in total bank balances with the RBZ. The total value of bank balances with the RBZ increased from US$197 million in 2009 to US$778 million in April 2016. The growth in bank balances with the RBZ has allowed for its ratio to total deposits to remain relatively flat over the past seven years.  The ratio of bank balances with the RBZ to deposits has actually increased slightly (from 17% in 2009 to 18% at April 2016). Compare this to the trend in the ratio of ‘hard cash’ to deposits over the same period.

Zimbabwean private sectors knows

Whilst we doubt that the private sector in Zimbabwe appreciates just how the government has been printing money, we do believe that it finally understands that there is a second currency in Zimbabwe. Whether one wants to call it the Zim dollar or RTGS does not matter. However, we firmly believe that the private sector knows that it is using a second currency and that it does not to have the same value as ‘hard cash’ in its paper form.

The reason for this is the cash limits. Whilst we were in Harare, the ATMs were generally down, and those that worked had cash withdrawal limits of between US$50 and US$500 per day. CBZ told us that they were the only ones still offering withdrawal limits of US$1,000 per day, but at their tellers.

Because of the scarcity of ‘hard cash’, we learned that if a bank customer wants to cash his/her RTGS and does not want to wait for their bank to pay, it can be done in the black market at a rate of 1.10x. In other words, the black market is telling Zimbabweans that their RTGS is worth 90% of its face value.

Notably, the 10% discount on the face value of the RTGS is 5ppt higher than the effective discount the government is putting on RTGS. We say this because, while in Zimbabwe we learned that the government has now decided to make all the banks release the foreign exchange earned by exporters to their nostro accounts outside of Zimbabwe. Once the funds are received, the government will wire the export proceeds plus a 5% export bonus to the beneficiaries’ local accounts in RTGS. In other words, US$100 of export proceeds is now worth US$105 in the RTGS.

With total debt of around US$10 billion, we understand that the Zimbabwean government has been actively trying to build its US dollar cash reserves. To do this, it recently announced that it would convert: (i) 100% of all gold and diamond exports into RTGS with an export bonus, while it would keep the hard cash proceeds; (ii) 50% of all other mining exports into RTGS with an export bonus, while the remaining 50% of cash receipts will be given to the exporter; and (iii) 80% of tobacco exports into RTGS with an export bonus, while the remaining 20% of cash receipts will be given to the exporter.

One banker estimated that if the government had adopted this approach in 2015, it would have cashed around US$2.7 billion of the US$3.6 billion in export proceeds. Clearly this approach will allow the government to raise a significant pool of cash while the exporters continue to export.

From the perspective of the exporters, we note that while the RTGS allocations do come with a 5% bonus, this is not very meaningfully when bank withdrawal limits are US$1,000 per day at the maximum and the street premium for ‘hard cash’ is 10%.

In our opinion, the big risk in Zimbabwe is that the government cannot keep the street premium for ‘hard cash’ at/or below 10% or even hold the spread between what it pays for ‘hard cash’ and what the street pays at 500bp. Failure to do so would be devastating for Zimbabwe and its banks. It could ultimately usher in a new era of hyperinflation.

Kato Mukuru is the global head of equity research at Exotix Partners


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