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Zimbabwe Investment Notes  Edition:

Quarterly  Date: October 2020 

Issued by: Imara

Asset Management Smoke and Mirrors! 

It has become increasingly difficult to analyse the  economy by researching the numbers. The same  can be said for corporate accounts where hyper inflationary accounting further muddies the  picture. Part of our problem is knowing which  numbers to trust and believe. The numbers  published may not be incorrect but they may not  tell the whole story. At the same time, the  economic authorities appear to have embarked on  a media blitz highlighting that the new auction  system has been a huge success and has brought  the required stability to prices and the exchange  rate. Government statistics have presumably been  delayed in their publication by COVID-19; we have  only just received the July Monthly Economic  Review from the RBZ. This highlights the ZWL  economy. Missing from economic data is the  growing US dollar cash economy. Therein lies the  crux of the issue, there is an informal USD cash  economy, an official USD economy and an official  ZWL economy! To focus on one, will not provide us  with the entire picture. 

Far from sitting on our laurels during the  ‘lockdown pandemic’ we have been busy  interviewing corporate managements virtually to  get a better understanding of what is happening in  the economy through sales volumes and trading  conditions. To a certain extent it opened our eyes  to what might be happening in both the ZWL and  the USD official and cash economies. 

On the face of it, the situation in Zimbabwe could  be a lot worse. For now there is food on the  supermarket shelves, specialist shops sell luxury  items, there is plenty of fuel in the service  stations with few to no queues but only if you pay  in US dollars. This is a far cry from 2008 when  Zimbabwe last experienced hyper-inflation. At  that time there were no US dollars and trading in  US dollars was illegal. Although Government  legally ended the multi-currency system in July  2019, in practice it never really went away and  indeed Government has very much supported it in  recent months.  

We have written in previous Notes about our views  that the ZWL would be doomed to failure for  anything but a transactional currency. (See also  our paper: “Zimbabwe – dollarization and rabbits” 

dated April 2020 on the subject). It was introduced  at ZWL2.5 to USD1 in February 2019, and one year  or so later was worth ZWL100 to USD1. That can  hardly be described as a success. Allowing US  dollar transactions has essentially saved the day  from a supply perspective. If you are fortunate  

enough to have or earn US dollars, you can buy  most things.  

This ‘compromise’ won’t assist the long term  future for the Zimbabwe economy however. The  entire banking and savings system is built upon the  ZWL. We wrote about the decimation of the  domestic savings base in our January 2020 Notes.  Over recent years the fixed asset base of the  Insurance and Pension industry has not been able  to keep pace with the devaluation of the ZWL. We  estimate that the total valuation of insurance and  pension fund assets at about USD1.2 billion at the 

end June 2020. Of that liquid assets amount to  around USD20 million. That’s simply not sufficient  to provide any meaningful investments for the  domestic economy. Speaking with a number of the  banks whose capital base in US dollars has been  close to destroyed, at best the largest loan that  could be given amounts to around ZWL500million.  That’s little more than US$5 million which barely  covers the working capital requirements of one of  the larger corporates. Bottom line, it implies that  it is close to impossible for the domestic ZWL asset  base to fund any large investment or working  capital requirements such as the forthcoming  agricultural season.  

Government can of course guarantee bank loans to  the agricultural sector, or indeed it could transfer  ZWL to the banks for on-lending to the agri-sector.  Since Government is planning a fiscal deficit for  2020 it does not have the capacity to do that  without creating ZWL, or printing it. That of  course undermines the ZWL further, the resulting  devaluation thereby making the banking, insurance  and pension industries even less relevant.  Government could borrow the money from  offshore in foreign currency (and does so) from the  likes of Afreximbank but that simply adds to  foreign debt that Zimbabwe will find hard to  repay.  

The latest inflation number for August was 761%.  This of course is naturally a ZWL figure. The  economic authorities are suggesting that we should  be looking instead at a blended rate of inflation,  presumably because some products are priced in  USD which rarely change and others in ZWL that  do. That way inflation would appear lower than it  actually is. But this is economic nonsense and we  are not aware of such an approach elsewhere in  the World. The vast majority of people in  Zimbabwe earn ZWL and so ZWL inflation is key. A  blended rate might of course look better and  perhaps is an attempt to appease those calling for  large salary increases to compensate for a real loss 

in spending power. It was interesting that  Government chose to pay the civil servants with a  ‘temporary’ USD allowance of USD75 per month in  addition to their ZWL earnings. Initially due to last  three months as a cushioning allowance, it has  recently been extended to the end of the year. As  we wrote in our July Notes, the USD allowance  would be paid into civil servants’ new Nostro FCA  Domestic bank accounts but they could not then  convert those into real USD or transfer the funds  outside the country. Initially a swipe card was  meant to be connected to this new account but we  understand from the banks that this measure was  delayed.

Instead the banks convert the funds into  ZWL at the auction rate on request for use in the  shops. In this regard, the allowance is hedged to  some extent to a fall in the official exchange rate  (but not the parallel) and so is better than a direct  payment in ZWL. The economic authorities  meanwhile need to create these nostro balances,  which in our July Notes we defined as RTGS  dollars, since they are not necessarily backed by  real USD. That begs the question as to whether  they appear in the monetary numbers and if they  do, where are they? Ultimately they will be  converted to ZWL and join the formal ZWL  economy and the ZWL monetary statistics.  

Much of Government’s recent policy actions have  centred around the foreign exchange auction  system. This was introduced in June with the first  rate set at ZWL57 to USD1. At the time the  parallel rate was trading at ZWL100 to USD1. The  auction rate has since settled around ZWL82, with  the gap between the official and parallel rates  narrowing to around 30%. The ZWL82 rate has  barely moved at all in recent weeks which  immediately makes market participants suspicious  that the rate is being manipulated. The RBZ  controls the auction and supplies the auction with  the US dollars that either it has or on behalf of  exporters.

Exporters themselves are not allowed to  participate in the auction by offering their own  export proceeds at an offer price that they  determine. Speaking with the corporates who  require US dollars, most seem to receive some  monies through the auction system, but for those  who don’t earn US dollar revenues but who require  substantial US dollars for inputs, licences or capex,  the auction system is wholly inadequate for larger  amounts of foreign exchange. A market-based  foreign exchange market would allow an exporter  to sell the necessary US dollars to the domestic  importer but the exchange rate would likely be  very different from the auction rate and more in  line with the parallel rate. The RBZ appears  unprepared to allow that for the time being. 

The demand for US dollars through official  channels has fallen substantially now that the RBZ  and the economic authorities have allowed  businesses to charge for their services in both US  dollars and ZWL – so long as the foreign exchange  rate used is set at the auction rate. In reality we  suspect that this will not necessarily be the case  for USD cash transactions. This new policy has  

been a saviour for businesses who can in many  instances earn sufficient US dollars for their own needs without the need to access the auction  market. We have spoken with a number of  businesses across different sectors; US dollar sales  represent in the majority of cases around 50% of  revenues, but in some cases as high as 75% or  more. Further, the bulk of fuel is now charged in  USD which implies the RBZ does not have to find  foreign exchange for the purposes of importing  fuel.

Government wants a slice of the action too  demanding that tax on forex revenues be paid in  forex and not ZWL. Further 20% of forex domestic  nostros must be handed over to the RBZ for their  use in return for ZWL at the auction rate. If the  Government was serious about de-dollarisation, it  would insist on tax being paid in ZWL forcing  businesses to convert their US dollars into ZWL in  the foreign exchange market. Clearly the  economic authorities have little faith in the ZWL,  preferring instead foreign exchange. For  businesses earning the USD cash, there will of  course be an incentive to under disclose any  revenue earned in this way. Zimra for one will be  the loser.  

Another advantage for businesses being able to sell  in USD is that they can pay employees a portion of  their wages in USD. This will to some extent help  to alleviate the brain drain that Zimbabwe  suffered back in 2007/2008. Of course businesses  that only earn ZWL revenues will be unable to do  that; the entire financial sector is a case in point.  Retaining staff will prove tough in such businesses;  where employees won’t need to leave the country  to earn foreign exchange as they did in 2007/2008,  they can simply change sectors!  

Speaking with business people today as compared  with our discussions in May/June, is like comparing  chalk and cheese. Back in May, businesses were  struggling to emerge from a harsh lockdown. Sales  were in ZWL, business hours were reduced,  productivity was low and accessing foreign  exchange was tough given an artificial exchange  rate peg of ZWL25 to USD1. Those same business  people are now far more optimistic, as capacity  utilization is rising, revenues are in both USD and  ZWL, accessing foreign exchange for inputs is  easier, creditors can be paid off and so forth. But  that optimism is off a very low base with the July  to September quarter that much better. To put it  into perspective, as one business person put it,  their volumes were down 50% on a year ago during  the first half of 2020, but last year’s volumes were  50% off the year before! So whilst the latest  quarter has seen a substantial improvement, we  are far from the peaks of 2018/2019.  

A simple analysis of activity over recent years  would highlight that volumes in 2018 were high  and in some businesses (e.g. Delta) at an artificial  peak as the economy was operating under the ‘one  to one’ illusion where RTGS prices were too low in  USD terms. When the illusion started to shatter  from October 2018 and then with the advent of 

the new ZWL at ZWL2.5 to USD1 in February 2019,  demand started to fall. It then collapsed in July  2019 when the multi-currency system was made  illegal and selling products or services in USD was  banned. March 2020 saw the start of the COVID-19  lockdown, with demand collapsing further. So the  most recent quarter’s optimism should be put into  some sort of perspective! 

Whilst the short term may be improving, the  longer term prospects remain constrained. After  all, ZWL salaries in real terms are at best 70%  lower than they were, so volume demand has  necessarily collapsed. Those who can access USD  cash will be better off but that cash will be coming  from under mattresses or from within the informal  economy. There is little chance that much of it  will end up in the financial system. The general  populace once again does not trust the formal  financial system having had their USD savings  ‘stolen’ when their USD assets and cash were  forcefully converted from USD into RTGS in  2018/2019. Which brings us back to the size of the  banking system as compared to the real economy.

It is simply not large enough to finance the  economy. The same can be said for the  Government’s own income in real terms. It is small  relative to 2017/2018. The temptation to print  money to fund infrastructure programmes or  agriculture will be all too great and hence we  remain highly skeptical that the current stability in  the ZWL can last. Then again, the ZWL economy as  compared with the USD formal and informal  economies has and will continue to decline in  relevance as the multi-currency system takes hold  once again. So analyzing the ZWL data will  overtime become a pointless exercise – if it isn’t  already. 

It is nevertheless interesting – and maybe for  amusement – to look at some ZWL monetary data  as published by the RBZ last week, being the July  Monthly Economic Bulletin. As we have highlighted  above, it only tells a part of the story. The RBZ  monthly statistics co-mingle different currencies – 

ZWL, USD domestic nostro etc. – but not with the  US dollar itself. A more serious distortion creeps in  thanks to the use of the official auction rate to  translate foreign assets and liabilities against a  hyperinflationary background. It is impossible to  guess where a truly floating exchange rate would  settle if exporters could participate at the auction  directly without the central bank acting as a go 

between to set the offer rate, but with the auction  rate consistently 30% or so over-valued compared  to the parallel rate, the statistics are clearly  distorted. The official statistics show just what  damage there has been to the financial sector;  when translated back into US dollars the total  assets of the banking system amount to just  US$2.8bn and total loans a paltry US$430m. 

Both Reserve Money (M0) and Broad Money (M3)  have been growing quickly but this is to a large  extent due to the translation of various currency  items into ZWL. For example, foreign currency  

deposits in the depository institutions (i.e. mainly  the banks) have risen to 60% of M3 (as at the end  of July 2020) which compares to 24.4% in July 2019  as the ZWL has devalued. [Various definitions of  “dollarisation” exist, but one IMF research  document (see Dollarisation in Sub-Sahara Africa:  Experience and Lessons”) would regard a 30%  threshold of foreign currency deposits as a share of  total banking deposits to be dollarisation.] Using  the central bank’s official exchange rates, M3 was  US$1.85bn in July 2019 and US$1.71bn in July 2020  i.e. flat. It was US$1.25bn using the parallel rate,  i.e. a one-third collapse in broad money over the  year and which possibly more accurately reflects  the true fall in real GDP. Our corporate interviews  would largely agree with this number. A typical  sub-Saharan country would demonstrate a broad  money to GDP ratio of between 20%-30% – Zimbabwe’s was 32% in 2018 compared to 22% for  Zambia for example. At the auction rate, this  range would suggest Zimbabwe’s formal ZWL GDP  is today around USD6bn or US$400 per head  assuming 15m people. This is roughly one-tenth of  the threshold level for Middle Income status of  US$4,000. 

Figures on reserve money are now being published  weekly – which hints that this is therefore a fairly  “harmless” number to let into the public domain.  Reserve money grew by 3.9x in the year to July  2020, whereas M3 grew by 7.8x and the official CPI  rose by 8.3x. The exchange rate rose by 8.3x (i.e.  it devalued by 88%) so it is easy to see reserve  money is fairly irrelevant as an indicator whereas  M3 is far more correlated to inflation and  devaluation. In passing, there is a target for  reserve money, but this has changed reasonably  frequently – it is now a growth of 25% q-o-q from  15% y-o-y at the start of 2020. Goodhart’s Law – named after Charles Goodhart who was a member  of the Bank of England’s Monetary Policy  Committee – covers this: “when a measure  becomes a target, it ceases to be a good measure.”  What is interesting though is how the pace of  devaluation and the rise in the CPI tracks M3 even  though M3 is published with a considerable lag,  currently over two months. 

One number that stands out from the RBZ Survey is  the rise in Central Bank liabilities to non-residents  (i.e. foreign debt). These are translated at the  official exchange rate and have risen from  US$0.29bn in July 2019 to US$5.07bn (as of July  2020). The big rise occurred during Q1 2020 such  that by April 2020 liabilities to non-residents  amounted to US$4.36bn. Two possible explanations  spring to mind although the lack of an official  explanation has inevitably given rise to  speculation. The first is external borrowing  collateralised by future mineral output to pay for  domestic spending (food imports etc.) and to kick start the auction system that started in late June.  The fall in these liabilities of around US$100m  between June and July could reflect a run-down of  foreign exchange to supply the auction which has  seen turnover of around US$100million per month. 

This however is a modest number compared to the  rise in liabilities to non-residents between July  2019 to date. The second explanation is that this  reflects the legacy debt issue. If so, and assuming  GDP (for the formal ZWL economy) really is in the  region of US$6bn, then these liabilities to non 

residents must surely be reaching some kind of  prudential limit for the institutions that have  supplied this debt. Either way, corporates have  had two major incentives to hoard ZWL – leading  to the tight ZWL monetary conditions we saw  recently; the first was to raise ZWL to put onto the  RBZ at 1:1 as legacy debt, and the second was to  pay for foreign exchange at the auction rate at a  30% discount to the parallel rate. Our ‘bottom-up’ 

micro meetings suggest that corporates are now  just about able to live with a 70% retention ratio,  so the immediate pressure on ZWL liquidity is  reduced. It will tighten again if inflation and the  parallel rate start to move while the auction rate  remains fixed. 

The sum of Net Foreign Assets – of which Central  Bank liabilities to non-residents is a component – and Net Domestic Assets is Reserve Money. So as  these components change, so reserve money  changes. An inflow into the country will increase  reserve money and an outflow will reduce reserve  money and tighten monetary conditions. But, it  remains hard to believe the RBZ can produce a  figure for reserve money weekly without also  producing a full balance sheet; that would be more  useful. 

The mere fact that foreign debt has risen so much  in 2020 suggests that at least some financial  institutions are willing to lend that money to  Zimbabwe. It is far more than would be received  from the Paris Club or the IMF under normal 

circumstances should they have been able to lend.  The loans though would not be concessional as the  multi-laterals would provide, but on commercial  terms which is far more expensive. One can also  make the point that the mantra that Zimbabwe is  suffering due to sanctions does not follow. If it did  foreign debt would not have increased in 2020 to  the extent that it has! The very fact that there  have been net foreign inflows may explain the  relative stability in the parallel rate over recent  months. We doubt however that these inflows are  sustainable over the medium to long term.  

Zimbabwe may have escaped relatively unscathed  health wise from the COVID-19 crisis that has  battered the World. Once again the official data  may not be as comprehensive as in the western  World. Speaking with the companies we have  heard that their employees have suffered  relatively little from the virus. One company  tested all of its employees, numbering into  thousands, utilizing the PCR test. Just over 1%  tested positive and of that number, 50% showed no  symptoms whilst the other 50% had mild  symptoms. This ratio of asymptomatic cases is in  line with global data (up to 80%) suggesting that  the effect of the virus circulating in Zimbabwe is  

no different to the rest of the world but that some  special factors have reduced the incidence of the  spread in Zimbabwe. Zimbabwe’s lockdown has  not been as harsh as say South Africa. April and  May were closed down, but the easing was  relatively rapid from June, and those in ‘essential  services’ appeared to be many; mining,  agriculture, food supplies, medicine, financial  services could all operate during the first  lockdown. The scientists can work out if and why  Zimbabweans have not been affected as much;  whether it was the sunny winter weather (Vitamin  D), the BCG injections that every child in  Zimbabwe receives which may have built a  stronger immune system or an early lockdown that  closed the borders. We are not qualified to  comment. 

We hope we have highlighted in these Notes in  some way the difficulties of analysing the  Zimbabwe economy in October 2020. The smoke  and mirrors that can be used by the economic  authorities to present a picture of the economy  are many; they may not be lying in terms of the  data, but the data simply does not tell the whole  story. Our focus will therefore continue largely on  our discussions with management that have to deal  with the day-to-day issues within their businesses.  That should give us a much better understanding  of the economy as a whole.  

The current ‘multi-currency system’ as it stands  today could be with us for a while but over time  we would expect the ZWL economy to represent a  decreasing share of the overall Zimbabwe  economy. Overall economic growth will be  constrained by the availability of US dollar cash  within the economy which won’t change until such  time as the financial system redollarises and starts  to lend again. But even then, who would trust  their real dollar savings in a locally based financial  institution under current circumstances? 

As far as the investment climate is concerned  foreign investors have continued to sell the ZSE  taking advantage of the auction system to  repatriate their proceeds now that the Old Mutual  mechanism is no longer an option. It is unlikely  they will return any time soon. After the disastrous  first decade of the new millennium that  culminated in hyper-inflation and a violent 2008  election, foreigners – as with most Zimbabweans – genuinely thought the Government of National  Unity together with a US dollar monetary system  would finally allow Zimbabwe to turn over a new  leaf and grow rapidly. Foreigners invested heavily  as a result driving the ZSE to new heights in 2013.  By 2016, the US dollar system had been infiltrated  by unbacked RTGS dollars which weakened the  monetary system and eventually broke it,  culminating in the introduction of the ZWL in  February 2019. As we wrote in our April Notes:  

‘By introducing the ZWL in February 2019 and  converting all RTGS dollar assets and liabilities  into ZWL assets and liabilities, Government  successfully stopped Financial Dollarisation by 

making it illegal. Prior to that time, an RTGS  dollar was officially at par with the USD although  in reality that was not the case. The effect of  redenominating assets and liabilities into ZWL was  to enable the government to fund itself again by  printing money and/or Treasury Bills and to  rescue the banking sector. The flip side of such a  policy was to break the illusion that Zimbabwe  supported property rights, the fundamental  backbone of a modern economy. Whilst in 2002,  around 4,500 commercial farmers lost their  property rights with the farm invasions, the entire  population together with foreign investors lost  their monetary property rights as their US dollars  were exchanged for ZWL paper. All at a stroke of  a pen.’ 

Once bitten, twice shy – there are plenty of other  attractive places for foreigners to invest their  funds. Sadly they have been bitten by Zimbabwe  once too many times for them to be able to justify  to their own trustees that this time will be  different.  

For domestic investors who don’t have access to  US dollars, the ZSE remains the only viable option  for new investment or as a hedge since money  market assets will lose value over time. Sadly  investment options on the market have been  reduced by Government’s insistence that Old  Mutual, Seed Co International and PPC Ltd be  suspended and ultimately relisted on a new  exchange in Victoria Falls. A number of corporate  actions are in the pipeline which will see a number  of other companies delist or absorbed into their   

parent companies. Overall that will reduce the  available liquidity on the ZSE. 

We have to be very aware of the risks of holding  any ZWL asset that could lose all of its value as  occurred in 2009. The ZSE has risen strongly so far  this year in US dollar terms and has at last proved  a great hedge against the devaluation. Hard assets  such as property and equities listed on the ZSE  therefore make up a larger proportion of pension  and insurance fund assets as monetary assets,  including prescribed assets, have lost substantial  real value over the past few years. 

Despite the USD gains on the ZSE so far this year,  asset values based in US dollars remain very low by  historical standards and arguably are lower now  than they were when the economy crashed in  2008. With business conditions now improving post  lockdown and with the re-introduction of the  multi-currency system albeit by default, we expect  to see strong gains in volume growth and  profitability from the current very low base. That  should sustain the gains in equities once the  foreign selling ends. There are some excellent  businesses in Zimbabwe which we can be part  owners of via the ZSE. Our regular corporate  interviews give us much encouragement despite  the economic challenges that we are all  experiencing.  

John Legat,  

Chief Executive 

Imara Asset Management (Zimbabwe) Ltd 

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