AT a time when we were wondering what monetary policy would look like without the money printing press, it appears the central bank is not doing a bad job after all. Reading the recent monetary policy, our thoughts on what ought to be priority issues were pretty much summed up in the statement. But there is certainly more runway that the central bank needs to manoeuvre before the financial sector stabilises and the economy is back on track.
One good takeaway is that in the absence of a money printing machine, monetary authorities and government are obliged to pay attention to fundamental drivers of economic growth rather than easy and flirting solutions. Competitiveness of companies; Human capital development; Regulatory policies; and Infrastructure development creep up on their To Do List. As we witnessed in the last decade, printing money is a quick remedy which regrettably comes with painful economic side-effects. So, if our wish mattered at all, we would vote for a US dollar for life.
ZAMCO, a state controlled asset manager with the mandate to clean up bad loans and bring the sector back to sanity is a good start. Based on the monetary policy statement, ZAMCO will buy Non- performing loans (NPLs) from banks in exchange of Treasury Bills (TBs) and Cash. ZAMCO as an asset manager will raise cash from selling securities (subscriptions) to what it calls a “broad-based investor group” comprising pension funds, diaspora funds and foreign and local investor classes. It will also raise money from TBs that government will sell. What is not very clear for now is who will be tasked to recover loans from borrowers? Elsewhere, central banks who have been on a similar path understand well that buying NPLs is easy but collecting them is a completely different job.
The central bank faces difficult choices. To begin with, the central bank’s foremost interest is to “stabilise the banking sector” - recovery of loans is secondary. With that background, it is easy to see why ZAMCO might turn out to be a quasi-bailout of banks. In the interest of keeping banks within healthy capital ratio thresholds, the central bank will favour an outcome where bank assets are not severely discounted but remain sizeable enough not to deplete the capital of banks. If our deduction is correct, it is not unreasonable to expect ZAMCO to pay the NPLs at a premium of their real worth or what the open market would pay. This quandary might stoke fears of moral hazard and a hidden household tax. No easy answers here.
To secure adequate funds from the broad investor group, both ZAMCO’s subscriptions and the TBs will need to offer significantly high returns. We worry both instruments will have a crowding effect on bonds issued by companies – securities that finance the productive sector. Unlike US and European policy of flooring treasury bills’ returns in order to drive investors to take more risk in corporate bonds and bank loans, ZAMCO’s program will likely achieve the opposite effect.
We believe that the key question that ZAMCO should perhaps contemplate is “how do we clean up non-performing loans while preserving, and at best stimulating distressed companies”. If only the first part of the question is addressed, we risk attaining a stable financial sector at the expense of a productive sector. But we know well that a financial sector is only as good as the productive sector. The RBZ is reported to have stated that it will focus on NPLs backed by collateral. This might be a prudent move but it will still leave the financial sector fragile. Presumably the collateral demanded is in form of assets which the same companies are dependent on for their operations. By the time ZAMCO is done recovering the loans, the underlying assets (companies) would have folded.
To tie in the twin goals of financial stability and economic growth, NPLs will require patient capital backed by investors that have the expertise to nurse struggling companies back to life. On the solution presented by RBZ, what may be missing is, for a lack of a better name, a robust and regulated shadow banking system. This system would comprise investment houses and fund managers who have the flexibility to work at different levels of a capital structure.
Such institutions can manage distressed debt and are open to turn some of the debt into equity and can also wait long enough to recover their money. Right now commercial banks by their mandate do not have that flexibility to manage distressed debt and restructure capital structures of heavily leveraged companies. The pressure to meet certain capital ratio thresholds robs banks off the patience to work with struggling companies.
Our view is that, in more cases than not, it is more prudent and profitable to finance distressed companies than it is to sink capital into new and unproven ventures. So, as Western Europe warms up to Zimbabwe and releases funds for entrepreneurial and commercial development, distressed funding needs to be prioritised with our view in mind.
From the lessons learnt in Europe and America, it is too much of a burden to solely rely on banks to play the role of financing companies. Instead of owning all bank loans, American banks currently own about 20% of outstanding bank loans. It follows that banks should rather focus more on originating loans and conducting due diligences than holding assets. When banks are made the sole intermediary of capital, while their mandate remains narrow, we end up with a bloated banking sector holding loans turning bad. NPLs is an age-old problem, which is not so much the result of imprudent lending as it is the consequence of a poor design of incentives and structure of banks.
The reader may question where the money to promote a secondary market will come from? Banks are visibly cash squeezed but we do not think corporate organisations are in the same boat. Our recent Market Outlook paper indicates that (request a full copy from research@emergent-research.com), on aggregate companies have been accumulating cash balances in the last 12months. We believe there are cash rich companies which if presented with reasonable risk adjusted returns, will be ready to fund their cash starved peers through an intermediary. This view will only succeed if the secondary market is well supported by creditor protection rights; rule of law and skilled market players.
Another source of liquidity is insurance and pension funds who hold what can be viewed as permanent capital. The regulators should strongly consider widening the pool of alternative investments that insurance companies can invest in. For example, NSSA keeps at least 65% of its assets in real assets. Pension funds and insurance companies need to employ specialist market players who can track high returns with a sober dosage of risk.
The last source of liquidity we have highlighted in earlier posts is the Diaspora. Besides some of the political concerns that Diaspora cite as reasons for holding back, an underdevelopment of the capital markets and lack of middle market investment players who see value beyond stocks, real estate and bonds is obvious. The regulatory authorities, who have been supportive thus far, will need to continually adapt and hand hold some of the players until they can stand as fully fledged money managers. The horrors of 2002-2006 should not stop us from liberating the markets.
According to central bank’s policy update in September, Bank loans were about $3.8billion. Cash balances of listed companies were at their highest in five years totalling $405million.During the same time NSSA’s pension fund had assets slightly above $600m. In 2013 remittances were an estimated $2billion including informal funds. Unless we have intermediaries who can effectively connect capital with human capital/enterprise, illiquidity will remain. It is helpful to remind ourselves that capital follow ideas everywhere – even in tough environments.
Ray Chipendo is Head of Research in the Johannesburg office. Taurai Duku is an Associate in the Harare office. They can be contacted onray@emergent-research.comand taurai@emergent-research.com