Understanding Zimbabwe`s Bond market Revival: Insights from Ritesh Anand

Ritesh Anand

The Zimbabwe Stock Exchange recently anounced that plans are already underway to re-introduce a bond market/fixed income securities market after it collapse in 2001. This can be seen as a positive development to further deepen Zimbabwe`s financial markets. However, there are certain risks that  such a move may bring and I sought the insights of renowned market analyst, Ritesh Anand to better understand the implications of the bond market revival.


Ritesh Anand is the founder and Managing Director of Invictus Capital, a boutique investment banking platform providing securities trading, corporate advisory, and asset management services in Zimbabwe. He has over 18 years experience in fund management, entrepreneurship, emerging markets, and private equity.

I asked Ritesh a couple of questions, and below are his responses.
 
What will be the role of the bond market in Zimbabwe’s financial market if re-introduced?

Zimbabwe is a bank based economy – capital markets play a little role since they are not yet advanced.  The reintroduction of the bond market in Zimbabwe will play the following role in the development of the economy.

a)    Alternative source of domestic debt finance .Companies have been relying on bank lending for debt financing which exposed the Zimbabwean economy to the risk of a failure in the banking system. Non - performing loans have been on the rise and affected economic activity in credit market. Companies are credit constrained and where forced to reduce investment spending due to interest burdens and restrictive loan covenants, hence reducing aggregate demand through the multiplier effect.

b)    In a banking crisis bond market can help accelerate the resolution of a banking crises by allowing the banking system to recapitalize its balance sheets through securitization (issuance of bonds backed by non – performing loans). Considering the coming on board of ZAMCO, the bond market would be a platform to securitize acquired non-performing loan book through issuing bonds for subscription to potential investors. The development of the bond market will argument one of the funding options for ZAMCO.  Some banks may decide, if not comfortable with discount rates offered by ZAMCO, to securitize and clean their balance sheets on their own on the bond market. 

c)    Lower Cost of Capital.  Bank lending is costly in Zimbabwe. Lending interest rates were ranging from 6-35% in 2014 according to the Reserve Bank of Zimbabwe statistics. These high rates can partly be attributable to loan administration costs, and costs of monitoring and information asymmetry. There is no operation credit bureau at the moment in Zimbabwe, resulting in high information asymmetry and high moral hazard by borrowers. By passing banks (disintermediation) – corporate bonds provide a platform for companies to access finance with lower intermediation costs, hence translating into lower interest rates. Bond market facilitate bank disintermediation by allowing direct access to capital markets through removing the middle man and related costs.

d)    Reduce risk associate maturity and currency mismatch. By issuing bonds, firms tailor asset and liability profiles to reduce risk of maturity and currency mismatch on their balance sheet thus reducing overall cost. This is a problem of information asymmetry. Considering the transitory nature of deposits in the Zimbabwean banking sector  that made up close to 50% of all  industry deposits, corporate borrowers have been undertaking long investment commitments and facing difficulties of matching long -term cash inflows from their investment assets against short term cash outflows from bank loans in a bank reliant financial system. This maturity mismatch has been threatening corporate insolvency and a number of companies fell by the way side partly due to this problem in the current liquidity crisis hit economy. Companies have been staying away of entrepreneurial ventures that have long term payoff due to incompatible short-term financing options

e)    Broadening of capital markets , hence more  variety of asset choices for investors for diversification and alpha generating activities

f)    Efficient pricing of credit risk. Bank determined interest rates in Zimbabwe is not competitively determined, thus may not reflect the true cost of capital to the borrowers.

g)    More efficient allocation of capital to more productive areas of the economy. Expectations of all bond market participants are incorporated into bond prices.

h)    Promotes financial stability, through reduced concentration of credit risk  in the banking industry because a few banks such CBZ  account for the  bulk of bank lending activity. The threat of growing non-performing loans that reached 20.42% in December 2014 is a cause for concern, hence the decision by the Reserve Bank of Zimbabwe to establish ZAMCO to deal with the issue so that it does not clog the banking industry. Corporate bonds would lessen systemic risk for the bank-based  Zimbabwe economy.

i)    More diverse financial system- Credit risk spread across a number of bond investors, reduces the risk borne by the banking sector.

How big do you think the fixed income market can potentially grow to be?
 
The market has been growing of late, from continued of Treasury Bills by the government. Infact, the market has been pumped with Treasury instruments with tenors ranging from 1-5 years, issued primarily to settle creditors to the government. According to the Reserve Bank of Zimbabwe, TB issuances registered a 141.81% annual growth in 2014. This growth is expected to remain strong considering ZAMCO needs to acquire non-performing loans and continued dwindling of fiscal revenue. 

According to the Reserve Bank of Zimbabwe, Treasury Bills to the tune of $1.4 billion were outstanding as at 31 December 2014. This figure, together with less than $100 million in the corporate sector ( Bindura, fidelity housing bonds, etc) and IDBZ ( ZESA, Hwange and other infrastructure,  rehabilitation bonds), could grow to at least 2.5 billion by end of 2016, dominated mainly by government debt securities. With the introduction of bond market, the market growth could be limited to some extent since activity from the corporate world would be constrained by waning aggregate demand.

Companies could also consider issuing bonds as a way to refinance expensive bank loans acquired from 2009 to date. Much activity would be coming from government or government agencies such as the IDBZ to meet infrastructural development needs.  Hence, the fixed income market would be predominantly be a government bond market considering its fiscal deficits and appetite for credit to supplement waning tax revenues.

What sort of companies do you see benefiting the most from the revival of the bond market?
  
a)  Government to benefit the most. Fiscal capacity to service the debt would be an albatross to Treasury. Interest will be driven more by domestic investors that have prescribed asset ratios and liquid asset ratios to meet. Government will be a key player in the development of a bond market.

b)    Blue chip companies such as Delta, Econet , Innscor, and some high capital expenditure firms such as mining firms would also benefit. Delta and econet have been managing to source cheaper sources of capital offshore, so the bond market won’t add any significant benefit at all.

c)    Given a direct relationship between fiscal deficits and significance issuance of government debt instruments, the development of the bond market is inextricably linked to the direction and management of fiscal policy.

What immediate risks do you foresee affecting the Zimbabwe bond market?
 
a) Lack of sufficient economic growth that could generate appropriate issuers and investors. 

b)    No Stable and sufficiently low interest rate environment that could facilitate fixed income investments. If the 20-45% discount rates of Treasury bills in the market are anything to go by, this shows that investors are highly risk averse and this level of interest rates won’t support a bond market. Evidence from Brazil sovereign debt that was recently downgraded to junk status by S & P is testimony to this. The Interest rates in Brazil were too high( at 14.25%) for corporate bond to survive and deep and prolonged recession cultivated a difficult environment for the bond market to survive.

The stability of the base interest rate at 14.25 percent throughout at least the first half of 2016 and the government’s projected primary deficit of R$30 billion next year were the major underpinnings for S&P’s stance on the path of the national debt service requirements and for its rating downgrade. As a result of the deficit, the ratio of public-sector gross debt to GDP in Brazil is expected  to escalate to the neighborhood of 70 percent in 2016 from the current level of 64.6 percent.

c)   Inadequate levels of investable funds in Zimbabwe.  The country`s domestic market is dry.

d)    Low savings and investments rates, so no anticipated strong investor participation in supporting domestic bond market development. Even at government level, more than 70% of government revenue is committed towards recurring expenditure.

e)    Economic performance-declining economic activity, low aggregate demand as reflected by deflationary fears in the country , hence no greater need for fund raising by corporates.

f)    Declining income, no new pension contributions as companies have been closing down- no breeding ground for demand for assets. Figures from a number of pension funds indicate that companies have been failing to remit monthly pension contributions due to low economic activity. Much of the investments being made in the country have been re-investments or portfolio restructuring initiatives. 

g)    There is however fiscal incentives from the government considering drive to finance fiscal deficits but the government has been effectively been playing in the bond market by virtue of ever increasing outstanding treasury bills in the market.

e)   Given high perceived country risk, over concentration of sources of finance in the domestic financial system.

f)    Government debt securities are used as benchmark securities for investors and issuers for pricing purposes if the bond market is active. No drive for the government bond market to be active considering factors highlighted above. Activity in the Treasury Bills market is testimony to this.

g)   Difficulties in pricing credit risk through constructing term structure of risk free interest rates if government bond market is not sizable and does not work efficiently for the pricing of corporate bonds.

h)    Liquidity risk an issue in the bond market, as determined by turnover and bid-ask spread in price an issue in Zimbabwe. Consider examples of TBs currently trading in Zimbabwe;

i)    No derivative markets in the form of options, futures , forwards and swaps to argument liquidity levels and for risk management purposes. Derivatives are  Important for the government bond market to be a viable benchmark security in pricing.

 j)    Development of an organized and active derivatives market is thought to foster efficient price discovery in the secondary market for bonds which can in turn lead to improved liquidity.

k)    Unclear regulatory and tax framework for corporate bond market, this affect activity and interest among issuers and investors. Government may consider removing taxes for bonds to be lucrative.

 l)   Credit rating dilemma….considering the status of fiscal position and macroeconomic fundamentals of Zimbabwe.

m)    Can the government manage the fiscal position well to incentivize domestic and international investors to invest??? A question in every investor’s mind, especially international investors.

n)    Large foreign and domestic government debt position and debt service costs relative to GDP and tax revenues are sticking issues to investors, hence high perceived country risk that would call for a higher risk premium and for the bond to be categorized as non-investment grade.

o)   On a positive note, inflationary expectations are low, hence a conducive environment for debt securities.

p)  Consider capital account balances and positions- low FDIs, low exports and portfolio flows to argument capital account position. Factors seriously considered by foreign investors.

q)    Soundness of the banking system a cause for concern for secondary market liquidity and efficiency. Related securities such as repo markets and interbank not functional, raising fears of liquidity shortages.

r)    Prescribed asset and liquidity asset ratios high, hence high risk of “buy and hold” strategy by pension funds and banks limiting secondary market trading.



Risks continued...
 
•    More liberalization of the financial sector called for. This can be achieved by strengthening supervisory and regulatory framework and information infrastructure. Development of credit bureau a step in the positive direction.
•    Need for a proper and explicit definition of the safety net
•    Review foreign investor policy and exchange control law
•    Consider integrating domestic bond market to SA through  cross listing and sharing infrastructure
•    Smooth settlement system….. CSD a step in the right direction
•    It will take time for some companies  to grow and stable balance sheets, cash flow generation and earnings stability that support a good rating on corporate bonds.



Ritesh Anand is the founder and Managing Director of Invictus Capital, a boutique investment banking platform providing securities trading, corporate advisory, and asset management services in Zimbabwe. He has over 18 years experience in fund management, entrepreneurship, emerging markets, and private equity.