Economy contracts as headwinds remain pervasive in 2019
Recent contractive fiscal and monetary reforms, including the 2% IMT tax and the re-introduction of a domestic currency (ZWL$) as the sole legal tender, have been highly stagflationary in the short-term. The government sanctioned hikes for fuel prices in order to curb demand and assuage its foreign currency obligation despite at least 60% of the industrial sector being dependent on fuel for production, particularly mining and agriculture. Therefore, consumption will be significantly subdued as growth in incomes will lag expenditure growth, with inflation already at record levels since 2012.
The Ministry of Finance now projects GDP for 2019 to contract by 2.1%, in line with the IMF SMP projection, weighed down by underperformance in agriculture, mining, manufacturing and tourism expected to contract by 15.7%, 3.6% and 4.9%, respectively. The World Bank forecasts a larger contraction of c3.1%.
Monetary developments and re-introduction of ZWL$
In June, the central bank re-introduced the Zimbabwe dollar through Statutory Instrument (SI) 142, subsequent to an earlier announcement this year regarding the creation of an interbank FX market where the ‘RTGS dollar’ would be traded. While the premium in the parallel FX market fell immediately after the establishment, it has since risen, reversing the temporary reduction in economic distortions.
The RBZ also announced the adoption of a monetary policy framework based on monetary targets to help anchor inflation and stabilise the exchange rate, but suggested in the February 2019 Monetary Policy Statement that it would remain active in the inter-bank market.
The introduction of the FX interbank rate saw a material increase in the value of local companies’ foreign-obligated payables in excess of the cash resources on the balance sheet, presenting potential liquidity and solvency challenges for several businesses. Hence, the central bank also pledged to take over Zimbabwe dollar (ZWL) ZW$1.2bn of companies’ foreign legacy debt at a rate of 1:1 between the ZW$ and the US dollar.
Increased vulnerabilities in the sector
To augment the fiscal authorities’ policies, the central bank has adopted the Monetary Targeting Framework, intended to curtail the rise in money supply. The RBZ has projected that reserve money supply will grow between 8-10% by the end of 2019 as it has introduced measures to mop up liquidity from the market through the 2% IMT tax and the assumption of the US$1.2bn legacy debt from local corporates at a rate of 1:1, sucking out ZWL$1.2bn from the money supply.
In order to achieve the projected growth, tame inflation and stabilise the exchange rate, other proposed measures include TB auctions, savings bond issuance and participating on the interbank market through foreign currency sales.
We believe that a balance should be struck by the monetary and fiscal authorities between stabilising inflation and exchange rate volatility while ensuring adequate supply of liquidity to the productive sectors of the economy. The authorities need to fine tune policies that enable methodical release of liquidity into the market and improve the efficiency of the interbank market.
Maintain under review (U/R)
We maintain our U/R rating for all banks under the IH Banking Universe as the severe dislocation between interest rates within the core lending business and current inflation remain a cause for concern in the pursuit of real returns. Additionally, the introduction of the ZWL$ as a currency exposes the banking sector to solvency risk, due to potentially significant mismatch between foreign currency assets and liabilities.
Of the counters in the IH banking universe, we anticipate that while financial services groups such as CBZ and FBCH are significantly exposed to risk – as the insurance and banking sectors have been negatively impacted by the floating of the ZWL – their relatively higher property exposures are going to be the major focus in attempting to preserve shareholder value and potentially put them in better positions. We will likely review our recommendations after the release of H1 19 earnings, as the introduction of the new currency will give us a clearer picture of the solvency and potential mismatches in individual balance sheets.