How to price the Zimbabwe risk

Ray Chipendo
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HARARE,– All investments involve an element of risk. The risk component is ostensibly behind the volatility in Zimbabwe’s currency markets.

Among the panel discussions at the Financial Markets Indaba — a forum to promote understanding investments opportunities in the southern African country — which was recently held in London was the topic “Zimbabwe – how are we pricing risk”? It was interesting to notice the varying views towards that risk. What would you say is the most important risk in Zimbabwe? Is it policy consistency; currency; corruption; red tape; labour skill; or is it price?

How we define and measure risk determines our investment decision making. But herd mentality, fear and greed are all too powerful forces that often determine how we think about risk. The examples below help to probe this assertion.

Equities risk- value vs growth investing

Risk definition and pricing does drive investment decision making-whether right or wrong. For example, at 380 points, ZSE has more than doubled year to date. That presents a 50% price risk if you, like me, believe that the market was fully priced beginning of the year. Money pouring into equities is leaving RTGS currency making the case that investors are attaching a devaluation risk of >50% on RTGS. Implicitly, we can argue that at the suggested current discounts of 35-45% to the dollar, investors buying into the ZSE believe RTGS will experience a further 50% devaluation.

Another place where risk pricing is strange is in equities. Beginning of the year SeedCo share price was 98 cents and today it hovers at around 250 cents – a 150% rise. At the same time, BNC share price has in recent years plunged from highs of 10 cents a few years ago and has remained unchanged at 4 cents since beginning of the year. Both companies have turned from loss making to profit in just under one year. Without going into deeper fundamental analysis and despite BNC’s underlying issues, such a discrepancy may help to outline the important observation that buyers of the current market are momentum driven and not concerned with the fundamentals.

How risky are Treasury Bills

Treasury bills have also been unjustifiably neglected. Perhaps I am too young to be assertive here, but for as long as I have followed markets, the Zimbabwe government is yet to default on local TBs. Not because the State is a faithful borrower but that it always have means to either print the currency or make capital markets actors like banks and pension funds buy TBs to refinance maturing ones. But more important than government’s “track record” one needs to assess the potential impact of TBs’ defaulting to understand the likelihood of that happening. For example, if TBs were to default, some of the local banks will grind to a collapse and pension funds would fail to honour redemptions by retiring working men and women. Consequently the whole ZAMCO programme would have been a self-defeating exercise – replacing an NPL with another NPL. But again, the unthinkable has often happened in Zimbabwe.

the questioning of the risk attached to TBs holds water then prevailing discounts of up to 30% maybe the result of an excessively fearful market. More glaring are cases where TBs have traded at double digit discounts weeks to their redemption.

If betting against the stock market (growth stocks and blue chips) is an informed strategy, perhaps it may be useful to think of holding TBs now. In the event of a correction, some of the funds will rush out of equities into TBs and bank balances as the only near- liquid assets. The result is a price appreciation from which holders of TBs can realise a return.

Final words for policy makers

If a lack of confidence is the main cause of the forex cash shortage and the massive discounts to RTGS, then more confidence is the solution.

Each time the invisible hand feels arm-twisted by policy makers it knee jerks swinging to extremes. Such is the case in the currency market. Granted, government accepts that we have three currencies and allow them to trade freely, the discount to US dollar will moderate and settle for a rate that is much smaller than prevailing on informal market.

By outlawing this currency market government is creating a pricing vacuum which media and informal traders are happy to occupy – however informed they are. As currency trading is pushed into the grey area, policy makers are inadvertently responsible for paving way for the large discounts we see today. If banks, shops and bureau de changes are all allowed to freely trade bond notes, RTGS and forex at market related rates, US dollars will eventually move off streets and back into official markets.

More important, a drying in foreign investment in the economy emanates from a worry that an investor will not be able to retrieve his US dollar investment down the road. That lack of currency certainty is a stronger push force than high returns in Zimbabwe are a pull force.

With a predictable market where banks and funds can market-make the demand and supply of different currencies, foreign investors can be comfortable to invest their dollars at a premium knowing there will be a fair market to convert their RTGS back into US dollars when need be. The answer lies not in some unconventional monetary thinking but in returning to that simple faith in the power of the invisible hand – the market.

Ray Chipendo is a Director at Emergent Capital Management, an investment advisory and private management firm.  This article was first published by the Source.