Financial market distortions are not only a source of vulnerability for the economy but they are a hindrance to growth.
The existence of a plethora of financial market distortions across the Zimbabwean economy should be a cause for concern for policy. As we progress to put in place an economic revival plan for Zimbabwe, in line with the President’s vision 2030, we must bring into sharp focus the issues around financial markets and their stability in the new dispensation.
The upheaval in the markets which manifested itself last year largely as a surge in stock market prices and a dislocation in the foreign exchange market which has spilled into the real goods market in the form of multi tier pricing, must be tackled head on if we are to put the economy on a sustainable path to recovery. We have seen a rapid decline in real asset valuations in the property markets, we have seen the contraction of private sector credit and we have seen the resurgence of inflation, all being signs that things are not as good as they can be.
The reason market distortions become topical is very simple. When prices of financial and real assets exhibit very high variability, it also means that the returns for investors in those asset classes also are very variable. This is the essential definition of risk in the economy. When prices are changing rapidly, whether up or down, that usually indicates fundamental problems in the market.
In trying to understand the causes of observed market distortions, we need to do a bit of root cause analysis to answer the question: what are some of the causes or sources of the various market distortions?
The adoption of the multi currency system (dollarization) was a natural response to hyperinflation. From February 2009, the economy enjoyed stability engendered by the advent of dollarization. Inflation disappeared overnight and in fact for the better part of three or four years the economy enjoyed very low if not negative inflation. However dollaristaion brought with it a few chunky challenges, such as the lack of a Lender of Last Resort in a banking system, which is characterized by Liquidity Silos. About 70 to 80% of banking sector liquidity is held by 20 to 30% of banking institutions.
The other source of distortions in the financial system is the multiple tier pricing of Treasury bills issues by the central bank. There are many distinct classes of Treasury Bills that have been issued. Some are non tradeable TBs, which is a bit of a misnomer because TBs are supposed to be liquid assets. Some TBs are issued as capitalization or lending instruments, while others are issued as marketable securities. These factors have contributed to the absence of a vibrant secondary market in the instruments. It is diffcult in a market without a visible yield curve to accurately price such instruments
Bond Notes —Backed by Afreximbank but can banks get Forex on demand on the back of the Backing? The same distortion has been carried forward to clients who cannot get access to cash on demand. One to one exchange rate between bond note and USDollars is a distortion. Gershams Law clearly says that you cannot circulate two fiat currencies of same face value when the intrinsic values are different. The currency with higher intrinsic value will be mopped up and will disappear from circulation
There are shortages of currency (both local and hard currency) from the formal market but there is plenty of cash in USD and Bond notes in the informal sector. Why? This is because in those informal markets , market forces and the rules of supply and demand are in play. Prices are fluctuating daily between cash notes Bond and dollars and RTGS depending on the interplay between supply and demand. Informal markets have established clear trading rules which are respected by everyone. This is critical to understand. There is no one interfering with that market and it is working perfectly. We need to learn from it.
Directed interest rates- Directed interest rates are also contributing to price distortions, particularly on bank lending portfolio. Interest rate caps have tempered with the risk versus return trade off. When such interest rates caps are imposed there will be credit rationing. This is because banks price their loans at the margin and as bank margins get squeezed to unsustainable levels banks will begin to seek to lend only to higher quality borrowers. Marginal clients become too risky as banks are unable to recoup potential losses at lower rates so they stop giving credit to those borrowers perceived to be of higher risk. That is why there is an apparent credit squeeze. I have argued in my past writings that the apparent decline in lending by banks over the last two or three years is not a result of crowding out per se but a result of these pricing distortions being imposed by persuasive regulation. Interest rate caps are a form of financial repression and are not good for the markets.
The writer is an economist. The views expressed in this article are his personal opinions and should in no way be interpreted to represent the views of any organizations that the writer is associated with.