Last week, the parallel market rates in Zimbabwe sky-rocketed. According to the excellent @ZimBollar on Twitter, we began the week here:
And then ended the week here:
Some Terminology and Background
For non-Zimbabweans (and perhaps some Zimbabweans as well), there is a lot going on here. So here is a quick FAQ for background:
What is RTGS?
RTGS is an acronym for “Real Time Gross Settlement”, and it’s a shorthand reference for money locked in the banking sector part of Zimbabwe’s national payment system. Money within that sector (ie. money in bank accounts) is electronic. At this point, it is mostly un-cashable (ie. you can’t withdraw it in cash) and mostly un-transferrable abroad (ie. you can’t use it to pay for your imports, or your holidays, etc).
The bottom line: RTGS is essentially a geographically-constrained Zimbabwean version of the US dollar.
What is Bond?
Bond notes were issued to try and alleviate the ‘un-cashable’ness of RTGS bank balances. The constraints on the bond-note printing, relative to the scale of electronic/RTGS Treasury Bills being issued by the Zimbabwean government to cover its fiscal deficit, meant that bond notes developed their own market. And those RTGS balances remained uncashable.
Why are these rates in percentages?
These rates are quoted as the ‘premium’ you would have to pay in order to acquire either US dollars or bond. Let me do a quick conversion for you:
Remember, these are all officially “US Dollars” – just US dollars with different degrees of usefulness and risk.
What is the OMIR?
The OMIR is the “Old Mutual Implied Rate”. It was very popular during the hyperinflation of the 2000s. Basically, Old Mutual lists its shares on multiple exchanges (the LSE, the JSE, the Zimbabwe Stock Exchange, etc). In an ordinary setting, you would expect there to be a degree of price parity between the share prices across the exchanges – as the shares are the same.
This ‘price parity’ should be maintained because it is possible to transfer a share owned on the JSE to the ZSE (for example), and sell it on a different exchange to the one you purchased it on. This allows for ‘arbitrage’ of long-term pricing differences.
So what happened this last week?
In theory, you might have expected the parallel rates to stabilise:
- Most of the election questions have been settled (in practice, if not on Twitter);
- The new cabinet was warmly received; and
- Zimbabwe’s new Finance Minister, Professor Mthuli Ncube, is a technocrat with a long CV of credentials. And he’s talking about currency reform.
All of that is extremely positive. And yet, “carnage” in the alternative market ensued.
Here are the competing theories that I’ve heard suggested to explain it:
- Old Mutual investors, trying to take advantage of the arbitrage betweeen exchanges, cashed out this week, and caused a run on the rate;
- The Zimbabwe government printed a whack-load of new treasury bills; and
- The new Minister made a comment about withdrawing bond notes.
Let’s address those options.
Option 1: Old Mutual Investors cash out
This is the easiest one to start with. Here is the last 10 days of trading activity on the ZSE (Zimbabwe Stock Exchange) for the OMU share (the Old Mutual share):
So it’s true that the share price fell dramatically.
But let’s quantify that. Using closing share prices, the total ‘money’ that changed hands here in physical trades was $4.5 million for the entire week. In RTGS terms, mind.
Zimbabwe’s national payments system processes about $3 billion of transactions each week. So in terms of money flow, the Old Mutual trade contributed some 0.15% to the week’s monetary flows.
Is this the stuff that running rates are made of?
Option 2: Government issues treasury bills
When government goes to the parallel market with freshly-borrowed money – either through its civil servants (who just got paid, and want to secure the value of their salaries) or on its own behalf (to secure foreign currency for essential fuel imports, as an example), there is big pressure on the rate. Government is a massive financial player.
And the Ministry of Finance has said that the fiscal deficit is being financed with Treasury Bills. In 2018 Q1, government was overspending by about $90 million per month. Here is the direct quote from the 2018 Q1 Budget Report and Outlook:
Actual expenditure outturn in the first quarter of 2018 was US$ 1.385 billion against a target $US 1.112 million. A budget deficit of US$ 273.2 million was recorded and was financed largely through domestic borrowing. Of this expenditure, US$1.102 billion (79.6%) was on recurrent expenditure while US$283 million (20.44%) was on capital expenditure.
So that was Q1. Since then, there was a civil servants wage increase came into effect on 1 July 2018 – so that should be increasing that deficit spending.
But I can’t see mention of much that is really ‘new’ news. The RTGS/USD rate has continued to worsen all year – which is symptomatic of a continuous drip-feed of extra RTGS money into the system through deficit spending. Unless there was some really big expenditure that was settled in this last week that we don’t know about, the constant deficit-spend should not cause the RTGS rate to move so quickly.
And even if there was a sudden expenditure hit, I wonder if it would also explain the sudden collapse of the RTGS/Bond rate.
To me, the far more obvious influence on last week’s rates was that bond note comment…
Option 3: a comment by the new minister about Bond Notes
On Sunday 9 September, the new Finance Minister was quoted as saying the following in the Sunday Mail:
“I am very clear that there have to be currency reforms and the (current) currency approach is not working.
“In doing so, there are three choices that I will explore and pursue with urgency: One, adopt the US dollar only and remove the bond notes from circulation through a demonetisation process and also liberalise exchange controls.
“Two, adopt the rand by negotiating to join the Rand Monetary Area, and this will close the gap in loss of competitiveness against our largest trading partner, South Africa.
“Three, adopt a new Zim dollar, and here one needs to be clear that it has to be backed by adequate foreign reserves and macroeconomic conditions for its stability. Foreign currency accounts will also be introduced. For sure, currency reforms will be implemented.”
“I would like to implement this by year-end.”
There are about $400 million bond notes in circulation.
Anyone holding those bond notes as a hedge against the devaluation of RTGS just heard that their bond notes were potentially going to be ‘demonetized’ – ‘with urgency’ – ‘by year-end’.
Now those are the kinds of phrases that can easily spark a currency run.
But why would the RTGS rate be affected by the potential withdrawal of bond notes?
The markets for US dollars, RTGS balances and Bond notes are all inter-related.
That is: RTGS and Bond holders are both chasing the same pool of USDs. So if Bond holders suddenly want to not be holding bond notes, then given that they were already trying to preserve value, their preference would be to convert their bond notes to USDs.
That dries up the supply of USD in the market for both Bond notes and RTGS – which means that the RTGS/USD rate would fall as well.
But perhaps you would prefer a more financial-style explanation for that. So here goes.
The Bond-RTGS-USD Arbitrage Trade
As of last Monday, the ZimBollar rates in the market presented the following disequilibrium:
The important rates:
- the direct RTGS/USD rate was 81%; but
- the implied RTGS/USD rate (based on the RTGS/Bond and Bond/USD rates) was 88%.
- Buying USD 100 with RTGS straight would cost you RTGS 181.
- But if you went and bought Bond 161, to then buy USD 100 in the Bond/USD trade, that would have cost you RTGS 188.
Well here’s a strange thing: the USD trading for two different RTGS prices. And surely one could make money off such a strange thing?
In fact, one could:
If you start with USD 100, you could:
- Sell your USD 100 for Bond 161;
- Sell the Bond 161 for RTGS 188;
- Use that RTGS 188 to buy USD 104 (because the rate is still 81%).
- That’s USD 4 profit, for doing nothing other than trade the money markets.
What should happen, as more people do this, is you’d get:
- a growing demand for Bond from USD-holders;
- a growing demand for RTGS from Bond-holders for the arbitrage trade; and
- a growing supply of RTGS for the RTGS/USD trade.
This should cause the Bond/USD rate to stabilise, and the Bond/RTGS and the RTGS/USD rates to weaken, until you’re back toward equilibrium.
However. If the Bond rate is dropping because of some exogenous factor (like a demonetisation panic), then:
- the Bond/USD rate does not stabilise – it continues to drop in isolation, allowing the arbitrage trade to continue; while
- The Bond/RTGS and RTGS/USD rates continue to weaken as traders take advantage of the arbitrage trade #moneymoneymoney
Which does explain why you’re seeing the following rate moves:
- The Bond/USD rate is falling (that’s the panic);
- The Bond/RTGS rate is falling (that’s both the arbitrage trade and the panic);
- The RTGS/USD rate is falling (that’s the arbitrage trade, and the shortage of USDs);
- The OMIR is strengthening (that’s the longer-term positivity about currency reform).
How does it stabilise?
- The USD-traders get ahead of the arbitrage, and start to price the RTGS/USD rate high in anticipation of the arbitrage (which seems to be the point that the market was reaching on Friday morning, when the arbitrage had almost disappeared); or
- The Bond Note self-demonetizes by reaching parity with RTGS. If Bond notes and RTGS traded at 1:1 (or thereabouts – there’s always inconvenience and risk associated with this kind of money trading, so a slight premium is probably acceptable), then the rate run would run out of arbitrage steam.
That said, here’s a disclaimer: this is Zimbabwe, so of course, anything could happen; and perhaps there are other drivers happening in the background that we’re not aware of yet.
However, the rates do not seem to have moved much over the weekend:
And as for that OMIR – I don’t think it’s especially relevant for last week’s movements. The Zim money markets move far too quickly for the six week window it takes to move those shares around.
But my guess is that the Old Mutual share is moving because the market is now pricing-in currency reforms before year-end, and making that Old Mutual share very over-priced.
Which would be a silver lining to all this rate-running.