The New Zim Bond Notes… Are Not What Worries Me

So, to follow on from yesterday’s post, here’s the grim Zimbabwean summary:

The Balance of Payments is completely shot. From 2009, the Zimbabwean economy stumbled along, paying for all those imported foodstuffs, goods and services with export proceeds from the sale of commodities (mined resources and tobacco), remittances from the diaspora, and the capital inflows from foreign investment. Then over the last few years, commodity prices collapsed and remittances started to slow (almost certainly due in part to the depreciation of the Rand). And while we’re here, recent indigenisation fears, political instability around succession, and the drought, have made foreign investors…cautious. So there’s been some capital flight.
This is not good for a banking system.
Specifically, it means that the banking system starts to tear in two:
1. You have “real” bank balances, which are the foreign receipts that can be used to make foreign payments; and
2. You have “domestic” bank balances, which is money within the Zimbabwean banking system that cannot be used to make foreign payments.
And to complicate things further, there is that third type of money: physical bank notes – which can be used for foreign payments as well, because US bank notes are accepted tender across the world.

Now, the minute that there is even a hint that not all US dollars have been created equal, you get Gresham’s Law playing itself out with a bang. That is: bad money drives out good. In the current Zimbabwean context, good money is:

Physical bank notes; and
“Real” bank balances.

While bad money is “domestic” bank balances.

In practice, what this means for the men and women on the street, and for businesses in general: you go down to the bank immediately and convert your bad money (your bank balance) into good money (bank notes).

And you also get exchange rates developing between US dollar notes and US dollar bank balances, where people buy cash at a premium. Which sounds bizarre, but then so is everything else about this.

As the cash-good-money gets “driven out”, there’s a massive liquidity crisis: the banks are sucked dry of cash, and they’re certainly not receiving normal cash deposits in return (because the cash is now staying out the domestic banking system – no one wants to swap good money for bad).

Also, to be clear, it’s not like this cash all gets stored in mattresses. These kinds of banking crises are often precipitated by capital flight, and in turn precipitate further capital flight. And much of the cash leaves the country: in buses, on planes and on foot. Sometimes, for safe-keeping – but also (at least at first), to pay for imports.

Now, of course, this is a broad simplification of a single issue. There are other factors at play in the Zimbabwean economy: lost infrastructure, an overextended civil servant wage bill that consumes all the collected taxes and then some, high levels of government regulation, dramatic corruption, near zero capital investment, almost no production, high unemployment (or, at least, very low levels of formal employment [4-5%], with most of the labour force involved in subsistence entrepreneurship), foreign disinvestment.

But the issue at hand is the cash crisis, and that’s what these new regulations are trying to address.

How to Unskint a Cat

So to go back a step here, because of hyperinflation and the fact that so much of the work force operates outside of formal employment, Zimbabwe is already a mostly cash-based society. Sure, it has some mobile banking, but in terms of bank accounts with debit cards and POS devices, not so much. So most people either get paid in cash, or they draw their cash immediately on receipt of salary.

But when you have the physical bank notes leaving the system (either for capital flight to other countries, or to pay for foreign imports, or for safe-keeping in a mattress), then you suddenly get an imbalance of payments in the “cash” sector. And the economy starts to become locked in stasis, because:

Employers can’t draw the cash to pay their employees.
Employees who have bank accounts can’t draw their salaries.
People receiving money through remittances can’t draw their remittances, or the money transfer services can’t issue them the cash.
The retail sector is not primed to accept domestic bank balance transfers via debit card.
And most consumers don’t have debit cards anyway (otherwise, you’d have had more POS devices in the first place).

Awkward.

At this point, the Reserve Bank gets asked to do something already. And unfortunately, there are not so many palliative fixes:

The Reserve Bank could try to introduce a new form of scrip-currency – preferably one that no one would want to hoard, and which no one would be taking out of the country.
The Reserve Bank could try to encourage the use of another country’s currency – preferably one that no one would want to hoard, and which no one would be taking out of the country in a hurry.
The Reserve Bank could try to encourage the use of electronic means of payment (debit cards, etc).

The country could also aim for political solutions, like IMF loans. But those aren’t within the control of the Reserve Bank (and if anything, the recent attempts to settle the IMF arrears in order to be eligible for future IMF loans was a major contributor to the Balance of Payments crisis).

And as of Wednesday evening, it seems that the Reserve Bank of Zimbabwe is attempting both of those first two options, all at once:

They’ll be introducing bond notes, which are to be backed by a US $200 million loan from Afrexim Bank. And they’re using bond notes instead of importing the US dollar currency itself, precisely so that the cash will then stay within Zimbabwe’s borders. It looks like they’re going to force it into circulation by offering an “incentive” to exporters, who will then attempt to use the bond notes to pay suppliers, salaries, etc.
They’re forcing compulsory conversion of 50% of all foreign US dollar receipts into Rands (40%) and Euros (10%) – presumably, because these don’t travel as far or as freely into foreign lands (and let’s all be grateful that the Rand conversion isn’t Chinese Yuan conversion).

Final Thought

Yes, the bond notes could be seen as a backdoor introduction of the Zimbabwe dollar. To be honest, I’m not sure that’s the biggest issue here, because people can just reject its use (they have before, like they did with the original one).

In my mind, the far greater issue here is the Reserve Bank of Zimbabwe (RBZ) using compulsory conversions of exporter remittances to force Euros and Rands down the throats of a reluctant populace.

That, to me, seems to be the real backdoor – while everyone is panicking about bond notes.

Here’s my concern…

Just last week, if you wanted to pay for something in Rands in Harare, you’d have been offered an exchange rate of R20 to $1.

But with US dollar export remittances, the RBZ will do the automatic conversion of 40% of the proceeds “at the prevailing market exchange rate”.

Some math:

Exporter receives a $10,000 receipt from a customer.
$5,000 arrives into the USD account, $1,000 arrives into the EUR account, and $4,000 arrives as R59,840 in the ZAR account, at the prevailing exchange rate of R14.96 to $1.
The exporter owes his employees $4,000 in wages, so he transfers that R59,840 into their bank accounts.
The employees then go and pay for groceries – and the retail outlet is still using an exchange rate of R20 to $1.
That R59,840 will buy them $2,992 worth of goods.
Which is definitely not $4,000 worth of goods.

Meaning that: until the Zimbabwean economy transitions toward accepting ZAR and EUR payments at something close to “the prevailing market exchange rate” offered by the Reserve Bank, the whole thing is going to be highly disruptive. And it will hurt.

Rolling Alpha posts about finance, economics, and sometimes stuff that is only quite loosely related. Follow me on Twitter @RollingAlpha, or like my page on Facebook at www.facebook.com/rollingalpha. Or both.