Investors sceptical of govt guarantee

Having come from a protracted period of economic shrinkage, both the private and public sectors have a huge overhang of uncompleted capital projects.

Report by Collins Rudzuna

In both sectors, debt financing is one of the key ways of raising money to finance capital projects. Private sector entities have had some success in raising money both locally and offshore, but the public sector is lagging behind.

While in other countries bonds are common conduits for raising debt financing, Zimbabwe’s bond market had all but dried up.

A recent effort by the Infrastructure Development Bank of Zimbabwe (IDBZ) to raise US$30 million for Zimbabwe Electricity Transmission and Distribution Company (ZETDC) counts as one of the first attempts at issuing a bond in a dollarised Zimbabwe. Sadly, this noble cause was met with limited success, achieving a subscription rate of just 59,41%.

The most obvious reason the bond issue was under-subscribed is the limited liquidity available in the market. Households, pension funds and businesses who normally participate in bond issues are themselves in need of money and hence incapacitated from investing.

Pension funds could also not liquidate other asset classes to comply as there are no buyers with enough liquidity to take the assets on time and at the right price.

One way of encouraging certain classes of investors to support public sector debt issues is to set a minimum level of “prescribed assets” allowed in each portfolio. For the most part pension funds and other investors who are required to hold prescribed assets are non-compliant due to limited availability of such assets.

One would have thought they would therefore have jumped to get their hands on this ZETDC bond. Yet that was not the case as evidenced by the 59,14% subscription rate.

The case presented for the bond is a sound one; funding the installation of prepaid electricity meters in households. Barring unforeseen circumstances, it is reasonable to assume such a project can generate enough cash flows to meet interest and capital repayments.

In fact, ZETDC has set aside cash flows from some of their key clients specifically to service this bond.

A 10% coupon is also not too bad especially when viewed by comparison with the bleak stock market performance forecasts for the coming year. The market’s lack of interest therefore seems to have another justification other than limited liquidity.

In our view, the overriding reason why this recent bond issue had limited success, and the reason why many issues of various short-term bills have failed is that default risk is still considered high even where there is merit in the business case.

Normally, a guarantee would offset this effect but it seems the market just does not have that much confidence in government guarantee attached to this bond issue and the failed short-term bill issues.

Government’s credit record is tainted by defaults on funding from the IMF and World Bank in excess of US$10 billion and, more recently, the Reserve Bank’s default on gold bonds. As such investors are still uneasy about default risk.

CBZ’s US$50 million diaspora bond had 85% support — a success rate far better than the rest despite a relatively low average yield of 8%.

The CBZ diaspora bond was guaranteed by Afrexim Bank which made it more attractive to investors. We believe if a reputable international institution such as Afrexim Bank had been the guarantor in place of the government for the IDBZ bond, more funds could have been raised to finance this important infrastructure project.

In fact, it is our conviction that any future bond issues should have such guarantees if they are to get widespread support. To be able to offer these guarantees, the international institutions might require having certain covenants met.

Depending on what conditions the guarantors set, quasi-government borrowers like ZETDC would be forced to be more accountable which would improve their credit rating. Eventually this would benefit them as they would be able to borrow more cheaply in future.

Official estimates for public capital expenditure needs run into billions of dollars. Debt financing is undeniably an important source of the financing necessary for scaling this enormous financial hurdle.

The US$17,8 million raised for ZETDC represents the first stumbles of a baby that quickly needs to learn to run. At this stage guarantees from reputable international entities are necessary to give comfort to potential lenders.

Admittedly, however, while they cannot be a permanent solution they are an indispensible temporary solution. As a permanent long-term solution the country has to work at restoring confidence in government guarantees on bonds.

To achieve this of course would entail re-establishing government’s creditworthiness. In South Africa, Eskom bonds have a government guarantee but are so popular that 20% of them are held by small investors.

One key outstanding issue that would put Zimbabwe on the right path is finding a workable solution to our external debt which is more than US$10 billion — even higher than our GDP! This may require softening the country’s reluctance to seek the assistance available to nations classified as Highly-Indebted Poor Countries.

Additionally, we would have to accept limitations on how the country’s finances are run, a concession which may be politically unpopular but necessary. For now, we have to accept that a government guarantee on any bond has very limited value in the eyes of investors.

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