By Farai Dyirakumunda
THE local financial markets have responded decisively to the latest monetary policy announcement highlighting that several of the new initiatives h
ave a direct bearing on the outlook and performance of different markets.
The direction of interest rates has been the subject of uncertainty and from the latest policy announcement, the tone has been set by the Reserve Bank governor for the interest rates to remain low for the remainder of the year. This tallies with the remarks made by the Minister of Finance about the unsustainability of the high rates quoted for treasury bills (TBs).
Credit to government has underpinned excessive broad money supply growth, which has been on an upward trend, increasing from 528,2% in February to 669,9% in May 2006. High money supply growth in a declining economy has been proved to have inflationary consequences and Zimbabwe has not been an exception. A correlation exists between the two and the recent upsurge in inflation is partly attributed to money supply.
The overall expansion in domestic credit as at May 2006 is weighed more toward credit to government (mainly through TBs) and this has grown by 927,5% compared to credit to the private sector (made up of loans and advances from the banking sector) which grew 455% in the same period. Reducing TB rates is therefore an apparent attempt towards slowing down the rate at which domestic credit grows for the remainder of the year.
With 91-day TB rates down to 200% from recent levels around 510%, fixed deposit rates have correspondingly declined. This also coincides with significant TB maturities of up to $52 trillion for the whole month (using the old currency).
Against such background there is little room for the appreciation of the money market rates in the near future. A continual depression of deposit rates is therefore inevitable. Indicative investment rates for fixed deposits on the money market are therefore within the range of 50%-190% for investments within the seven-day to 90-day tenor. The effective annual rate for a 90-day investment at 200% is now 406% and this is notably lower than an effective rate of 2 400% at a nominal rate of 500%.
The Reserve Bank governor reduced accommodation interest rates from 850% to 300% for secured lending and 900% to 350% for unsecured lending. The immediate implication is that lending rates from banks will be revised downwards given that the lending rates tend to be aligned to accommodation rates.
In theory, the lower lending rates are supposed to stimulate borrowing for productive purposes and give an upward supply side response. A number of corporates are however reluctant to increase their borrowings given that interest rate inconsistencies from the past have resulted in a number of casualties.
Export-oriented companies will likely rely more on offshore structures with more predictable rates while domestic companies will probably limit their borrowings to critical working capital requirements.
Funding long-term commitments such as capex using debt may be suicidal should there be an unexpected swing in interest rate policy. Individuals on the other hand may increase their borrowings for consumptive expenditure but not for the acquisition of higher-value assets.
Overall, while a reduction in lending rates will be welcome for borrowed entities, banks will probably remain cautious in their lending.
The outlook for banks and financial institutions has been upgraded following the abolishment of the mandatory two-year paper on institutions with long positions. The two-year paper had an effect of punishing the bigger players for enjoying strong deposit market share following the flight to quality by depositors.
The banks have then agreed in principle to operate a non-segmented inter-bank money market. In the immediate outlook interest margins and profitability for most banks will be improved and the reduced accommodation rate will also ease the interest burden on institutions that utilise the accommodation window on a particular day.
Another noteworthy development for financial institutions is a further reduction in statutory reserve requirements to 40% on demand and call deposits from a previous high of 60% and 30% on savings and time deposits from 45% prior to the recent adjustments.
The overall implications of the above policy initiatives on banks is an improvement in liquidity and liquidity management during the second half of the financial year. Improved profitability will therefore make the September 30 capitalisation deadline attainable and there is additional reprieve regarding compliance to US dollar-linked capital requirements.
Banks should however not bask in the reprieve but instead work toward buttressing their capitalisation ahead of any further reviews. A certain degree of investor fatigue may be anticipated if in the future, banks have to call on shareholders to recapitalise their institutions.
The stock market has yielded huge windfalls for investors in the aftermath of the monetary policy. The industrial index has been powered by huge gains in large cap counters such as PPC, Old Mutual, Meikles and Econet in addition to broad-based buying across the market.
The first positive response emanates from an inverse relationship between the direction of interest rates and the equities market. When there is a sustained reduction in deposit rates investors will shift their asset allocations towards shares and the trading patterns over the past few days give credence to that observation.
Additional positive responses are also arising from hard currency generating companies that will benefit from a devaluation as well as an increase in forex retention.
The slashing of three zeros on the local currency also had an unexpected effect of creating an illusion that some share prices were cheap. This has particularly been felt on penny stocks or stocks that have low nominal values such as Willdale, Medtech, Pelhams and CFX which all experienced a huge uplift in apparent response to their meagre nominal values.
In the immediate outlook investors will maintain a higher weighting towards equities relative to the money market but some correction is forthcoming on counters that are overheated. The market will also inevitably experience profit-taking in the near term but beyond that the primary trends point towards further significant upside in shares.
* Farai Dyirakumunda is an analyst at Interfin Securities.