HomeAnalysisExplaining how the bond notes failed

Explaining how the bond notes failed

RESPONDING to questions in Parliament of Zimbabwe on Monday, the Reserve Bank of Zimbabwe (RBZ) governor John Mangudya said he did not believe that the bond notes, which he introduced in 2016, failed.

He challenged that anyone with sufficient evidence of the notes’ failure should convince him.

His denial and challenge for unequivocal evidence of the failure of bond note is the subject of my article. Over the years, I have written sufficient literature to highlight how bond notes have failed and this is not a cryptic conjecture, but one that is simple and straightforward.

The bond not was introduced in the guise of an export incentive. An export incentive is a scheme designed to drive the production of export goods by awarding exporters an extra financial benefit for their produce.

It can be achieved in numerous ways for example tax breaks, lower royalties and credit facilities, among others. Ultimately a country will be seeking to earn more foreign currency from its exports.

In the case of Zimbabwe, 2016 marked the year in which currency challenges were heightening in Zimbabwe. The reason the economy faced currency challenges is because after 2013, government began to increase its expenditure disproportionately to its budget.

These excess expenditures were mainly consumptive and by 2018, the cumulative total of annual deficits was now at US$7,6 billion. The annual average deficit between 2014 and 2018 was US$1,5 billion. In essence what this statistic means is that Zimbabwe expended an average of US$1,5 billion per year for four years up to 2018. Where did the money it spent come from?

Deficits are typically actual money spent but outside of budgeted expenditure. The expenditure is primarily a function of revenues earned by the country (taxes) in different forms. Normally, a budget is set in line with expected future revenues for the year in question. Once income projection is done, a budget is created. A budget is slightly higher than the income expected. The acceptable deficit levels are within about 5% of the targeted revenues or budget.

Now, when the government exceeds its budgeted expenditure, it borrows from the open market to cover the gap. This is what the government was doing post-government of national unity (GNU) and the gap kept growing with each passing year.

The growth in the deficit over the period is also a demonstration of the compound effect of Treasury Bills (TBs) rollovers.

The chart below shows the growth in Treasury Bills stocks. The government through the RBZ issued more TBs with the passage of time and by 2018, the cumulative total was about US$6 billion.

In short, TBs are a form of government security issued to creditors who in turn extend credit to government. In return, government promises to pay interest and redeem the paper on maturity.

The red line on the TBs Chart below shows that government’s issuance significantly increased from 2014 onwards and by 2018 the total outstanding was about US$6 billion.  This trend and even the values are so much in line with the deficit levels shown above.

The mechanism of TBs issuance is that government tenders and commercial banks together with insurances firms, asset management and pension funds purchase the TBs. In other words, these entities release their liquidity to government, which in turn spends the same to cover its deficit.

As government spends the liquidity, aggregate demand is artificially raised and prices move, this could have a short-term positive impact on output (GDP).

On the other hand, the coupons (interest) earned on the TBs contributes significantly to money supply growth given their quantum and rollovers.

Banks reported significant growth in interest income, with a bigger portion of the growth coming from earning assets, notably TBs. The results were that total deposits in the economy shot all the way up to US$10 billion by 2018 from about US$4 billion in 2014.

This huge deposit base was not supported by the actual liquid cash in the banking system and this led to massive cash shortages. The actual liquid cash which is measured as notes and coins plus the nostro balances in the system totalled only as US$400 million compared to US$10 billion.

The low amount of liquid cash compared to total deposits reflected the RTGS liquidity trap which RBZ sought to stem through bond notes. The bond notes were a form of RTGS monetisation and its failure mirrored the failure of the underwriting currency the RTGS, which collapsed by 2019.

As an export incentive, this measure did not increase exports, in fact, it only helped maintain production levels by countering the loss of value emanating from a forced exchanged regime of 1:1.

Exporters were on average losing between 10% and 20% of exports value and getting a 10% incentive only cut their loss but did not improve their fortunes.

In fact, 2011 to 2013 (three years) were better years in terms of export performance compared to 2017, which was a year after the bond notes were released.

The growth in exports from 2018 onwards also reflected on the strengthening metal prices.

  • Gwenzi is a financial analyst and MD of Equity Axis, a financial media firm offering business intelligence, economic and equity research. — respect@equityaxis.net

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