HomeAnalysisInterest rate hikes: A two-edged sword

Interest rate hikes: A two-edged sword

Tafara Mtutu
THE last six weeks have seen the prices of commodities on 52-week highs despite the unresolved Russia-Ukraine conflict. In fact, Russia remains determined and continues to advance in Ukraine while Nato member states continue to pour artillery support to Ukraine.

We opine that the prices of commodities fully reflect the impact of the conflict, but even more so, the increasing possibility of a recession in 2022. This is largely on the back of global inflation and central banks’ economic response to the conflict.

Commodity price levels, as proxied by the S&P GSCI, surged to a six-month high of 822,3 barely a month into the Russia-Ukraine conflict but the trend has been reversing ever since.

As of July 22, the index had receded to 669,9 points, which is roughly the same level of the index just hours before Russia began the invasion into Ukraine in February.

What could be perplexing to many is why commodity prices would be back to pre-conflict levels despite the continuing impact of lower energy supply, especially in Europe.

Germany, for example, recorded its first trade deficit for the first time in 31 years and the constrained supply of energy warranted the central bank’s downward revision of GDP growth forecast in 2022 to 1,9%.

Further, there remains no short-term solution to Europe’s energy crisis, and the United States has begun tapping into its reserves after it signed off on more than five million barrels of oil from the Strategic Petroleum Reserve earlier this month.

Ripple effects saw year-on-year inflation surge to 8,6% in the Eurozone and 9,1% in the US in June 2022. However, corrective measures taken by several central banks, largely centred on increasing interest rates, have seen aggregate demand falling and this has extended to aggregate demand for commodities.

In June, the World Bank revised global economic growth estimates for 2022 down to 2,9% from an initial projection of 4,1% in January.

The changes were premised on the conflict’s disruption to economic activity, investment, and trade in the near term, a withdrawal of accommodative monetary and fiscal policies.

Even more so, the increase in interest rates is likely to maintain the low growth rates globally as increased costs of borrowing and higher money market returns incentivise savings, curtail borrowings, and subsequently reduce aggregate demand.

We maintain that supply-side inflation pressures will continue to persist in the second half of the year because of the largely unresolved energy supply disruptions and, given the trimmed economic growth forecast, this could push several economies closer to a recession by 2023.

To better understand how this affects Zimbabwe, we turn to the country’s biggest source of imports – South Africa. Zimbabwe’s annual import bill accounts for 43% of total GDP, and South Africa accounts for about 50% of these imports.

With these statistics in mind, an increase in the cost of producing goods in South Africa, say through increased interest rates, holds dire implications for Zimbabwe.

South Africa increased rates by an unprecedented 75 basis points to 5,5% on July 21, its biggest hike since September 2002. The increase in interest rates will also see the rand appreciating against the US dollar and this potent combination will make Zimbabwe’s imports more expensive in USD, shrinking disposable incomes notwithstanding.

As a result, we expect this to complement the recent local interest rate hike in fanning inflationary pressures in Zimbabwe despite efforts to contain inflation by mopping ZWL liquidity.

We note several stocks on the Zimbabwe Stock Exchange (ZSE) and Victoria Falls Securities Exchange (VFEX) that will likely be affected by these supply-side inflation shocks.

More specifically, companies with a combination of (i) very limited inflation pass-through ability, (ii) very elastic products, and (iii) an extensive import bill.

Companies like Padenga, RioZim, Bindua Nickel Corporation and CFI Holdings exhibit one or more of these characteristics. Padenga’s crocodile skin business is quite elastic and the economic challenges in its markets in Europe and Asia could weigh on the business’ sales volumes throughout the year.

In addition, we note that the disparity between exchange rates used to convert some of its export proceeds could present downward pressures of margins in its gold operations. We opine that a similar effect will likely play out in BNC and RioZim in FY22.

CFI could also face margins pressures as a specialised FMCG retailer. The business retails agriculture inputs such as fertilisers and it ranks high on the RBZ’s latest list of recipients of foreign currency on the interbank auction.

Further, the increased scrutiny of pricing modalities by the government could see the business selling some of its products at government-influenced price levels as presidential elections draw closer.

We note several other companies that exhibit one or more of the characteristics above, but the impact will likely be immaterial.

  • Mtutu is a research analyst at Morgan & Co. — tafara@morganzim.com or +263 774 795 854

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