By Cavan Osborne, portfolio manager, Old Mutual Investment Group (MacroSolutions)
Zimbabwe continues to be a market I struggle to understand. The macro-economic reading I had done, and the recent stock market performance, painted a really desperate picture. The commentary from company management was also very mixed. So, on arriving in the country recently, I was surprised by just how vibrant the capital, Harare, was. There were a number of traffic jams on route to a guest house in smart suburb and all 18 rooms were booked for the week.
A severely depreciating exchange rate
The last time we visited Zimbabwe was in 2019 and the local Zimbabwe dollar had just been introduced (or reintroduced) following the dollarisation period. The official rate was Z$2 to the US dollar and the parallel rate was around Z$4. Fuel was scarce at the time and there were long lines of cars parked outside filling stations in the hope of supply arriving.
Maybe the busy feel of the place was simply relative to previous visits when shop shelves were bare, and roads were near empty. The official exchange rate has since moved to above Z$600 and the parallel rate is at Z$820, after recently touching Z$1000 to the US dollar. To put that in perspective, if, when I last visited in 2019, I had exchanged a $100 note at the parallel rate I would have received 400 “Zim Dollars” in cash. Assuming I had held that in cash at home and then exchanged it on arriving at the airport, I would have been given 20 US cents today – a loss of more than 99% in three years.
The depreciation of the currency has been particularly severe in the last six months. There are probably many specific reasons for the collapse, but it usually comes down to supply versus demand. As the currency weakens, any person or business wants to get rid of the ‘Zim dollars’ as fast as possible. Further, if there is a risk of the payment being delayed then the service provider needs to build in expected depreciation into any business deal. When hyperinflation hit Zimbabwe previously, prices were changing during the day. We were told stories of golfers paying for halfway drinks at the start of their round as the price may have doubled after nine holes.
A packet of Lay’s was selling for $2,479 at the Pick n Pay. At the official rate this translates to $4 and $3 at the parallel rate. This is three to four times more than what the same bag of chips sells for in South Africa.
Increased supply of local currency
These future pricing actions lead to inflation and ultimately hyper-inflation. The Zimbabwean government has been paying its construction contractors, for example, using Zimbabwe dollars. Contractors were inflating prices to account for the future cost of raw materials, for instance, and potential delays in payment. Therefore, with inflation running at 20% per month for instance, if government delays payment by three months an extra 60% needs to be added to the price. Then, when contractors get paid, they immediately hit the street to change to hard currency, thereby perpetuating the supply side.
Until April 2022 interest rates were capped by regulations at 40%. Businesses were borrowing money that would quickly be converted into US dollars to buy raw materials and secure capital goods. This added even more supply of the local currency. Borrowing was full tilt. Corporates could borrow at less than 4% per month while inflation was running at more than 20%. The business would buy goods that held value in hard currency, hoping to resell at the inflated values and repay the loans. There is speculation that some borrowers invested in the stock market and this added more pressure to the currency.
The sharp currency slide has upset the authorities who are now putting measures in place to punish the perceived perpetrators. The 15 largest bank lenders were investigated and banned from borrowing for a period. The borrowing rate has been pushed from 40% to 200% and from August the government declared that all government payments must be in Zimbabwe dollars. The government is said to have also stopped paying many of its contractors and suppliers. So, with suppliers not flooding the market and the big lenders not taking additional loans – the supply of Zimbabwe dollars has dried up leading the official rate to stabilise and the parallel rate to strengthen. According to zimpricecheck.com the rate official rate is now at Z$660 and parallel at Z$900. This is around the narrowest percentage gap in many years.
Both Delta (the local beer and soft drink manufacturer) and Simbisa (fast food company) spoke of a change in the payment mix from 30-40% US dollars to 80-90% US dollar sales since July 2022. In fact, the switch has been so dramatic that it is now making servicing Zimbabwe dollar loans and payment of taxes in the local currency a concern. News articles are saying parents are having difficulty paying school fees as schools are demanding payment in local currency.
The government starving the market of local currency is not sustainable – so we would expect this situation to reverse. With elections scheduled for early 2023 the expectation is that the government will release Zimbabwe dollars back into the system. Companies and individuals have seen this story before and seem far better prepared.
The government continues to strongly influence the operating environment. While some industries seem to have relative freedom, others remain highly regulated.
Econet is the dominant telecommunications provider in the country. In 2019 it unbundled its mobile money business, Ecocash, listing it separately. Given the currency shortages, and the large inbound remittance flows into Zimbabwe, I had expected Ecocash to be a hugely successful business. But the growth has been muted relative to other mobile money providers on the continent. The growth has been halted by government interference. The introduction of a 2% e-levy (electronic transfer levy) discouraged its use. Up until May this year only Zimbabwe dollar transactions were permitted. When US dollar transactions were legislated, they came with a 4% e-levy. But probably the biggest growth hinderance was the banning of cash out. Mobile money development in Africa starts as a cash-in/cash-out service. People earn money in the cities and then use the service to transfer money to families in rural areas who would cash-out using local agents. Without the confidence that that cash is accessible, users are reluctant to make use of the service.
The Zimbabwe stock exchange has also had a rollercoaster time. It started the year by rising 200% in Zim dollar terms and more than 100% in US dollars. But it has all come tumbling down since the local reference interest rate was pushed to 200%. The central bank has indicated that it will not be reducing the rate until inflation drops below 5% per month (currently more than 20% per month).
Our take on current investment opportunity
Our fund has a single exposure to Zimbabwe though its investment in fast food company Simbisa. The investment case at the entry time was the global trend of eating out of home. Further, it has roughly half its stores in African countries outside of Zimbabwe. Hyper-inflation makes assessing the performance challenging – but it is positive that volume growth remains positive. For the 12 months to June 2022, Simbisa indicated that its customers count was up 28% year on year. At its last reporting date, Simbisa had 500 outlets, and management is confident of opening 100 new stores each year. In September, the company declared a small US dollar dividend. While the company is delivering where it can, from a return perspective this has all been overshadowed by the 99% collapse in the exchange rate.
Zimbabwe is a country with potential, but the longer the current situation persists the more challenging it will be to attain its potential. The lack of investment over the last 20 years will mean there will be a need for significant catch-up spending before investors are likely to see cash returns. Econet, for instance, is reporting spending 2-3% of its revenue on capital projects, versus an industry norm of 12-20%. The recent figures are distorted by hyperinflation, but they do highlight the lack of access to foreign currency to pay suppliers. So, when the foreign exchange market does open, it will likely go through an elevated spending period before shareholders get cash rewards.
When underdeveloped countries need a boost, they often turn to the IMF for assistance. But IMF money has strings attached. For investors, loans from the IMF typically provide confidence as the greater fiscal oversight often means greater currency stability. Yet for Zimbabwe, the IMF has said it will not consider lending until the country deals with the payment or renegotiation of external arrears. Zimbabwe has shown no indication of addressing the situation.
While activity levels in Zimbabwe appear to be the highest I have seen in the last 20 years, with no expectation of the currency repatriation situation changing, we will not be considering investing fresh money into the country.
This article was first published by Old Mutual Investment Group.