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The recent European debt crisis has without any doubt proved that Government debt is not risk free, after most of the region’s periphery countries faced imminent default in the absence of bailouts from the European Central Bank and the International Monetary Fund. Furthermore, the downgrading of US Government bonds from their AAA rating by Standard & Poor during that same period also created a belief that even the most reliable Government could also default.

The Government of Zimbabwe has since the beginning of 2014, been issuing treasury bills in all shapes and sizes with the largest of batch being worth US$103 million to clear the Reserve Bank of Zimbabwe’s debt to banks and farmers.

On the back of the country’s de facto dollarisation, the Zimbabwean Government has had the convenience of only needing to float domestic debt to raise foreign currency, unlike its regional peers who can only obtain foreign currency through balance of payments and borrowing from abroad.

In an economy which Government has full control over its monetary policy, treasury bills would be deemed next to risk-free because Government can always print money, as a last resort, to repay bondholders when faced with an imminent default.

The introduction of the multi-currency regime in Zimbabwe has meant that the RBZ cannot print money when faced with a default and in the absence of foreign currency reserves this means that there is no security for Government’s issuance of treasury bills in US dollars.

Unlike the Euro zone periphery countries that eventually got bailed out by stronger economies within the European Union, it is however unlikely that any country will bailout Zimbabwe in the face of an imminent default.

For this reason, Government should use wisely whatever funds it has raised on the domestic market, through channelling the funds to capital projects that have the ability to payback and also towards the productive sectors of the economy that are currently in dire need of affordable capital.

Using funds raised from treasury bills to fund recurrent expenditure is tantamount to abuse of the country’s national savings, and will leave a huge and unnecessary debt burden, that will have to be paid for by future generations.

Furthermore, because hyperinflation decimated the bulk of the country’s national saving, this only means that Government’s ability to borrow domestically is significantly constrained and also cannot be done on a sustainable basis in an economy that is currently shrinking.

Other key risks that bond holders face are inflation risk, interest rate risk and liquidity risk.
Inflation risk is a serious issue when buying Government bonds because of the relatively long tenure of the bonds and also the fact that most bonds have interest rates that are pegged to the inflation rate, therefore in periods of high inflation investors become worse off as inflation outpaces the bond’s rate of return.

With the country currently under siege from deflationary pressures, the threat of high inflation remains subdued in the short and medium term.
Interest rate risk, however, remains high in the Zimbabwean economy because of the volatility in liquidity within the financial markets.

There is an inverse relationship between bond prices and interest rates, implying that when investors sell their treasury bond during times of high interest rates the price they obtain for the bond will be lower than when the same bond is sold when interest rates are low.

Liquidity risk is also another important consideration for Government bond investors in Zimbabwe because of the absence of a functional secondary market to trade the bonds.

Unlike the well-established Zimbabwe Stock Exchange, the market for bonds is still in its infancy and therefore buyers on the secondary market are hard to come across.

Overall the country still has a long way to go with regards the development of its domestic debt market and if Government continues to waste the proceeds from domestic debt issues on recurrent expenditure, a default on some of Government’s domestic debt would definitely occur in the near future.

In the absence of effective monetary policy tools, what is key at this juncture is for Government to strengthen the soundness of fiscal position which we believe will restore confidence in the country’s domestic and foreign debt holders as the country would be in a position to repay all its outstanding debt.

This can be achieved through, increasing capital expenditure whilst reducing recurrent expenditure, the promotion of foreign direct investment through attractive investment policies, strengthening the country’s manufacturing industries and other productive sectors, promoting beneficiation of minerals and agricultural commodities, formalizing the informal sector to enable government to expand its tax base, taking bold action against corruption and plugging revenue leaks in
the economy, and maintaining Government economic policy consistency across all sectors.

Once the country’s fiscal position is strengthened the country will be in a position to repay its foreign debt obligations and also build foreign currency reserves which would act as security against the issuance of both domestic and foreign debt.

In passing, the extent of corruption in Zimbabwe causes huge leaks in money flows destined to activate productive projects and as such is a huge impediment to fund raising in the country.

This article was written by Zimnat Asset Management for FinX.