The Markets Don’t Lie
In the Finance and Investment world, There is one belief that we all hold constant, and that belief is the fact that the behavior of the Market is the ultimate indicators of the investment climate of a country.
We are seeing a lot of information and statements coming from multiple parties about the true state of Zambia’s economy. However one has to look at the data and what the Markets are saying through their actions. Markets operate on supply and demand- the more attractive your economy through a strong constitution, rule of law, policy consistency and economic management the higher the FDI demand and Investment demand by local players. If the current Market behavior and indicators are anything to go by, then all of us should be a little concerned about the state of affairs.
If we analyze the existing Euro Bond,- The market value of that Eurobond is now $600 million, a 20% decline from its original value. The yield of Zambia’s Eurobond that matures in 2022 has climbed sharply, by 270 basis points, since issuance, from 5.63% to a peak of 8.33% on March 20 of this year.
The structure of the Euro bond means Zambia pays just over $42 million in interest every year with the entire principal payment of $750 million due in 2022. The Eurobond is now trading in the secondary market, where it can be bought and sold freely on the open market. The fact that the yield or interest rate rose to 8.33% has no impact on Zambia’s payment obligation. As far as the country is concerned the amount they need to pay annually in interest payments remains fixed. However the yield reflects the current market price of Zambia’s debt and the view the Market has about Zambia’s debt. A rising yield means the value of the Eurobond, trading in the secondary market, is reducing in value and has to be sold at a price lower than its original face value. In short, investors who purchased the Zambian Eurobond back in 2012 and wish to sell their bonds today to other investors, would have to sell at a lower value and take a loss. Based on the current yield of 8.33%, the market value of the Eurobond has reduced from $750 million to $600 million in value. I will digress a little bit and as a side note I must mention, Markets can be wrong at times (usually because they don’t have the right information), but they eventually correct themselves- So if the Market has wrong information about the state of Zambia’s economy, and there is a brilliant plan for economic growth that we don’t know about or we truly have reserves, or even excess funds in the newly created IDC sovereign wealth fund, then the smart play here would be to do a Bond buy back and catch the Market off guard, In a perfect world, if we purchased the entire Eurobond back at current market prices, Zambia would make a cool $150 million in . But if only life was that easy and the mechanism I described was that simple, with the manner in which information flows today, the market has all the relevant information about Zambia and has determined that it is not as attractive as an investment as it was back in 2012.
The question then becomes, why is this a problem? There are many reasons that cause bond yields to rise, in this case of Zambia, most market analysts are pointing toward the increasing risk associated with the Zambian economy. Take for example the following quote from the Financial Times:
“Zambia is not doing as well [as other African countries] economically and fiscally,” said Max Wolman, senior investment manager at Aberdeen Asset Management. Its new bond would “have to be fairly attractively priced. Investor appetites are definitely not as strong as they were in 2012.”
Now for the most part Zambian can borrow all it wants. But when your perceived risk increases, so does your cost of capital, it means you have to offer more attractive rates to investors to compensate them for the risk they are taking, which ultimately leads to borrowing becoming more and more expensive for Zambia. If Zambia was to issue another international bond at $1 billion dollars, the Market is looking at average price of about 9% (which is what the current Eurobond yields are reflecting).This would result in interest payment of $90 million a year with the entire $1 billion then due at maturity
The market indicators become even more bleak- when you take into context what is happening with the Zambian kwacha. Zambia is planning on issuing this $1 billion dollar international bond , after the last two Treasury bill auctions failed. The central bank raised a combined 186 million kwacha of the 1.2 billion kwacha it offered (An abysmal 15% success rate). Nothing reflects a bigger loss in the confidence of the kwacha then the Market simply not wanting to buy Government debt in kwacha. If Markets do not lie, I ask you the question, what does it mean when investors ( domestic and international) will not buy your product?
What is happening to the Zambian Kwacha is just the beginning of what is about to come.
I am not going to discuss in detail the real life impact the declining kwacha will have on ordinary Zambians, but I will say, we should be worried. As an import driven nation the risk of runaway inflation increases each day. And what is inflation? It is waking up tomorrow and everyday there after realizing that you are poorer and have less money in your pocket. That K2500 kwacha that you earn every month no longer has the same purchasing power. While your income has remained the same, the price of fuel, transport, food, airtime, beer and all other commodities have risen in price. How is inflation combated? Well one way is through monetary policy like raising interest rates, in the manner in which The Bank of Zambia (BOZ) policy rate has been raised to 12%. The challenge with this move is the inconsistency in policy which impacts investor and Market confidence. When you claim to have a policy to stimulate the economy, create jobs, increase investment into the economy and into Small Medium Enterprises (SME), raising rates has the completely opposite effect because you are reducing the supply of money and making money more expensive to borrow.
From a Market and Economic perspective- a declining kwacha puts the Zambian economy at a greater risk. We have been doing a lot of borrowing recently and that borrowing is always conducted and serviced in United States Dollars, while the Zambian government collects its revenue in Kwacha. Take the Eurobond interest payments that we are making. This is currently pegged at just over $42 million annually. When the currency hovered around K5.6 to the dollar, our interest payment were K236 million kwacha. Today at a rate of K6.4 to the dollar, those interest payments have risen to K270 million kwacha annually. All else being equal this now means more and more of our tax kwacha will be diverted from other areas to go towards debt servicing, and if there are no subsequent spending cuts, or alternatively, increases in income through tax revenue and exports, then the future for Zambia will become very bleak and we must all prepare for some very tough times.
A major question is how do we change the Market perception and behavior towards Zambia and turn the tide? Well, we can continue trial and error policies by pumping reserves into the Economy to stabilize the kwacha or revoking Statutory Instruments, which in my opinion may make things worse at this point especially if there is a run on the Kwacha. But the answer and road map is far simpler on paper. Confidence must return to Economy and to the Market. We must understand the Markets and understand what levers drive the Market. And when we do, we will find that those levers are quite simple and you realize that the Markets and Economy are primarily driven by the THREE P’s
People- Who are the people running the economy? What are their educational levels and level of expertise? What is their track record on delivery and execution? Do they have integrity? What is the leadership style? Is it a diverse team that thinks differently from each other thereby enhancing the number of ideas at the table instead of saying yes to one opinion? What is the perception the market has of them? And what is the confidence level of the market towards the people in leadership?
Process- This is really an issue of governance, a clear policy framework and economic direction. It address questions like how strong is the constitution? What is the rule of law? Is the economy and government stable? How clear are the policy objective and goals? How is the business environment? What control systems are in place to ensure resources are allocated and utilized correctly? What is the level of corruption?
(I personally weep for the People who confidently argue that the constitution is just a piece of paper, or we have other priorities and areas to develop and the constitution should be not be one of them. When the Markets hear these statements, they run for the hills, as these statements show a country or a group of People with no regard for establishing a framework for good governance that will empower people and the institutions that serve the people. Have a strong constitution and rule of law, investor and consumer confidence will grow, money and development will come.)
Performance– How is the country performing, how has it performed, how do you expect it to perform going forward and what is the proof?- In the news we hear the phrase “there is unprecedented development in Zambia” This statement sounds great and its a great marketing and campaign line- but what does this really mean? and what proof is there to show this unprecedented development? Show strong performance and the Market will react positively.
“Acknowledge The Problem, But Live In The Solution.”
There is tragic failure of leadership (and ordinary people in general) to acknowledge the problems that Zambia is facing. I recall President Obama once using this old expression that “You can put lipstick on a pig. It’s still a pig.” Meaning you can dress up and disguise the problems all you want, but the problems are still there. So what I am saying is let us stop with the games, stop with the hypocrisy, stop with the bootlicking, stop with the pretending, stop with the propaganda, stop with the politics, stop with sitting on our behinds waiting for a handout, stop with the bickering and let us stop with the stupid tribalism as we are all Zambians united under one nation. Like many of you, I am sick of it, and like many of you, I love my Country and enough is enough! It is only by acknowledging the problems, can we then unite, move forward and live in the solution.
Now what is the Solution?….That is the million dollar question, I have given you some of the answers from a Financial perspective, but I have not touched on the best answer. but I will give you a hint.. You are the Solution..