Trade on the Zimbabwe Stock Exchange (ZSE) has been halted for weeks, after government ordered a halt to investigate what it said are illegal activities undermining the currency. The ruling ZANU PF party has also recommended the delisting of Old Mutual from the ZSE. This is in addition to action already taken to suspend the fungibility of shares in Old Mutual, PPC and Seedco.
In this article, the Investment Professionals Association of Zimbabwe (IPAZ), professional body made up of financial analysts and members of the Chartered Financial Analysts (CFA) Institute argue that these steps pose a grave threat to the future of the ZSE, and to investment as a whole.
As CFA Charter holders, IPAZ is duty bound to protect the integrity of the capital markets and advocate for the protection of investors interests in Zimbabwe.
It is with that in mind that we find Government’s action in closing the Zimbabwe Stock Exchange (ZSE) and the suspension of Old Mutual Limited, Pretoria Portland Cement (PPC) and Seed-co International Limited to be not in the best interest of investors and the integrity of the markets and the country at large.
Following a Government directive, the ZSE suspended all trades on the 26th of June 2020. According to the Government statement, the closure of the ZSE was meant to stop the slide of the local currency (ZWL$) on the unofficial markets, alleging that the ZSE along with EcoCash were collaborating to sabotage the country by causing the collapse of the Zimdollar.
At the core of Government’s argument is the Old Mutual Implied Rate (OMIR) which is a rate implied by market participants when they trade in Old Mutual Limited shares listed on the ZSE.
A look at the history of the ZSE and the role any stock exchanges plays in the growth of an economy and empowerment of entrepreneurs and ordinary investors, suggests that such a move would have more long-term negative effects on the country than what the authorities seek to correct.
We advocate that alternative solutions be found instead to address the underlying causes of the currency weakness than attacking financial markets which are simply transmission mechanisms that reflect the underlying views of the various market players. If anything, the message carried by these markets, can prove a very useful source of information for policy-makers.
Why is the ZSE a hedge against inflation in Zimbabwe?
Zimbabwe is currently experiencing hyperinflation, which is the rapid increase in the prices of goods as a result of too much money chasing after few goods. Official year-on-year inflation was reported as 785.6% to May 2020. Rising inflation represents a loss of value of the purchasing power of the currency, hence it is not surprising that the USD has gained 667% over the ZWL during the same period.
At the same time, the Old Mutual Limited share price kept pace with inflation as the share price rose 785% on the ZSE from ZWL$ 9.60 per share to ZWL$ 85.00 per share.
Faced with threats of loss of value, savers and investors prefer to hold assets rather than cash. For local investors such as pension funds and insurance companies, the Zimbabwe Stock Exchange, alongside other real assets such as property, becomes the only avenue for investors to protect value as they cannot hold on to cash.
The folly of holding on to cash or investing in monetary assets was clearly evident when most pensioners lost their entire pensions during the 2006-2008 hyperinflationary episode.
A loss of value for pensioners can end up being a social burden to the state.
Are foreign investors to blame for the currency collapse?
Since the demise of the Zimbabwe Dollar from June 2009 to Dec 2015, foreigners invested a net US$ 469.3m cumulatively on the ZSE. They represented about 16% of the total turnover of the ZSE over that period of US$2.8 billion. Government collected about US$114.1 million over the period or US$17.5 million per annum in taxes which approximates about 4%3 of each trade.
In 2016, when the Government re-introduced the ZWL as the bond note, the action “spooked” foreign investors who became net sellers of about US$ 80m and $100m worth of shares in 2016 and 2017 respectively.
The @ZSE_ZW says it is halting trade following Friday’s announcement by Govt suspending the market. pic.twitter.com/oUHPF91KLQ
— newZWire (@newswireZW) June 28, 2020
What causes the devaluation of a currency?
Several factors are responsible for the depreciation or appreciation of a currency:
National inflation rates: The currency of a country with high inflation tends to depreciate whilst the currency of the country with lower inflation tends to appreciate. Let’s assume that a 20kg bag of mealie meal costs ZAR 100.00 in South Africa. The same bag retails for ZWL$100.00 in Zimbabwe, implying an exchange rate of ZWL$ 1.00 = ZAR 1.00.
In the coming year, SA expects inflation of 0%, whilst inflation is expected to be 20% in Zimbabwe implying that the mealie price should rise to ZWL$ 120.00 per bag versus ZAR 100.0 per bag in SA implying an exchange rate of ZWL$ 1.20 = ZAR 1.00. If the exchange rate remains at ZWL$1.00 = ZAR 1.00 i.e. does not adjust, Zimbabwean mealie meal will not be competitive in the market.
Zimbabweans will buy (import) cheaper mealie meal from SA whilst people in SA will buy less Zimbabwean mealie meal. Zimbabwe’s capital account will depreciate as we import more mealie meal and export less. To restore an equal price in mealie meal between SA and Zimbabwe, the ZAR needs to appreciate by 20% or the ZWL$ depreciates by 20% to reflect higher inflation so that the exchange rate is ZWL $1.20 per ZAR 1.00. This is the PPP5 theory.
Changes in real interest rates: Financial flows into debt instruments are attracted by high expected returns i.e. high real interest rates where real interest rates is the difference between the interest rate and expected inflation. If Country A’s bonds yield 10% but inflation is expected to be 4%, the real interest rate will be 6%.
Differences in economic performance: Financial flows into equity securities (public or private) are attracted by high expected returns. Investors will be attracted by the high performance of individual firms and the economy as a whole.
Changes in investment climate: Investors will favour countries that have a good investment climate with low risk (i.e. they dislike uncertainty). As the investment climate improves and risk is lowered, the local currency appreciates whilst the opposite is true.
A good investment climate has the following characteristics:
- A stable political system
- Fair legal system that protects the rights of all investors
- A tax system that is fair to foreign investors
- Free movement of capital
- Monetary authorities that favour price stability
Expansionary monetary policies that are not anticipated and not matched with local production will tend to result in the twin effects of a decline in the real interest rates and upward pressure in domestic price levels as too much money chases fewer goods.
None of these factors are due to actions of the ZSE, Old Mutual Limited, OMIR, foreign or local investors. The ZWL depreciation is largely due to Government fiscal and monetary policy decisions.
Dual listed shares
Zimbabwe is not the first country to have dual listed shares.
Dual listed shares are common the world over and well-established in most progressive countries with progressive stock exchanges. Examples are Anglogold (JSE & NYSE), Goldfields (JSE & NYSE), BAT (JSE & LSE), Unilever (LSE, NYSE & AEX6). Locally, PPC (JSE & ZSE) and Seedco (BSE7 & ZSE) are also dual listed.
The Ministry of Finance suspended Old Mutual Plc, Seedco Limited and PPC’s fungibility status on the ZSE and these companies are failing to receive the merits of their fungibility status on the ZSE due to this 12 month suspension.
.@ZimTreasury suspends fungibility of shares in Old Mutual, PPC, Seedco. Until now, investors could repatriate earnings by buying shares on the ZSE & selling them abroad. The share price comparison gave rise to the Old Mutual Implied Rate, used by some as an exchange rate gauge pic.twitter.com/u9ev9oxCww
— newZWire (@newswireZW) March 15, 2020
Given that the Old Mutual Implied rate has been so topical and experiences the most fungible trades we shall focus on Old Mutual Limited but this is not to say PPC and Seedco International have not been equally prejudiced.
Old Mutual shares are listed on the London Stock Exchange (LSE), Johannesburg Stock Exchange (JSE), Namibia and Malawi and the Zimbabwe Stock Exchange (ZSE). At the time of listing in 1999, the shares were fungible, meaning that an investor could move shares between the five registers and trade them in the exchange (market) of preference.
This fungibility or ability to move the shares between the different markets and share registers eliminates huge discounts or premiums developing between the five markets because the shares rank pari passu (equally the same) in all five markets therefore, there should be no reason for a big price disparity between the different markets.
How is the OMIR calculated?
OMIR is an acronym for the Old Mutual Implied Rate. Since each share of Old Mutual Plc (OMU) ranks the same regardless of the exchange they’re purchased, it follows that there is an implied exchange rate underlying the different share prices. On the 25th of June 2020, Old Mutual shares traded at £ 0.56 per share, ZAR 11.78 per share and ZWL$ 82.00 per share on the LSE, JSE and ZSE respectively. The US$ per £ rate was $1.2443 = £1.00, ZAR per US$ was ZAR17.46 = US$ 1.00 and the Zim$ weighted auction rate was ZWL$ 57.36 = US$ 1.008.
If we convert all the share prices to their US$ equivalent, we get prices of $0.70 per share for the LSE price and $0.67 per share for the JSE shares implying that the JSE shares trades at a 3.2% discount to the LSE shares and US$1.43 per share on the ZSE. The OMIR is calculated as the ZSE share price in ZWL$ divided by the LSE or JSE share price in US$ to derive an OMIR of ZWL$ 117.69= US$1.00 for the LSE price and ZWL$ 121.58 = US$1.00 for the JSE price.
If we use the weighted auction rate, the Old Mutual ZSE share price is equivalent to US$1.43 per share, implying that ZSE shares trade at a premium of 105% and 112% relative to the LSE and JSE shares respectively.
The premium has not always been huge. On the 4th of January 2000, the official exchange rate was ZWL$38.00 per US$1.00 versus the OMIR ZWL$41.04 = US$1.00. From 2009 to 2015 when the US$ was the official currency and there were no restrictions in terms of moving money in and out of Zimbabwe, Old Mutual shares listed on the ZSE traded at a discount to shares on the LSE and JSE.
For instance, about 10 years ago on the 30th of June 2010, Old Mutual shares on the ZSE were US$1.53 per share versus US$1.88 per share on the LSE and US$1.91 per share on the JSE representing a 19% and 20% discount respectively.
The OMIR – Why does it exist in Zimbabwe?
Ideally, the Law of One Price should hold for identical assets even if listed in different markets. Investors should not make sustainable long-term profits if the markets are efficient and there are no restrictions. Arbitrage will work to correct any, mostly temporary, price misalignments. Investors will buy where the asset are cheaper and sell in the ‘overpriced’ market.
The increase in supply should ultimately bring about an alignment in the prices. In Zimbabwe, due to challenges with repatriation of proceeds for foreign investors, fungible shares like Old Mutual provide the only legal mechanism available to move funds between countries. As a result, demand for the shares, predominantly by foreign investors leads to a demand in the fungible shares.
Local investors seeking a currency hedge have also participated. Investors with free funds, enticed by a relatively ‘higher’ price in Zimbabwe were buying Old Mutual in other registers and selling them on the ZSE.
This helped provide the much needed liquidity for foreigners exiting and at the same time balanced the share register as only a certain number of shares can be moved across registers. While Old Mutual is also listed on the JSE and LSE, there is no active arbitrage between these markets as fungibility and movements of assets between the 2 exchanges is generally seamless, with no restrictions. In addition, investors can easily access and repatriate their proceeds upon sales.
There are no restrictions between the JSE and the LSE, as a result a proper price discovery mechanism exists.
Existential threat to the ZSE
Closing the market creates an existential threat to the operations of the following institutions;
- Life companies
- Pension Funds
- Short term insurance
- Asset Managers
- Custodial services
Delisting Old Mutual and listing it on a USD only market? It won’t work
This could be an unviable option for a number of reasons.
We currently don’t have a USD only market, so to propose that Old Mutual be re-listed on a yet to be established exchange whose modalities, rules, efficiency, viability are unknown could prove chaotic. It is unknown how long it will take to establish another exchange and whether the new exchange would function any better than the ZSE.
Meanwhile, shareholders that require liquidity cannot sell.
‘Old Mutual shares are used as a currency hedge. this will not change’
Shareholders and investors in general are the ones who stand to gain or lose from such a decision to delist their shares listed from the ZSE, hence procedurally, such a decision should be subject to a Special Resolution by members in general meeting.
Migrating to a US$ exchange is unlikely to serve any purpose for Old Mutual shareholders. Old Mutual shares are largely used as a currency hedge or a store of value by Zimbabwean investors. This status will not change post migration to a USD exchange.
Investors that are holding Old Mutual Limited shares want exposure to the specific properties that it is a large multinational company with an LSE, JSE listing and relatively low risk rating and is fungible. S&P9 rates Old Mutual Limited debt as investment grade A+ for Long Term debt versus BB- (sub-investment grade) for South African government bonds.
If the Old Mutual Limited shares are traded exclusively in US$ as envisaged, this may entail that local investors would rush to dispose the shares in favour of holding US$ cash, which could be detrimental to the country in the long-run as the share will end up more in the hands of foreigners than locals.
What halting ZSE and de-listing Old Mutual means
- Failure to attract foreign investors
- The attack on property rights increases Zimbabwe’s political risk
- Not encouraging for would be multi-nationals, such as Nestle, that may want to list on the ZSE
- Creates unnecessary panic among investors
- Lack of tax revenues for Zimra
- Damage to the country’s image
- Discourages a savings culture which is the bedrock of economic growth for the country
We consider the abrupt closure of the ZSE to set a bad precedent and detrimental to the economy in the long-run. In our view, it is not the ZSE, Old Mutual Limited, PPC or Seedco International’s listing status nor the OMIR that are responsible for runaway inflation and the rapid depreciation of the ZWL$.
If indeed Old Mutual was being used by certain individuals, syndicates and or corporates to illicitly manipulate the markets and or exchange rate, then would it not have been more prudent to gather such evidence and prosecute those entities rather than suspend the market as this sets a bad precedence whilst the collateral damage is excessive?
The action to close the ZSE and threat to de-list Old Mutual Limited creates an existential threat to the country’s financial, insurance and investment industry.