Bond notes to date: An assessment and a projection

IN May 2016, the Reserve Bank of Zimbabwe (RBZ) announced plans to introduce bond notes backed by a US$200 million Afreximbank facility, to act as both an export incentive and as a means of addressing cash crisis. The bond notes are to fund export incentives of up to 5% which will be paid to exporters of goods and services and diaspora remittances.

by Obert Gutu

On Monday November 28, 2016, RBZ introduced the bond notes despite resistance from the public. The central bank governor Dr. John Mangudya announced that like the bond coins, which were already in circulation, the notes would trade at par with the United States dollar and requested the public to report any form of malpractice and abuse of bond notes including but not limited to hoarding, defacing, disfiguring or unlawful use of notes and manipulation by person or banks or currency dealers or traders in connection with the use of bond notes.

He also announced that the bond notes would be deposited into existing US dollar accounts and therefore there was no need to open new accounts. The introduction of the surrogate currency came as a result of a liquidity crunch that emanated from the lack of fresh capital as foreign investors fret over Indigenization Laws and a general lack of policy consistency that a took its toll in 2015 and culminated into a deep cash crisis in 2016. For instance, in November 2015, depositors could withdraw US$3, 000 at ATMs and a maximum of US$10, 000 per day from banking halls, but this dwindled to as little as US$20 per day subject to availability of cash by end of 2016.

Introduction of a local currency, by any name or means, sparked fears from the public that government was trying to smuggle back into circulation the defunct Zimbabwe dollar after the adoption of the multiple currency regime in 2009 dominated by the US dollar. Nightmares of hyperinflation and memories of food shortages haunted citizens whose suffering was still fresh in their minds. For over six months, citizens attempted to block the introduction of the surrogate currency through filing lawsuits challenging the manner in which the bond notes were imposed upon Zimbabweans. The public also protested and petitioned against the same.

So far denominations of $1 and $2 have been introduced in the market. The decision to introduce lower denominations of bond notes was premised on fears the new currency could cause inflation. On the first day of circulation, teething problems hampered transactions with some service providers refusing to accept the notes which they were not familiar with. The situation has however, since improved with both formal and informal business accepting the surrogate currency as legal tender.

The withdrawal limits of bond notes vary from $50-$100 per day and a maximum of $150-$300 per week depending on the bank. Although the RBZ announced that it has engaged the Retailers Association of Zimbabwe, fuel companies, representatives of the various business associations and the Consumer Council of Zimbabwe on the use and acceptability of bond notes as a medium of exchange in the country, it is surprising to note that the central bank has also called for the amendment of the RBZ Act to impose stiffer penalties for anyone or any business that refuses to accept bond notes as legal tender.

It is clear there is something that is not transparent, more so considering that the central bank governor has always insisted that the bond notes will not be forced on anyone who did not want them.

As at 31st December 2016 the RBZ had paid the export incentive to 80% of exporters of goods and services including diaspora remittances through the issuance of bond notes in the sum of $72.9 million. The major beneficiaries under the Export Incentive Scheme (EIS) were tobacco growers ($29.4 million), gold producers ($10 million) and diaspora remittances ($5.4 million).

According to a report from the RBZ, a number of firms that had ceased exporting due to the uncompetitive domestic economic environment that includes high cost of production and the strong USD have started to export as a result of the EIS. However, although this might be true, the RBZ failed to provide statistics to that effect, that is, the number of firms, sector and capacity.

The Bank further states that productivity which is considered a panacea to the current economic challenges bedeviling the nation is gradually increasing as a result of the EIS. This includes the expansion of the tobacco crop grown this agricultural season and the reduction in the smuggling of gold as the 5% incentive awarded to gold producers over and above the international gold price has been regulative to discourage smuggling without taking into account the negative effects of land degradation by gold panners.

What is noticeable is that there has been an increase in the use of plastic money and electronic banking which now accounts for 50-70% of sales for most of the bigger retail outlets in Zimbabwe, including fuel dealers. However, this could have been achieved without introducing the bond notes as this was an effective way of dealing with cash shortages.

Globally, society has become cashless especially with the advent of technology and the internet. This paradigm shift towards plastic money and electronic banking had a positive and complementary effect to the efficient circulation and use of bond notes. This had also had a positive effect of discouraging queuing for cash at banks across the country. However, it is too early to attribute all these developments to the introduction of bond notes as they have not yet endured the test of time.

Many believe that the introduction of bond notes by the RBZ was a way of mopping up US dollars from the market for use by the government to pay for imports. This simply means that the “drip feed” basis of the RBZ is the reverse injection of bond notes to replace US dollars taken out.

The liquidity crisis is now being felt by importers who are failing to finance their inputs from outside the country. Media reports recently revealed that ZANU PF recently purchased over 365 double cab vehicles and buses from South Africa for its 2018 election campaign. In an economy starved of foreign currency, it is anyone’s guess where the money came from.

It is a well known fact that the cash crisis did not come as a result of poor monetary policies but from very limited production for export in the crisis-burdened Zimbabwean economy. So these financial measures from the RBZ will not provide the much needed solutions to the current crisis either. Even the incentive under statutory instrument 62 meant for Import Substitution Industrialization (ISI) only brought limited benefits compared with the damage caused by the minister of Indigenisation’s policy inconsistencies earlier in the year, for instance, leading to company closures.

In short, the problems in the country are political in nature as a result, for example, of policy inconsistencies that undermine and discourage investment. The country needs Foreign Direct Investment (FDI) that can be attracted through an enabling business environment. A number of countries have managed to attract FDI through policy targeting, take for an example, Israel, a desert and under embargo from its neighboring countries has managed to attract the much needed FDI through start-ups and venture capital.

Its policies are targeting the critical sectors of the economy and Israel has become a leading exporter of technological and electronic devices the world over. It has managed to attract major multinational companies to establish research centres in the country. Companies like Microsoft, Intel, Google, Yahoo, General Motors, Samsung, Apple, HP and IBM have managed to establish research and development centres in Israel because of its policies. To stimulate the Zimbabwean economy, the answer lies, not in the fiscal or monetary interventions but a real shift in government policy although this is not to say that the fiscal and monetary authorities have no role to play.

Due to the general lack of confidence in the surrogate currency, there is much fear that its value will crumble much in the same way as the Zimbabwe dollar tumbled against foreign currencies. Bond notes are not being kept for future transactions but used to transact immediately. Therefore, long term measures are needed that will stimulate the industrial sector as well as boosting the much needed exports. The country must take advantage of big economies such as China as export markets for its locally manufactured products and not the other way round.

Disadvantages of bond notes

  • The medium of exchange function of the bond note is questionable.
  • As the Presidential Powers (Temporary Measures) (Amendment of the Reserve Bank of Zimbabwe Bond Notes) Act which was used to issue bond notes is only temporary the bond notes expire after 180 days unless they are confirmed by an Act of Parliament. What is however, surprising is that they do not have an expiry date.
  • The bond note is essentially useless, the mere fact that it cannot be used to settle international transactions disqualifies it as a medium of exchange in the broader sense of the word.
  • Although, the central bank promises full and perfect 1:1 convertibility between the US$ and the bond note, the two are not equivalent and never will be no matter how the RBZ may sugar-coat it.
  • The operational modalities and inefficiencies induced in converting the bond note into a US$ balance immediately discount the value of the bond note.
  • The bond note cannot qualify as a store of value as it is founded on a non-existent notion of value (a liability backed by another liability). By design, the note is self-depreciating in that it is backed by foreign debt.
  • For as long as the Afreximbank facility is open, the debt underlying the note accrues interest, and the longer interest continues to accumulate, the weaker the value of the note becomes, and the higher the amount that has to be repaid in future.
  • The effects are worse if you are to consider that the notes are not backed by any underlying earning asset or production.
  • What the central bank is doing is the theoretical equivalent of printing money. At the time when the Afreximbank facility expires, the central bank is left facing two types of liabilities (a) The loan facility to Afreximbank plus accrued interest, and (b) up to $200 million face value bond notes with no underlying facility to back the notes.
  • In other words, the central bank would have created money out of thin air, unless of course it withdraws the bond notes when the facility expires, in which case the bond notes should carry an expiry date. As to whether the bond notes will be withdrawn upon expiration, it is anyone’s guess.
  • Furthermore, the bond note is an implicit tax on residents in that the debt underlying the bond note will eventually have to be repaid.
  • And like every external claim on the government, the facility will be settled by taxing residents or reducing expenditure, leading to a leakage of the much needed revenue outside the country.
  • If the claim that the note will have perfect convertibility is true, then each time the note is presented and the bearer of the note demands the greenback underlying the bond note, for the purposes of settling a foreign transaction, this is equivalent to a draw-down on the Afreximbank facility, that is, Nostro balances, though with partial replacement.
  • The draw-down is partially counterbalanced by shifting the nature of claims in the banking sector (replacing a strong claim with a series of weak claims) i.e. when locals require funds for transacting locally, they are issued with the same bond notes that would have been previously presented to the central bank for a claim on the US$ in the Nostro accounts.
  • The US$ of locals is then used to fund Nostro balances, creating the illusion that the bond note system will self-sustain (at least in the short to medium term). However, what will happen is that bond notes will chase US$ out of the formal banking sector into the informal sector. Eventually, when the Afreximbank facility is terminated the bank will face challenges funding its Nostro accounts. It is consequential that someone will be left holding a worthless piece of paper.
  • What is more worrisome is the fact that the introduction of the bond notes does not curb the causes of capital outflows and neither does it address the incentives to do so.
  • If anything, forced adoption of the bond note is likely to result in businesses demanding more cash payments, possibly hard currency to settle transactions, and will exacerbate dissaving by households. Bank deposits will be limited to transitory salary inflows and transitionary balances.
  • All speculative and precautionary cash balances will be kept outside the banking sector with the potential to amplify liquidity challenges.
  • Given that memories of Zimbabwe dollar loses during the hyperinflation phase are still very fresh in the minds of most Zimbabweans, and that confidence in the banking sector has not recovered since 2013, this latest move by the central bank will propel the in-formalisation of the economy and growth of the underground economy.
  • A major challenge for business is that the forced conversion of US$ to Rands and Euros will induce unnecessary exchange rate risks and will complicate cross border transactions.
  • As for the reduction of individual balances and increased tightening of the cross border transactions, these measures are likely to see an increase in the liquidity challenges in the banking sector as households rush to withdraw their funds in order to beat the full roll-out of the bond notes.
  • Consequently, some indigenous banks without strong relationships with corresponded banks and with inadequate liquidity reserves may falter. Given that the central bank has limited capacity to inject liquidity in the very short term, further reductions in daily withdrawal limits are expected should the bank runs continue.
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