2010 budget: Fiscal, monetary policies need coherence

Understandably, the high expectations were due to the fact the budget serves two major economic functions.
Firstly, it is a device by which the government can set national priorities, allocating national output among private and public consumption and investment, and secondly provides incentives to increase or reduce output in particular sectors.
Unfortunately, a reality check shows that the 2010 national budget has come at a time when other supporting policies are either dysfunctional such as the monetary policy or highly ineffective such as the supply-side policies.
Achieving macro-economic objectives becomes very difficult under such economic conditions.
Despite the constrained environment, the minister did his best under the circumstances to apply his usual tools — government expenditures and revenues — so as to steer the economy on to a steady-state growth path.
Budget’s constraints
From a macro-economic point of view, it is through fiscal policy that the national budget affects the key macro-economic goals: (a) high growth, (b) high employment, (c) stable prices and (d) satisfactory balance of payments position.
Herein lies the catch: The commonality of objectives among fiscal policy (unveiled by the Finance Minister) and monetary policy (which is announced by the central bank governor).
Since the macro-economic objectives of the fiscal policy are the same as those of monetary policy, an important question is: Can these objectives be achieved by employing fiscal policy alone given that the monetary policy went with the Zimbabwe dollar?
In other words, are fiscal and monetary policies mutually exclusive events that can achieve their objectives independent of each other. The answer is a definite no! The two are complementary! But the fiscal policy, through the National Budget, although it is also a demand-side policy, cannot work like its peer (monetary policy) as it uses totally different tools.
In his fiscal policy, which is contained in the 2010 National Budget, the Biti did wonders with the tools at his disposal — government spending, transfer payments and taxes. But the issue of pricing of financial products, which the productive sectors rely on for their expansion and working capital requirements, is something that was left alone because they are not fiscal policy tools.
In fact, the Biti shocked the discerning public by reading the riot act to banks telling them to lend to productive sectors otherwise he would invoke laws that will force banks to play ball.
Maybe that’s the complementarity between fiscal and monetary policies at work as that riot act is now being read by both Biti and Reserve Bank governor, Gideon Gono.
However, be that as it may, let us hasten to say that we are not calling for an immediate return of the monetary policy to complement the fiscal policy, although that is the ideal situation. We are very much aware of the fact that the monetary policy will remain jobless for some time because the conduit through which it is supposed to function (transmission mechanism), lacks an important ingredient, the Zimbabwe dollar, as it became moribund. The reasons for its death are well documented and we do not wish to repeat them here suffice to say that we do not miss the Zimbabwe dollar.
What we are saying is that we should not expect everything from the National Budget because its tools to achieve macro-economic objectives are just not enough to do the job! Those of monetary policy cannot be used as they went with the Zimbabwe dollar.
As a result, we are going to remain stuck with passive monetary policies from countries whose currencies we are using, especially the United States.
Expectations from the National Budget should further be reduced because the fiscal policy, together with its departed friend monetary policy, are only part of the national macro-economic policy arsenal to achieve the said objectives. This is because these policies work on the demand-side of the economy’s markets.
There are also policies that work on the supply-side of the economy that need to be looked at which are currently not being put to optimum use due to a number of challenges some of which border on politics. The macro-economic objectives and tools available to a government are illustrated in the diagram above.
Macro-economic policy
objectives and tools
As has already been discussed, each of the policies stated in the diagram above, which constitute typical macro-economic policies of a country, have their unique tools which are limited in effectiveness as each does not realise all policy objectives alone.
This is the predicament that the fiscal policy, through the National Budget, currently finds itself in in Zimbabwe. This is because other supporting policies such as the monetary policy are dysfunctional while supply-side policies have become ineffective.
The problem with our fiscal policy is also clearly illustrated in the diagram below.
The Venn diagram is demonstrating the idea that the various policies at the policy makers’ disposal in Zimbabwe are not mutually exclusive events whereby the authorities can choose to use one policy instrument at a time to achieve all the macro-economic objectives. The policy instruments depend on each other, which means the absence of one policy instrument like the monetary policy makes fiscal policy or supply-side policy ineffective.
Biti’s 2010 National Budget should therefore be viewed in this light. The National Budget (fiscal policy) alone is not enough to fully realise our macro-economic objectives!
Where is stability coming from if the budget can’t do it?
The implied assumption that has come out from our discussion above is that the National Budget is now the main instrument of economic management. This is because the monetary policy died with the Zimbabwe dollar and we have been forced to outsource it by virtue of our use of other nations’ currencies, especially the US.
As we will see, supply-side policies are not being given the attention they deserve due to a number of reasons, some of which are political. So we are left with a fiscal monetary policy.
But we are saying the fiscal policy alone cannot do much because it has to work together with other macro-economic policies.
Now one many ask: How come the economy has stabilised so well since the beginning of the year if the fiscal policy is that powerless? The Finance Minister answered this question well, saying the economic stabilisation that we are currently enjoying is due to the adoption of the multi-currency system at the beginning of this year. This is because its introduction, “. . . among other factors, directly contributed to the immediate containment of inflation by arresting rapid price movements and putting an end to rapid money supply growth as well as curtailing speculative activities”.
Against this background, the reiteration by the Minister that the inclusive government has no appetite for the Zimbabwe dollar is something that is extremely positive and re-assuring about the budget. This is because given that we have proved that the fiscal policy alone, through the National Budget, has no capacity to achieve the known macro-economic objectives because of the absence of other supporting policies such as monetary policies, dollarisation to take care of our economic stabilisation requirements.
In the meantime, we hope the authorities are learning about how to construct an effective stabilisation programme. One attribute of the programme is to live within our means, eating what we kill or gather. Above all, do not print money to finance non-existent output as that money becomes worthless.
Unfortunately, these lessons that are being learnt the hard way because there is no alternative. Any attempt at de-dollarising is tantamount to destroying all the economic progress that has been achieved since the beginning of the year!
Emphasis should now be placed on reducing our sovereign risk through working towards more stabilisation of the political environment so that we can harness international resources to augment domestic ones. In this regard, the continued difficulties in the implementation of the Global Political Agreement (GPA) will continue to curtail foreign investment and capital flows from multilateral and bilateral financial institutions. It is also reassuring that the Minister talked about these issues in his budget.
A closer look at the 2010 National Budget
Policies to promote production
Starting with issues that are still fresh in our mind, supply-side policies, we find that the Minister remembered the need to promote research and development. This is because large tax exemptions for research and development may cause an increase in research and development. This then may increase economic growth as it tends to increase total national product.
In the budget, the minister allocated US$55,61 million towards research, science and development which represents one percent of the projected GDP of US$5,561 billion.
Although the amount will never be adequate, it is a welcome development as it sends the right signal to researchers to shift production to the right.
We are, however, not sure whether the increase in tax-free income by US$10 to US$160 will do the trick to increase the supply of labour by workers necessary to increase output. Workers may have been excited if the tax changes were in percentage terms as this would relate to the various salary levels of workers in the economy.
Using absolute figures assumes that all workers earn the same salary which is not correct.
The minister did a wonderful job by reducing the corporate tax from 30 percent to 25 percent as the resultant positive effect on profitability will increase the number of firms and the output of existing firms as they may plough back their profits to realise more production.
As a result, national output and employment will rise over time. This has a positive effect to the government as both the tax base and tax revenue rises. The tax base will rise because of more firms entering various industries while the tax revenue will rise because of increased profitability by existing firms.
An important supply-side policy that the inclusive government is still to develop “chemistry” with is the land reform programme. Given that we are an agricultural economy, this programme is supposed to breathe life into the other productive sectors of the economy as they depend on the agriculture sector for their inputs.
For instance, agriculture output accounts for 63 percent of manufacturing inputs. In the budget, the minister is not very keen to commit financial resources to commercial farmers, especially A2 farmers, as he wants to first address some outstanding issues which include the land audit, security of tenure as well as funding for extension workers.
As a result, A2 farmers will have to finance themselves through credit facilities provided by the financial sector.
The minister, however, has a soft spot in his heart for small-holder farmers. He has apparently been moved by the Malawian experience whereby government assistance to small-holder farmers with seed and fertiliser packs has significantly increased food production.
For instance, during the 2008/2009 agricultural season, Malawi produced about 3,5 million tonnes of maize yet Zimbabwe, which needs about 1,8 million tonnes per year, only managed 1,1 million tonnes.
Armed with this information, the minister is targeting to assist one million vulnerable rural households with crop input packs comprising 10 kilogrammes of maize and sorghum seed, 100kg of compound D and 100kg of ammonium nitrate fertiliser. A figure of US$98 million was set aside for this purpose.
Some more US$95,3 million will come through the vote of credit to support vulnerable small farmers. With sufficient attention from government, the small-holder agricultural sector could offer one of the best ways in returning the country’s breadbasket status.
Commercial farmers (A2) will only be entertained in the 2011 budget or the 2010/2011 agricultural season, presumably after the minister has dealt with the outstanding issues. This is because the minister has promised to mobilise US$600 million in the 2010/2011 agricultural season to put 1,45 million hectares and 65 000 hectares under maize and wheat, respectively together with 75 000 hectares for tobacco with a potential yield of 200 million kg.
Sustaina-bility of the budget
An important attribute of any budget is that tax revenues must cover recurrent expenditures. If tax revenues are not enough to cover recurrent expenditures, it means the country is living beyond its means and will develop serious economic challenges and eventually collapse.
A good example is the 2007 budget where the government suffered a primary deficit of Z$8 trillion. What happened is now history, but a simple thought of the events that took during that period leads one to develop goose pimples. Let’s not talk about the pre-2008 era and consider the positive developments captured by the 2009 budget.
Probably, for the first time in the history of Zimbabwe, the primary budget is positive at US$76,3 million, thanks to the cash budgeting policy. This is for the first 10 months of the year. Even the total budget balance is US$47,9 million. Indeed we have been living within our means through eating what we kill or gather.
The 2009 budget, however, has one big flaw — it’s not sustainable because the capital budget is extremely low. Having planned to raise the capital budget to at least 18 percent, the budget out-turn for the period to October has produced a laughable four percent, which means 96 percent went to recurrent expenditure.
A capital budget that is continuously being squeezed by recurrent expenditure budget does not promote national investment through gross fixed capital formation (GFCF). The 2009 budget ceases to be growth promoting and the fiscal policy will definitely fail to positively impact the macro-economic objectives. Fine, we are living within our means, but we are not investing in infrastructure to provide an enabling environment for business to thrive so that the tax base and tax revenue rise and makes it easier to finance the secondary deficit which is created by expenditure on capital projects.
The sad thing about the 2009 budget is that a greater of the recurrent expenditures are employment costs like wages and salaries, which constitute about 60 percent of total costs. Given that these costs are non-discretionary, the Minister has little room to manoeuvre which means we are likely to see the same structure being perpetuated in the 2010 budget and beyond.
The ideal split between recurrent and capital budget should be at least 75:25 with a bias towards the capital budget. Surprisingly, the 2007 budget performed well on the capital budget. This probably reflects the massive farm mechanisation drive that the government pursued although a large chunk of it was financed outside the budget through quasi-fiscal activities by the RBZ.
Using this analytical thrust, the 2010 budget has performed badly on the primary budget as it is showing a deficit of US$238,2 million, but is well on the capital budget of 22,42 percent of total expenditure. The cardinal rule which must be observed at all times is that we must not live beyond our means.
It’s okay to have an overall deficit as long as the primary budget balances or is positive because it means the deficit has been incurred through the capital expenditures which promote growth.
This puts a question on the cash-budgeting policy! The minister expects to finance the deficit of US$810 million through support from donors. What guarantees are there that we will get the support which amounts to 36 percent of the budget given that the international community has demanded progress on the political front especially the full implementation of GPA before they can loosen their purses? Let’s be financially disciplined and those of votes of credit should come as bonuses.
A nation of consumers
The observation by the minister that the bulk of our taxes are coming from indirect instead of direct sources is a worrisome economic anomaly. Indirect taxes are placed on goods and services while direct taxes are levied on income and wealth.
Since indirect taxes are paid only when a particular purchase is made, they are therefore taxes on consumption, hence, they are also called outlay taxes. An increase in indirect taxes shows an increase in consumption by the nation whereas a decline indicates a decline in consumption. On the other hand, direct taxes are taxes on production as income and wealth can only be earned by engaging oneself in productive ways.
An increase in direct taxes indicates an increase in economic activity and vice-versa.
In this regard, Zimbabwe is a nation of consumers because government is getting most of its revenue from indirect taxes and less from direct taxes. For instance, the table below shows that indirect taxes such as value-added tax (VAT), customs and excise duties, among others, constituted 75 percent of total government revenue during the fiscal year 2009 whereas direct taxes such as pay-as-you-earn accounted for only 19 percent.
Due to the slow movement and availability of information, tax figures for the 2010 budget are still to be seen and analysed, but given the continued low capacity utilisation by companies and low disposable incomes, the government will continue to find it difficult to reverse the tax proportion situation.
Indirect taxes are expected to continue to constitute the bulk of government revenues compared to direct taxes.
The extension of the zero duty on imports of basic commodities, although it’s a fair idea if we consider the resultant positive effect on inflation through continued low prices, means that consumers will continue to enjoy commodities at affordable prices.
However, the proposal by the minister to reduce corporate taxes has an effect of increasing direct tax revenue (corporate tax revenue) due to the resultant increase in the tax base and tax revenue.
Banks, productive sector
credit: Statutory reserves should be scrapped
Biti also urged the banking sector to increase their lending to the productive sectors of the economy. Let us take this opportunity to proffer a possible solution that the authorities can use to achieve this noble policy objective of increasing bank credit to the productive sectors.
Initially, it was the central bank governor, as the monetary authority, who has been very vocal about this issue.
Official figures show that currently, banks are committing about 50 percent of their deposits as credit to the productive sector, a figure which the authorities want raised to around 80 percent.
We propose here that the authorities should temporarily scrap the statutory reserve requirements so as to help improve the loan-to-deposit levels to above 50 percent.
This proposal is being made after realising that the statutory reserve and/or liquidity ratios no longer serve their traditional purposes. Traditionally, these statutory reserve requirements had two purposes: (a) to ensure that banks are liquid all the time so that they can efficiently service their clients (depositors) thereby maintaining confidence in the banking sector; and (b) to control the money-creation ability of banks through the multiple-credit creation process, in a bid to control inflation.
This means that the statutory/liquidity ratio is also a monetary policy instrument.
Given the advent of the multi-currency system, these functions of the statutory reserves have been made redundant such that there is no longer any need for the central bank to continue taking this money from banks.
Currently, the statutory reserves have become taxes, something which should be of interest to the minister as it is another revenue source to be included in the budget.
In the case of the first function, banks are no longer benefiting in any way from paying statutory reserves as they do not get any financial assistance from the RBZ if they face temporary liquidity challenges. In other words, the central bank is no longer able to perform its lender-of-last resort function. Given this situation of the redundancy of statutory reserves, they have become a tax as already noted.
Right now, banks are left with 90 percent of the deposits to lend while the other 10 percent of the deposits is sitting at the central bank where their traditional role of bailing out banks is not being performed. These funds are better left at the banks so that they lend them out to their clients (borrowers).
In the case of the second function of statutory reserves (monetary policy instrument), the idea here is that bank loans create bank deposits which increase the total volume of purchasing power, that is, the quantity of money. This phenomenon is only an economic problem in a situation where a country uses its own currency as banks will create money that is over and above what the central bank would have injected into the economy.
Zimbabwe today does not have this problem as the central bank is not in any way able to print money such that anybody who is able to create money like banks, as long as they are not Zimbabwe dollars, should be given the exalted status they deserve. We have liquidity problems and we know that banks can create money by extending loans, but we continue to limit their ability to do so. Therefore, is no reason for keeping statutory reserves at the moment. They should be scrapped so as to unlock more lending capacity to banks. This is a win-win solution which will spare the minister the effort to look around for laws to force banks to increase credit to the productive sectors.
Implications on markets
Zimbabwe Stock Exchange
Foreign investor participation on the Zimbabwe Stock Exchange (ZSE) increased in the year as the political environment improved following the formation of the inclusive government. There was, however, a general outcry on the charges prevailing on the market which, at 7,5 percent, were too high compared to those prevailing in the region, especially in South Africa.
The equity market investors, thus, welcomed the reviewing of the charges by the minister as shown in the table above.This reduction in the total cost of trading on the ZSE is likely to result in renewed interest in the market since some investors were deterred by the high charges and were opting for the money market. Such renewed interest should result in an increase in market turnover with consequent increased business for all the stakeholders on the bourse, including government.
Hitherto, the equities market had become illiquid as it had become expensive to buy and sell shares, the cost of which would not be compensated by the performance of the bourse which has been fettered by liquidity challenges affecting the economy.
Productive sectors
Investors should also consider sectors that are likely to benefit from the budget statement. Below is a table for the growth rates for some of the selected sectors:
In July the minister identified agriculture as the “midfield general” in driving the economy. The 10 percent growth is underpinned by improved performance of tobacco, maize, groundnuts, soybeans, sorghum and tea. However, cotton, wheat, sugar, dairy and horticulture production decreased slightly.
The minister pledged government commitment to continue to initiate arrangements for the mobilisation of financing for the agricultural sector. In this environment investors should consider adding the following counters for their portfolios; Seed Co, TSL, BAT and Ariston
Mining
The mining sector, which had most of its mines either closed or operating well below capacity at the beginning of the year, is showing signs of recovery after having taken advantage of positive policy measures under the Short-Term Emergency Recovery Programme (STERP).
Such positive measures include the removal of forced foreign exchange surrender requirements and the full retention of export proceeds. This sector is expected to grow by two percent in 2009 and 40 percent in 2010 compared to a decline of 30 percent in 2008.
The growth will be underpinned by a 24,6 percent increase in gold production, 5,7 percent increase in nickel and 3,9 percent increase in coal production.
With a projected growth of 40 percent in 2010, mining remains a good buy. We, thus, recommend RioZim on the back of firming gold prices.
Infrastructure development
The minister noted that investment in infrastructure facilitates economic growth and development and that the current infrastructure bottlenecks are a major constraint of economic growth and development. Thus he focused on infrastructure investments that maximise existing capacity and guarantee reliability of public services.
It is a pity, however, that the capital budget out-turn during the first 10 months of 2009, at only five percent of total expenditure, was not satisfactory on account of constrained revenues.
Capital expenditure for the period to October 2009 amounted to US$28,4 million against a budget provision of US$178,1 million or 31 percent of total expenditure.
The fact that there are provisions for the completion of selected government buildings and rehabilitation of schools infrastructure, opens opportunities for counters that are into infrastructure development and M&R, Gulliver, PGI and Lafarge.
Tourism
The development of infrastructure comes at a time when the tourism sector is faced with a huge opportunity through the 2010 World Cup to be hosted by South Africa.
This, coupled with the removal of travel warnings by many countries, has seen occupancy levels increasing. As a result, the sector is set to grow by 10 percent in 2010.
The government has developed strategies to boost tourism, focussing on: (a) destination re-branding; (b) review of our international marketing strategy; (c) development of market-specific marketing programmes; and (d) targeting the world’s top tourist generating markets. Investors should thus consider African Sun, RTG and TA Holdings for their portfolios.
Manufacturing
The manufacturing sector, which recorded a cumulative decline of -91,1 percent between 2000 and 2008, is now on a recovery path thanks to the dollarisation of the economy which has made planning easier through the reduction in inflation and use of stable currencies.
The increase in bank deposits from US$475 million in April to US$1 billion in October 2009, allowed banks to begin lending, also targeting the manufacturing sector, whose share of loans and advances constituted about 22,3 percent of total loans by October 31 2009.
Capacity utilisation has increased from 10 percent in 2009 to current levels of about 40 percent. The sector is estimated to register a positive growth of eight percent in 2009 and 10 percent in 2010. In this sector, investors should target counters like General Beltings, Zimplow and Cafca.
Money Market: Cost of
capital to remain high
The huge appetite for funding that has characterised the period since the beginning of the year when the multi-currency system was introduced remains deeply seated in the economy. The high demand for credit coupled with a background of debilitating liquidity crunch and continued high sovereign risk due to political factors, has caused punitive lending rates.
In the National Budget, total demand for funding from line ministries added up to US$12 billion against projected revenue of US$1,44 billion, implying that the budget can only accommodate 12 percent of the ministries’ funding requirements.
This situation should be very worrisome to the business sector as they used to get most of their business from government. Not only is business from government reduced, it is also a high risk borrower.
We used to be told that governments do not go broke, so just extend credit to them as they will surely repay because they knew they would instruct the central bank to print the money. This is not possible in a dollarised environment as the authorities cannot print money.
In this environment, the business sector needs to look for other sources of business. Although the budget is very mean in terms of numbers, the deficit of US$810 million for 2010 will surely have to be funded. If we assume that this gap will be closed by external assistance (vote of credit) it means we are very much exposed as a nation. This is because of the obvious problems of getting funding from such sources especially against a background where GPA implementation is not moving well.
The funding gap means that we are expecting 36 percent (US$810 million out of total expenditure of US$2,25 billion) to be bankrolled by the international donor community. The question is: How feasible is this given that the donors first want to see good performance on the political front?
Assuming that we do not get enough joy from the international community, there are obvious funding requirements which the domestic economy, especially financial markets, cannot stomach. This, coupled with the business sector’s thirst for credit to ameliorate the decade-long recession, points to a situation of a sustained high-interest rate environment relative to those prevailing in the region.
Even if we assume that the budgetary support of US$810 million for 2010 could be realised from the donor community, the additional financial injections are evidently not enough to improve the liquidity situation so as to translate into a fall of interest rates.
The 2010 budget’s US$2,25 billion spending provision, inclusive of the US$810 million budgetary support, can only cater for 19 percent of the ministries’ funding requirements, a development that will obviously give rise to sustained high lending rates on the back of a thin funding base in 2010.
This situation, as has already been noted above, has been worsened by the continued inability of the RBZ to perform its market-making role through such functions like the lender-of-last-resort. This is because, given the dollarised environment, the RBZ has no capital to manage local money market and interest rates.
In the event of adverse movements of interest rates on the local economy due to market structural dislocations, the RBZ is unable to intervene to smoothen or normalise the liquidity and interest rate situation on the local money market through open market operations.
As already noted, a softening of the prevailing lending rates, which currently range between LIBOR plus eight to 20 percent for 30 to 90-day paper, is hugely depended on the stability of the inclusive government which, in turn, is a function of the gospel adherence to the provisions of the GPA.
This is because a stabilisation of the political environment will, among others, unlock foreign currency inflows through foreign direct investment, capital flows from the International Monetary Fund (IMF) and other multi-lateral financial institutions.
The minister is assuming such positive developments on the budget through the votes of credit.
Given the complications that continue to afflict the political environment, through the ballooning of outstanding issues, we expect interest rates to continue oscillating within their current ranges, firming from their current levels to ranges between LIBOR plus 10 to 25 percent for 30 to 90-day borrowings.
This is because the expected continued political noise will keep our risk premium high due to the resultant continued high sovereign of country risk.
High systemic risk continues
to haunt the financial sector
As already noted, the RBZ can no longer perform its much-needed lender-of-last-resort function following the introduction of the multi-currency system. This is because the central bank just no longer has the financial resort to perform such a function.
The National Budget has not helped the situation. Having been allocated a mere US$3,5 million for the second half of 2009 to cater for its operation, the RBZ was given US$10 million in the 2010 budget, again to cover operational expenses.
Nothing was provided to capitalise the central bank for it to resume its lender-of-last-resort function. In fact, the budget is actually silent on the plan to recapitalise the central bank so that it executes its market-making roles, but is very forthcoming on plans to reform it. Although it’s a noble idea to refocus the RBZ’s institutional framework to its core business of financial sector supervision, monetary policy and ensuring efficient payment system, we are saying the reform process should run concurrently with the central bank’s activities.
We should not defer central bank activities so that we first fix the institutional framework first, no. The two should run together, which means the budget should provide the necessary financial means.
Given the current situation whereby the central bank is inactive, systemic risk on the local financial sector is running very high. This is because any banking institution that finds itself in a temporary liquidity stress cannot seek accommodation from the central bank.
If a banking institution fails to cover its temporary liquidity gap by borrowing from individuals, corporates, institutional investors and the inter-bank market, it will surely go under as the central bank cannot offer any financial assistance since it remains severely under-capitalised.
To make matters worse, the authorities are adding the risk burden of banks by demanding that they should increase their loans to the productive sectors to at least 80 percent of their deposits from the current 50 percent.
Intermediation to remain
affected by thin savings
The economy’s deposit base, currently estimated at US$1,061 billion From C9
as at end of October 2009, remains low for financial institutions to effectively execute their intermediary role on the economy.
Contributing to the thin deposit base is a decrease in the savings habit due to low disposable income coupled with financial dis-intermediation emanating from the now entrenched informal economy.
Furthermore, confidence is still to fully visit the financial sector as some holders of large amounts of foreign currency are afraid to show their cash to the authorities by placing it in the formal channels.
Low interest rates on deposits of between zero and three percent, does not encourage one to keep his/her money in a bank as the opportunity cost is very low. These reasons, for the decline in savings, have been complicated by the fact that about 90 percent of the total deposits are transitory in nature and cannot be utilised by financial institutions to create long-term credit for the deficit units.
Formal national savings that can be used by banks may remain low unless the economy has grown to a level where households can have meaningful disposable incomes that can be saved and confidence has returned to the local economy and efforts have been made to bring most of the businesses into the formal economy.
Since these issues need to be tackled comprehensively with all macro-economic tools being collectively put to use, including the political sphere, the National Budget has no capacity to address these issues.
Against this background, although the authorities will continue to encourage banks to offer long-term credit to the productive sectors, the reality on the ground dictates that financial institutions structure their lending in the short-term with financing being largely restricted within the seven to 90 days area. Yet this is not what industry wants.
If we consider the longer turnover cycle of the majority of companies, the short-term facilities granted by financial institutions are generally unfavourable to the capital needs of the industry as a whole.
Default risk arising from the short-term nature of the assets created by financial institutions through lending will need to be prudently managed as the liabilities financing the assets are also short-dated.
The National Budget can be used to restructure the asset and liabilities of financial institutions so that they become long-term through floating longer-dated stock to finance the deficits in a bid to match the long-term funding requirements of industry.
Given that we are coming from a deep recession, this conversion of the tenor of bank assets and liabilities so that they become long-term and conform to the credit requirements of industry, is also a long-term process. This is because the investing public do not have enough cash to lock away for such long periods although this can be solved through the secondary markets of those financial instruments.
A common thread that runs through all these arguments is that the central bank should be present playing an active role in all these proposals being proffered! This is because all these bond market instruments need to be administered through the RBZ.
Against this background of the need to avail long-term assets in the financial markets, the minister should be commended for re-introducing the prescribed asset requirements for insurance and pension funds.
Although we know that the economy is still facing liquidity challenges, we need to start somewhere. This is just one attempt to ensure the availability of long-term assets and liabilities which conform to the long-term funding requirements of industry. — Courtesy of Kingdom Financial Holdings Limited.