Currency risks and inflation spur ZSE rally

Source: Currency risks and inflation spur ZSE rally – The Standard September 17, 2017

Currency risks and rising inflation have spurred a rally on the Zimbabwe Stock Exchange (ZSE), which has seen share prices firming and the market capitalisation breezing past the $10 billion mark.

BY NDAMU SANDU

The benchmark industrial index more than doubled to 379,37 points on Thursday, up from 145,27 recorded at the beginning of the year.

Market capitalisation nearly trebled to $10,86 billion on Thursday up from $3,91 billion registered at the beginning of the year.

To an investor, this rally is too good to be true at a time the economy has been underperforming.

This also comes at a time the performance of foreign investors on the bourse has been on a decline compared to last year after companies struggled to remit dividends due to foreign currency constraints in the economy.

Investment analyst Ranga Makwata said the rally on the market was being driven by entities (institutions and individuals) with excess real time gross settlement (RTGS) balances in the banks who are concerned about value erosion in the wake of rising inflation and currency risks in the economy.

“Investors are worried about a possible return of 2008-like hyperinflation and thus are seeking the protection of equities, which will self-adjust to inflation,” he said.

Makwata said bank balances and bond notes were losing value against the real US dollar with discounts of around 40% being quoted on the streets with the Old Mutual implied rate showing discounts of more than 80%.

“Clearly, the 1:1 relationship between the local dollars and real US dollar is no longer holding outside the formal channels as buyers of foreign currency are prepared to pay more for it, as it becomes scarcer,” he said.

In November last year, the central bank introduced bond notes under the $200 million export incentive facility guaranteed by Afreximbank.

The central bank said the bond notes were at par with the dollar.

However, the bond note has lost value on the parallel market.

The situation is scarier when one sources dollars using RTGS balances.

Makwata said one effect of the discounts on the local currency was the inflationary pressure it was exerting, especially on imported products whose prices were now being increased regularly.

However, price increases are not sustainable because disposable incomes remain low, thus reduced demand could force merchants to lower prices to support sales volumes.

Makwata said high market capitalisation values had to be looked at in the context of the value of the currency being used.

“The values are large in absolute terms but if the currency discounts are also applied on those values, they shrink substantially in real US dollar terms,” he said.

“Nothing short of inflationary pressures and of course speculative behaviour could explain the market activity we see today.

“The business fundamentals of most companies remain depressed and thus cannot support the current market valuations.”

Makwata said the rally could also be driven by foreign investors who cannot access their dividend payouts due to the current forex crunch.

“There are some foreign investors who have money in Zimbabwe, maybe through dividends ,which have not been remitted because of problems with foreign currency movement from the country,” he said.

“Some could be using those ‘blocked’ funds to buy shares, as a value preservation strategy.

“The more fearful ones are probably buying Old Mutual shares on the ZSE hoping to sell them on the London Stock Exchange (LSE).

“That way, they would have succeeded in taking out their money, of course using a longer and more costly process.
“That’s why the Old Mutual share price on the ZSE has increased much faster than on LSE or JSE [Johannesburg Stock Exchange] thus implying a weaker bond /RTGS value against real US dollars.”

IH Securities said the current rally has been influenced by factors such as liquidity, preservation of value and the fear of missing out.

“The maturity of TBs [treasury bills] at various points during the year created significant RTGS balances,” the firm said.

“At the same time, the widening of the Old Mutual implied rate, which is being seen as a proxy for devaluation, has consequently led to a switch from RTGS balances/near cash assets into hedge assets.

“With limited investment classes available, local institutions have crowded into equities partly resulting in the current rally.”

The widening in the perceived rate is early nerves around upward pressure on inflation leading to equities being seen as a way to preserve value in the current environment, it said.

Brokerage firm, IH Securities said since the rally started, there had been “more and more retail investors wanting to participate, as they see an opportunity to invest RTGS dollars into an asset moving ahead of other cash and non-cash assets and thus presenting an opportunity to make real returns if timed accurately”.

In its economic and equities review for the first half of the year, MMC Capital said the equities would be the preferred investment choice in the outlook due to low returns on the money market instruments.

“Given the unconvincing returns on money market instruments and insufficient alternative investments, the majority of investors will likely view equities as the preferred asset class, on a long-term perspective, though concentrating on the second tier segment of the market, considering that the recent rally has predominantly benefitted the top tier segment,” it said.

Will this rally come to an end at some point?

IH Securities said at current levels, the market had run past fundamentals and that corporate earnings would not justify implied valuations.

“We foresee an inevitable market correction, particularly as retail investors begin to take profits,” it said.