Bonds: Cheap money politics or savvy intervention

Source: Bonds: Cheap money politics or savvy intervention – NewsDay Zimbabwe May 24, 2016

The Reserve Bank of Zimbabwe (RBZ) announced a $200 million bond notes issue to provide a fiscal buffer against cash shortages.

BY BHEKI NGUBENI

The article looks at the stability of the model, specifically inflationary concerns, end user response to changes and the degree of consistency between expectations and real world observations.

Origins and development

In 2014, RBZ initially introduced bond coins as a store of value mechanism and price lowering measure. Bond coins were touted as a stopgap improvisation to alleviate operational inefficiencies at points-of-sale and lower the price of sub $1 goods and services.

Bond notes, however, have shifted from the foundational “bond” impulse moving from a soft transaction facilitation tool to a hard structural adjustment instrument.
RBZ’s reflation objectives seek to stimulate the economy, in the process enhancing business activity through money financed increase in real government spending paying for real goods and services by printing money.

The difficulty in analysing and critiquing the bond hypothesis lies in its changing complexion, whereby, the idea started off as an efficiency mechanism and rapidly transformed into an aggregate economic model.

On paper, such action can induce demand for local goods due to the currency’s contained nature, more so, in farming output, where locals have direct control and ownership, nevertheless, careless fiscal application generally leads to high inflation only. The experiment could yield the same result as Gideon Gono’s hyperinflation years.

Evidence from Russia in the late 1890s supports the proposition that government must catalyse financial development and economic growth by directly fulfilling the functions of banks if they feel the need to intervene. Similarly, a report by the United Nations quantified the cost and benefits of state interference, concluding that the policy is a positive step towards financial liberalisation on condition that developing nations do not use it for political and personal gain.

Future value of bonds

Once in circulation, it is possible to quantify the linear decay rate of a single bond for each stimulus round using data to forecast future value assuming certain conditions remain true. It should be noted that the analysis assumes that in subsequent periods, the level of government quantitative easing is maintained at the advised rate and that no further increases in money supply occur.

Condition 1: normal physical notes and coins/bank deposits = $500 million
Condition 2: proposed quantitative easing/stimulus package = $202 million
Condition 3: error/disturbance term (unbanked funds)probabilistic value = $7 billion
Condition 4: GDP/goods/services and single household spend per year remains constant.

The original sin re-engineered

The inability of businesses to borrow in their local currency is known as the original sin. Should a local currency devalue, foreign currency-denominated debt burden becomes much greater and can result in defaults. This is often cited in as a problematic issue for borrowers in developing countries.

In Zimbabwe, the risk is reversed, private SMEs that acquired dollar denominated debt will soon be able to service their balance sheet outgoings in bonds, leaving the banks in a lurch should the domestic currency devalue. Again, in the likely event that government will use bonds to finance its expenditure programmes, banks and wealthy depositors have to bear the full risk of a volatile closed economy currency by accepting bonds.

Critical success factors

The institution has effectively ignored the potential maladies of 2008, such as record hyperinflation, high unemployment, bank runs, high cost of capital, social disharmony and ultimately a national crisis. It’s not well developed to control all the risks making it difficult to obtain buy in and user acceptance.

Furthermore, the end user has a natural negative bias towards the policy given past experiences emphasising the difficulties and risk in making the change. There is a possibility of outright market rejection unless the bank can provide tangible concrete evidence of better resource use not increasing the money stock for consumption purposes only.

Deposit insurance might help mitigate risk, providing much needed reassurance to depositors, who can find comfort in the knowledge that there is a redundancy procedure in place in the event of policy failure.

There is an urgent need to abandon experimental ideological socio-economic principles and converge to international standards and codes in order for the financial system to function and to avoid more traumatic experiences.

Ultimately, market acceptance criteria will be based on the degree of concentration or availableness of bonds. An injection of $200 million or less comes across as manageable, but we are already seeing daily banks runs and, unlike bonds coins, the market is a bit edgy and unwilling to commit until trust can be established between all stakeholders.

●Bheki Ngubeni (MSC, BA) can be reached at bheki213@yahoo.co.uk