Is the lack of liquidity the biggest challenge for the Zimbabwean economy?

Many a business woe has been put down to the problem of liquidity - everything from slow sales to non-performing loans to less robust economic growth. If there was more credit out there, the saying goes, a lot of our problems would be resolved and the economy would be pumping.

This is not very different from the common mantra in Zimbabwe dollars era where many businesses blamed the deposed currency for their problems. With hindsight and as we all know some of these entities/ individuals may have had their best times during hyperinflation and they are struggling in the stable environment which they so much clamoured for.

If there is one sector of the economy that understands liquidity, it is the banking industry. Cash after all, is their stock and trade. Liquidity is something they have to think about and manage everyday. Those that have failed in this endeavour have found themselves embroiled in the infamy of corrective orders, curatorship and even liquidation. This goes for local players as it applies to any banker right round the globe.

The question of liquidity is, in my view, ultimately one of credit. Is every individual and business that needs credit and, more importantly, deserves that credit, able to get it? In an economy where there is insatiable demand for liquidity by creditworthy economic players, we should be able to make a few predictions about the banking sector and their loan books:

1. There would be small non-performing loans. The banks would be overwhelmed by quality borrowers and would only lend to the cream of the crop.

2. The borrowers would also go out of their way to maintain their good standing with the banks as they would be aware that there is a shortage of credit. They would be willing to put up security giving the banks generous cover as well as sign personal guarantees.

3. Given the low risk, and strong cash flows from their loan portfolios, the banks would aggressively deploy their deposits and capital and have loan to deposit ratios in excess of 100%.

Thankfully, we have just exited the December 2012 full year reporting period and can compare the prediction of the theory above with the reality on the ground in the banking sector.

Non-performing loans are generally rising with Bankers Association of Zimbabwe president George Guvamatanga recently alluding that the average in the sector is about 12%.

From the announced results, banks are reporting high credit defaults and the same is confirmed by credit retailers as well as companies that are supplying products and services on credit. Poor credit quality affects liquidity because if a borrower cannot pay when due, the lender has to fund that position. The more non-performing loans a bank has the poor its liquidity becomes. In other words lenders are creating or worsening the liquidity problems by lending to people/companies of poor credit standing in search of high returns.

The situation is being exacerbated by that the central bank cannot create some liquidity through monetary policy intervention since it cannot print the foreign currencies we are using in primary transactions. In others countries, for instance in the US where quantitative easing is being used, liquidity injection from government becomes a mitigating factor in the sense that it brings in new money which is used to meet these commitments.

So firstly, it is clear that there are lots of non-performing loans out there. Therefore not all credit is quality. Having said that however, it is also quite clear that the 85% to 99% of the loans on bank books are kosher based on the reported NPL ratios ranging from 1% to 15%. One can therefore conclude that the demand for liquidity from creditworthy economic players is actually limited. Many of those that are clamouring for liquidity certainly do not deserve to be afforded any credit and giving them money is almost suicidal.

Secondly, given the high level of actual write-offs, the bank exposures are not always fully secured. Security is meant to be a failsafe and would be generously provided by a quality borrower desperate to raise some liquidity. In this market however, the quality borrowers are able to borrow significant amounts, at low interest, without mortgaging their land and buildings or plant and equipment. These borrowers have lots of leverage on the banks and not the other way around. The shortage then is in quality borrowers the banks would love to lend to and not liquidity, it would seem.

Lastly, many of the banks indicated that they will be more focused on managing liquidity in 2013 than growing their loan books. If the banks have taken a deliberate view to limit lending, it means that they have had their fingers burnt by impairments and are not excited about increasing their exposure. Would this happen in a market with an abundance of quality borrowers?

Of course, there is an interesting alternative theory that posits the following: If there was more liquidity in the economy, many non-performing loans and struggling businesses would turnaround. Many loans, some would argue, are non-performing because the tenure is too short and the interest rates too onerous. The bar for performance therefore becomes too high and failure then becomes the path of least resistance. Business is also slow because consumers cannot access credit to fuel consumption, finance car loans or secure 25yr mortgages.

The argument above appears rather circular. Perhaps it is useful to examine economic performance in other countries where there was plenty of liquidity to go around. Many in Greece and Cyprus would argue that liquidity based on debt is not a panacea for economic prosperity. Also the subprime mortgage crisis in the US stemmed from excess liquidity which prompted lenders to dole out loans for house buyers whose credit quality was subprime (below average).

If everyone in Zimbabwe could borrow as much as they wanted, irrespective of their credit worthiness, would this party end in long-term sustainable wealth creation or tears?

In conclusion, fundamentally, it is wrong to pin our problems on a mythical liquidity crisis. We need to have an honest discussion about what underpins robust economic growth and take the necessary steps to achieve this. Otherwise one day the floodgates of liquidity will be opened, only to usher more pain and misery when the party is over.