Return of the Zimdollar, now a Black Swan event

The Zim government's dogged determination to keep the multicurrency system is an even that has to be celebrated by the populace in general and the financial markets in particular. The fact that the Zim dollar will not return in our life time is now a near-certain event, albeit a black swan one. The black swan, of course, being a highly improbable event whose occurrence has a highly a devastating impact.

Arising from the aforesaid, two things are becoming clear. Notwithstanding the recent introduction of the so-called Zim bond coins to relieve consumers of the burden of lack of small change, by and large, the Zim government has kept its promise of not re-introducing the Zim dollar. The prospects for its future re-introduction have waned and waxed over the years. Against the backdrop of some erratic irresponsible statements to the contrary by opponents of the now-copper-bottomed multicurrency system, Finance Minister Chinamasa (who is credited with introducing the multicurrency system) has stuck to his guns backed by the central bank which has branded the multicurrency system as being a necessary variable for the economic revival of Zimbabwe. Indeed the multicurrency is a sine qua non to the country's well-being.

On the back of the foregoing, it is the responsibility of financial markets participants to recognize the fact that the government has played its part by stabilizing the financial system through stable currencies, elimination of foreign exchange risk, consumers are free to switch between currencies, the lowest inflation rate in the world, among other factors. Market participants need to be innovative and realize that because the Zimbabwean government is generally regarded by the financial world to be in default on its international obligations, it will take ages for that kind of uncertainty to disappear. Whether the government is in financial sanctions or not is neither here nor there. The fact of the matter is that Zimbabwe has defaulted on its international obligations, consequently because of this very technicality, it cannot ordinarily secure funding in the normal course of business. Those who doubt this assertion need to talk to anyone who has ever sat on a credit committee of any company or agency tasked with extending debt to Zimbabwe. The ubiquitous financial models instantaneously throw out Zimbabwe due to its history of recent default on its loans. More than a leap in imagination is necessary to convince such committees otherwise.

What this means is that the local market participants need to be innovative and come up with ways and means to ameliorate their difficulty. They need to fill the gap as it were. The world of credit derivatives immediately springs to mind. In particular the so-called credit default swap (CDS) should come in handy for the Zim financial system. This is a way of transferring the risk of default to those who are ready and prepared to bear it. It is a form of insurance against a debtor failing to pay his debt timely. The CDS provides for the seller of such CDS to pay the holder (investor) the amount equal to the value of the defaulted position. This could be protection for investors in loans or bonds within the Zim financial system. The seller of the CDS receives a fee or premium while the buyer receives protection against default by the borrower of an insured loan.

Selling protection on a company's bonds is similar to owning that entity's bonds. Buying protection against a certain company's default is analogous to holding a short position in that company's bond issuance, i.e. the possibility of selling a bond the investor does not own given a certain event and market movements. If the anticipated default does not occur, the seller profits from the premiums received. The CDS market serves as a good indicator of the level of risk associated with a particular market. If such a market were to be active in Zimbabwe, investors would be able to independently assess the perceptions of default risk associated with investing in the country. Investors would be able to express views independent of politically motivated rhetoric about the country and its institutions.

Originating from the 1990s, the CDS market is now a fully fledged global market available to any investor from emerging markets to advanced economies with its size currently topping US$25 trillion in size. By virtue of being credit derivatives, the CDSs have had their fair share of problems alongside other derivatives. During the recent financial crisis, CDS tended to compound the crisis through systemic risk in the sense that the failure of one major seller of CDS protection, .e.g. AIG, could ricochet and crystalize into further losses on firms on whose bonds it would have sold protection. The other concern on CDS is that there are circumstances where conflict of interest arises. Since buying a CDS protection is akin to buying an insurance on a house you do not own, the possibility of such a house burning down through arson by the insured, thus enabling the insured to cash in on his CDS protection can not be ruled out.

Notwithstanding the risks highlighted above, the CDS is a form of risk mitigation tool that Zimbabwean market participants need to consider as a measure to ameliorate the misperceptions of the risk of default that constantly dogs any investor into the country. Such investors could buy protection against default using CDSs.


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Colls Ndlovu is an independent financial analyst and he writes in his personal capacity. He can be contacted on collsndlovu@gmail.com