Deafening silence on Zim’s bond market

By Tafara Mtutu | Mar. 31, 2023

VFEX

Three months after its listing on the VFEX, the Karo Mining bond is yet to register its first trade on the secondary market.

The debt raised by the bond issue was to fund the development of the Karo Project whose net asset value was pegged at US$770 million by parent company Tharisa.

The bond markets in both developing and developed economies are known for being notoriously illiquid because of the nature of key bondholders like pension funds and insurers who typically buy and hold until maturity.

A major reason behind this is to immunize — a process that encompasses matching cashflows in assets to cashflows in liabilities — their legal obligations which are often run into perpetuity on aggregate.

That said, we note that Zimbabwe’s bond market lacks some pre-requisites for a functional market which likely worsens the odds of additional bonds being listed, and we unpack these shortcomings below.

We identify four key pre-requisites that are necessary for any active bond markets, namely:

An efficient government bond market,

Credible and independent ratings agencies,

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Existence of market makers in bond markets, and

Sound management of government debt.

An efficient government bond market is typically the starting point of the bond market.

The government often requires long-term finance for projects like infrastructure development and interest on these bonds is often paid out of taxes.

It is widely accepted that debt instruments issued by government are regarded as being free of risk, but this assumption has been under scrutiny in recent years by some.

Corporate bonds, by virtue of being riskier than sovereign bonds, trade at yields above their counterparts’ risk-free rate, and the number less in comparison to government bonds.

In the absence of government bond yields, assessing the appropriate level for corporate bond yields becomes an exponentially complicated exercise.

However, in well-functioning markets, other benchmark rates such as swap rates, interbank rates, and overnight lending rates serve as appropriate guides. South Africa, for example, has a functional government bond market from which corporate bond yields can be benchmarked on.

In addition, South Africa has the JIBAR, repo, and prime rates, which are common reference rates in the country’s fixed income markets.

Zimbabwe, on the other hand, has no listed government bonds and comparable publicly stated reference rates.

Ratings agencies are also necessary because they provide risk measures for various entities, and this allows investors to understand the credit risk of various borrowers.

They simplify risk assessments of bond issuers such that institutions and government entities can access credit facilities without having to go through lengthy evaluations.

There are three main agencies that rate issuers’ bond issues, and these are Fitch Ratings, Moody’s, and S&P Global.

The ratings provided by these agencies also serve as a benchmark for financial market regulations and investment mandates.

Some laws now require certain public institutions to hold investment-grade bonds, which have a rating of BBB or higher.

This also holds true in some wealth managers’ investment mandates. These major ratings agencies do not cover any bond issues in Zimbabwe (including the Karo bond), and this makes the country relatively unattractive especially to foreign bond investors.

However, Moody’s affiliate, GCR, provides credit ratings in several countries, banks, and insurers on African continent, including Zimbabwe and its players in the financial services sector. We are yet to see a credit rating on the Karo bond by GCR.

Market makers also play a key role in providing liquidity to the debt market.

This role is typically fulfilled by merchant and investment banks, but the services of entities such as discount houses’ border on the lines of market-making for fixed income instruments.

However, this role has mostly been undertaken by private advisory players who trade T-bills and other fixed income instruments over the counter because discount houses in Zimbabwe have either closed or are under judicial management.

We also add that the management of existing government debt heavily influences bond markets.

Poor management of debt often deters foreign investor participation, and this type of investor is key to a well-functioning bond market in developing markets.

In South Africa, for example, foreign investors held 25.4% of government bonds in February 2023 and we attribute this to the solid debt management policy in place.

Zimbabwe, on the other hand, has over US$13 billion in external public debt with more than 50% in arrears.

As a result, the country has failed to instil confidence when it comes to debt management and remains cut off from multilateral institutions like IMF and World Bank.

The growing debt also hinders growth in the bond market indirectly through a “crowding out” effect.

We opine that pension funds and long-term insurers are the most affected because of the pivotal role of fixed income in these players’ operations. By extension, pensioners in Zimbabwe are also affected because of pension funds’ limited ability to preserve value through asset diversification.

Mtutu is a research analyst at Morgan & Co. — [email protected] or +263 774 795 854.