Private creditors role in easing financial crisis

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File pic of the RBZ head quarters in Harare.

“Happy families are all alike; every unhappy family is unhappy in its own way.” — Tolstoy.

An analysis of recent financial crises finds that private creditors’ behaviour, whether rational or irrational, can precipitate crisis and may lead to financial contagion.

For example, Summers (2000) examines the causes of financial crises in Mexico, South-East Asia, Russia and related economies and finds that the behaviour of private creditors may cause unexpected outcomes.

Fischer (1999) investigates the role of private sector in forestalling and resolving financial crises and discusses ex ante measures including contingent financing arrangements, from commercial banks, debt service insurance, official enhancements of new debt, embedding call options in interbank lines, modification of sovereign bond contracts and a concerted roll over and restructuring of interbank lines.

The term private sector creditors or private creditor was first adopted in the late 1990s in the context of the discussions on bond restructurings and capital account crises.

It describes, in general, the contributions and efforts of private sector creditors to manage the liquidity crunch. Specifically, it means that the private creditors share of the crunch by incurring monetary losses

The simultaneous occurrence of financial and liquidity crises has inspired academics and policymakers to focus on the role of central banks in easing the crunch. For example, Fischer (2001) and Pa’ramo (2009) find that central banks; as the only player with no liquidity constraints, can overcome liquidity crisis by injecting additional cash into the economy. Central banks, on the contrary, have no comparative advantage in credit risk management accruing to a low level of tolerance as regards credit risk and the reputational costs and perceived as being associated with a “credit event”.

Causes of liquidity crisis in Zimbabwe

Illicit capital outflows and poor capital inflows:

There is a huge growth in capital outflows in the country. Capital inflows remain subdued on account of growing investor uncertainty and political upheavals. Diaspora inflows are stunted due to adverse global economic developments.

Fiscal deficit:

The fiscal deficit remains a challenge mainly because of the undercapitalization of the industry. Capacity utilization has been at a mark below 50 per cent in the past 3 years, with the CZI releasing a 2017 weighted capacity utilization figure of 45.1

High import bill:

The economy could have been in a better financial position if the money used to import goods was channeled towards reviving of local industries. The country’s import bill in the first quarter of 2017 was at $3,3 billion. The economy has money but much of it is going towards imports.

For example, the country imports about $6 billion annually compared to $3 billion in exports5.

According to the Central Bank, the country imports $2 million worth of apples and $700 000 worth of mineral water among other consumables. The economy’s imports are highly skewed towards consumptive products, and not capital goods.

Loss of sovereignty:

Domestic bank deposits are denominated in foreign currency (United States dollars mainly) and both the banking sector and the Reserve Bank of Zimbabwe lack sufficient stocks of foreign currency to cover a surge in withdrawals.

Increased holding of the United States dollar:

People feel safe to have United States dollars stashed at home than in their bank accounts because they may not get it when they need to carry out internal transactions.

Perceived increased living standards:

The introduction of the multi-currency regime in 2009 lowered the inflation rate to record figures since independence. The stability in prices, liberal bank lending rules and rates created high demand for imported goods especially mobile phones and second-hand vehicles. The outcome was inevitable outflow of foreign currency and also domestic currency.

The role of private sector in managing liquidity crisis in Zimbabwe

Private sector involvement is crucial in effective liquidity crunch management in Zimbabwe. International funding agencies like IMF, World Bank and African Development Bank have traditionally participated in crisis managing in both emerging and developing economies.

Over the recent years, however, they have been known to be unable to do so because of limited resources and moral hazard. For these two reasons, private creditors need to share some of the financial burden.

Proficient crisis resolution in Zimbabwe requires a set of operational mechanisms through which private sector engagement can be fostered which include;

Bond exchanges:

In the recent financial crunches, bond exchanges have been a common technique to facilitate the involvement of the private creditors. Bond exchanges sum to the existing bonds for new ones with different conditions. In these bond contracts, participating bondholders agree to replace their existing bonds with different terms. Subject to the terms of the new bonds, the reprieve provided by this instrument varies from temporary cash-flow relief to a reduction in the face value of the unsettled amounts.

Bond exchanges do not unswervingly deal with collection action problems as they oblige consent of individual bondholders.

However, in some instances, legal techniques have been employed to bind in minority private creditors. The experiences with this instrument in other countries so far has revealed that private creditors and debtors have been able to re-negotiate sovereign bond contracts with high participation rates and limited litigation despite the lack of a negotiating framework.

Interbank roll-overs:

Interbank roll-overs are informal agreements in which foreign commercial banks commit to temporarily sustaining a given level of short-term exposure to a crunch-stricken economy. Experience with interbank roll-overs has been sundry.

The South Korean roll-over proved to be a success in providing a provisional breathing space before a complete restructuring was put in place.

The roll-over in Brazil was also deemed successful as the country’s close contracts with private creditor banks, its continuous disclosure of information and a solid adjustment program were judged useful in that respect. Contrastingly, the Turkish scenario tells an unsuccessful story. The rollover was substandard, with creditor banks reducing their risk exposure by at least 40 percent during the nursing period.

A key observation from these past experiences relates to the necessity for well-timed action so as to minimize and/or eliminate large seepages before a rollover is attempted in Zimbabwe.

Standstills:

Standstills are all cases of provisional suspensions of sovereign debt service payments, either with or without the consensus of creditors. In cases of liquidity crises (for example, payment problems), it may suffice to put in place counteractive policy measures and to resume payments after a short while.

It is critical to note that a standstill is not a detached instrument rather; it has to be seen as a bridge to achieving a more pragmatic solution through the use of other instruments for sovereign debt restructuring.

Empirical evidence on standstills and private creditors is scant, except, for claims of commercial banks. Standstills can facilitate the involvement of Zimbabwe’s private creditors. In recent bond exchanges, Russia, Argentina and Ecuador, standstills have been invoked.

Private contingent credit lines:

Private contingent credit lines refer to standing credit with private banks upon which countries are entitled to draw in case of a crisis. There are a few recorded instances of countries that have negotiated credit lines which include Argentina, Indonesia, Mexico and South Africa.

These private contingent credit lines provide a safeguard against adverse developments. However, the scant empirical evidence submits that these credit lines may have to be crafted differently to be a lucrative instrument. The narrow use of this instrument globally owes to (a) dynamic hedging and (ii) rigid fee and spread structures which discourage adjustments in line with a country’s credit rating.

Capital controls:

Capital controls have been applied in Russia (in June 1998), Malaysia (in September 1998) and Ukraine (in September 1998) in a bid to restrict capital movements. Theoretically, capital control regimes have the potential to provisionally ease foreign funding challenges.

They can also work well as companion tools to other instruments. Empirical evidence, however, finds that capital controls have not been instrumental in restricting capital outflows.

The actions of private sector players are a fundamental element in crisis management in Zimbabwe. Solving the liquidity crunch should be aimed at creating a balance between domestic adjustment, private funding and official lending. Excessive reliance on one component may not be feasible and sustainable.

Proficient crisis resolution in Zimbabwe requires a set of operational mechanisms through which private sector engagement can be fostered. There is also an urgent need to promote continued use of banks for transactions and deposits of daily collections.

In experiences from recent financial crises evidence shows that instruments such as bond contracts, interbank credit lines and clauses in bond contracts (collective action clauses) have been used in developed and emerging economies.

These instruments can be adopted and used in our case to ease the liquidity crisis. Policymakers are urged to increase production of export goods and limit increasing imports, where Zimbabwean firms are able to supply, and promote the Buy-Zimbabwe Campaign

In conclusion, “If we do nothing and hope that the free market fixes the problem sooner or later, we risk aggravating the situation”.

While the Reserve Bank of Zimbabwe focuses on using monetary policy and financial sector reforms as solutions-to the crisis, it must also prescribe policies that encourage the participation of private creditors.

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