Arbitrage – the terminal wound bleeding the Zimbabwean economy
By Admire Maparadza Dube
Zimbabwe’s economy has been teetering on the brink for a good two decades. Some would aver perhaps for more like three decades. The reasons for this, for such an erstwhile promising country at independence from colonial rule in 1980, are as varied as the number of people from whom one solicits an opinion on the matter.
Some say Zimbabwe’s downward trajectory was engendered by the government instituting the Economic Structural Adjustment Program (ESAP) under directions of the International Monetary Fund (IMF) in 1990. On the same ESAP others say that it was well intentioned. Only its effectiveness was hampered by recurring droughts, they say.
We have mentions of the haphazard land acquisitions of the late 90s destroying the base for the very agro-based economy and that coupled with inefficient (if not downright corrupt) reallocation of that land to new farmers who mostly did not have the means and/or the technical knowhow to make meaningful contribution, spelt doom for Zimbabwe’s economy.
Others state the government’s missteps came in 1998, when it chose to weigh in on the conflict in the neighbouring Democratic Republic of the Congo (DRC). Not only did the cost of this intervention drain what little remained of Zimbabwe’s bank reserves, it also alienated the country from the international community – in 1999, both the World Bank and the IMF suspended their aid provision due to an unwillingness to fund Zimbabwe’s military spending in the DRC.
Yet a lot more are convinced Zimbabwe’s economy has been strangulated and choked by western powers imposing economic sanctions on the nation. The reasons for these sanctions, and their nature, are a major topic on their own right and will not be dealt with here as they deserve thorough examination in their own right.
What is, however, being dealt with here are the efficacies of economic interventions being made by the authorities to arrest and, perchance, improve the country’s growth prospects. More so, how these mitigations have themselves turned into economic scourges that are bleeding the economy instead of aiding it, in form of arbitrage wounds.
This arbitrage is it oversight, incompetence or deliberate opportunity cracks intentionally ignored to allow pilferage which benefits a select few? This is the main import of this article. The political and social assuagements being employed to improve the economy (along with their effectiveness) will not be interrogated here as this discussion is from an economics and finance angle, in the main.
Arbitrage, in the purest sense, describes the act of buying financial instruments (assets that can be traded on an open market like contractual right to deliver or receive cash or evidence of one’s ownership of an entity that represent partial ownership of a company, shares, stocks and the like) in one market and simultaneously selling them in another market at a higher price, thereby enabling investors to profit from the temporary difference in cost per unit.
This would happen without any inherent change in the stock itself but mostly by taking advantage of a loophole. Loopholes like trading hours (before computerisation) where a trader bought stocks in the Asian market and offloaded them later at American trading times when Asia has closed for the night and before it adjusts prices to what is happening in America where it will still be daylight.
In general economic terms, arbitrage has come to mean the practice of taking advantage of a price difference of the same item or financial instrument due to gaps like policy, practice, distance, time and others, without necessarily beneficiation, improvement or normal profit mark up.
Arbitrage therefore becomes a transaction that involves no negative cash flow at any probabilistic or temporal state and a positive cash flow in at least one state. In simple terms, it is the possibility of a risk-free profit after transaction costs. For example, an arbitrage opportunity is present when there is the possibility to “instantaneously” buy something for a low price and sell it for a higher price.
Zimbabwe has many such arbitrage examples and these have been allowed to exist to the detriment of the economy and they are a terminal wound bleeding the economy and thus working against other commendable economic interventions.
The first example that jumps to mind and which inspired this article in the first place, is on gold. This is easily the first as it is a very topical issue currently following the recent arrest of Zimbabwe Miners Federation president Henrietta Rushwaya on the 26th of October 2020 at R. Mugabe Airport for allegedly trying to smuggle over 6kg of gold on a flight to Dubai.
Zimbabwe government’s sole gold buyer is Fidelity Printers and refineries (FPR). Dealings in gold in the country are governed by Gold Trade Act chapter 21:03. A few entities and individuals are authorised under section 14 (1) of the said Act to deal in gold under licence.
These are the official miners, licensed gold buyers and jewellers and gold recovery works licence holders. Licensed gold assayers are only allowed to handle gold which is “not in the form of alluvial, amalgam, retorted, smelted or refined” form.
This means trade in this mineral is heavily regulated. Those under licence can only sell to other licence holders who in turn sell to FPR. In fact, licence holders are compelled by the Act to sell all their gold by the 10th of the month next following the date of securing or procuring that gold under Sec 6(1), necessarily meaning gold ultimately flows to FPR with the government through relevant departments retaining the right to export.
Where the arbitrage arises is in gold pricing model by FPR and the differing United States Dollar (USD) retention regimes after a licence holder gets paid. It is imperative at this juncture to point out that this has always been the case for a long time where various prices and schemes are given to different gold suppliers.
This is very tempting for people to exploit and make money. And very damaging to the fiscus each time they do.
Large Scale Miners (LSM) from May 2020 receive 70 percent of their sales proceeds in foreign currency, up from 55 percent, with the balance to be paid in local currency at the prevailing exchange rate, which the Reserve Bank of Zimbabwe (RBZ) announces every Tuesday after auctions. Yet small scale miners were for a while paid in full in foreign currency.
Now, if one considers that for the past 3 years, from 2017 to 2019, Artisanal and Small-Scale Gold Miners (ASGM) delivered more gold to FPR than LSM and that ASGM sector accounted for 63 percent (17 478,74kg) of total gold deliveries (27 650,26kg) to FPR in 2019, it does not take much analysis to deduct that many LSM were delivering their gold under ASGM licences to take advantage of this price distortion. The benefit for the LSM being they got paid 30% more foreign currency if they used ASGM licences than using their own.
The loser in this is the state (and therefore the people of Zimbabwe) as FPR potentially depleted more national foreign currency reserves than it should have as it pays for this legislated distortion.
Gold delivery figures to FPR have however plummeted. Granted, production has also gone down but not by the same percentage as deliveries. This likely means gold is now finding its way outside Zimbabwe through unofficially mandated channels.
It is no coincidence that this reduction in deliveries happens after 3 years of exponential growth in gold production in the past three years of over 500% and also coincides with yet another introduction of price distortion. ASGM are still being paid 100% in foreign currency but now at a flat of fee of US$45 per gram of fine gold.
Gold prices on the international market are hovering around record highs at above US$60 per gram. The difference is so large the temptation to take the gold outside far outweighs the crime risk of doing so with a price disparity of a minimum US$15 per every gram between selling locally or illegally exporting.
To put the variance into perspective, gold seized from Henrietta Rushwaya of a reported 6kg would have fetched US$270,000.00 at FPR under ASGM licence.
Under the LSM licence and with purity above 90% it would have fetched US$232512 in hard cash under 70% retention scheme and the balance of 30% would have been transferred to a bank account in local dollar currency (ZWL 8106354.83 at this week’s RBZ rate of ZWL81.3499 to US$1). This is a far cry from the +US$360,000.00 all in cash she would have got outside Zimbabwe wherever that destination would have been, had she not been arrested.
This was potentially foreign currency lost from the country’s coffers but who is to say how much more has gone out collectively this way or another and in varying quantities? We can blame the miners and gold dealers all we want but why are the distortions (spelt loopholes) for arbitrage not being plugged? For whose benefit, when the country’s economy is bleeding unnecessarily?
More baffling was the decision by the RBZ to maintain the ZWL rate at par with the USD in November 2016 when they introduced the bond notes instead of freely floating the rate as normal economics practice dictates. This created a massive arbitrage gap where only a few individuals and entities who could access the “cheap” USD from the RBZ made a killing, while exporters were getting chocked as they were compelled to sell their exporting proceeds at a ridiculous 1:1.
Initially, importers with access to this cheap forex made massive profits selling their products at extortionate black market rate quoted prices of as high as 1.100. They later realised that they could make an even a bigger margin by accessing that forex form RBZ and not need to import anything. Instead, they would go straight o the black market where they could off load it at a 100 times instant profit! Goes without saying shortages of critical goods became the order of the day.
The exchange rate was later pegged at 1US$ to 25ZWL which only narrowed the arbitrage gape by 25% right up to June 2020 when the floating rate was adopted with the Foreign Exchange Auction system being put in place.
The conundrum of distortions spills to many other sectors of the Zimbabwean economy. In maize meal, at one time the wide gap between the market price and the subsidised price has created undesirable arbitrage opportunities for unscrupulous players, resulting in the market and supply distortions. Importing costs were higher per tonne than the price the government sold onwards to the millers for, per tonne.
At one point millers were rumoured purchasing from the government then doctoring import documents to sell back to government via the Grain Marketing Board (GMB) as profits for doing so were higher than actually milling and packaging the maize meal, resulting in shortages.
The arbitrage in other sectors like fuel and oils is well documented in various other articles it almost defies logic to try and add a voice on to this already ubiquitous chorus.
It is not difficult to see that the authorities have an intention to infuse soft socialism into hard capitalist economics by introducing what they view as subsidies and interventions. All these are intended to cushion the less fortunate among us. It is however very regrettable and one might add unfair for the authorities that some entities then abuse these for selfish designs.
Be that as it may, it will not augur well for anyone to realise that the terminal wound bleeding the Zimbabwean economy by way of all these arbitrages is almost always allowed to exist for months on end. And the individuals most benefiting seem to be influential and wealthy figures and not the poor folks for whom the subsidy is intended in the first place.
There exists a very thin line between wrong policies and corruption if the very policy makers or entities within smelling distance of the promulgating offices, then go on to materially benefit from said policies’ loopholes.
Authorities take extortionately long to react, like they did with mobile money and stock exchanges. Letting them run parallel banks and increase broad money supply for close to a decade.
Old Mutual because of dual listing, the Old Mutual Implied Rate calculations (as it has counters internationally besides Zimbabwe) became the unpronounced business rate for foreign exchanges. It only became less significant a few months ago when Old Mutual was taken off the Zimbabwe Stock Exchange bourse and now being relocated to the USD denominated Victoria Falls Stock Exchange. This was aided by the recently introduced RBZ Foreign Exchange Auction System. Years of bleeding had passed.
Zimbabwe is beset by a myriad of challenges. Many of them political. Some challenges are economic and even geographical, like unmitigated like storms or erratic rains. That is not to say we should allow nefarious activities to reign where well intentioned policies to cushion the poor are taken advantage of.
There should exist an environment where significant consequences are meted to perpetrators. Where loopholes are found, authorities should be found expeditiously plugging them.
Growing the wealth of a nation, and indeed any entity or individual, is as much about increasing inflows as it is about reducing unnecessary outflows. And Zimbabwe has for the past few years been mortally leaking through the wounds of arbitrage.
Admire Maparadza Dube is a Financial Analyst, Banker, MSc, CFA, PhD Student. He can be reached on email ([email protected])