Deflation hits banks

Published: 25 April 2014

Local Banks will increasingly reel from persistent deflation as analysts fear growing depressed demand for loans and massive defaults on borrowing by companies and individuals struggling under a liquidity crunch-gripped economy.

Latest Zimbabwe National Statics Agency (Zimstat) figures, show the country's year-on-year inflation rate shed 0.42 percentage points on March 2013 rate to close the month of March 2014 at -0.91%, meaning prices decreased by an average of 0.91% points between March 2013 and March 2014, as the economy suffers from a liquidity crunch that has pushed prices downwards.

Deflation refers to decrease in the general level of goods and services when the rate of inflation falls below 0% and is different from disinflation.

In contrast, disinflation is the decrease in the rate of inflation - a slowdown in the rate of increase of the general price level of goods and services over time.

Banker and financial advisor Clive Mphambela said deflation could impair the ability of borrowers to repay loans, increase vulnerabilities and sharply reduce bank earnings.

He said, the economy may see the collapse of some of the companies that have been producing at the margin, because the decreasing prices will push them to a scenario of making losses, which will significantly impact on the banks' balance sheets through loan exposure.

In the just ended reporting season for 2013, banks have generally bemoaned the level of non-performing loans, which according to the Reserve Bank of Zimbabwe average 16%.

Mphambela said the situation in the country will further be exacerbated by the government's reduced fiscal space.

"Under this scenario the government was supposed to inject some money into the system through what is now termed 'quantitative easing' to boost economic activity," he said.

"The government might be forced to abandon cash budgeting, and start borrowing from the banking sector through the issuance of treasury bills so as to meet its obligations as revenue inflows declines. In the medium-term we are going to see the government envelope shrinking as the tax base falls," added Mpambela.

Economist Brains Muchemwa, said apart from discouraging investment and robust consumption, the persisting deflationary pressures have seen asset prices generally coming down.

He said this had a capital-eroding impact on banks foreclosures, especially for loans issued before 2013 when asset prices were at their peak.

"Resultantly banks are not only hypothetically losing income when marking to market their real estate portfolios, but are actually crystallising capital erosion as foreclosure asset prices fall far short of the amounts required to cover for the bad debts," said Muchemwa.

"This continues to worsen the liquidity crunch in the market."

Econometer Global Capital (Econometer) head of research Takunda Mugaga said by nature, deflation should benefit lenders as the purchasing power will strengthen, implying an incentive to lend in principle. However, Mugaga said deflation impacts negatively on the turnover of firms through depressed market prices for goods and services.

"This in turn diminishes firms abilities to meet obligations as they fall due leading to growing non-performing loans," he said.

"The appetite for capital investment will be low since most companies will prefer to trade in finished goods considering the margins will be much higher than for locally produced goods."

Industry is suffering from lack of capital which has seen a number of companies retrenching or shutting down, thereby reducing spending power.

The month on month inflation rate in March 2014 was -0.22%, shedding 0.27 percentage points on the February 2014 rate of 0.05%.

Going forward, inflation is expected to remain subdued due to depressed aggregate demand, stable international oil and food prices, as well as strengthening of the US dollar against currencies of our major trading partners.

- theindependent