Arbitrary closure of the ZSE spells doom for the yet-to-be-launched Victoria Falls Stock Exchange

Week 3: Continued closure of the ZSE is causing illiquidity as institutional investors are currently in limbo


By Colls Ndlovu

*NCX Index = 56%*
For the week ending 10 July 2020
This implies a loss of confidence of 44%

This is reflective continues to reflect the death of the currency black market. This has the effect of narrowing the spread between the weekly auction rate and the mark-to-market value of the Zim$ as obtaining on the day. The continued closure of the Zimbabwe Stock Exchange is also causing illiquidity as institutional investors are currently in limbo.

The latest inflation rates are not yet out. The release of the inflation rate by ZimStats will also have an impact on the direction of the NCX index given the fact inflation rate is one of the variables used in the computation of the NCX Index alongside the foreign exchange rate, inter alia.

Improvement on the confidence level relative to prior week where the NCX currency Index stood at 53% with a 47% loss of confidence.

The narrowing spread between the mark-to-market value of the Zim$ and the auction rate implies that the two are moving towards each other in the direction of unification of the exchange rates. This has a positive impact hence the improvement in the currency confidence index.

The increasing probability of the unification of the multiple exchange rates and the potential for lower inflation will then cause the currency to strengthen going forward.

The monetary authorities and the markets in general must all strive to improve the currency confidence index in the interest of stabilising the financial system.

Arbitrary closure of the Zimbabwe Stock Exchange

The continued unilateral and arbitrary extrajudicial closure of the Zimbabwe Stock Exchange is likely to doom the yet-to-be-launched Victoria Falls Stock Exchange. Authorities will be hard-pressed to convince foreign investors to put real money into such a risky destination.

With the stock exchange closed how do fund managers calculate their returns? How are they expected to calculate Alpha – that is – excess returns or the extent of underperformance?

Even the risk measures are compromised since the stock market gives an indication as to the level of volatility in the economy.

If volatility is unknown how then can such critically important measures of risk like beta be calculated?

Beta – as we know – is a measure of an asset or portfolio’s volatility relative to that of the market as a whole (market as a whole is shown by the stock exchange: which is closed).

Alpha being the excess return of a portfolio above the return of the stock exchange assuming the stock exchange is used as a benchmark.

So the closure of the stock market is having some severe adverse repercussions on a hell of a lot of other areas.
The NCX Currency Index for example provides the beta for the currency confidence index relative to the currency market as a whole. The market as a whole represents the combined wisdom of the market and has a beta of 1 – i.e. 100%.

In line with the greater fool theory – only greater fools will invest in the Vic Falls Stock Exchange given the events at the ZSE.

For the benefit of the children

For the benefit of our children who are studying quantitative finance and econometrics, just like the Black-Scholes Option Pricing model, the NCX Currency model is a multivariate model because it uses multiple variables to compute the beta of the currency confidence relative to that of the market as a whole.

So how do the Economic Agents use this RBZ Auction rate to peg their prices weekly.

The auction rate is used as the reference rate – like the exchange rate you see on TV news daily. On Tuesday the auction rate averaged about US$1 to Zim$65.

What this means is that transactions elsewhere can then use this rate as the exchange rate up until a new exchange rate is establishedthrough by the next Tuesday during auction.

But th question of whether the auction rate is the fair value or not is a different question altogether. Suffice to say that other platforms like the Zimbabwe Stock Exchange that usually offer an additional window from which the currency exchange rate can be gleaned are currently closed.

At the time of the closure the Old Mutual Implied Rate which tracks the real market valuation of the Zim dollar – stood at US$1 to Zim$122.

What the NCX Currency Confidence seeks to do

That is why the NCX Currency Confidence Index tracks the spread (extent of disparity) between the officially established rates and the mark-to-market value of the Zim$. The wider the spread the more confidence is lost. The obverse of this assertion is true. That is to say, the narrower the spread – i.e. as the spread compresses – the greater is the confidence in the currency.

For confidence to start assigning value to the currency – it has to be sustained and durable in fact and in appearance.
So for the Zim$ it still has a mountain to climb in the sense that it must first close the spread between the official exchange rate (auction rate) and the free market rates (black market rates, OMIR, etc etc).

Once that gap is closed or reduced to negligible levels, then the question which arises will relate to the sustainability of that closure. If sustainable and durable – then the currency will begin to slowly but surely appreciate in value against the US$.

On the other side of the equation is the question of inflation.

As we know the Zim inflation is purely caused by excessive money supply in line with the Milton Friedman dictum that inflation is always and everywhere a monetary phenomenon caused by excessive money supply.

This immediately brings us to the monetarist equation of the quantity theory of money.

So what happens on the exchange rate side must be looked at relative to what is happening on the inflation rate side. Because an aggregation and weighted average of these two variables are what gives us the direction of the NCX confidence index.

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