FOREIGN banks are demanding fully funded letters of credit (LoCs) from domestic banks meant to facilitate vital imports by customers due to a worsening foreign currency crisis in the country that threatens to wreck recovery and further ruin the frail economy.
LoCs, which are indispensable for international transactions since they guarantee payment, allow suppliers to considerably lessen the risk of non-payment for delivered goods by transferring the risk of the buyer to the bank, according to experts.
Under normal circumstances, LoCs do not require upfront funding by importers’ banks, but the situation in Zimbabwe is said to have dented the creditworthiness of local banks, resulting in rejection of unconfirmed LoCs by foreign lenders.
Unconfirmed LoCs are issued without remission of cash to the offshore bank of suppliers on the basis of trust that the originating bank would honour its commitment in the event that the buyer to whom the LoC is issued defaults on international payment commitments.
Banking sector and industry sources said the situation was now so grave that it threatened to undermine productivity in the economy, at a time government was spearheading increased output after banning the import of at least 100 products to promote the revival of local industries.
A banker said the worst affected sectors were manufacturing and mining, which are essentially the bedrock of the country’s economy and currently the critical pillars of foreign currency mobilisation.
“Foreign banks are no longer willing to take the risk of local banks,” the banker said, indicating that the problem started when the central bank started rationing offshore cash holdings by local banks, resulting in their creditworthiness becoming questionable.
He said foreign financial institutions were now only accepting “confirmed letters of credit” from Zimbabwe banks.
He said a confirmed LoC entailed the originating bank putting cash into the suppliers’ bank to guarantee that the LoC would be honoured.
“The situation has undermined international trade,” said the banker, noting that many manufacturers were failing to ramp up production because of the situation.
The Confederation of Zimbabwe Industries, the country’s main industrial body, said local banks were facing increasing difficulties in issuing guarantees.
“It is a problem that we have always had because of the country risk that we have. Not all bank guarantees from local banks have been accepted because of the internal banking challenges that we have had,” CZI president, Sifelani Jabangwe, told the Financial Gazette.
“These are the closure of banks and the inadequate currency issues that we are currently having. Foreign markets have been accepting guarantees from the big four banks because they have confidence in them.”
Bankers said the creditworthiness of local financial institutions plunged after the Reserve Bank of Zimbabwe (RBZ) directed in 2014 that all banks reduce their nostro account balances from 30 percent of total bank deposits to a paltry five percent.
A nostro account is a bank account held by a local bank with a foreign bank, usually in the currency of that country. Nostro accounts are used to facilitate foreign exchange and cross border trade transactions.
RBZ governor, John Mangudya, said then that keeping large balances in nostro accounts was tantamount to providing liquidity to offshore jurisdictions where banks held their nostro accounts.
Mangudya’s move was also meant to ameliorate a liquidity crunch in the economy, which had been tightening due to a widening trade deficit.
However, the situation worsened, prompting government to resort to a number of measures, including an import ban on selected products to preserve foreign currency and a foreign currency allocation system that prioritised productive sectors.
That system, however, has failed to function efficiently, with priority sectors alleging that they were still not getting foreign currency to import critical raw materials.
A payments gridlock therefore ensued, with miners, foreign airlines and manufacturers failing to pay foreign suppliers due to critical foreign currency shortages.
Last year, Mangudya reviewed the nostro limits upwards, from five percent to 10 percent of a bank’s total deposits. But bankers said this was still too little to mitigate the crisis.
“The high trade deficit gap will continue to counter the potential impact of reviewing the nostro limit,” said a research note by Stanbic Bank.
A dealer with a local bank said banks were currently “significantly constrained to raise confirmed letters of credit.”
“Foreign currency problems are affecting the ability of local banks to issue letters of credit. Foreign suppliers are not happy with supplying goods before payment on the basis of unconfirmed letters of credit. But we don’t have the cash to pay upfront,” he said.
The Confederation of Zimbabwe Small Scale Chrome Miners (CZSSCM) said it had been gravely affected by the rejection of unconfirmed LoCs issued by local banks.
The association said chrome buying houses, who act as intermediaries between producers and buyers, had failed to access funding based on LoCs originating from domestic banks.
“Since Zimbabwean letters of credit issued by the banks are not recognised outside of Zimbabwe, therefore buyers have to develop their own financing arrangements outside of the country via short term financing vehicles,” said CZSSCM, in a letter to Mines and Mining Development Minister, Walter Chidhakwa (pictured), dated May 8, 2017.
The alternative sources were “more expensive and have high interest rates and require the shipment of chrome to be heavily insured, adding to the cost of doing business with Zimbabwe”, said CZSSCM.
Mining industry players said some resources firms were taking advantage of off-take agreements with deep-pocketed buyers to circumvent the LoCs crisis.
Others were getting support from offshore parent firms to ensure speedy supply of raw materials without LoCs.
Nonetheless, the mining industry, which accounts for over 50 percent of export earnings, has had meetings with the RBZ to agree on a deal that would allow them to make payments, which have been in the queue since last year, to foreign suppliers.