CURRENCY SWAP OR SOVEREIGN DEBT?

Sunduzwayo Madise

22 February 2015

The other day (Nation, 12 February 2015) the Minister of Finance was quoted to have said that one of the reasons for the Kwacha’s appreciation in value was a currency swap deal that Treasury had done with the PTA Bank. Now any attempt to stabilise our currency must always be commended but maybe the question to be asked is at what cost to us, and to the future generations. The Minister was quoted that the deal was worth $250 million (about K18 Billion) but that this does not mean Malaŵi had borrowed (heavily) from the PTA Bank but rather the deal was simply a currency swap and that ‘nobody will lose out’. According to the article, the PTA Bank paid to the Reserve Bank of Malaŵi (RBM) in US Dollars, and the central bank was acting as the agent of Treasury. The Minister is quoted further to have said:

instead of us owing the RBM, we owe PTA Bank. They paid that borrowing from RBM in Dollars. This is called currency swap because nobody is losing out. RBM bought Dollars so you could also say PTA bought Malaŵi assets from RBM, so it is a swap and there is no borrowing.  

This immediately raised some eyebrows amongst financial experts who most agreed that this was not a currency swap but rather an issue of sovereign debt. In order to delve further and analyse what has happened; it is imperative that we look at these two financial terms and what they mean.

Currency Swap

A currency swap involves the exchange of principal and interest in one currency for the same in another currency. It is therefore essentially a foreign exchange agreement of a loan in one currency for equivalent aspects of an equal loan in another currency; although it need not be restricted to a loan. In corporate finance, it is treated for all purposes as a foreign exchange transaction. Let us give an example of a typical currency swap. Suppose for example a Malaŵian company requires South African Rands and a South-African company needs Kwachas. These two companies will then agree a currency swap deal to allow them to access the currency they require. They will agree upon the interest rate as well as a common maturity date.  Currency swaps can also be done by states and between states and other corporations, usually but not always, of international nature.

Currency swaps are all about obtaining financing at mutually beneficial terms.

1.  They allows parties to secure cheaper financing (usually debt).
2. They are also an insurance of sorts, a type of risk-mitigator. It is a way to hedge against exchange rate fluctuations, especially for countries whose currencies are susceptible to volatile swings in the exchange rate (mostly of a depreciative nature). 
3. It provides a buffer against financial instability and turmoil which could arise by a crisis in the liquidity since the borrower borrows with its own currency. Consider a situation where the borrower borrows in foreign currency and then the local currency significantly loses value, the borrower would face a liquidity crisis as it would need to acquire more of its local currency to pay back an equivalent in the foreign currency.

 So let us apply this to our current situation in which the Minister is quoted to have said that we have entered into a currency swap with the PTA Bank. This would mean that the PTA Bank needed Kwachas and we needed Dollars under a loan deal arrangement (mutual borrowing). We then went into a deal to pay in Kwachas for Dollars in a reciprocal loan arrangement with an agreed interest rate for a set period. Is this what happened here?

Sovereign Debt

Sovereign debt refers to bonds (IOUs) issued by governments in a foreign currency. It is important to distinguish this with the bonds issued by the government domestically in its local currency, such as Treasury Bills or the recent issued Zero-Coupon Bond. Sovereign debt is targeted to international investors, including governments. It is common for governments to buy each other’s debt. For example China is the biggest buyer  of US debt. But because the US Dollar is freely convertible, the US does not have to issue its sovereign debt in a foreign currency other than the US Dollar. In contrast, if a country like Malaŵi decided to issue sovereign debt in Kwachas, the chances are it would not be bought because internationally the Kwacha is not considered a freely convertible currency. It is also considered a premier currency. Several factors influence this such as economic strength of the country of issue, stability of the currency play and foreign exchange restrictions. Most currencies of third world countries cannot be traded on the international bond market.

Sovereign debt is guarantee by the state. Therefore if the country is financial stable, and has good development indices, its debt will be deemed a safe investment. Internationally these debts are rated and those considered risk-free are given the highest ranking of AAA (Standard & Poor and Fitch ratings). Debt from developing countries is usually perceived as riskier and to hedge against risks associated with it, may be sold only if the returns (dividends) are much higher. The term junk bonds is sometimes used to bonds considered of non-investment grade. On the flip side, junk bonds are high-yield bonds, and characterise most bonds from third world countries. There are investors who actually specialise in buying junk bonds because of their high return. If one thinks about it, it is really easy to understand why. Suppose you go to a bank to get a loan, if at the end of the bank’s assessment you are a risky borrower, the only other way you may get the credit (other than being denied) is to get in on very high interest. The high interest reflects the risky nature of the transaction. The bank is hedging its risk by charging higher interest. The case of the katapila lender quickly comes to mind! Katapila is a risky business. Chances of default are high. To mitigate against this, the interest rates are high (mwala ku mwala – 100% per month is not uncommon).

Analysis of the Minister’s words

Let us be clear on one aspect, both currency swaps and sovereign bonds involving loans. Therefore to say there is no borrowing involving a currency swap is simply not true. A currency swap in corporate finance is not just an exchange of currencies. The fundamental difference is that a currency swap is mutually beneficial and in this way, the Minister is correct that nobody loses. Everyone pays (back) in their own local currency and that is where everyone benefits (if you discount the cost of borrowing itself). But is what happened here a currency swap?

According to the quote attributed to the Minister, the deal can be broken down into:

1. And agreement by Treasury with the PTA Bank to make available finance in foreign exchange amounting to $250million (he says this is not borrowing) 
2. PTA Bank will pay the funds via the Reserve Bank (acting as agent of Treasury) 
3. This will mean that instead of Treasury owning the central bank, it will owe the PTA Bank
4.  RBM has ‘bought’ the Dollars and PTA has bought Malawi’s assets (and according to the Minister there is no borrowing).

 Now looking at the above steps, it becomes quickly self-evident that there is confusion of corporate finance principles being brought in here. The agreement to have PTA Bank make available to us through then central Bank $250 million is clearly a loan, one involving sovereign debt. We are selling our national debt to the PTA Bank. Put in another way, we have agreed on a loan with the PTA Bank through which we will borrow $250 million to be repaid to them at an agreed interest over an agreed time. But we will have to pay back $250 million in foreign exchange plus interest.

The second and rather contradictory aspect is that Malaŵi and the PTA Bank have agreed to sell each other something. PTA Bank has agreed to buy some unnamed Malaŵi assets for the price of $250 million.  RBM is said to have bought the Dollars and PTA to have bought our assets. The first question is with what has the RBM bought the Dollars? With Kwachas? Or with some other unnamed assed? And the follow up question is if this ‘asset’ is not sovereign debt, then what asset have we sold to the PTA Bank? If it is sovereign debt then there is no currency swap and the issue is settled. But even if it was not sovereign debt, would it still qualify as currency swap? To answer this we must ask ourselves the question: have we had exchanged loans with the PTA Bank and agreed that we would pay them in Kwachas whilst they pay us in Dollars? Is this what has happened here? From what we have been told, the answer would have to be in the negative.

Concluding remarks and further thoughts

This is not a currency swap. We have sold sovereign debt to the PTA Bank and there is need to disclose the full deal in terms of maturity and the interest (yield) that is payable and when this is payable. And whilst we are at it, we may start considering how many Kwachas we will need at the date of maturity to repay the $250 million because when it matures, there will be a legal obligation to pay. It is only after making this analysis that we can make draw conclusions whether this deal is good for us as a country. The agreement is not just a financial one, it is a legal one too. Legal rights and enforceable legal obligations arise from it.

And this also applies to all other international loans. I have heard successive finance ministers boasting about how the country was getting a good deal because the loan they had negotiated was of zero percent (0%) interest. I have always wondered whether they are ignorant of what they are saying or they do not understanding how the world of finance actually works. Let me explain this by using a simplified example. Suppose we borrow $1 million in 2015 at 0% interest; and the loan is to be repaid after 20 years. The good thing is that when the loan matures in 2035, we would only be required to pay back $1 million (the terms of repayment would depend on the terms of the loan agreement). But suppose in 2015 the Kwacha is at $1 = K450 and suppose in 2035 the Kwacha has depreciated substantially and is at $1 = K4,500 (God forbid). This means that in 2015 we received K450 million as a loan but come 2035; we would have to pay back K4.5 Billion. Now anyone who says that by obtaining a loan in foreign currency at 0% or at a low interest rate is a deal needs to recalculate the actual cost of borrowing by factoring in the depreciation of the Kwacha over time (economic and statistical models are available to do this and make projections) . I have noted that apart from Treasury, several Malaŵian corporations have also borrowed from international financiers, especially on the London loan market (in Pound Sterling). I do hope they have done a proper due diligence of the actual cost of the loan. It maybe sometimes be cheaper to borrow locally and pay back in good old Chilembwes!

Coming back to the issue of currency swaps, and considering that the Minister of Finance is an expert in finance, I can only conclude that he has been misquoted. 

LISTENING TO DANIEL KACHAMBA

Sunduzwayo Madise: 20 February 2015

I must confess that despite the proliferation of good music, 90% of the music that I listen to is Malaŵi music (all of it) plus gospel (Grace Chinga, Lloyd Phiri, Thocco Katimba, Marching Soldiers etc). The remaining 10% is usually roots reggae and Malawian reggae (Anthony Makondetsa, Limbani Banda, Evison Matafale, Black Missionaries, Soul Raiders etc.) And somehow, the older it is, the merrier. I guess it just shows that I am not getting any younger too! Now Lucius Banda is a constant presence with the occasional mix up with other artists. But if it is Malaŵian music, I will listen to it, especially if sang in the local languages (even if I may not understand it; like some of Joseph Nangalembe’s, Allan Namoko and Namakwa Brothers Band’s classics). So the other day as I was driving I was listening to Daniel Kachamba. Listening to this great son of Malaŵi brought memories, fond memories. Kachamba made me remember kale langa. And talking of Kale, my collection of Edgar ndi Davis is missing Energy Saver!

But before I travel down memory lane, let me say a thing or two about Daniel Kachamba. I had not listened to his music, I must admit, for almost 3 decades such that this was a rewarding experience. In fact it was revitalising in a way. I quickly decided that the folks that had decided to honour him with the honorary title of Doctor of Music had it spot on. Now let me digress and tell you the story that we heard around this title. Daniel Kachamba had at some time gone to perform in Europe. He was, like most Malaŵian acoustic artists of the time, a one-man band. We were told the hall (cannot recall exactly where it was) was packed and when he was presented to the audience, a few thought they had been given a raw deal. Why? Because they expected a band which would make them dance the night away. Only if they had known! The tall, slender man from Malaŵi sat on the cow-skin strung drum (probably made of some dissected drum), took a flute which had a special wire that used his ears as support and placed it around his neck, took a home-made rattle in his right hand, and then bent down and picked his acoustic guitar and strung the strap his neck and settled himself facing the audience. The next thing that happened was an explosion of music that left the patrons dumbfounded. This one man was producing music from his guitar, his mouth, the flute, the drum (using his leg) and the rattle (by shaking the very hand he was using to play the guitar). The sum of it was the sweet magical music that Malaŵians had all along listen to and enjoyed on MBC Radio. And to add to it all, Kachamba would play his guitar with the hand in circular motion; going clockwise then anti-clockwise and then alternating, but not losing the rhythm! And to add to it all; he had a unique way of actually turning his back to the audience, hoisting the guitar above his head on to his rear neck; and playing the guitar ‘blindly’. And yes, there was dancing and all. In the end, the little man from Nyasaland was dubbed Doctor of Music. That is the story we were told when growing up. This same richness in music is what made me go back memory lane and prompted the writing of this piece.

Now I should know exactly what the European folks were confronted with. I had grown up knowing Daniel Kachamba as a musician. When we were staying in Kabula, my father used to run a bottle store styled Malonda gha Mariba Madise. This is Zulu/Nguni/Ngoni for [selling] business of Mariba Madise. Mariba was the middle name of my elder brother. At that time when I first saw the sign, I did not know it. I knew him as Hlekwayo. However I do not think that my father meant that the business belonged to Hlekwayo! If he did, he never showed it. I do not even recall my brother, who probably knew the significance, boasting of owning the shop! Good man he was.

Now ordinarily a business should be one where the ultimate aim is to make a profit. I do not think this was the type of business my father had in mind. In fact I doubt if he ever made a profit at all! For all I know he pumped more into the business than what he got out. I was later to understand what it was all about. It was a way for him to socialise with his friends. A brief history of my father will help put this into context. My father was arrested in 1959 in Mzimba as a young man deemed ringleader and troublemaker during the 1959 3^rd March State of Emergency in Nyasaland. He and some who were rounded up were transported via Nkhata-Bay on ship (he called it a kind of Gwendolyn[1]) to Chipoka, then onwards by train to Blantyre. He said they were supposed to be airfreighted to Kame, in Ghana,[2] while their leader, Kamuzu, was sent to Gwelo (now Gweru) prison, in Southern Rhodesia (present day Zimbabwe).[3] He told us that what saved them was that they had just missed the plane to Kame, and they were sent to Kanjedza Dentition Camp to eat, and wait for the next plane. As it turned out, they ended spending almost a year there until their release. He told us that he found it uncomfortable in prison because he was detained with his apongozi, Qabaniso Chibambo.[4] Oh, yes, my father respected local custom! Under local custom, you must ‘avoid’ your apongozi. After his release he was permanently ordered to stay in Blantyre and explicitly told never go back to Mzimba! Of course, things changed after independence, but this initial forced incarceration seemed to have left an indelible mark on him. I think my father was in a way torn apart. I think he missed his village life and wanted to continue experiencing it even within a city setting.

To me therefore, the bottle store was his solution to this dilemma. He used it as a way of re-living his village life. At the bottle store, traditional foods were prepared such as roasted makunda, mangh’ina, roasted deer meat. The ‘insides of the goat’ were also favourite! We used to call them bath towels! Cooked [goat][5] blood (ubende)[6] mixed with a few pieces of fat and small pieces of intestines was reserved for the older men. Of course as the cook; I made sure I had a good taste! Every Christmas he would slaughter a goat for the home and occasionally one for the bottle store for him and his friends! Well as I grew up, most of the slaughtering and skinning was left to me (but there is another story for another day). He used to take me and my young brother Dingiswayo hunting near Lirangwe with his Greener shot-gun to hunt Nyisa (yet another story for another day). The long and short of it all was that the bottle store was like importing the village into the town. It was a popular joint among his peers, and they came from all walks of life, and all corners of the country too. 3rd March was a day in which all shops were supposed to be closed in Malaŵi. We closed our bottle store alright, to everyone else except my father and his close circle of friends. No one would keep him from his ucwala or phele. No one could separate my father from his beer. He only stopped drinking when his health failed him. But I figured having spent time in detention, he deserved it and that somehow this 3^rd March quarantine did not apply to him. Interestingly, he never commented anything about politics, and when people started talking about politics he would quietly, silently but tactifully move away. I also noticed that the local Youth Leaguers[7] kind of avoided confronting him. I think they did right for my father had presence, and could instil fear when he chose to or wanted. Obviously traits of his Ngoni upbringing, as far as I know he never feared anyone, and once physically demonstrated to me two things: never let anyone jump the queue and never allow anyone to insult your wife (but that is another story there!).

The first bottle store was in Goliyo in Ndirande. Then he decided to expand, and got a spot at the corner of B.F. Chinseu’s Building at Chinseu, also in Ndirande. During this time we moved from Kabula to Chilomoni (another story there) and then finally to Chinseu, just behind the Chibuku Tavern (lots of stories there). I noted that the business was now styled Malonda Madise! So how is this all connected to Daniel Kachamba?

As part of the entertainment, we used to have travelling musicians that would come to the bottle store. By the time the bottle store moved to Chinseu, it was the local magnate of local musicians. We had people like Saleta Phiri and Amlamu Band (which when it became an ‘electric’ band changed to AB Sounds). We had Stonard Lungu who was popular because of his rich Mangoni vibes and wit. We had Ndingo Brothers Band of the aRosemary musanyade fame; and I recall they had one chap who had such a deep raspy voice (if you have heard of the song by Fuji Kasipa featuring Njati Njedede[8] you will know what I am talking about). And yes we also had the great Daniel Kachamba coming to sing. Namakhwa Brothers Band was a constant feature on the menu too, always leaving the patrons in stiches! At that time, the price (kubetcha) for a song was 20 Tambala for these prime artists. Once in a while, Robert Fumulani from Chileka would pop in, and when he did, he brought a drummer and an electric guitar which he would plug into the single amplified speaker we had and one or two other artists. And usually the price for each song was higher when he did; he was regarded as a ‘proper band’, and occasionally travelled nationally. Once these local artists arrived, we would stop playing the turn-table (usually it was Eric Donaldson, The Hurricanes, The Great MBC Band, Maroon Commandos, Manu Dibango etc). They would play late into the night. And once in a while, three or four artists would all converge but this did not provide a headache for them or for the patrons. They would quickly collaborate and play each other’s songs for hours on end; making everyone happy (that was the first time I saw different artists not only singing on one stage, buts collaborating!) To me seeing Daniel Kachamba, Stonard Lungu, Namakhwa Brothers Banda, and Ndingo Brothers Band playing together was just out of this word.

So listening to Daniel Kachamba made me realise how fortunate I am to have been in the presence of these great musicians. It triggered a memory, but it also reminded me of how rich our local music is. I know his music is not easy to find, but if you can source it, listen to Dr Daniel Kachamba. His brand was/is called Kwela music and is an infusion of South African beats, jazz and local Malaŵi music. Together with his brother Donald,[9] they formed the Kachamba Brothers Band. But the memories I have are of the Doctor himself! As for my father, he also introduced me to reggae music. He loved Alpha Blondy. He also loved Kenny Rogers. And yes he loved Franco Luambo Makiadi!  But that is a story for another day.

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[1] http://en.wikipedia.org/wiki/SS_Gwendolen

[2] http://www.maphill.com/ghana/kame/

[3] http://en.wikipedia.org/wiki/Hastings_Banda

[4] Long-time powerful Minister in the MCP Government and father of politician and former Ambassador Ziliro Chibambo

[5] It does not have to be goat; it includes blood of cattle or sheep too

[6] This is interesting because the Zulu translation of ubende is spleen

[7] The Youth Leaguers were foot-soldiers of the MCP, the only party in power then. Also known as Chiswe, they were better known for their ruthlessness, unreasonableness and occasional theft of property like eggs, chickens under the guise of donations for Kamuzu. They never came to our home as far as I can recall!

[8] https://www.youtube.com/watch?v=CX0lZ65rXMg

[9] http://www.allmusic.com/artist/donald-kachamba-mn0001449747