Africa’s second largest copper hotspot,Zambia, grapples with economic malaise reflecting in a persistent currency slide, the key precipitator of an inflation spiral whose momentum has been accelerating in the period. Zambia’s growth target of 1.8% for 2021, risks being a mirage if the root cause of misaligned economic posture is not addressed timely. For a long time, fiscal and monetary policy have been disconnected yet the central bank continues to be burdened with the task of fixing the problem. Top central bankers Jerome Powell (United States Federal Reserve Chair) and Mark Carney (former Bank of England Governor) at Jackson hole, Wyoming meeting of global central bankers, in 2019 said, monetary policy tools cannot be used to correct fiscal blunders as a consequence of political decisions the world has made. The fix lies in correcting the fiscals. This was at a time when the US fiscal side was echoing the need for interest rates to be lowered yet debt was amassing while for the British, a dark Brexit uncertainty cloud hovered over England. This is not so far fetched and is applicable in the Zambian context because half the structural and balance sheet vulnerabilities are fiscal induced which the central bank has been expected to try and correct making monetary policy management a daunting task.
The purpose of this article is to highlight 10 things that the Kwacha is saying about the health of the Zambia economy:-
1. The Bank of Zambia attributes pressures in the foreign currency markets to be attributed to mismatches in supply and demand fundamentals that is causing a widening backlog (dollar scarcity). This is constantly exerting pressure on the exchange rate. However delving into the drivers of supply and demand allows us an appreciation of what exactly the pressure points are. Zambia needs dollars for an array of factors to include debt service for foreign currency denominated debt, agriculture inputs such as fertiliser and petroleum which critical as a driver of economic growth. Arguably it is understandable that Zambia doesn’t have oil hence the imports but not being able to manufacture fertiliser is making the famed inout support program a costly venture as it is a major driver of forex demand. Zambia continues to import ammonium nitrate from South Africa its largest trade partner for manufacture of explosives, an opportunity for local manufacturing pulse, a sector that can improved the Southern African nations earning capacity. This would cushion the economy from endogenous shocks from dollar demand related hurdles especially for importation of commodities.
2. The decision to have mining firms pay tax in dollars directly to the central bank addressed dollar supply pressures which the MinFin needed for foreign currency debt service but simultaneously created market supply deficits through sucking 45-55-% of open market flows distorting cyclical conversion support for the kwacha every month when tax conversions were due.
3. Dwindling sentiment on the back of a confluence of factors ranging from rating downgrades, fiscal fragilities and its pandemic amplified effects, has led to asset sell-off pressure as offshore players seek to exit the Zambian market. This is on the back of elevated sovereign risk. Zambia’s hat-rick in downgrades by the rating agencies, triggered by a default on coupon payments on its 2024 and 2027 bonds, caused a widening in credit default spreads (CDS) on its dollar bonds sending its Eurobonds to worst performing status of emerging and frothier (EMF) market assets.
4. Feeble foreign exchange reserve structure continues to leave the central bank with very little ammunition to cushion external shocks. Ideally any central bank should ease pressure through selling currency on then open markets to stabilise currency volatility. This has not been occurring for fear of depleting stock of reserves which could dent import cover (<3m). Zambias reserves have plummeted to decade lows of $1.2billion from highs of $3.7billion is good years. Part of the earnings capacity challenges save for weak manufacturing capacity have been the anomalies in the mining industry through ownership structures that have kept Zambia on the receiving end of a hard bargain. Even in times when red metal prices have rallied to 10-year highs on the London Metal Exchange (LME), the benefits will still remain sub-optimal to the Southern Africa nation because it has always been a minority shareholder in the mines. With reorganisation of mining ownership coupled with a bullish copper outlook gives hope to Zambia’s earning capacity with benefits fully accruing to its citizens.
5. Interventions by the monetary authorities to inject liquidity back into the system that the economy has been for a long time been starved through a build up in domestic arrears, is breeding dollar demand. A domestic arrears dismantling program carried through awarding suppliers and contractors government securities, only addresses a local currency liquidity quagmire but while breeding more demand for dollars as Zambia is a net importer either way. Suppliers paid in Kwacha will still find themselves in a queue for dollars at commercial banks.
6. For a long time Zambians have proxied the exchange rate for a growth indicator to the extent that depreciation causes panic about an economy shrinking. For nations with a strong trade balance, that is correct, however this does not hold for net importers as depreciation sometimes signals an economy trying to claw back lost growth. Players will be Kwacha liquid but seeking dollars to import materials for production purposes. Post COVID for 2020 and in 2021, this is another driver of exchange rate pressure.
7. A weakening currency is signalling fatigue for balance of payments (BOP) support bailout. Zambia formally requested to International Monetary Fund (IMF) assistance in 4Q21 a move that, if had been taken early years back, fundamentals would be more bullish than the current bears. Seeking assistance from the IMF has been a discussion point since 2016 yet formal engagements were recently commenced with Zambia heeding the Washington based lenders advice to hire a financial advisor for debt restructure purposes as demonstration for need to restore fiscal fitness. Zambia’s recent engagement with the Robinson Davies team that concluded on March 03, revealed that further engagement was expect in the coming weeks for which technical policy intervention most appropriate for the copper producer, would be communicated. Zambia seeks a rapid credit facility (RCF) with hope of graduating into a fully funded extended credit facility (ECF). The copper producer remains optimistic about a program but timing remains uncertain especially with the polls coming up this August. Likelihood of an ECF before August remains low.
8. Futuristic, should the currency slide persist, inflation will remain elevated as cost push inflation effects will not only keep input prices inflated but speculation will always remain opportunistic in such an environment. The central bank targeted band of 6-8% will, according to the last rate decision meeting (MPC) communique be breached for 8 quarters (2years). The cost of living will in the end bear the brunt of Kwacha depreciation. Higher inflation is a barometer for a bearish interest rate trajectory and a deterioration in credit asset quality. The rate hiking cycle is overdue but pandemic times are suppressing the climb but not for long.
9. Linked to the previous point, a weak currency driving higher input inflation, private sector pulse will remain in the doldrums as has been in the last 23-months. Zambias purchasing managers index (PMI) has consistently printed below 50 weighed by energy related and rising input prices. A weak pulse signals the anaemic contribution to growth by the manufacturing sector which could be signalling feeble growth prospects. Other drivers of suppressed business fabric are related to COVID effects on supply chain distribution etc.
10. Monetary policy management in pandemic times will remain a daunting task as hiking rates to curb slides has been constrained on social concerns to cushion impact on citizens. The central bank has however continued to clutch in and out potential interim measures to attain financial sector and price stability. However the root cause remains the fiscal side as a consequence of political decisions skewed towards infrastructure spend. This has caused mismatches between project completion to self sustain repayment of debts incurred for these investments. The resulting pressure has been to service debt using other revenue streams but at the expense of growth in real sectors.
The Kwacha Arbitrageur
