As Africa’s second largest copper producer grapples with a runaway Kwacha, its central bank today hiked its benchmark interest rate 150 basis points to 12.5% exactly 9 days after cash reserves were scaled 9% to 26%. The Bank of Zambia black swan move left the market net short and tight liquidity wise as tame excessive inflationary pressures. The highest cash reserve ratio observed in history was 30% in 1994 when the Bank of Zambia was under an International Monetary Fund (IMF) Structural Adjustment Program. With the benchmark interest rate raised, credit costs are expected to scale with implications on growth and an environment grappling with inflation and other cost of living pressures.
Foreign exchange risks remain elevated as has been the key driver of rising inflationary pressure. The copper currency continues to flirt with lows of K26.95 for a unit of dollar which has transmitted into higher petroleum costs, waning private sector pulse and lack of liquidity from tightening sterilization measures. January Purchasing Managers Index headlined 49.2 from 49.8 in contraction as lack of liquidity, currency depreciation and higher fuel costs bottleneck business expansion. Inflation as advised by the Governor, Dr. Denny Kalyalya, is widening further away from the 6-8% target band and was only is expected to realign in 1Q26 which triggered the action taken by the regulator.
“Deviation from the target band has been driven by persistent currency depreciation and drought effects impacting food production,” Kalyalya said. In the fourth quarter of 2023 the Kwacha depreciated 17.5% against the dollar to K24.75 whose pressure has persisted in 2024, the Governor said. The market continues to see high demand from businesses seeking to recoup pandemic losses coupled with muted mining driven currency supply.
In the fourth quarter of last year, BOZ sold $215 million ($184 million from mineral royalties and $31.4 million from reserves) in the quarter to stabilize prices, the monetary policy communique revealed. Foreign currency interbank trading activity sharply constricted to $14.4 million in the fourth quarter from $185 million in the previous quarter as supply hurdles persist.
Foreign exchange reserves rose to $3.3 billion (3.7 months of import cover) from $2.9 billion as at end of third quarter. This was supported by IMF and World Bank disbursements in the period, Kalyalya told the meeting.
Growth printed higher in the first three quarters of the Zambian economy but in an inflationary environment fueled by rising asset prices. Earlier in the month the BOZ raised the cash reserve ratio extending to vostro accounts and idle government deposits which was pre-empted in an IMF Country Report released after the Article IV Mission team completed its review on Zambia in 4Q23. The report did cite the additional latitude that the central bank has to tighten monetary policy to keep tame the currency.
Zambia will see an uptick in funding costs as monetary conditions tighten. The Southern African nation is in the labyrinth of a debt restructure whose compeletion is earmarked for 1H24 as signaled by the MinFin. These developments are likely to protract the curve compression earlier forecast as prospects of full debt restructure beamed.
Foreign exchange supply remains muted as mining production remains fairly muted to meet the rising supply which the central bank seeks to curb with tighter monetary conditions. The BOZ still has latitude to tighten monetary policy further should variables not respond favorably to the current interventions taken.
The Kwacha Arbitrageur