Amid currency tumult in Africa’s second-largest copper producer, Zambia, the recent monetary tightening spree by its central bank seems to have started yielding the desired results. The Bank of Zambia raised its cash reserve ratio from 9% to a record 26% effective 05 February, the highest since 1994, in a move to stem the copper currency losing streak that had extended 58% (since July 2023), sending the Kwacha to flirt with highs of K27 per unit of the dollar. Currency risk, being an anchor risk manifesting in the widening cost of living as petroleum prices scaled north in a widening inflationary environment, further benchmark interest tightening was effected 150 bps to 12.5% in the first-rate decision meeting of the year 2024 on 14 February.
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The monetary regulator has successfully mopped liquidity from the market, which has dented aggregate demand to purchase scarce dollars, which have been a function of muted mining production. With forecasts of weak mining production in 2024 despite key pronouncements of explorations and investments in addition to the resolution of historical impasses and signing of equity partners for key mines, production is only expected to take a positive cue in the next 1-2 years and above. This could mean the foreign exchange supply quagmire will be another theme of this year. Over the last 6 days, the kwacha has rallied 16.7% to current levels as the copper currency scarcity tames insatiable demand for dollars resulting in a stronger local unit. Another key driver of the runaway was speculation that has sharply subsided in the period as the trajectory points to an extended rally that has in turn forced speculators to offload dollar holdings onto the market to cut their losses.
The last few weeks saw widened spreads between offshore and onshore pricing that started to narrow as tighter monetary conditions ensued. Kwacha scarcity has extended to offshore players that seek to lock in on dollars. The scarcity of Kwacha is evident in the deep subscription of the sophomore bond sale where the BOZ sold K1.12 billion of the K2.0 billion assets on offer. As at market close on Monday 19 February, the foreign exchange markets in the Southern African nation closed at an average of 22.5337/22.9804.
Market analysts foresee the Kwacha sprint steaming out and eventually bottoming at K21.00, which is around the fx rates 200-Day moving average, as importers could gold rush for the dollars for international purchases (imports). Intraday the copper currency recorded a huge 10% appreciation, the largest movement since 27 November 2015. However, the end-of-day average saw the kwacha appreciate 7.84%, which is the largest end-of-day appreciation since 20 June 2023, when Zambia announced reaching a historic $6.2 billion agreement with its official creditors (8.7% appreciation) and the 3rd largest single-day appreciation on record, with the largest being 11.83% on 27 November 2023, which was the last time the central bank went on an aggressive monetary tightening spree with a 15% policy rate and an 18% statutory reserve ratio.
The sustainability of the current trajectory is a function of the red metal producers ability to address its structural issues as these monetary measures are temporal. What remains factual is that the supply side requires stimulation by boosting exports while curbing the sanguine appetite for dollars for import reasons. With muted mining production expected in 2024, supply may remain unchanged while the expansion of the economy will persistently exert demand for foreign currency. Zambia’s key drivers of foreign exchange includes agriculture inputs, petroleum products, heavy machinery and other manufacturing inputs.
Central Bank intervention could be limited to the extent to which reserve build-up is not worsened as the copper producer builds resilient import cover. The BOZ however did, last week, sell on the open market circa $135 million in total which satisfied most of the back log demand. This cushioned some of the pressure the market experienced.
“One has to think of the exchange rate as the reflection of the level of water (dollars) in a household’s water tank with water flowing in for storage (exports and international receipts) and water flowing out for usage (imports and international payments). With the flows of imports and exports currently fundamentally unchanged, the aggressive monetary policy measures are more like a family deciding to ration their water usage to get rid of wastage and stick to only critical water usage. This doesn’t solve the core problem but does buy us time for the longer-term more structural issues to play out and potentially stabilize the exchange rate”, said Munyumba Mutwale, Managing partner at Zatu Financial Consultants in a note to clients.
The hike in cash reserves has paralyzed demand to a large degree which has in turn fueled local currency scarcity that is pushing its price higher in rising funding costs. This is evidenced by a surge deposit mobilization campaigns as commercial banks seek to attract liabilities. With tighter monetary conditions generally credit growth risks being hampered not only by widening interest costs from costly loans but in part due to drought conditions that could weigh lending portfolio through dented output, power bottlenecks and potential scale up in transfer and convertibility risks. Drought threats in El Niño weather have been predicted in 2024 a dejavus experience last seen in 2015/16 season.
Commenting of the recent developments, First National Bank Economist Chileshe Moono said, “Bank of Zambia’s tactical interventions has stemmed the 100+ day depreciation of the local currency. The sharp increase in the statutory reserve ratio, which squeezed kwacha liquidity from the market, coupled with sell of foreign currency on the market triggered selling activity from local and offshore players holding dollar positions against the kwacha. We then saw some speculative action from both buyers and sellers of foreign exchange as they looked to maximize their positions. Buyers have generally stayed out of the market on the expectation that the exchange rate will move further in their favor while some sellers have been panic selling. These actions tend to be self-fulfilling and have driven the rate lower over a relatively short span of time. The actions over the last few days raise questions on the validity of the excess demand that exists on the market. While we agree that there’s a real mismatch between demand and supply for foreign exchange, the actions of market participants over the last few days suggests that a portion of the excess demand could be purely speculative. A foreign exchange demand validation process could be necessary to ensure that demand USDZMW moves are reflective of the real demand and supply conditions on the market. Going forward, there is scope for further appreciation of the local unit. We see support level at K20.00.”
On the cusp of a breakthrough in the debt restructuring faculty, Zambia will seek to close a deal within the first half of the year according to the MinFin. This is critical for the red metal producer whose market has not only grown weary of the wait but is yoked with a foreign currency default rating that keeps capital unfairly priced on the back of widened sovereign premiums. Until the dollar bond debt stock is restructured, rating agencies will protract credit rating upgrades, which generally have implications for asset valuations.
The recent sharp appreciation also on the other end shocks the balance sheets of agriculture exporters whose performance for 2023 was the highest on record in Zambia’s history with $1.05 billion in exports.
The Arbitrageur
