The central bank in Africa’s copper hotspot will commence deliberations for its pen ultimate rate decision meeting for the year 2021 on August 30 for 2 days with the announcement to be made on September 01. The Southern African nation has seen its currency, the Kwacha sprint to earn worlds best performing after a sentiment boost following a leadership change outcome of the August 12 polls that saw President elect Hakainde Hichilema ascend to Zambia’s highest office after outperforming 6th Republican President Edgar Lungu.
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The red metal producer, currently grapples with an inflation spiral hovering at a two decade high, fueled by rising global food prices while simultaneously in the labyrinth of a debt restructure following its series of coup defaults on dollar bonds in pandemic era. Growth remains constrained by third wave corona virus residual effects that the business ecosystem manifests despite subsiding risks with positivity rates as low as 4% from highs of 28% at the peak of winter. Health authorities continue to warn of a fourth wave, as variants such lambda invade the globe.
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The pandemic era has seen central banks globally ease monetary policy through lowering benchmark rates to allow for cheaper credit to cushion against growth erosion. Bank of Zambia monetary policy committee (MPC) did cut rates to record lows of 8%, the lowest since the BPR started being tracked in 2012, while the statutory reserve ratio (SRR) was slashed to 4% from highs of 18% once upon a time.
SDR BOOST, NEW HEAD OF STATE, POST ELECTION BOND BUMP TRADE PRE MPC
The week of August 23 commenced with the Washington based lender the International Monetary Fund (IMF) crediting special drawing rights (SDR) to member states in a record multilateral response plan and a brace of government debt offerings in a fortnight treasury bill and monthly fixed income sales which coincide. Zambia’s reserves are set to receive a $1.3 billion boost to the current $1.4 billion which will improve import cover to over 3 months. After the swearing in of the President – elect, markets expect a rally extension in exchange rate while Fridays debt offering is expected to attract offshores in a ‘post-election bump’ trade which is forecast to support the local currency.
WHY MONETARY POLICY TIGHTENING IS KEY FOR SUSTAINABLE CURRENCY BOOST
With subsiding political risks following change in leadership that bred confidence in the Zambian markets, the copper currency has been on a 6 day winning streak with a 12.8% appreciation. However the rally has left many players uncertain about sustainability. Major drivers of the strengthening include dollar sells by players that had initially held foreign exchange speculatively in uncertain times and offshore players searching for yield given the state of the global economy marred by elevated inflation and ultra thin returns on treasuries. The window however could be narrowing after the US Fed announced late last week that it would scale down on market tapering as it moves in to reign in on inflation as the US economic growth momentum levitates to pre-pandemic levels.
There will be need for the central bank to manage the level of excess liquidity in the Zambian financial system as a result of stimulus programs through quantitative easing methodologies that continue to prove inflationary. The current fundamentals characterized by an exchange rate sprint, elevated inflation in a suppressed environment point to the need to tighten liquidity management at reserve ratio (SRR) and not benchmark interest (BPR) rate levels for the reason that the policy rate upward adjustment would increase cost of credit at a time when COVID19 effects are evident in the economy from a cost of living perspective.
We shy away from the BPR because of its weak transmission mechanism in curbing inflation pressures but are of the view that the SRR does achieve the desired results in managing money supply related effects on price stability. Hiking the reserve requirement will supplement the Bank of Zambia’s efforts in stabilizing currency through release of foreign currency reserves on the open market whose cost is depletion if that was the only means at the central banks disposal. Zambia’s central bank is vividly in a better position to reign in currency risks from a stronger supply side from scaled copper price induced mineral royalties and offshore flows in a bond rally.
IMPORT STIMULUS BUT EXPORTS PRESERVATION KEY FOR RESILIENT GROWTH RECOVERY
The sharp appreciation provides economic stimulus for most business entities, previously dented by a ravaging pandemic, that have been given an overnight boost in lower input import costs (from a revaluation perspective) which provides an opportunity for them to claw back lost opportunity but on the contrary this has eroded gains that export orientated entities such as in the agriculture sector that have contributed to growth. It is for that reason that the central banks rate decision committee (MPC) will weigh the upside and downside risks posed by the recent currency rally to determine the best yet optimal level the Kwacha should draw a line in the sand to support both sides of the trade inflow and outflow equation. On a trade weighted basis, the Kwacha should be valued at 15 – 16 for a unit of dollar which reflects undervaluation from the current exchange rate levels of 16.585/16.915 signaling further latitude for appreciation, however overvaluation, should the streak continue will hurt exporters and thereby dent growth in that respect.
All things constant (ceteris paribus) the central bank is likely to keep the benchmark interest rate (BPR) unchanged at 8.5% while some form of tightening will be expected on the reserve ratio (SRR) as the committee reigns in on inflation risks to quicken alignment to the 6-8% target band.
The Kwacha Arbitrageur, Cynical Investor and the Futuristic Africonomist