There exists a thin line between finance and economics in modern day. The same macroeconomic variables (inflation, currency, growth, volatility, pricing etc) are analyzed using economic and finance theory. There are however common mistakes that both finance and economic analysts make as a result of either using terms synonymously or generally lack of astuteness and proficiency in the area of specialization. A vivid understanding of these terms draws a tangible line distinguishing proficient from self proclaimed analysts who run the risk of misleading non-finance practitioners. We will take some time to reveal some of the common mistakes analysts make.
Devaluation vs. Depreciation Some analysts use the terms depreciation and devaluation loosely when in essence the two are totally different concepts. Depreciation is the weakening of a currency paired against another and is a function of supply and demand fundamentals. If dollar demand versus the Kwacha is high, then the latter currency will weaken because one needs more of the unit to buy the other. (i.e, if K10 are required for a dollar today while K15 will be required tomorrow then we say the Kwacha has depreciated because one requires more units for a unit of dollar. Depreciation is driven by market forces. Devaluation on the other hand is the deliberate weakening of a currency by the central bank for various reasons such as aligning to underlying commodities or to make export positions competitive. Nations that devalue currencies in Africa include Angola, Malawi and Nigeria in times when the price of crude tumbles. Devaluation is usually an indicator of the exchange rate regime a sovereign is running. Angina runs a managed regime while the likes for Zambia and South Africa operate floating rate regimes which allow currencies to swing as a reflection of supply and demand fundamentals.
Depreciation vs. Volatility There is a significant difference between depreciation and volatility. Depreciation is one way traffic swing as a currency weakening while volatility refers to variability of currency strength both in the appreciating and depreciating direction. Statistically volatility is the standard deviation or variance of metrics from the average. In the last few weeks the Kwacha has not been volatile but has been a depreciation path to current levels but year to date the currency has been volatility because of it touch a record high (appreciation) of 12.45 while also slide to a trough (depreciation) of 14.3 but has traded for an average of 12.6 per dollar. (Volatility addresses the deviation from the 12.6 in both the appreciation and depreciation direction).
Corporate vs. Sovereign Bonds. Some analysts loosely use the term corporate and sovereign bonds which is a very misleading conception. The two are all fixed income instruments but the distinguishing factor is the issuer. If the issuer of the bond is a corporate entity then the paper qualifies to be called a corporate bond while of the issue is a sovereign or a government, then the paper is government security. Some analysts have conducted analysis on capital markets and loosely referred to government securities are corporate bonds. The bulk of Zambian bonds (98%) are government securities with very few corporate bonds running or trading because an corporate issuances are on merely listed on the local bourse. Corporate bonds on the Zambian market are highly illiquid due to very weak price discovery mechanism. Subscribers of corporate bonds are pension funds that lock up liquidity and await set coupons and principal at maturity. However government bonds (govies) are more liquid with an active curve which is the term structure of Kwacha interest rates used to price their valuation.
Recession vs Slowing Growth There is a tendency for a slow down in growth to be expressly called a recession which is another misconception. Slow down in growth is defined as economic expansion lower than the previous velocity recorded while a recession is a negative move or contraction. Zambia, in good years expanded by 6.7%-7% but has more than halved this momentum to now an expected 2.2% in 2019., this does not entail Zambia is in an recession. Zambia’s economy is expanding but a much slower pace however if the economies gross domestic product moved from $26 billion to $22 billion, then it would be accurate to say the economy has receded and as such the copper producer would be in recession. However a persistent slowing down economy runs the risk of running into a recession if not addressed.
These series will run weekly to plug the finance and economic awareness gaps for the benefit of non specialized faculties.
The Kwacha Arbitrageur