LUSAKA (The Business Telegraph) – The Zambian foreign exchange market has seen a series of changes this year as the central bank constantly revises its Interbank Foreign Exchange Markets – IFEM framework rules. Disease pandemic globally has exerted pressure on emerging and frontier market currencies that sold off this year as demand for riskier assets waned causing liquidity flight to safety in the dollar, precious metals such as gold and above all US treasuries.
Weak reserves and drivers of sanguine dollar demand. Pre COVID, Zambia had economic challenges key of which are balance sheet vulnerabilities, energy bottlenecks, high interest rates, weak currency and weak foreign exchange reserve levels at decade lows of under $1.5billion with import cover below 3 months. The central bank has for a while been unable to sell dollars on the open market to stabilize the currency for fear of depleting the feeble reserve buffer. Sanguine dollar demand was a persistent theme in the copper producers year 2019 for debt service purposes as it needed to pay up coupons for its eurobonds and other debt classes. The red metal producer paid circa $1.7billion in debt service last year while other drivers of dollar demand include petroleum purchases, execution of the Farmer Input Support Program – FISP whose fertilizer imports required to be funded in dollars. Other sources of dollar demand were asset sell off pressure as sovereign risks weighed causing rising disinvestment risk in the government securities market that forced offshores with maturities, to buy dollars as they externalized proceeds of investment instead of rolling over. The central bank itself has been the largest off taker of dollars as it seeks to shore up falling foreign exchange reserves.
Central bank interventions. The Zambian foreign exchange market has seen significant evolution following revisions to its foreign exchange trading rules which could be morphing the copper producers exchange rate regime to a managed float. Zambia has stood out as one of Africa’s best floating exchange rate regimes second to South Africa evidenced by the ABSA AFMIndex that has since its launch, captured the red metal producer as having the most transparent exchange rate regimes. Over the years the central bank has dictated the bid-offer spreads while guiding the marketable trading lots of between $500k-$1million for interbank trading.
This year has seen more interventions such as the “15 pips crawling peg” introduced in April to slow the pace of depreciation at a time the exchange rate was in ‘free fall’ mode in the absence of adequate reserves. Then the central bank introduced the personal liability for traders if found causing currency volatility swings which was odd for the market that is driven by supply and demand fundamentals. Though not directly related to the central bank, the Zambian authorities dollarised mining taxes which in part addressed the foreign exchange supply side yet this will shrink the currency open market by 40%-45%. The last intervention was naming of authorized brokers for foreign exchange trading namely ICAP Securities, Emerging Market New York, GFI Money Market Africa Ltd and Continental Capital. Common in jurisdictions like Kenya and Nigeria, this will cause a step type of currency exchange rate movement that could cause wide swings not good for the market.
Limited array of tools, listed options. Traditionally with very limited tools at the central banks disposal which is a homogenous challenge most African reserve banks have, currency slides are dealt with through monetary policy tightening. However this option is proving very incompatible and counter intuitive in COVID pandemic era where growth is muted and sluggish in the wake of feeble consumer demand requiring a boost through interest rate cuts which ideally doesn’t support exchange rates. Central banks are left with minimal options but to temper with their exchange rate regimes. One such example is the Bank of Zambia that has constantly reviewed its IFEM framework to tame currency depreciation. It is however unlikely that Zambia could be moving onto a foreign exchange auction system that will see dollar rationing and allocation to key sectors as like it is done in Angola.
The Kwacha Arbitrageur
