Drought, tight liquidity, and Kwacha volatility are three critical issues keeping traders on edge in Zambia, Africa’s key red metal market. Recent treasury bill sales have been undersubscribed, with the latest absorbing only 30% of the K1.8 billion offered. As the Bank of Zambia aims to raise K1.6 billion in fixed income assets this Friday 24 May, the cash-strapped market could lead to significant undersubscription. Zambian authorities are urgently seeking funds to mitigate the drought’s impact on the 2024 agricultural budget, which requires K23.4 billion. Current market liquidity is hovering around K287 million.
Despite raising its key interest rate by 100 basis points to 13.5%, the market remains skeptical about whether this measure is sufficient to counter foreign exchange risks given the supply constraints. Analysts anticipated a hike in cash reserves to stabilize the Kwacha, but concerns about growth risks due to prolonged energy rationing and a sharp decline in agricultural output persist.
Given the current foreign exchange risks and economic headwinds, the prevailing yield levels may deter offshore investors from Kwacha assets, potentially resulting in low interest in this Friday’s bond sale.
Zambia’s dollar liquidity is constrained by reduced mining flows, while demand for grain and petroleum imports is likely to keep the Kwacha under pressure for the remainder of the year.
Morgan Stanley’s outlook on Zambia underscores the need for a cautious approach to sovereign bonds amid climate risk-induced challenges. The international bank recently rated Zambian dollar bonds as a “dislike” ahead of a bondholders’ vote influenced by drought concerns.
Zambia is nearing completion of its Eurobond debt reorganization, with the exchange expected in June, addressing about 77% of its external obligations.
“We no longer see risks as balanced and thus move Zambia’s bonds to a dislike stance, as the drought is likely to have far-reaching consequences for the economy,” said Morgan Stanley Analyst Neville Mandimika.
Two weeks ago, the International Monetary Fund downgraded Zambia’s 2024 growth forecast to 2.3%, citing environmental risks that strain power generation and food security. Funding remains a significant challenge for Zambia, as local commercial banks and pension funds may lack the liquidity to absorb upcoming bond issuances. The central bank recently raised its cash reserve rate to a near-historic high of 26%, tightening market liquidity as government deposits are redirected to the Bank of Zambia. Despite asset maturities, liquidity remains concentrated in a few banks, leaving many market players short.
Commenting on the matter, Executive Head of Treasury and Trading at Opportunik Global Fund, Dean N Onyambu, in a note to clients said, “Before the Bank of Zambia Monetary Policy Committee meeting on May 15th, we tipped the monetary authorities against misinterpreting potential Kwacha appreciation as a reason to postpone raising the statutory reserve ratio by 850 bps, as market expectations suggested. Instead, the central bank increased the policy rate by 100 bps and left the cash reserve ratio unchanged. This decision soured market sentiment, leading to the exchange rate bottoming on the same day. Despite their rationale of avoiding aggressive tightening in a weak economic environment, we view this as a potential policy mistake. While we recognize the anticipated economic weakness in the latter half of the year, the central bank will face the challenge of weakening growth while supply-side factors drive inflation higher. Addressing inflation is crucial since growth will inevitably be weak. Anchoring inflation could mitigate the adverse effects of moderated growth on the populace, as inflation has remained elevated for a while, severely impacting household finances.”
Other factors weighing the foreign exchange markets include elevated consumer imports in the region of $250 million to $300 million on average per month coupled with elevated grain prices globally are likely to add to the pressure as climate threats continue to manifest in different but extreme was such as flooding in Asia.
“Higher inflation is pushing a lot of bids to longer dated higher yield bonds as market suspects inflation should subside in the long term but remain elevated in the medium term,” ZATU Financial Consultants Managing Director Munyumba Mutwale said.
“By not hiking the statutory reserve ratio and with upcoming security maturities, the central bank has potentially set the stage for accelerated Kwacha depreciation in June 2024 due to increased market liquidity. The easing in the tight offshore funding market complicates the situation. Non-resident investors who have yet to divest are likely to do so, creating a significant divergence between the onshore spot rate, supported by central bank FX interventions and moral suasion, and the more fluid offshore market. Exchange rate stability remains a key concern,” Onyambu said
“Considering Nigeria’s recent policy changes, where the policy rate was raised by 150 basis points to 26.25%, Zambia should consider a similar approach. If fiscal authorities are concerned about locking in long-term funding at high rates close to 30%, they should allow shorter-end yields to rise significantly, to 25%-30%, above the overnight interbank rate of 20%. This move would match some peers on the continent and attract offshore investment into the shorter end of the curve, temporarily inverting the yield curve. The latter would make short-term yields more competitive, alleviate divestment pressures, and stabilize the FX rate, thus helping anchor inflation. Additionally, eliminating taxes on T-bills, which are more burdensome than bonds due to their application on capital gains, could further attract investment in the short-term securities market and reduce divestment pressures. This diversification would reduce the concentration of Non-resident Holdings (NRH) in longer-tenor government securities, which currently heavily favors bonds at around 97%,” he said.
Other factors weighing the foreign exchange markets include elevated consumer imports in the region of $250 million to $300 million on average per month coupled with elevated grain prices globally are likely to add to the pressure as climate threats continue to manifest in different but extreme was such as flooding in Asia.
For the local market, inflation is eroding the attractiveness of assets, while a depreciating Kwacha makes current yields unappealing to offshore investors who may demand a higher sovereign premium to take on government risk. The likelihood of a local currency sovereign rating downgrade looms large given the economic challenges Zambia faces.
The Kwacha Arbitrageur
