Africa’s red metal producer and the first nation to set the pace for complex debt restructure under the G20 common framework Zambia, will have its sophomore rate decision announcement on Wednesday 15th May. Last monetary committee session saw the central bank raise the benchmark interest rate 150 basis points to 12.5%. This exactly 9 days after the cash reserve ratio hike of 9% to 26% was effected. This was the second highest seen in Zambia’s history with the highest being 31% in 1995 when the red metal producer was on an International Monetary Fund structural adjustment program. This sterilization measure was unique as it extended to not only government deposits but vostro balances leaving the market acutely short Kwacha. Triggering contractionary monetary policy, was a currency slide that sent the Kwacha flirting with levels just below K27 for a unit of dollar which was at the time breeding notorious inflationary pressures.
The Southern African nation is in the labyrinth of a severe drought that has threatened power supply and food security as dam levels at the worlds largest man-made lake the Kariba plummets to alarming levels of 13.24% representing 477.41 meters (06 May) compared to 25.0% a year ago. This has sent blackout shivers should the copper producer not hedge with alternative sources in the next few weeks. The state has commenced importation of power from neighboring Mozambique but this is not adequate to plug the widened deficit. El Niño effects extend to the agricutlure sector that has borne the brunt of destroyed maize crop planted on over 1.1 million hectares of land triggering emergency interventions that include winter maize crop and irrigation initiatives supported by tax scraps on energy and watering equipment imports. President Hakainde Hichilema earlier in February declared drought as a natural disaster and emergency for Zambia sending calls to cooperating partners to assist with humanitarian support to cushion the impact.
It is vivid that Zambia’s 2024 agriculture sector budget allocation will need a boost revealed by a K23.4 billion ($940 million) funding need to absorb the drought effects. Inflation as measured by the Zambia Statistics Agency’s consumer price index headlined 13.8% for April, a 26 month high as food prices take a cue from soft commodity scarcity and rising input prices. Zambia made significant strides in the area of external debt reorganization with 77% of the obligations restructured comprising $3.05 billion of dollar bonds which bond holders will highly likely nod in the coming vote. The Situmbeko led MinFin will seek to restructure the remaining portion of private non-bond holder debt to the tune of $3.4 billion a significant portion of which rests with the Chinese. This has left markets wagering over when the international rating agencies will upgrade the red metal producers foreign currency long term issuer rating from the current default status. Rating agencies such as Moody’s have hinted that Zambia could likely be in the ‘CCC+ to B’ territory when the restructure completes.
BEARISH PRICE PRESSURE OUTLOOK
Since the last monetary policy tightening actions, government security maturities levitated have market liquidity conditions, from the reserve hike levels, yet the distribution skew remains fairly uneven with the bulk of cash in the hands of a handful of banks. This has been the source of currency depreciation pressure in the wake of muted mining activity constraining foreign exchange supply on the market. Despite significant strides in the mining faculty the transition between investment injections and actualization of production could require longer time horizons for benefits to accrue and improve dollar supply. Key mines with significant injections recorded include First Quantum, Mopani and Luanshya Copper Mines while Konkola grapples with financing needs to meet operations and creditor dues currently in court. Other explorations that have kept Zambia on the map will commence production in the medium to long term. It is evident that the strong decarbonisation global drive has made Zambia an attractive investment destination for its green metals but in the medium to long term.
THE GRAVITY OF ENERGY WOES
Factory pulse as measured by purchasing managers index slid into contraction for the fifth time in a row weighed by input price pressures on account of rising petroleum prices triggered significantly by weakening currency and rising crude prices as geopolitical tensions persist in the Middle East. April data reveals stronger decline in private sector performance as demand dampened sending the manufacturing pulse index to 47.7 from 48.8 in March. (Readings >50 reflect expansionary while <50 are contractionary in nature).
“Despite business confidence reaching a 10-month high amid hopes of stabler economic conditions, headwinds in business conditions, reduction in money in circulation, and a higher cost of living all resulted in the downturn in the PMI for the month,” Musenge Komeki, Head of Treasury Sales said in a Markit Economics Report.
Effective 01 May, the state owned power utility ZESCO limited announced a 10% hike on retail tariffs as part of its 5 year tariff adjustment plan that commenced 2022 to 2027. This development was a recommendation of the Energy Markets Regulatory Capital cost of service study aimed to improve the power utilities negative jaws. This has been criticized by citizenry at a time when power supply is unstable and runs with an 8-hour deficit daily in most parts of the country. Most recently the power utility called on a force majeure clause to the mines that consume 55% of the grid citing no guarantee for power supply stability. This did signal how grave the power situation is for Zambia.
Petroleum prices were hiked 14% for May after the energy regulator effected a fuel pump price adjustment to reflect the copper currency exchange rate and global crude costs.
KALYALYA’S MONETARY QUAGMIRE – PRICE STABILITY VS GROWTH
The argument around growth prioritization versus stabilization of prices through tighter monetary measures remains topical for the central bank. With deliberations commencing the week of 12 May, price stability remains the overarching mandate of the central bank skewing market expectations towards to rate hikes. However growth is still an outcome that must be considered. Petroleum, electricity and food price pressures are likely to lengthen the period with which the BOZ would tame inflation back to within the 6-8% target band and as such leaves the committee with limited options but to hike both the statutory reserves and the monetary policy rate.
“For the upcoming MPC announcement on 15 May, we expect the Bank of Zambia to raise the policy rate by 100 bps to 13.5%. We also forecast an additional increase in the statutory reserve ratio by 600 bps to 32%,” Dean Onyambu, Executive Head Treasury and Trading at Opportunik Global Fund said in a note.
BOND YIELDS NEED TO CLIMB HIGHER
Since the debut MPC in February, the secondary market bond curve has flattened. The yields for 3-year to 5-year bonds have increased by an average of 175 bps, while 7-year to 15-year bond yields have risen by an average of 95 bps. Currently, bids for the shorter end of the curve range between 22.50% and 23.25%, whereas bids for the longer end range from 24.25% to 27.25%. Due to our ongoing concerns about currency weakness and the absence of more deliberate measures to address the foreign exchange structure, such as reinstating SI-33 (de-dollarization regulation) or redirecting mining sector tax receipts back to the foreign exchange market, we would prefer to see bond yields closer to 30.00% to provide more attractive entry levels, Onyambu said.
HIGH COPPER PRICES BUT MUTED PRODUCTION
London Metal Exchange copper is trading for $9,910 a metric tonne a wave that Zambias constrained production continues to deprive the Southern African nation of tax revenues. From a base of 687,000 metric tons in 2023 there is very little to support a hypothesis of a significant jump in production for 2024 to support foreign exchange supply. Electricity supply bottlenecks could further impact mining output at a time the country is gearing for a rebound but in the long term.
LIKE A THIEF IN THE NIGHT – SRR HIKE ODDS
Precedence has been set with SRR hike announcements usually a week or two to the main MPC. This has kept the market nervous in the week around a potential cash reserve hike requirement. Zambia’s peers with elevated reserve levels include Mozambique at 39.5% and Nigeria at 50%.
Given the current structural issues in the Zambian economy characterized by widening credit risk fragilities fueled by a worsening drought situation we assign a 70% likelihood of a 600 – 900 bps cash reserve adjustment and 100 – 150 bps widening in the benchmark interest rate in Wednesdays announcement. A very minimal chance of keeping the current status quo at 5% while the remaining 25% could be to have the statutory reserves raised gradually but a 150 bps hike in the policy rate.
The Kwacha Arbitrageur
