The Zambian Kwacha has gyrated on either side of 17 as vulnerability and volatility persists in a disease pandemic era. COVID19 has amplified some of the fiscal risks that have successfully transmitted to the currency and money markets such as depreciation trajectory and an elevated yield curve. Zambia’s central bank  runs feeble reserve levels shy of one and half yards in dollars yet import cover in nominal terms has widened to 2.6 months (Reserves: $1.39bln vs Imports: $544.1mln) as imports shrivel in a muted business environment. The Bank of Zambia does not have adequate reserves to sell dollars in the open markets for price stability let alone it is the largest off taker of foreign exchange as it not only shores up reserves but stocks up green back to meet debt obligations as they fall due. Zambia’s debt has risen to $11.23bln of which $3bln comprises eurobonds for maturity 2022, 2024 and 2027. With an economy slowly reopening post partial lock down, petroleum and agriculture input demand could add an additional wave of dollar appetite exacerbating pressure on the exchange rate. 

THE JULY EFFECT

The ‘seesaw’ pattern observed historically has been, rally every tenth of each month and a share of the last week of every month as players gear up for tax payments and month end payroll respectively. Off course once in while when VAT refunds are paid out players are flush Kwacha and this distorts the pattern and as such conversions mute. However there is a time of every year where historically, a predictable pattern is plotted when mid – year provisional and Pay As You Earn – PAYE taxes coincide. When this happens there’s a conversion surge of dollars to local currency that trigger as sharp rally in the copper currency. This we call the ‘July Effect’. The acute volatility the market continues to track between March and June, signals potential for this winning streak to replicate. The only uncertainty is just the depth of the dip given the vulnerability of the currency.

HERE IS WHY

Bank of Zambia still largest off taker of dollars. State demand for currency is executed through the central bank as borrowing agents. If this pattern is that obvious, the Bank of Zambia could also be lying in wait to buy cheaper dollars in July.  Last year, $430mln of the net $580mln purchases were executed  between June and October.  with the BOZ being the largest off taker of dollars could limit the downside.

Managed currency suspiscions. The pattern could be altered significantly as conversions from the mines are now somewhat muted given their remission of mineral royalties in dollars directly to the central banks. A smaller portion to meet other taxes will still be observed but given pressure on foreign exchange reserves in absence of debt relief, moratoriums or external financing, it is highly likely there could be increased pressure to extend receipt of taxes in USD beyond just mineral royalties. This however has not actualized as at yet. If it does, introduction of the crawling peg which has not been effected would be the second step towards a managed currency with a likely move towards introduction of an foreign exchange auction system where banks may have to access USD liquidity from Bank of Zambia.

ZAMBIA’s ECONOMIC OUTLOOK

Economic outlook still remains bleak as downside risks continue to outweigh positives. Copper is on rebound trading at $5,524/MT as China posts stronger private sector activity yet these benefits from commodity markets are negated by feeble mining sentiment given litigation risks in the energy and mining industry that has and will continue to erode value in the medium term. Mining entities are not churning out as much copper due to strains ranging from high operating costs, ore body depletions and the litigation environment adding to decongestion of mines in disease pandemic era. The Copperbelt Energy Corporation – ZESCO energy impasse has potential to scare crow investment sentiment as such it is advisable for both parties and the authorities to address the ‘purported expropriation’ vis ‘common carrier’ paradox which if left unaddressed could be interpreted as potential nationalization of transmission and distribution. It is a very delicate period for Africa’s copper producer as mining plays a very key role in economic pulse of the nation. In the long term Zambia has taken steps to restore fiscal fitness after taking on Lazard to restructure its $11.23bln debt, a step towards getting IMF bailout which will be good for investor flows. Until that actualizes debt service will still be the biggest pain point for the Zambian fiscals.

THE WORLD IS REOPENING FINALY

The spreads between Non Deliverable Forward – NDF and after tax treasury bill yields has significantly narrowed suggesting a possible shift towards some portfolio investments. Fiscal posture remains elevated and unchanged but could see some benefit from the ‘cheap money’ out there due to all the easing. Liquidity provision through quantitative easing has clearly acted as a morphine injection to the markets that are in recovery mode notwithstanding the civil unrest, potential US-China trade impasse and coronavirus infections. Dollar shine is fading and so is appetite for gold and US treasuries.  

The Cynical Investor and Kwacha Arbitrageur

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