Zambia’s central bank expected to keep rates unchanged next week – Pre MPC analysis

The central bank in Africa’s second largest producer, Zambia will hold its first rate decision meeting next week beginning deliberations on the 17 February with the announcement on monetary policy stance to be made on Wednesday 19 February. The last Monetary Policy Committee (MPC) meeting hiked the benchmark interest rate 125 basis points to 11.5% to curb a currency slide that yielded little fruition until the central bank resorted to tighten the cash reserve requirement 400 basis points higher to 9% effective 23 December 2019 that saw the mopping of K1.6billion out of the financial system.

Inflation driven monetary policy. Energy price risks were the key drivers of elevated inflation as consumers bear the brunt of higher electricity and fuel costs. Having closed the year at 11.7% lagged currency depreciation effects and energy price risks pushed inflation 80bps to 12.5% for January sending monetary policy tightening shivers as the rate decision meeting draws nigh. Inflationary pressure is forecast to be high in 1H20 and will be the focus of the central banks monetary stance.

Inflation spiral could elevated the govie higher. Yields on government securities remain elevated as repricing risks persist with the one year treasury bill priced at 28.24%, 2 year ebbed higher 145bps to 30.95% while the 5 year rose to 33.5% as the 15 year bond climbed 100bps to 30%. An elevated Kwacha demand curve signals interest rate risks pressure as commercial banks reference the curve for credit pricing. Rising inflation continues to erode compensation premiums for investors that take sovereign risk in government paper.

The MinFin needs to ignite fiscal stimulus. Zambia’s fiscal head in his economic brief was alive to risks to growth not only from debt sustainability perspective to climate change effects on energy which widened the copper producers fiscal deficit to 8.2% on a cash basis for 2019. Growth for Zambia was subdued to under 2% but as the MinFin projects 3% economic growth for 2020, which we believe could be a mirage given the current fiscal posture. It is evident that the fiscals need to ignite growth in a suppressed environment and that at this point will only be achievable through a hold or monetary policy easing stance – the former is very likely.

Kwacha weakness is another key theme. Currency risks remain high as reserves remain anaemic at $1.45billion leaving the economy Vulnerable to external shocks. Dollar demand for external debt service and petroleum funding will persist in 2020 in addition to the central bank being the largest off taker for foreign exchange. The central bank has the cash reserve option to curb future currency slides but at the expense of private sector growth. The currency has traded stably but in a weak zone north of 14.5 for a unit of dollar.

Private sector pulse remains subdued. Lack of liquidity coupled with an elevated cost environment from rising energy prices, manufacturing momentum has slowed on the back of higher input prices and waning aggregate demand. This is a quagmire that requires fiscal stimulus in an environment where monetary policy has bottomed. Purchasing Managers Index readings for Zambia were last above 50 in February 2019. Growth prospects for the red metal producer could be overly ambitious at 3% given the risk environment marred by fiscal imbalances while the external environment effects of an economic slow down in China as corrona virus infects commodities market.

Flat FX reserves could signal economic contraction. December 2019 gross reserves ebbed marginally to $1.45billion representing 2.1 months of import cover from 1.6 months at $1.41billion in June. Mathematically this translates to a constriction in imports signaling waning aggregate demand in the period. This negates the hype around the trade surplus reported by Zambia Statistics Agency (ZSA) alongside the January inflation number of 12.5%. This is a testament of an economy signaling need for stimulus and a business agenda to ignite growth.

Cash reserves a more likely tool than policy rate to navigate the storm. The BOZ has more latitude to use its cash reserving requirement tool than the benchmark interest rate to manage monetary policy this year. However we attach a 90% probability of any deviation in monetary policy stance of SRR of 9% and BPR of 11.5%. Should inflation continue spiraling higher, the central bank will could consider tightening reserve requirement in the May meeting.

The Kwacha Arbitrageur