A new Standard Chartered bank assessment on Zambia released yesterday is now pointing to an even stronger Kwacha very soon, largely due to the windfall tax. Excerpt:
Now the mining sector faces a higher royalty rate (from 0.6% to 3%), higher corporate taxes (from 25% to 30%, although losses may still be carried forward according to a predetermined 75:50:25 formula), and – most significantly - will see a windfall tax imposed on copper earnings of up to 75% .... Moreover, it is probable that these payments will be made in ZMK, significantly increasing the demand for ZMK relative to the FX inflows to which the market is accustomed. There is some possibility that payments might be made in USD to the Zambia Revenue Authority, which will then convert the proceeds at an average interbank USD-ZMK rate in an off-market transaction with the Bank of Zambia, thus preventing the inflows from impacting the market severely. However, at the time of writing, our information suggests that tax payments will be due - and made – in ZMK. A sizeable currency appreciation appears imminent.
What will the impact of all of this be? Official attitudes to currency appreciation are still ambiguous. While Zambia, as a net oil importer, will benefit in the near term from a stronger currency, other factors are likely to dominate government thinking. Although Zambia plans to reduce its traditional reliance on donor financing, for the moment, the contribution of donors to Zambia's budget is large enough for the authorities to be wary of seeing dramatic and sustained currency strength. (The proceeds of the windfall tax have not been included in the 2008 budget. With domestic revenue collection set to surge, Zambia will be able to make rapid progress in reducing its traditional donor reliance, should it wish to do so. But questions about revenue sustainability and the optimal means of development financing must still be considered).
In recent years, Zambia has also tried to boost its 'non-traditional' sectors, especially agriculture and tourism. While we believe that demand for high-end tourism may be relatively inelastic with respect to the exchange rate, and that a stronger ZMK may actually help with the cost of imported inputs for agriculture, such as fertiliser, (to say nothing of the cost of much-needed infrastructure development), the authorities - under the influence of various lobby groups - may not be receptive to this view. There is therefore a risk that sharp ZMK appreciation might be met with an official effort to reverse or slow the currency's gains. We have incorporated this into our currency forecasts, with a mid-09 USD-ZMK rate of 3500, compared with a rate of 3120 by the end of this year. But it is not just the currency impact of kwacha strength on the economy that should be considered. The impact on future mining sector developments is equally important.