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Saturday, 21 June 2008

More stable...but in the wrong direction?

Nominal Kwacha per dollar Vs violatility

Nominal Kwacha per dollar vs Real Effective Exchange Rate

Agriculture Exports 2002 - 2007
Import and Export Shares, 1960 - 2007

13 comments:

  1. Cho:

    Your graphs are very instructive. I particularly want to expand on the Real Effective Exchange Rate (REER). If I recall correctly, REER is a measurement of trade balance, interest rate differentials, inflation differentials, capital expenditures and so on. The graph suggests that the REER is deteriorating while the nominal value of the Kwacha is appreciating. This disconnect is often seen in developing country economies that are suddenly a beneficiary of "windfall" capital and portfolio inflows. The Kwacha has appreciated in part due to portfolio inflows from investors seeking a real interest rate return and an appreciating currency.

    I met last week with Ms. Razia Khan of Standard Chartered. She is the analyst who has been promoting the Kwacha and T-Bills as an investment. Her premise remains that the Kwacha will continue to appreciate as the mining companies are now forced to convert hard currency earnings to Kwacha to settle their higher tax obligations derived from the windfall tax and the variable income tax rate which you have written about. I do not see evidence that the real return on Kwacha T-Bills justifies the portfolio flows. With inflation rising to 11+% again and T-Bills a mere 250 basis points above the current inflation rate, the risk-reward is not sufficient. Thus, one is left to rely on Kwacha appreciation. The graphs you have posted suggest that the Kwacha is vulnerable. What is the view on the ground? And lastly, does the Copper Supply Corp. who according to Standard Chartered will increase production from 500,000 tonnes annually to 1,000,000 tonnes annually in the next several years really able to produce such volumne given infrastructure, particulary energy constraints?

    Many thanks,

    John T. Sullivan
    Kerry Emerging Global Opportunities, L.L.C.
    Washington, D.C.

    ReplyDelete
  2. Real effective exchange rate =
    (trade share w/ country 1)*(RER w/ country 1)+(trade share w/country 2)*(RER w/ country 2)+…


    That means that Zambia's REER got worse mainly because they trade with so many dollar/dollarized countries whose currency depreciated.

    So you can have huge capital and portfolio inflows without your REER worsenning if you trade with countries in a similar situation.

    ReplyDelete
  3. Random Africa:

    I would like to correct your statement. According to the Direction of Trade Statistics, Zambia exports (over $3.82Bn in 2006)went principally to South Africa, Switzerland (probably Swiss middle men)and the European Union. Imports during the same period ($3.022Bn) were principally from South Africa ($1.43Bn), UAE ($313MM) and the EU ($289.7MM). With the exception of the UAE none of the currencies are tied to the dollar.

    Yes, Zambia's principal export copper and copper related products (88% of export value) is set in USD on international markets.

    The Kwacha however is now viewed by portfolio managers (I used to be one!) as a proxy for copper prices.

    Lastly, what you have described as the Real Effective Exchange Rate (REER)is incorrect. You are alluding instead to the trade weighted exchange rate which only follows the old economic argument of comparative advantage. The REER is far more comprehensive.

    ReplyDelete
  4. I didn't make it up, brother.

    http://www.investopedia.com/terms/r/reer.asp

    Real Effective Exchange Rate - REER


    The weighted average of a country's currency relative to an index or basket of other major currencies adjusted for the effects of inflation. The weights are determined by comparing the relative trade balances, in terms of one country's currency, with each other country within the index.

    This exchange rate is used to determine an individual country's currency value relative to the other major currencies in the index, as adjusted for the effects of inflation. All currencies within the said index are the major currencies being traded today: U.S. dollar, Japanese yen, euro, etc.

    This is also the value that an individual consumer will pay for an imported good at the consumer level. This price will include any tariffs and transactions costs associated with importing the good.


    And it compares the relative trade balances which probably makes a place like SA neutral. Without mentionning that copper exports are in dollar.

    ReplyDelete
  5. John,

    With regards the vulnerability of the Kwacha. The general consensus seems to be that the Kwacha is moving towards a higher equilibrium unless the government intervenes - and thus far they have refused. BOZ's role is one of stability not necessary to ensure a competitive exchange rate.

    It is true that much depends on copper production but the expansion in other minerals,including Nickel, and begining of uranium trading possibly from Sept is raising the prospect of a diversified mining industry in 2009.

    With regards the oil pressures. You have seen recent statistics on the higher consumption of diesel..something like 30% rise in demand. I think fuel costs are less of challenge compared to power outtages. But the government policy there again is one of prioritising power to the mines ahead of household consumption. In short, I think the 1m tonnage is within grasp.

    ReplyDelete
  6. Cho:

    Thank you for your thoughtful comments. Zambia appears to be following the pattern of several other resource rich exporting nations when it comes to currency management and imported inflation. By allowing the domestic currency to appreciate with some upward tinkering of interest rates (Brazil comes to mind), the mandarins at the Central Bank and Finance Ministry keep a lid on inflation, maintaining price stability. I do however question the efficacy of such FX policy beyond a six month horizon. Why? Zambia's FX policy is predicated on world copper prices (88% of total export receipts - ref: World Bank & EIU)even if mining is diversified, copper will continue to domonate. If there is a reversal of copper prices, then what? Parallel to this argument, what happens to Zambia's power sector which is vulnerable to hydrological risk (drought or flooding)? Lastly, what happens to non-mining exports so necessary in an economy that needs to diversify its trade basket mix? The mandarins appear to be mis-allocating resources, mis-judging power needs and lastly too reliant on copper to support the Kwacha. I do sincerely hope that Zambia is creating an annuity fund ("rainy day fund")to capture the current copper windfall. Once mineral resources are exhausted (as is expected in neighboring Botswana - diamonds), a country that has not prepared for the event has invited significant problems. Is Zambia considering a windfall resources fund?

    John T. Sullivan

    ReplyDelete
  7. John,

    I would emphasise that Zambia’s mineral capacity is largely untapped. The challenges for Zambia are to create a stabilisation fund as you have suggested and also use the current windfall to invest in infrastructure and diversification of new minerals. We have large mineral capacity in Luapula and Northern provinces, leaving aside the latest discoveries in Southern and Eastern province.

    The government is considering a stabilisation fund, though the details have not been revealed on how it may work. A key issue is that the government may decide not to allow mining taxes to be converted directly into Kwachas in the future to prevent the large Kwacha appreciations that may be detrimental in the long term.

    ReplyDelete
  8. I have recently uploaded a graph of Zambia versus Chile that may illustrate the merits of a different course : What can we learn from Chile?

    Certainly Chile with all the copper at its disposal has managed to stabilise its exchange rate much more than Zambia has done. The secret lies with what it has done with its windfall revenues.

    The Chilean economy has remained strong despite some symptoms of the "Dutch Disease", which are being minimised through a very careful management of the additional revenues flowing into the country from higher commodity prices. The majority of the Chilean copper revenues are kept offshore in foreign currency, easing the upward pressure on the currency.

    The plan of the Chilean government is to give 0.5% of GDP a year to the Central Bank, to offset the weight of the debts from a major bank bail-out in 1982–83. A further 0.5% is deposited to an offshore trust fund, on which the government can draw in the future to meet public pension obligations. Any surplus beyond 1% of GDP are channeled into a ‘economic and social stabilisation fund’, which should is also held abroad. In adverse times, the government can draw on this rather than contracting debt.

    This has helped strengthen Chile's counter-cyclical fiscal policy, as well as helped to restrain the peso's rise.

    Such management follows a historic prudent approach to exchange rate management which has allowed the Chilean REER to be significantly more stable than our Kwacha over time. The Chilean current REER is barely above its average of the past ten years.

    ReplyDelete
  9. Cho:

    You have made a fascinating comparison with Chile. I was involved in the Chilean loan workouts in the late 80s and early 90s. You brought back memories! I think it would be equally instructive to look at Peru which earns significant FX revenue from its copper and fishmeal exports. Given what I know of both countries' copper reserves and dispersion of income among the populace (Gini ratio), Peru would be a better comparison to Zambia. Nevertheless you have me thinking!
    BTW, are you or any one else out there following what is happening in Madagascar. I believe the country and an Australian mining company have announced a major copper find that will be exploited over the next five years. All reports are preliminary at the moment.

    John

    P.S. Thank you for the earlier comment about reserves. Are they proven or anticipated?

    ReplyDelete
  10. I'll look into Peru.

    No I have not been following Madagascar. I tend to focus on the immediate neighbours, with Mozambique provoking the most interesting. We know Angola holds great potential, and a stable DRC has vast wealth....but really Mozambique is one to watch...

    The Luapula reserves are anticipated.

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  11. Cho:

    Thank you again for the information. In Madagascar, several large Canadian and Australian mining firms have started to develop the Ambatovy fields for both nickel and copper.

    However, back to the subject of the Zambian Kwacha. I have yet to learn if the mining companies have been exchanging their hard currency earnings for Kwacha per the recently enacted legislation. Do you know where I can track this information? Will it come out of the Central Statistics Office, Ministry of Finance? I know that the enactment of the regulations did create some speculative buying from portfolio managers. Portfolio flows by definition are short term. If there is no concrete evidence of conversion through legislation, then the portfolio inflows may reverse themselves perhaps leading to the desired short term equilibrium sought by the Central Bank.

    ReplyDelete
  12. Cho:

    Thank you again for the information. In Madagascar, several large Canadian and Australian mining firms have started to develop the Ambatovy fields for both nickel and copper.

    However, back to the subject of the Zambian Kwacha. I have yet to learn if the mining companies have been exchanging their hard currency earnings for Kwacha per the recently enacted legislation. Do you know where I can track this information? Will it come out of the Central Statistics Office, Ministry of Finance? I know that the enactment of the regulations did create some speculative buying from portfolio managers. Portfolio flows by definition are short term. If there is no concrete evidence of conversion trhough legislation, then the portfolio inflows may reverse themselves perhaps leading to the desired short term equilibrium sought by the Central Bank.

    ReplyDelete
  13. My understanding is that they have to meet their tax obligations by end of next week.

    As they have now started exchanging the dollars for the Kwachas, the local banks are probably the best source. Indeed media reports have relied on the banks themselves. Citibank Zambia has been releasing such information to the Press.

    I'll find out whether such information is being made available by the Bank of Zambia.

    ReplyDelete

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