This chart is quite revealing because it shows the clear trend of the Kwacha over the last 3 years. Whilst some of the Kwacha’s current slide is seasonal, as retailers tend to buy most of their importants in advance of Christiams to avoid a slowdow in shipping activity, it is clear that the factors driving its decline are much more substantial.
Over the last month we have seen the Kwacha experience it's sharpest fall since PF came power and the lowest value in five years, if not more. The currency has substantially eroded in value since PF came to power in 2011. It is also clear that the ban in use of dollars, Kwacha rebasing and exchange control restrictions have not stemmed this substantial decline.
A number of things are clearly moving against the Kwacha. Top of the list is declining confidence in the Government’s ability to manage national finances. A recent IMF statement warned that GDP growth in 2013 is weaker than expected (2013 growth is only 6% against the 7.3% in 2012).
But more worrying is that Zambia faces significant economic challenges in the fiscal area as concerns escalate over the inherent weaknesses in our macroeconomic fundamentals. It is noticeable that the current fall in the Kwacha has coincided with the Fitch downgrade and the worsening economic outlook by Standard and Poor.
The credit agencies have picked up on the fact that Government finances have deteriorated sharply with projected deficit (8.5%) in 2013 twice the target level, and GDP much lower than forecast. Spending is likely to significantly over-run again in 2014, reflecting the cost of the public service wage increase and higher debt service costs. The GDP outlook for 2014 is quite bleak.
The problem for Zambia are also international. Despite our expansion in copper output the forecast of copper prices is negative. Zambia remains vulnerable to China’s ongoing adjustment which has seen copper prices fall by $3000 per tonne over the last two years. There’s a high likelihood of further fall in copper prices as supply expands off the back of new mines and expansions in Chile, Mongolia, Indonesia and Zambia. The lack of diversification of Zambia’s economy means a significant fall in copper prices may negatively affect the economy. These and other factors means that the Kwacha is increasingly now looking "less safer".
The bottom line of course is that there's no right or wrong level for the Kwacha. Whatever level the Kwacha finds it will have its pros and cons. The policy goal therefore must be to let the Kwacha find its 'natural' equilibrium in line with prevailing market forces. The goal of exchange rate policy under our current exchange rate mechanism is to aid stable adjustments. Zambia has a flexible floating exchange rate system. Indeed at our level the real exchange rate has made Zambian uncompetitive.
What we need is to ensure that BoZ continues to minimise currency volatility as the currency adjusts downwards. That requires prudent use of foreign reserves. Unfortunately, the reserves are dwindling. They are currently just at 2 months of import cover. This is below the Government’s 2013 target. International reserves have continued to fall over the last year as the Bank of Zambia has been directly funding Zambia's oil import bill and debt-servicing obligations. The Government has recently moved to halt the practice in an effort to stabilise the reserves.
What does this all mean for all of us? A weaker Kwacha means GRZ debt repayments become dearer. And of course with its inevitable credit downgrades going forward the cost of repayments will be higher.
At the individual level, the short term impact of weaker Kwacha is higher cost of imports, mostly for consumption purposes, but some significant ones for production as well! The elasticity of imports becomes crucial here, but needless to say, oil is a critical input for mining production costs, and a weak exchange rate, means higher domestic production costs for other sectors not least general transportation.
That said, a weaker Kwacha opens a window of competitiveness for non-mining sectors especially agriculture produce. The real question is whether the Zambian economy has diversified enough in recent years to take advantage of this window. We have seen some signs of diversification, but in general this remains aspirational.
GRZ cant change the fate of the Kwacha, but they can work to restore confidence in its finances and project to investors some degree of credibility. Recent policy initiatives have sent all the wrong signals. The deportation of investors, confusion on export taxes, media corrupt allegations against Chikwanda, political infighting and reckless borrowing all sends wrong signals.
They also need to use this "window" to encourage more diversification. But that requires money, which is a problem because GRZ is broke! So it plans to borrow! There’s talk of $1bn bond issue before Christmas before the Fed tapers QE. PF are in a rush for more debt to balance its books, but at what cost? That of course is a question to discuss another day!