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Thursday, 27 February 2014

Trial and error economics at BoZ

The Bank of Zambia (BoZ) has increased the statutory reserve ratios for commercial banks to 14% from 8% from March 10 in a bid to reduce liquidity and help prop up the free falling Kwacha (Source: Cavmont). What this means is that the Bank will have keep more money on its books and will not be able to lend as much.

When PF came to power it reduced the reserve ratio to 5% because it argued that it wanted to boost lending in the economy. Then it decided to increase it to 8 percent. And now it has made a huge increase to 14%. This is at a time when it has controversially capped commercial bank loan rates.

The decision to increase domestic borrowing will inevitably accelerate the crowding out private sector borrowing and make it even more difficult to bring down the cost of borrowing for ordinary Zambians, given the existing legally binding maximum lending rate imposed by the PF.

The other reason PF is worried of course it the rapid rising inflationary pressures primarily stem from rising food prices. Now then you add in the rapidly falling Kwacha. The inflationary pressures have been exacerbated by the sharp decline in the Kwacha which has lost over 4.3 percent since the beginning of this year.

Last week, Finance Alexander Chikwanda ruled out the possibility of BoZ intervening in the market by off- loading dollars in order to stabilize the Kwacha. He says the government will allow "forces of demand and supply to determine the currency's performance".

That is clearly not politically credible, a rate worse than K5.8 per $1 would be difficult to justify to even the most hard core of PF cadres. A recent Daily Mail editorial captures much of the PF cadre mood, "we are looking forward to have a stronger local currency so that the economy remains buoyant and life does not become too costly for the local people". [PF language translation: strong currency = good economy].

The increase in reserve ratios come off the back of yesterday's increase in threshold of domestic borrowing payable over a period of ten years from K200m (US$35m) to K13 billion (US$2.3bn). Domestic threshold for loans repayable over one year has risen from K10m(US$5.8m) to K20bn (US$3.8bn). Chikwanda says the increase in the domestic borrowing threshold is meant to help the Patriotic Front (PF) government implement various economic projects given the burgeoning budget deficit and limited room for external borrowing.

AUTHOR
Chola Mukanga | Economist 
Copyright © Zambian Economist 2014

2 comments:

  1. Some economists say in these circumstances that the central banks should just let the currency float and not use precious foreign reserves in trying to hold the value of the domestic currency. I think they say this because where a domestic currency is genuinely weak it should go to its true value and then fix it from there still having forex reserves for imports.

    Others say that the forex reserves should be weakened by using them to try and preserve the value of the domestic currency. This exposes the country to insufficient foreign reserves for key imports such as oil.

    Others says that interest rates should be increased to prevent the decline in the domestic currency. This is what South Africa, Turkey and others did recently when QE began to be tapered.

    What they all agree with is that this is a potential for economic hardship to come I.e. recession and often inflation.

    This seems to be where the country is heading.

    Your points about the effect the current policy has on a. Unavailibility of loans to the private sector, which means business and individuals. b. The cost of these loans becoming too high for the same, both mean lack of economic activity and depression.

    A useful barometer of inflation is how much does a 2litre bottle of cooking oil cost now compared to the start of the year. Perhaps the cadres will express themselves more vocally when these basic necessities of life begin to become more expensive.

    I understood the interest rate cap on bankswas because their rates were excessive. However if the fundamentals of the economy were fixed then they would have to come down naturally. i.e. starve them from profits through treasury bills being cancelled by the government. But the government has an unrealistic program which means that they are going to spend and spend and expect everybody else to get out of the way. It is statism. The government dominates the whole economy and so there is little economy left. I remember, in the Levy years, that this controlling of the market by the government through excessive borrowing, was identified as a major factor lack of development.

    ReplyDelete
  2. http://www.bbc.com/news/business-26368704


    For information showing what happens elsewhere in economic cycles.

    ReplyDelete

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