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Thursday, 13 March 2014

Saving the Kwacha

The Bank of Zambia (BoZ) has momentarily abandoned its "random walk" mantra by offloading foreign reserves to desperately keep the Kwacha under K6 per $1. Only last week Finance Minister Chikwanda was still saying government will allow "forces of demand and supply to determine the currency's performance". 

The decision to keep the Kwacha below K6 appears to be political rather economical. The Patriotic Front (PF) cadre base is struggling to come to terms with the new realities. The Kwacha is now at its lowest level against the US dollar. This morning it was trading at K6.0.

The Kwacha would certainly be in a much worse position without BoZ's latest intervention, and with that has come the ongoing erosion of foreign reserves.  The reserves currently stand at $2.67bn at roughly two months of import cover having declined since the start of January.  This of course is a return to the last year's disastrous policy  when BoZ drained the reserves in an effort to not only shore up the Kwacha but also fund importation of oil and pay off debts. Naturally the practice was heavily criticised by the IMF and other players, and we can expect the same this time round. 

The worry is that if BoZ continues to go beyond merely managing currency volatility we will eventually run out of foreign reserves. Already the ongoing reduction is reducing confidence in Zambia's ability to service foreign loans. Dwindling foreign currency reserves are always associated with a deterioration in a country's creditworthiness. By opting to sustain the Kwacha at that level BoZ will make Zambia's credit rating worse. It seems to me that when all things are considered it is only a matter of time before Zambia is downgraded again. 

What is interesting is that Gondwe is attributing the currently fall in the Kwacha solely to decline in copper prices and foreign investors pulling out because of concerns about the impact of eventual monetary tightening by the U.S. Federal Reserve. It is a relief that he has finally recognised the Chinese and copper factors. Something I have been warning about for some time. 

But as regular readers know that is not the full picture. The factors eroding the Kwacha are largely on the fiscal and political side. The Kwacha has substantially eroded in value since PF came to power in 2011. There is little investor confidence in the Finance Minister Alexander Chikwanda's ability to manage national finances. Indeed there are substantial questions around PF's economic policies in general. 

The fundamentals appear to be breaking down. It is no accident that the Kwacha's current sharp fall started with the Fitch and Standard & Poor downgrades in November 2013. Global credit agencies have rightly picked up the fact that GRZ finances are deterioting. Spending substantially overrun in 2013 and will overrun again in 2014. These facts simply reflect significant effects of the large public service wage bill, rising infrastructure commitments, higher debt service costs and lower than forecast and copper revenues. The recent rebasing of GDP is certainly helpful, but when all things are considered the Kwacha's depreciation is merely reflecting the broader relative negative direction of the economy. 

To make matters worse it appears politically Zambia is becoming unstable. It is no secret that we are experiencing significant political disharmony which has diminished confidence in the long term economic and political direction of the country. 

The various statutory instruments, deportation of investors, confusion on export taxes, constitutional impasse, restriction of political freedoms, corrupt public media, lack of consultation and fights with traditional leadership and reckless borrowing, are but a few of the many political challenges. To this we can add general poor coordination of political and economic decisions. It all sending the wrong signals.

People always ask me, what is the solution? 

We all need a degree of humbleness. This is a difficult question and opinions vary. But at the very least I hope we can all, after reflection, agree on what is not the solution.

The solution is not to let the Kwacha "bottom out" as some have poorly suggested. That would accelerate the serious danger of a spiral with rising debt, high inflation, worsening fiscal deficit, reduced FDI and political chaos. The falling copper prices and China's slow down all point to difficult times ahead. Doing nothing is not an option. 

Equally poor is the academic appeal to the real exchange rate as a long term reason for allowing more depreciation. We all want diversification, and I have written on it countless time, but that is not the immediate challenge. The challenge is economic stability. 

My view is that the immediate answer lies in restoring confidence. The country needs a totally radically new direction that would signal to everyone, domestic and international, that fiscal and monetary responsibility is now the new norm. This means new policies coupled with competent people leading key institutions. I would urgently recommend a clean state at BoZ and Ministry of Finance. And a new and improved way of coordinating and communicating economic and political decisions.

Chola Mukanga | Economist
Copyright © Zambian Economist 2014


  1. One of the problems with a deteriorating economy are the solutions adopted to solve the problem.

    It would seem that economic mismanagement does result in a deterioration of a national currency. This results in a lower real value of the currency. It is worth that because of the mismanagement in an import economy that does mean inflation. What cost $1 and 5 Kwacha to import now costs $1 and 6Kwacha to import. That is substantial inflation. But with less foreign reserves that is what the Kwacha is worth. The reserves have been depleted.

    I do agree that confidence building measures are vital but if reserves are thrown at the problem then soon enough there will be none and imports become restricted and even oil and fuel become in short or erratic supply so the economy totally collapses. Then price controls are introduced and the economy is finished very quickly. It does not matter too much if the kwacha is 5.95 or 6.05. It does matter much if the kwacha should be 6.05 but the government uses hundreds of millions of dollars to keep it at 5.95 when it should be 6.05. It is a waste of hundreds of millions of dollars. Also, the kwacha will start to regain strength from the day sound economic principles are reintroduced. Say it was today then the kwacha would begin to strengthen back from 6.05 to 5.95 without spending the hundreds of millions of dollars to shore up the currency. The 6.0 barrier is a populist level and can be no reason for blowing the foreign reserves. Populism in economics results in economic disasters.

    All this happens within a context of people struggling to make ends meet. They suffer more and they protest loudly so attempts are made to make things better for them by introducing economic measures like price controls. However this just makes matters worse as it is just a attempt to fix things by even more economic mismanagement.

    This can be fixed by the international bailouts but I don't think that will come to the country anytime soon. Economic mismanagement has largely been the history of the country apart from the Levy years. The massive debt write-offs will not happen again. So Zambia will eventually have to face this: wealth is a long-term goal achieved by sound economic and not populist management over many years. Inflation of less than 3 per cent; increase in productivity; restricted pay rises of less than 3 per cent for 10 years would see the country achieve a sound economic base. But populism will never adopt that position. Getting rich in a day will get people elected.

    Or there is today an immediate introduction of a sound domestic solution and the problems will be fixed today or from today rather.

    One government can ruin everything very quickly. A measure of the governments economic mismanagement could be a simple table showing key economic factors as to when they came to power and today. Factors include: inflation, Kwacha level, import cover reserves, percentage of government expenditure to GDP, domestic debt to GDP, foreign debt ratio to GDP, tax revenues to GDP etc.

    I envisage a President called Mr Prudent and a Minister of Finance called Mr Meany leading a party called the Sound Economic Principles for Ten Years Party. Inflation under 3 per cent for ever being the main economic target with parallel increases in productivity with low wage rises. Never be elected but they would make a sound economy. The future generation would benefit although the current generation will just have to suffer more.

  2. The BoZ governor is not being sincere and is very much trying to be economical with the truth.By placing the blame on majorly on international forces ie reduced QE by the Federal reserve bank and the slowing down of growth in china are not want we want to hear because the kwacha was still doin poorly even before the federal reserve was ploughing in the $80 billion into the market as part of its QE programme. Anyway,we understand his predicament in trying to please his paymasters. I have never had confidence in this man coupled with grandpa Chikwanda because they seem to be so archaic in their way of running the economic affairs of the country.
    As you have rightly pointed out,the root cause of our kwacha problems has been the lack of fiscal discipline on the part of government. In trying to please the masses with increased salaries, unplanned capital expenditures,excess borrowing they are now going haywire!
    Lack of listening to advice from others and having a parochial view of things with their manifesto in mind is having a negative impact and taking us backwards to the HIPC days.
    We really need a paradigm shift quickly and as you have rightly pointed out,a shakeup at MoF and BoZ might be a start.

    1. The more money in your pockets policy has just back fired terribly, soon 1 Dollar will be trading at 8 ZMW, especially with a no brainer like Alex as Minister in charge of our Finances.

  3. @ Anonymous I am with you a hundred %


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