Editor's note: BOZ Governor Michael Gondwe yesterday delivered the following Monetary Policy Statement. It is intended as a quarterly snapshot of the state of the economy, with particular focus on the monetary side.
The Monetary Policy Committee (MPC) met yesterday, 18 th November 2014, to consider developments in the domestic economy over the third quarter of 2014. In its deliberations, the MPC also considered global economic developments and their likely ramifications on the Central Bank’s ability to achieve its core objective of maintaining price stability.
GLOBAL ECONOMIC DEVELOPMENTS
The prospects for global growth have worsened since the August MPC meeting, with repercussions on commodity prices and global financial flows.
In October the International Monetary Fund downgraded its growth forecasts for 2014 from 3.7% to 3.3%, with global growth in 2015 forecast to remain subdued. The United States of America and the United Kingdom continued to show firm progress in their recovery from the global financial crisis, but growth in the developing economies and emerging markets is forecast to slow down in 2014. Growth in Sub-Saharan Africa is, however, expected to remain robust.
The risks to the globaleconomy include rising geopolitical risks in Eastern Europe and the Middle East, deflation in the advanced economies and slow growth, particularly in the euro area.
Reflecting these global trends commodity prices fell over the third quarter, a trend that has been maintained in October and November 2014. Average crude oil prices declined to US $100.4 per barrel from US $106.3 per barrel in the second quarter. In October, average crude oil prices fell further and are currently below US $80 per barrel. Average copper prices rose to US $6,996 per metric tonne in the third quarter from US $6,795 per metric tonne in the second quarter. However, in October and November, copper prices have fallen back to levels seen in the second quarter of the year.
The uneven pace of growth in the advanced economies and rising geopolitical risks have also contributed to the strengthening of the US Dollar and concomitant financial flows from emerging and frontier markets. These financial flows have led to greater exchange rate pressures in emerging and frontier markets, including Zambia.
Having tightened monetary policy significantly during the second quarter, the Bank of Zambia maintained the policy rate at 12% during the third quarter as inflation remained elevated at an average annual rate of 7.9% for the quarter.
As a consequence of tightening of monetary policy, short term interest rates were misaligned with the overnight interbank rate rising significantly above the policy rate corridor. The Bank of Zambia, therefore, eased liquidity conditions through open market operations, in order to bring the overnight interbank interest rate back within the policy corridor of plus or minus 2 percentage points of the policy rate.
Inflationary pressures stabilized over the third quarter with annual inflation falling to 7.8% in September from 7.9% in June 2014.
This drop in annual inflation was attributable to the decline in annual food inflation which fell to 6.9% in September from 7.8% recorded in June 2014 reflecting improved food supply. However, food inflation remained elevated when compared to the corresponding period in 2013, when it measured 6.5%.
Annual non-food inflation in September rose to 8.8% from 8.0% in June, after having risen to a high of 9.2% in July. As was indicated in the discussion of inflation risks going forward in the August MPC statement, the rise in non-food inflation reflected the pass through to general prices of the sharp depreciation in the exchange rate, and the upward adjustments in electricity and fuel prices during the second and third quarter of the year, respectively. In October 2014, the annual inflation rate remained elevated at 7.9%.
DOMESTIC MONEY MARKET AND GOVERNMENT SECURITIES
Money market liquidity eased during the third quarter, after a significant tightening during the second quarter of the year. This primarily reflected BoZ short-term lending through open market operations (OMO), and was assisted by net Government spending and maturing investments in Government securities. As a result, the overnight interbank rate fell to 12.4% at the end of September from 25.2% at the end of June and has remained at this level in October and November 2014.
In the government securities market, there was a significant improvement in demand for Treasury-bills during the third quarter, particularly from foreign investors with the subscription rate improving to 122.5% from 56.3% in the second quarter. However, although the subscription rate on Government bonds also improved to 91.9% in the third quarter from 71.7% in the second quarter, they remained undersubscribed reflecting the preference for shorter dated securities by investors.
The improvements in the subscription rates for Government securities saw the weighted average Treasury bill yield rate decline to 18.5% at the end of the third quarter from 19.4% at the end of the second quarter. However, the yield rate on Government bonds trended upwards, with the weighted average bond yield rate rising to 18.9% at end-September from 18.1% at end-June 2014.
At the end of September, the outstanding stock of Government securities registered a modest increase of 1.4% to K21.1 billion compared with K20.5 billion at end-June, 2014. Treasury bills accounted for 49.8% of outstanding Government securities, whilst Government bonds account for 50.2%.
Foreign investors were a source of increased liquidity in the Government securities and their holdings of Treasury bills and Government bonds rose to K2.85 billion from K2.36 billion at end-June, 2014. This was equivalent to 13.7% of outstanding government securities.
The renewed interest of non-residents in the economy was also reflected in the capital market. The Lusaka Stock Exchange (LuSE) registered an increase in market capitalization of 1% and an increase in the All Share Index of 1.8%. In terms of non-resident participation, LuSE recorded a net inflow of foreign portfolio investment of US $17.4 million, compared to a net outflow of US $12.8 million witnessed during the second quarter of the year, with a total of US $19.1 million worth of stocks bought against sales of US $1.7 million.
DOMESTIC CREDIT AND INTEREST RATES
The growth in both domestic credit and broad money rebounded during the third quarter, after registering sharp declines during the second quarter of the year following the tightening in monetary policy. This reflected the easing in liquidity conditions by BoZ as well as some pick up in Government spending.
Domestic credit rose by 14.8% to K28.5 billion from K24.8 billion in June. This was mainly due to the 68.9% and 7.4% rise in lending to Government and households, respectively. Credit to public enterprises fell, however, by 21%. On an annual basis domestic credit grew by 10.9% at end-September compared to a decline of 5.1% in June 2014. At end-September commercial bank loans and advances had actually increased by 1.2% compared to a decline of 1.5% in the second quarter.
With respect to the overall composition of credit, households continued to account for the largest share of outstanding credit at 34.3% followed by agriculture (17%), manufacturing (11.7%), wholesale and retail trade (8.8%), and mining and quarrying (6.2%).
Broad money increased by 2.9% to K33.6 billion in September 2014 from K32.7 billion in June 2014, a reversal of the 2.2% decline witnessed in the second quarter of the year. The growth in broad money was driven by a 20.6% increase in net domestic assets following a 68.9% rise in lending to Government. Net foreign assets on the other hand fell by 6.7% mainly due to the decline in net international reserves. On an annual basis, broad money growth stood at 16.1% at the end of the third quarter.
Commercial banks’ average lending rate remained unchanged at 19.3% in September 2014. However, the commercial banks’ average savings rate for amounts above K100 and the average 30-day deposit rate for amounts exceeding K20,000 edged upwards to 3.6% and 6.7% from 3.5% and 6.6%, respectively.
Real interest rates remain high, with the real average lending rate rising to 11.5% whilst the real savings rate for amounts exceeding K20,000 remained negative at negative 1.1%.
FOREIGN EXCHANGE MARKET AND THE EXTERNAL SECTOR
During the third quarter, the foreign exchange market was characterised by lower volatility and the Kwacha appreciated against most of its major trading partner currencies and remained relatively flat against the US dollar. This was in contrast to the instability that characterised the second quarter of the year. Important drivers of the stability were, however, the measures taken by the central bank to reduce Kwacha liquidity in the money market.
The Kwacha closed the quarter at K6.26 per US Dollar – approximately the same level as at the end of the second quarter. Against the British Pound, the South African Rand and the Euro, the Kwacha appreciated by 4.8%, 5.7% and 7.3%, respectively. The overall supply of foreign exchange improved with steady supply witnessed from foreign corporates and the mining companies.
In keeping with its commitment to manage excess volatility, the Bank of Zambia bought US $85 million and sold US $69.1 million during the third quarter.
In real terms, the exchange rate as measured by the real effective exchange rate index, appreciated by 7.4% with the index moving to 98.1 in September from 105.8 in June.
External sector performance deteriorated during the third quarter, with the overall balance of Payments recording a deficit of US $123.2 million, compared to a surplus of US $740 million during the second quarter of the year. This largely reflected an unfavorable performance in the capital and financial account. The performance of the current account was also unfavourable with the deficit widening to US $22.3 million from US $21.9 million in the second quarter of the year.
Zambia’s trade balance rose by 0.5% to US $343.6 million over the third quarter when compared to the second quarter. Merchandise export earnings grew by 4.5%, largely driven by higher copper export earnings. However, non-traditional export earnings fell by 3.4% reflecting the decline in export products such as: cement and lime; machinery and appliances; raw hides and skins; sulphur; gemstones; fresh fruits and vegetables; wheat; and fresh flowers.
Preliminary data suggest that for the third quarter the fiscal deficit, at approximately 0.9% of projected GDP for 2014, remained within the programmed target for the year, largely reflecting Government efforts to contain expenditures. Total revenues and grants at approximately 4.7% of projected GDP were 3.4% lower than the programmed target as a result of lower than programmed grant disbursements, coupled with lower non-tax revenues.
Notwithstanding the above, tax revenues were 10.7% higher than programmed , reflected in the better than projected performance of domestic taxes, notably domestic Value added Tax (V.A.T).
Total expenditures at approximately 6.1% of prospective GDP were 10.8% lower than the programmed level, with lower than programmed spending on non-financial assets, use of goods and services, as well as social benefits.
INDICATORS OF ECONOMIC ACTIVITY
Selected economic indicators tracked by BoZ continue to suggest that the real GDP growth target of 6.5% for 2014 is likely to be achieved.
In the agriculture sector, the stock of maize grain held by the Food Reserve Agency (FRA) rose by 276.7% to 1,294,213 metric tonnes at end-September from 343,581.3 metric tonnes at end-June 2014. Rice stocks also rose by 37.6% to 2,097 metric tonnes. This reflected the domestic purchases by the FRA which, for maize, were higher than the 500,000 metric tonnes allocated in the 2014 Budget.
In the construction sector, the production of cement increased by 29.2% to 401,104 metric tonnes from 310,383.3 metric tonnes during the second quarter.
With respect to the energy sector, electricity generation increased by 1.3% in the third quarter to 3,554,249 Megawatt hours and on a year to date basis, electricity generation at 10,027,044 Megawatt hours, was also 4.4% higher during the same period in 2013.
In the tourism sector, international passenger arrivals at the four international airports increased by 10.3% in the third quarter to 175,265.
In the manufacturing sector production of clear beer and soft drinks rose by 20.8% and 2.6% respectively in the third quarter whilst the production of mineral water declined by 7.5%. However, on a year-to-date basis whilst the production of clear beer fell by 0.9%, the production of soft drinks and packaged mineral water rose by 29.1% and 35.3%, respectively.
Preliminary data indicate that mining sector output might be lower than originally forecast at the beginning of the year, although the prospects for increased mining sector output over the medium term remain strong as new projects come on stream.
THE BANK OF ZAMBIA POLICY RATE
Inflation remains elevated at the current level of 7.9% in October, 2014. Our forecasts are that inflation will remain at these elevated levels throughout the rest of the year and into 2015. This is above the inflation target of 7% for end-December 2015 announced by the Hon. Minister of Finance in the 2015 Budget Speech.
Over the third quarter and into the fourth quarter there has been a material deterioration in the external sector relative to conditions existing in August, when the MPC held its last meeting. This has adversely impacted the domestic economy and is compounded by the more recent declines in the price of copper and global financial flows that have seen the dollar strengthen globally. In addition, the low supply of selected food items may contribute to inflationary pressures.
Given the foregoing, and the need to ensure that the levelling off of inflation pressures over the third quarter is consolidated into lower inflation in 2015, the MPC decided to increase the BoZ policy rate by 50 basis points to 12.5%. The MPC also decided to maintain the statutory reserve ratios at their current levels.
The Bank of Zambia re-iterates its commitment to safeguard macroeconomic stability by focusing on the maintenance of price and financial stability and maintaining a flexible exchange rate regime. The MPC noted that the financial sector remains well capitalized, profitable and stable, and that the fundamentals of the Zambian economy remain strong. As already indicated we are confident that the growth target of 6.5% will be met, with the possibility of an even higher growth rate being achieved in 2014.
The next MPC meeting is scheduled to take place on February 8, 2015. In the interim, the MPC will continue to monitor financial sector developments as well as developments in the broader economy and will not hesitate to take appropriate monetary policy measures that safeguard macroeconomic stability and ensure that the country’s growth objective is not stifled.