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Monday, 16 March 2015

Killing the Kwacha, Revisited

The Kwacha has fallen to a record low against major global currencies (dollar, sterling and Euro). It currently stands at around K7.4 per US$1. This is worse than the collapse last year. 

The recent sharp falls appear to be driven by the strengthening of the dollar, as well as concerns around Lungu's health which has amplified existing policy uncertainty. But that is only a small part of a larger negative trend.

The Kwacha has been steadily falling since September 2014 after a period of strengthening last year when BoZ tightened liquidity and Chikwanda abolished SI33 & SI55. That is if you believe Gondwe and Chikwanda's version of their alleged "heroic" interventions. 

Our view is that those measures were mainly cosmetic. What actually strengthened the Kwacha was Chikwanda's signal of a new IMF programme at a time when policy confidence in Sata's government was low. 

The proposed IMF deal (similar to Ghana's current arrangement) was intended to restore policy credibility given the Sata administration proclivity to spend and spend.  But around early October 2014 it became clear that the IMF deal was unlikely to happen anytime soon given Sata's health. The Kwacha has continued to fall ever since. 

Of course since then many other factors have weighed negatively including the uncertainty around the presidential by-election results and impasse with mining companies over the VAT (now partially resolved) and the new mining fiscal regime (in force, but still under negotiation). 

Globally, the outlook on copper prices remains negative off the back of a slowing Chinese economy. When this is coupled with a tougher fiscal regime all of a sudden the Kwacha finds itself struggling for dollar supply.

The problem with a rapidly depreciation of the Kwacha is that it always risks generating a spiral effect. Government debt repayments become dearer and other costs of doing government business increases. On the production side the cost of imports also rise sharply (with inflationary risks).

On top of all this the Kwacha’s volatility (as we have seen in recent months) brings its own challnges. With reserves currently low the central bank has little room to manage downward volatility. 

This further makes the Kwacha a riskier alternative for investors because it becomes inherently unpredictable. It is also a big problem for domestic businesses who may find themselves struggle with planning future decisions. 

There's also the important point that low reserves (from increased BOZ intervention to maintain stability) reduces confidence in Zambia's ability to service foreign loans. This is why dwindling foreign currency reserves are always associated with a deterioration in a country’s credit worthiness. 

We make that point because there are many who are wondering why BoZ is not keeping the Kwacha at a certain level. Well it probably can't (as seen by the volatility) and shouldn't even attempt to do so (given its low reserves). 

Of course, it goes without saying that any spiral effect may lead to future credit downgrades, which may in turn lead to much higher cost of future repayments, and possibly greater indebtedness. It is not called a spiral for nothing. 

But this is not to say we are in this bleak spiral position. Our purpose is merely to point out the risks and draw your attention to why stability of the Kwacha is vital for the economy. We also aim to encourage more meaningful and informed debate rather than mere exchange of political slogans.

Chola Mukanga 
Copyright © Zambian Economist 2015

1 comment:

  1. The Press hasn't exactly been full of well thought out econonic measures streaming from the Min of Finance to shore up a failing economy has it? The clock is ticking. Once the first mine actually fails the economy will fall-in on itself very quickly. Things then become irreversible.

    There are two men with the power to take the difficult decisions: ABC and the President. Brinksmanship is not what's required when so much is at stake.



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