Editor's note : The Bank of Zambia released its quarterly monetary policy statement this week. It notes that lower than programmed revenue is putting pressure on the financing requirements for the Budget from the domestic market which is causing yield rates on Government securities to rise. BOZ believes "further fiscal adjustments are required to address revenue shortfalls and rationalise expenditure to achieve fiscal sustainability. This is critical to achieving a stable macroeconomic environment going forward"
The Monetary Policy Committee (MPC) met on 12th May 2015 to consider developments in the domestic economy as well as global economy over the first quarter of 2015, outlook for the second quarter and decide on the Policy Rate to achieve the Central Bank’s inflation objective to support macroeconomic stability.
GLOBAL ECONOMIC DEVELOPMENTS
The Committee observed that the global economy continues to post modest recovery. According to the IMF WEO, global growth is estimated at 3.4% in 2014 and projected at 3.5% in 2015. Underlying this growth is recovery in advanced economies, particularly the United States and the United Kingdom and a slowdown in emerging and developing economies. However, in advanced economies, there are different monetary policy stances with the United States’ Federal Reserve expected to raise interest rates from near zero in 2015, whilst in the Euro area and Japan, monetary policy will remain highly accommodative. The anticipated increase in interest rates in the United States poses challenges for emerging and frontier economies, including Zambia, as it is likely to be associated with adverse capital flows and increased volatility in exchange rates.
During the first quarter of 2015, commodity prices generally declined. The average price of copper fell to US $5,940 per metric tonne from US $6,445 per metric tonne in the fourth quarter of 2014. The average price of crude oil also declined to US $55.8 per barrel from US 62.3 per barrel during the same period. These developments could worsen Zambia’s terms of trade in the near term.
At its February 2015 Meeting, the MPC noted improved inflation developments. With inflation projections trending towards the 2015 target of 7%, the MPC decided to maintain the Policy Rate at 12.5%. However, towards the end of the first quarter, exchange rate volatility increased threatening to undermine the inflation objective. To address this, in March, the Bank of Zambia (BoZ) raised the statutory reserve ratio on both Kwacha and foreign currency deposits from 14% to 18% effective on April 8, 2015.
Annual overall inflation slowed down to 7.2% in March 2015 from 7.9% in December 2014. This was mainly attributed to the decline in both food and non-food inflation to 7.2% and 7.1% from 7.5% and 8.4%, respectively. The decline in food inflation was mainly due to sales of maize grain by the Food Reserve Agency at lower than market prices to moderate mealie meal prices as well as increase availability of fresh food items. On the other hand, the fall in non-food inflation was mainly attributed to the reduction in fuel pump prices by the Energy Regulation Board.
DOMESTIC MONEY MARKET AND GOVERNMENT SECURITIES
Over the first quarter of 2015, liquidity conditions tightened. The supply of liquidity tightened mainly on account of net BoZ sales of foreign exchange to the market, sales of Government securities, and withdrawals through open market operations. With the tightening in liquidity conditions, the volume of funds traded in the interbank money market declined and the overnight interbank rate edged upwards to 12.9% in March 2015 from 11.5% in December 2014.
In the Government securities market, the auction sizes remained unchanged. The auction subscription rate for Treasury bills increased to 68% compared with 52% in the fourth quarter of 2014. In terms of maturity preferences, the 364-day Treasury bill tenor attracted the most bids, largely reflecting the elevated yield rate. In the case of Government bonds, the subscription rate fell to 60% from 92.5% in the fourth quarter of 2015. Investor maturity appetite remained skewed towards the 3-year and 5-year benchmark bonds.
With regard yield rates, the Treasury bill composite yield rate edged up to 19.6% from 18%. At 21.1%, the Government bonds composite yield rate was virtually unchanged from 21.0% in the previous quarter.
DOMESTIC CREDIT, MONEY SUPPLY AND INTEREST RATES
During the first quarter of 2015, domestic credit grew by 12.8% from 12.1% in the fourth quarter. Similarly, money supply grew by 7.2% compared to 4.0% in the fourth quarter of 2015. Underlying this growth was increased lending to both the private sector and the Government. Commercial banks’ credit to the private sector rose by 4.9% compared to the 0.2% recorded in December 2014, with the agriculture, wholesale and retail trade, and mining and quarrying sectors as the major recipients.
Commercial banks’ average lending rate remained unchanged at 20.5%. Similarly, the average savings rate, for amounts above K100, remained at 3.4%, while the average 30-day deposit rate for amounts exceeding K20,000 declined marginally to 6.4% from 6.6% in December. Following the decline in inflation, the real average lending rate rose to 13.2% in March 2015 from 12.6% in the previous quarter. However, real deposit rates remained negative with the real average 30-day deposit rate for amounts above K20,000 at 0.8% and 3.8% compared to 1.3% and 4.5%, in the previous quarter, respectively.
The level of activity at the Lusaka Stock Exchange dropped in the first quarter of 2015. Market capitalisation fell by 1.6% to K65,395.0 million from K66,456.0 million in the fourth quarter of 2014. In addition, the All-Share index marginally declined to 6,103.7 from 6,160.7 previously. In terms of non-resident participation, the stock exchange recorded a net outflow of portfolio investment of US $5.8 million, compared with a net inflow of $0.8 million in the previous quarter as a total of US $2.0 million worth of stocks was bought against sales of US $1.9 million.
FOREIGN EXCHANGE MARKET
The supply of foreign exchange on the market declined during the quarter under review as reflected in lower sales of foreign exchange to commercial banks by the public, mining companies and foreign banks. To minimize volatility in the foreign exchange market, the BoZ intervened directly to address some of the lumpy demand in the market mainly related to fuel and fertilizer imports..
Rising demand, amidst lower supply and a stronger US dollar, resulted in a weakening Kwacha against the four major trading currencies notably the US dollar, British pound, Euro and South African rand currencies. This was compounded by declining copper prices, adverse sentiments emanating from the newly-introduced mining tax regime for fiscal year 2015 as well as the Fitch Credit Rating’s downgrade of the economy. By the end of the quarter, the Kwacha depreciated by 19% against the US dollar to end the quarter at K7.5767. Similarly, the Kwacha registered a loss of 5%, 12% and 13% against the Euro, British pound and South African Rand to close at K8.1419, K11.2041 and K0.6221, respectively.
Preliminary data indicate that the overall balance of payments deficit widened to US $405.2 million from US $131.9 million recorded during the fourth quarter of 2014, largely on account of unfavourable performance in both the current and financial accounts.
The current account deficit widened to US $223.3 million from US $179.6 million recorded the previous quarter, driven by a decline in the surplus on the balance on goods and lower secondary income inflows. The surplus on the balance on goods was 56.9% lower than the preceding quarter, explained by a higher decline in goods exports relative to imports. Goods export earnings were 31.2% lower than in the previous period, largely due to a 40.5% fall in copper export earnings following the drop in both realised prices and export volumes. Non-traditional exports decreased by 3.3% explained by lower earnings from petroleum products, fresh fruits and vegetables, electrical cables, raw hides and skins, gemstones, cotton lint, industrial boilers, cement and lime, electricity, sulphur, copper wire and fresh flowers. The general decline observed in most non-traditional exports could partly be attributed to lower global prices, increased local demand for some products and challenges related to the Vat refunds. Lower donor inflows accounted for the decline in the secondary income account balance by 83.1%.
Further, the capital account recorded a 19.8% decline on account of lower project grants. Similarly, the financial account deficit widened to US $220.5 million from US $1.8 million the previous quarter, following a higher accumulation of investment assets by the private sector.
FISCAL SECTOR DEVELOPMENTS
Preliminary data indicate that a budget deficit of 1.5% of GDP for the Central Government was recorded during the first quarter mainly due to lower than programmed revenues. Total revenue and grants were 3.0% lower than programmed as a result of lower non-tax revenues attributed to weak performance in mineral royalty revenues and the non-receipt of grants. On the other hand, total expenditure was 4.0% lower than the programmed amount. Lower than programmed revenue is putting pressure on the financing requirements for the budget from the domestic market which is causing yield rates on Government securities to rise.
The MPC decided to leave the policy rate unchanged at 12.5%. In arriving at this decision, the Committee took into account a number of factors including the following:
(a) The MPC noted the recent downward movement in inflation from 7.9% in December to 7.2% in March 2015, with non-food inflation being the main driver. This development is partly a reflection of the monetary policy measures taken in 2014 as well as the reduction in fuel pump price.
(b) The onset of the crop marketing season in the second quarter is expected to moderate inflationary pressure.
(c) The MPC also took account that monetary policy was recently tightened through the upward adjustment in the statutory reserve ratio from 14% to 18% effective 8th April 2015 and the impact of this measure is yet to be fully realized.
(d) The recent decision by the Government to resolve the 2015 mining tax impasse is likely to help dampen the negative sentiments in the economy and mitigate inflationary pressures.
To complement monetary policy, further fiscal adjustments are required to address revenue shortfalls and rationalise expenditure so as to achieve fiscal sustainability. This is critical to achieving a stable macroeconomic environment going forward.
The next MPC Meeting will take place on 11th August, 2015. In the meantime, the MPC will continue to monitor domestic and external developments and stands ready to take appropriate monetary policy measures to support macroeconomic stability.
Copyright © Zambian Economist 2015