Editor's note : The Bank of Zambia released its quarterly monetary policy statement in August. It noted the need for fiscal consolidation, by addressing revenue shortfalls and rationalising expenditures, in order to achieve fiscal sustainability and lower government security yield rates.
The Monetary Policy Committee (MPC) held its meeting on 10th August 2015. The MPC considered developments in the global and domestic economies during the second quarter of 2015, the outlook for the third quarter and to decide on the monetary policy stance aimed at achieving the Central Bank’s inflation objective in order to support macroeconomic stability.
GLOBAL ECONOMIC DEVELOPMENTS
The Committee observed that the trend of weak growth in the global economy evident in the first quarter of 2015, was sustained during the second quarter. Major emerging market economies, such as China, Russia and Brazil, continued to be sources of weakness to global economic growth, with deflationary consequences on most commodity prices. Over the quarter, the average prices for copper and crude oil (Dubai), for example, fell to US $5,833.0 per metric tonne (mt) and US $ 61.3 per barrel from US $6,295.0 per mt and US $63.7 per barrel, respectively. In addition, the brighter growth outlook in advanced economies, particularly in the USA, increased the prospects for interest rate hike over the next 12 months. This shifted investor preferences in favour of US dollar denominated assets and further supported the strengthening of the US dollar. As a result, there was pressure on the currencies of emerging market and developing economies which led to increased currency volatility and outflow of capital from these economies.
To address the increased depreciation and volatility in the exchange rate, which was likely to feed into higher inflation, the MPC raised the statutory reserve ratio on both Kwacha and foreign currency deposits from 14% to 18% effective on April 8, 2015. As a result of the tightened liquidity conditions, the interbank rate remained slightly above the upper bound of the policy rate corridor of 14.5% for most of the quarter.
Annual overall inflation declined marginally to 7.1% in June 2015 from 7.2% in March 2015. The decline was due to continued tight monetary conditions, complemented by improved seasonal supply of food items, as well as the pass-through effects of lower pump prices that led to favourable transportation and distribution costs. Food and non-food inflation declined to 7.1% and 7.0% in June 2015 from 7.2% and 7.1% in March 2015, respectively.
MONEY AND GOVERNMENT SECURITIES MARKETS
The further tightening of liquidity conditions through the increase in the statutory reserve ratio led commercial banks to rely on the interbank market and the overnight lending facility to manage their short-term liquidity needs. Consequently, the interbank rate rose to 14.6% at the end of June 2015 from 12.9% in March 2015. With the auction sizes for Government securities unchanged, the decline in liquidity levels resulted in lower subscription rates on Treasury bills and Government bond auctions. The subscription rates declined to an average of 42% for both from averages of 68% and 60%, respectively. Consequently, the Treasury bills composite yield rate increased to 21.2% from 19.6%, while the composite yield rate on Government bonds rose to 23.8% from 21.0% in the previous quarter. The 364-day Treasury bill continued to attract most bids, largely reflecting the elevated yield rate. With regard to Government bonds, investor appetite was concentrated in the 5-year maturity.
MONEY SUPPLY, CREDIT AND INTEREST RATES
Money supply declined by 1.6% during the second quarter to K36.9 billion from K37.5 billion in the first quarter, reflecting the tightened monetary policy stance. Correspondingly, growth in domestic credit slowed down to 1.7% compared with the 12.8% growth in the first quarter of 2015. This was mainly due to a decline in lending to private enterprises that fell by 1.3%.
The average lending rate for commercial banks rose marginally to 20.6% at end-June from 20.3% as at end-March 2015. However, the average savings rate (ASR), for amounts above K100, and the average 30-day deposit rate, for amounts exceeding K20,000, declined marginally to 3.3% and 6.4% from 3.5% and 6.6%, respectively.
With the decline in inflation and the rise in nominal interest rates, real lending rates increased. The average real lending rate rose to 13.5% in June 2015 from 13.2% in March 2015. Similarly, the real average 30-day deposit rate, for amounts above K20,000, increased to -0.7% from -0.8%, while the real ASR, for amounts exceeding K100, remained unchanged at -3.8% in the quarter under review.
FOREIGN EXCHANGE MARKET
Weaker commodity prices, adverse external flows, and the strengthening of the US dollar meant that external sector developments had a negative impact on the current account balance and the performance of the Kwacha in the second quarter.
However, the tightening of monetary policy provided support to the local currency. The Kwacha appreciated by 0.9% and 0.8% against the US dollar and the South African rand to end the quarter at K7.5117/USD and K0.6172/ZAR respectively. However, it depreciated against the British pound and the euro by 5.7% and 3.7%, to close the quarter at K11.8459/GBP and K8.4397/euro, respectively.
The current account deficit widened to US $305.9 million, from US $83.6 million recorded the preceding quarter, on account of unfavourable performance in the balance on goods, services, and the primary income account. The trade account recorded a deficit of US $12.5 million compared with a surplus of US $262.2 million recorded the previous period, following a decline in goods exports and a rise in goods imports.
Preliminary data show that the overall Balance of Payments (BoP) deficit during the second quarter of 2015 narrowed to US $27.8 million from US $405.2 million during the first quarter of 2015 following improvement in the financial account.
The continued weakness in the external sector is reflected in lower export earnings and foreign exchange supply and consequently exerting pressure on the exchange rate to depreciate.
FISCAL SECTOR DEVELOPMENTS
In his 2015 Mid-year Economic and Budget Review Statement, the Hon. Minister of Finance indicated that due to unanticipated external and domestic developments, the budget deficit was expected to be higher than innitially projected in 2015. He also indicated that going forward, the Government would address revenue shortfalls and rationalize expenditures to achieve fiscal consolidation. We welcome these actions by the Government as fiscal consolidation, along with appropriate monetary policy actions, will support macroeconomic stability and growth.
THE BANK OF ZAMBIA POLICY RATE
The MPC decided to leave the policy rate unchanged at 12.5%. In arriving at this decision, the Committee took into account the external and domestic developments discussed above. The MPC also took into account the following factors:
- In the third quarter of 2015, annual inflation is projected to be slightly above the end year target of 7.0%.
- However, emerging risks to the real economy arising from power rationing (electricity load shedding) are expected to adversely impact economic growth. In this regard, external and domestic risks to inflation must be balanced against the risks of a sharper decline in economic output than earlier anticipated, given the emerging challenges in the energy sector.
- Liquidity conditions continue to be tight following the increase in the statutory reserve ratio to 18% from 14%. The Committee is of the view that this measure, along with Open Market Operations, will continue to help contain inflationary pressures.
Fiscal consolidation, by addressing revenue shortfalls and rationalising expenditures, will help to achieve fiscal sustainability and lower government security yield rates. This is critical to achieving a stable macroeconomic environment which is essential for lower interest rates that support economic growth.
The next MPC Meeting will take place on 10 November, 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.