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New BoZ governor tasked with finding “magic wand” to stem Zambian kwacha slide

Denny Kalyalya was inaugurated as Bank of Zambia (BoZ) governor on Wednesday, March 18. The new central bank chief was appointed at a time of currency market turmoil, with the kwacha exchange rate reaching multiple all-time lows in recent days, and amidst an on-going impasse between the State and the mining sector with regard to the new mining fiscal regime. President Edgar Lungu tasked Mr Kalyalya, a former World Bank director, with restoring exchange rate stability, stating that “we expect you to find the magic wand and I know you will… We cannot say because the currencies in the region are failing we should allow our kwacha to slide where it is today.”

 Dr Kalyalya was appointed to the top spot amid a rout in the kwacha that is seeing fundamental concerns exacerbated by weak sentiment. The kwacha’s recent strong depreciation can be ascribed to idiosyncratic factors – scant hard currency inflows, some front-loading of US dollar purchases, and broader concerns regarding policy continuity, with yet another president showing health problems in office and the mining fiscal regime not revised as yet – against broader dollar strength. The drivers of kwacha weakness will need to be addressed to return the kwacha to stability: increasing policy transparency, quickening the pace of fiscal consolidation, and returning the goods trade position to health.

 The deterioration in the operational environment ascribable to political risk is increasingly spilling over to the monetary environment as well, shifting the onus on the monetary regulator to enforce a conservative policy to combat external vulnerability. The role of the BoZ’s Monetary Policy Committee (MPC) with regard to foreign exchange stability will thus be limited in the absence of policy reform and the current account’s return to health. It should furthermore be noted that a more conservative monetary policy stance will hurt domestic demand and private sector expansion.

 The absence of adequate government response to miners’ concerns will recede the central bank’s role to a defensive one, utilising monetary tools to ward off a balance of payments event without establishing confidence in the local unit. Political pressure towards a more accommodative monetary policy stance aside, a tightening bias with regard to the monetary policy stance is expected during 2015, including (but not limited to) more conservative liquidity management in support of the local currency. The thin foreign reserve buffer is inadequate to withstand a prolonged shock to the copper price; as such, the MPC could supplement open market operations and dollar sales with interest rate tools in order to avoid a rundown in foreign reserves.

There is an element of overshooting involved in kwacha depreciation, although recovery will likely only be limited and fall short of regaining recent losses. Foreign factors (the dollar-positive US interest rate normalisation) will be pivotal drivers of kwacha weakness in coming months – due to broader dollar strength, emerging and frontier market currencies will generally be worse off. This will be exacerbated by a negative trend in the goods trade position. As such, the revision of the mining fiscal regime should take high priority. This will become an increasingly time-sensitive issue as the spotlight is placed on US interest rate normalisation, which will negatively impact emerging and frontier market countries, especially single-commodity exporters.

Considering the downside risk to the copper price, further suspension of mining operations could be on the cards if the mining fiscal regime is not revised, or not revised to an adequate extent to return copper mines to profitability. This will impact not only the kwacha, but the fiscal and current account positions as well. However, this view implies that even if the mining fiscal regime is revised, the kwacha will not recover recent losses to the full extent. The revision will have a positive impact, but the kwacha will retain a bearish bias due to foreign factors.

On top of the country’s existing fiscal challenges, the government has reinstated the maize (corn) consumer subsidy at an estimated cost of ZK221m to the fiscus. The Ministry of Agriculture announced on March 17 that the price of a 50 kg bag of maize (sold to millers) was reduced from ZK76 to ZK65. The government furthermore gave the green light to the Food Reserve Agency (FRA) for the sale of a maximum of one million tonnes of maize on the domestic and export markets. With regard to the wheat deficit, the government has lifted a ban on wheat imports and waived the 15% import duty on wheat.

 Irmgard Erasmus (Fixed Income Analyst)

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