Zambia – Policy rate, statutory reserve ratio raised amid kwacha concerns

The Monetary Policy Committee (MPC) of the Bank of Zambia (BoZ, the central bank) elected to raise the policy rate for the first time in eight months at their meeting held on February 28. The benchmark interest rate was increased by 50 bps to 10.25% amid concerns of inflationary pressure emanating from the weakening kwacha exchange rate. Whilst the MPC acknowledged that the near-term upside risks to inflation “are generally on the upside”, the committee expects moderation in food price pressures due to an expected improvement in food supply as the harvest season commences. The policy tightening follows only days after the central bank tightened the belt on local currency liquidity. In a bid to reduce high liquidity levels and thereby support the kwacha exchange rate, the BoZ announced on February 26 that the statutory reserve ratio will be raised by 600 bps to 14%, effective March 10. The minister of finance, Alexander Chikwanda, however indicated that the central bank will refrain from intervening in the interbank market via dollar sales.

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The Zambian statistical authority, the Central Statistics Office (CSO), indicated in their monthly release dated February 27 that inflation accelerated for a fourth consecutive month. The overall consumer price index (CPI) advanced to 136.96 points in February, which translates into an increase in consumer price inflation to 7.6% y-o-y, the highest level since September 2010. CPI Inflation was registered at 7.3% y-o-y in January. Turning to the breakdown of CPI for February, the release indicated that food & non-alcoholic beverages contributed 3.9 percentage points to the overall rate, while non-food products accounted for 3.7 percentage points. Annual food price inflation, which carries a weight of 53.49% in the overall index, quickened to 7.5% in February from 5.9% registered the previous month, which was somewhat offset by a moderation in non-food price inflation. The latter declined to 7.7% y-o-y in February from a January reading of 8.8% y-o-y. Specifically, the growth in clothing & footwear declined to 6.1% y-o-y in February from 7.9% y-o-y in January, while the growth in the household furnishings and utilities indices decreased to 5.9% y-o-y and 8.4% y-o-y in February from January readings of 6.7% y-o-y and 9.6% y-o-y, respectively. The growth in the alcoholic beverages & tobacco index however accelerated to 12.2% y-o-y in February from a January figure of 11% y-o-y.

On a m-o-m basis, overall inflation declined slightly to 0.5% in February from 0.9% in January. On a sub-index level, monthly food price pressures declined to 0.6% in February compared to the previous month’s figure of 0.8%, while non-food price inflation eased to 0.4% m-o-m in February from 1.0% m-o-m in January.

WHY DO WE CARE? The kwacha exchange rate against the US dollar has plummeted by 4.8% y-t-d, posing considerable risk to price stability. While the increase in the statutory reserve ratio and the positive real interest rate should provide some respite for the local unit, we retain our bearish view on the currency, especially against a backdrop of weakening sentiment towards emerging and frontier markets brought about by the US monetary policy normalisation. In recent months, the government has implemented a number of measures to curb the kwacha’s depreciatory trend, including statutory instruments to monitor foreign flows, to little avail. Furthermore, we remain concerned about Zambia’s single-commodity dependence and vulnerability to demand dynamics from key exporter countries (China, Switzerland) and the performance of domestic revenue sources, especially since we consider external buffers to be insufficient, given the government’s debt expansion plans. In the short term, external debt interest payments may drag the currency lower. We are circumspect of the central bank’s ability to achieve exchange rate and price stability whilst fiscal policy is decidedly expansionary, which may give rise to a structural imbalance. Our baseline expectation is for the local unit to shed 5% – 10% of its value in 2014 while we expect CPI inflation to remain broadly stable at an average of 7%.

Analyst: Irmgard Erasmus

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