Rebasing the Zambian Kwacha analysed by Kampamba Shula

Rebasing the Zambian Kwacha

On 23 January 2012, GRZ gave approval to BOZ’s recommendation to rebase the Zambian Kwacha. The change over date has been set for 1 January 2013.

 •The rebasing will involve dividing the existing currency by one thousand (1,000). To illustrate, the current K50,000 note will become K50 following the rebasing exercise.
••The BOZ have indicated that the key drivers for implementing the rebasement are as follows:
1. To facilitate easier business transactions: use of smaller units simplifies accounting and reduces the risk of errors arising from data input and time spent reviewing such financial data.
2. To increase confidence levels in the Zambian currency: People tend to have less confidence in currencies with numerous zeros.
3. To reduce the costs associated with adapting standard accounting packages: Most accounting packages are developed in countries where currencies have significantly few zero’s compared to Zambia. Accordingly, Zambian entities purchasing these accounting packages, are required to customize them by increasing the field size to accommodate multiple zeros, at a cost.
4. To encourage an efficient payment system: the adoption of a rebased currency will enable easier use of vending machines, car park meters and other related technologies. In addition it will avoid the need to carry large sums of money for transactions.
5. To facilitate the introduction of coins: the rebasing of the currency will enable the BOZ re-introduce the use of coins, which are significantly more durable compared to notes.

In 2012 the Zambian Government began discussing plans to re-base the Kwacha. The reason for this was to reduce accounting errors by eliminating three zeros from the currency.

There has been wide media coverage to sensitize the Zambian public on the implications of the new re-based Kwacha. This has created a need for an economic analysis of the new re-based Kwacha.

Key Points

Amounts converted from old to new currency will be rounded off to two decimal places. When the third decimal of an amount converted is equal to or higher than 5, the second decimal is raised by 1. If the third amount is less than 5, the second decimal remains the same. E.g. K38,255 becomes KR38.26 and K38,351 becomes KR38.35. The exception is Wages and salaries, pensions, retirement funds and other social benefits of workers, which should be rounded upwards.
The exchange of old notes over the counter will be limited to K25 million (K25,000 rebased currency) per individual transaction.

Anti- Dollarization

 The anti-dollarization policy eliminated artificial demand of the US dollar, which was created by certain individuals and firms who quoted their services in US dollars. This was a timely move to bring stability to the exchange rate which suffered severe volatility in the earlier part of this year. Let me elaborate, given the rebasing of the Kwacha there is an incentive for individuals and businesses to hold their money in US dollars to keep value. This is understandable, but given that US dollar is not legal tender it will still be changed back to Kwacha. The benefit here is at least artificial demand has been eliminated and market forces of supply and demand can dictate the exchange rate.

Money Supply to Interest rate Policy

Money supply is the amount of total money circulating in the economy. This refers to the summation of notes, bank deposits and coins. The economic abbreviation of this is called M3.The Bank of Zambia was initially using a money supply mechanism to control monetary policy. This proved rather counterproductive as the interest rates remained high at micro-financing institutions though it slightly lowered in Banks. Bank of Zambia now uses an interest rate policy with a rate that stands at 9%.

Now Given the Rebasing it is estimated that the Interest will have rise somewhat to about 10% to cushion upward inflationary pressures.Let me explain further, certain individuals (you may know some or be the one) prefer to keep their money under a mattress or in a ditch on some farm (no pun intended).This money will have to come into circulation in the next 6 months for which the old kwacha will still be legal tender.
BOZ has placed a K25mil (old kwacha) transaction limit to changing the old currency to the new one.This makes an incentive for people with too much money to change at once to use it to purchase goods and services.This will effectively increase money supply and in turn raise the Inflation rate.

Inflation

Zambia has recorded a significantly lower inflation rate in the recent past years which created a solid fundamental ground on which the rebasing of the Kwacha would be sustainably effective. There is however, a high probability that there will be short term upward inflationary pressures as both the new and old Kwacha circulate in the economy simultaneously. This will increase the money supply temporarily as the old Kwacha will still be legal tender for at least 6 months.

The re-basing of the Kwacha has one notable change to the currency which is a hedge against inflation, Coins. The introduction of Coins as legal tender back into the Zambian economy will help keep inflation low in the long run, effectively. It may take some time for society to come to terms with the new coins which many may perceive as an inconvenience, which indeed they are, but a necessary one as I will explain.

By virtue of their nature coins are rather cumbersome to move around with. This inconvenience is surprisingly a component of a hedge against inflation. The velocity of money is higher at the lower ends of currency strength, meaning money changes hands faster at lower notes e.g. K10, K2, K1. Given the introduction of Coins this velocity is reduced which in turn reduces the growth in money supply and effectively inflation in the long run. Once most people have collected enough coins they will usually go to the Bank and change them, the Bank will in turn give its customers coins back from deposits thereby maintaining a stable money supply.

The most effective hedge against inflation that coins provide is in the overall circulation of bank notes. Unlike Zambia’s previous currency regime, coins allow for limitation of the notes in circulation by accounting for a decent portion of the total money supply in the economy.

Last but not least is what many would call a disadvantage of coins, they easily get lost. Surprisingly though this is also a hedge against in inflation as it marginally diminishes the money supply, thereby keeping inflation low.

Round off Inflation

Amounts converted from old to new currency will be rounded off to two decimal places. When the third decimal of an amount converted is equal to or higher than 5, the second decimal is raised by 1. If the third amount is less than 5, the second decimal remains the same. E.g. K38,255 becomes KR38.26 and K38,351 becomes KR38.35. The exception is Wages and salaries, pensions, retirement funds and other social benefits of workers, which should be rounded upwards.
"Round off Inflation" is a term that I have coined myself to describe the slight inflation or general increase in prices due to rounding off from the old to the new currency.This could affect essential commodities and luxury goods.For example for Shop owners who have been given a Government mandate to quote both the old and new price this will not be a problem.However for deals done on the "street" this will be a big opportunity for sellers to slightly increase their prices without consumers noticing the difference.This will cause round off inflation.

Advantages of Rebasing	Disadvantages of Rebasing
Reducing Accounting Errors	Adjustment phase may be frustrating
More accurate estimation of Money supply	Short term inflationary pressures
Creates Global confidence in Kwacha
More Effective Monetary policy

It must be emphasized that the downside to re-basing the Kwacha is the inevitable upward inflationary pressure. Part of this will stem from the dual circulation of both the new and old Kwacha but this will be rectified once the old Kwacha is no longer legal tender. The other part of this inflationary pressure will arise from the food and commodity prices. This will be because some wholesalers and retailers will have an incentive to slightly over quote their prices during this transition phase. This could have us see a visibly higher food and commodity inflation rate unless the Zambian Government steps into to regulate this transition. It can be foreseen that the Consumer could suffer unless corrective action is taken to ensure this does not happen.

Exchange rate
The Kwacha has been trading at about K5200 to the US dollar with a lower level of K5000 and an upper level of K5400.Check the graph below

  

 The graph above was prepared by myself with data that was made available to me for the period.
With Rebasing coming to effect I estimate that the Dollar will gain against the Kwacha.This is because a short term incentive for investors and BIG players will exist to short the Kwacha.In other words they will sell their Old Kwacha and trade it into Dollars until they feel the exchange rate has stabilised.This will drive up the Kwacha to about K5.5 with an upper limit of K6 to the Dollar.
These are only estimations and I will not be held responsible for trades and transactions made on this information.