The Inevitable Depreciation of the Zambian Kwacha - Causes, Consequences and Policy

Zambia is mostly a commodity exporting based economy with a lot of business people importing most of their tradables for sale. Hence when the kwacha depreciates the incentive for local business people to raise their prices is high. There is a general view among the public that a “strong” kwacha represents a strong economy. This view while having its merits is flawed for several reasons. Firstly most of Zambia’s exports are copper; hence a strong Kwacha usually means that copper prices are sufficiently high to sustain favorable exchange earnings. Secondly this view undermines the Government’s effort to diversify the economy away from copper. 
In Zambia outside the minerals sector, exported output is low, imported inputs high, and foreign currency debt low. These combine to create a strong probability that a depreciation of the currency would generate net disincentives to agricultural and manufacturing producers in Zambia. It is for this reason that many in the government and the private sector argue in favor of a "strong" (appreciating) currency, as a necessary support for diversification into agriculture and manufacturing. 
Currency appreciation is a blunt instrument to stimulate diversification, all the more because other instruments not involving the exchange rate can better target the desired outcome of domestic output and export diversification. This is the policy dilemma that exists in Zambia. The current policy attempts to promote diversification, but at the same time prevents the incentive for exporters to gain from increased foreign revenue. This is the same as attempting to cut a loaf of bread with a spoon; it’s very possible but clearly not a preferable course of action in light of conventional etiquette. 
If an economy is at less than full utilization of resources an appreciation will tend to reduce aggregate demand. The demand reducing effect comes through the cheapening of imports which would in the medium term lower domestic production of importables. For a non-diversified developing country, Zambia being an obvious case, nominal appreciation should result from long run increases in the productivity of exportables combined with declining structural inflation. This combination allows for continued export competitiveness and a "stronger" currency. Obvious examples of countries experiencing this benign combination are Japan and Korea. For Zambia this combination lies in the distant future. How distant that future is depends on policy implementation. 
Copper dominates the external trade of Zambia, and the nominal exchange rate has little short term impact on metal production or export. Zambia does not export copper because of comparative advantage in which relative factor scarcities determine comparative costs. In the case of Zambia, copper exports result from a specific natural endowment. In the absence of policy intervention by the Zambian government or Bank of Zambia, the level of the Kwacha responds to domestic copper production and the international price, on the one hand, and the international prices and domestic demand for major imports. 
In 2014 the Kwacha depreciated by 14% against the US dollar, whilst over the first quarter of this year it has depreciated by 15.6%. 
Exchange rate movements are strongly affected by the policies of the mining companies as to where they deposit and hold their export earnings. Were the mining sector in public ownership or if the private companies operated with full transparency, reported domestic production exports would accurately indicate foreign exchange earnings from the sector. 
The supply of foreign exchange by the mining sector has recently fallen relative to demand, and this cannot be purely explained by the reduction in domestic production because we have seen higher mining sector exports in 2014. The world copper price is the major short term influence on the level of domestic production, and this is the most important determinant of exports. This production requires imported inputs, and the copper sector trade balance represents by far the largest component of the overall trade balance. The foreign exchange market policies of the mining companies directly impact on flow of export revenue into the national economy. 
Diverging central bank policy has created a perfect launch pad for the dollar to move higher, particularly against the euro. The recent strengthening of the US dollar globally is also a reflection of the demand for US dollars relative to other currencies including the Kwacha. 
Inspection of the capital account balance shows a substantial increase in its instability since 2009. Because of the overwhelming importance of copper in the Zambian economy, it is obviously the case that the metals sector would be a primary determinant of capital account movements 
The exchange rate of the Kwacha against other currencies is determined in the interbank market. This market responds to both fundamental factors such as some of the demand and supply factors related to external trade, but it also responds to sentiments which tend to drive demand and supply away from fundamentals. Other issues have been raised with respect to mining tax policy and value added tax which also impact on sentiment in the market. 
The deterioration in the external sector continued in the fourth quarter of 2014 and the situation seems to be worsening at the beginning of 2015. Overall balance of payments deficit widened driven by unfavorable performance in both the current and financial accounts. The decline in export earnings is mainly explained by a contraction of 7.8% in copper export earnings following a decline in export volumes and averaged realized copper prices. The current account in 2014 registered a deficit of US $431 million, when compared to a deficit of US $284 million in 2013. Non-traditional exports fell from of US $3.6 billion in 2013 to an estimated US $2.2 billion in 2014 a drop of 39%. 
The hard reality of Zambia’s so-called liberalized reforms when placed against other liberalized markets of the US, Japan and the European Union (EU) shows that Zambia’s money markets are not liberalized due to structural imbalances in allowing for equal access to US dollar inflows. 
For many years the Zambian Government, NGOs, General Public and other stakeholders have talked about how much Zambia needed to diversify its economy away from copper. Despite a good 
performance in non-traditional exports over the past decade, copper still accounts for over 70% of Zambia’s exports. That statistic alone shows that the diversification policy has failed to live up to its expectations. 
Unless the export base expands the depreciation of the Zambian Kwacha, however moderate is inevitable. As long as policy makers continue to use the exchange rate as a policy instrument to stimulate diversification instead of using better tools, this policy will be an exercise in futility, however moderate. 
Monetary Policy; The Bank of Zambia needs to look at alternative measures of Quantitative tightening. Raising interest rates and reserve ratios are overused policy instruments which usually squeeze credit liquidity and make borrowing expensive for most stakeholders. There is another option, its effectiveness is up for debate but it is always worth the try. It is reverse quantitative easing or otherwise known as quantitative tightening. But this one is specific to the bond market. This means the Bank of Zambia will trade long term treasuries for short term treasuries, effectively draining the market of liquidity, without raising the rates. For this to work it would require shortening treasury periods from 3 months to one month to make it more effective. This is by no means guaranteed to be effective but it is a tool at the disposal of the Bank of Zambia. 
Secondly, the Bank of Zambia needs to make a concerted effort to make the foreign exchange market in Zambia more asymmetrical in terms of information and access to foreign exchange flows. The market in its current state has structural imbalances caused by a skewed control by mining companies and a few big traders. Sorting this out will prevent consistent deviations of the Zambian Kwacha from fundamental levels. 
Thirdly, the Ministry of Finance needs to aid the Bank of Zambia by Identifying the relevant practices by the mining companies, how these impact on the balance of payments, and whether government policy intervention is necessary. This area needs to be looked into thoroughly. 
Another policy recommendation regards how Official foreign exchange flows report that Switzerland is the largest importer of Zambian copper, a confusing statistic. Inspection of statistics from Switzerland show that the country neither imports nor exports copper, merely serving as the site for the buying and selling of copper contracts without any physical trade in copper ore or copper in any stage of processing. The ministry of Finance in collaboration with the Bank of Zambia and Ministry of Mines should create a copper contract exchange which mirrors and facilitates the same trade taking place in Switzerland. This option will require resolve as Zambia may effectively be cutting out a middleman. 
The last recommendation refers to the use of currency appreciation as a policy tool for diversification. This has to stop. If the Kwacha depreciates fundamentally, then let it depreciate moderately. Import input costs are high because of other reasons than merely the exchange rate. Zambia can review its import tariffs on inputs and even introduce tax relief for importers of inputs for manufacturing which has a higher return on tradables as the sectoral price indices indicate that the relative return was higher from manufacturing than agriculture. In short, policy should focus more on diversifying into manufacturing while looking for ways to increase productivity in agriculture.

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Strong Dollar - An Inflated Currency in a Deflated Global Economy by Kampamba Shula

With flexible exchange rates and wide-spread abandonment of capital controls the dollar is largely free to move up or down as market forces dictate
In this framework it is reasonable to infer that any observed weakening or depreciation of the dollar is most likely the result of a reduced demand for dollars in the foreign exchange market, an increased supply of dollars in that market, or some combination of both forces. Similarly, an appreciating, or strong dollar, is the consequence of an increase in the demand for dollars, or a decreased supply of dollars, or both in the foreign exchange markets.
The volume and speed of international asset transactions far exceed those of goods transactions. This means that at any point in time it is most likely that the relative demand for assets here and abroad will be the dominant force in the foreign exchange market, transmitting the essential energy that drives movement in the exchange rate for the dollar and other widely traded currencies.
Expectations about the future path of the exchange rate itself will figure prominently in the investor’s calculation of what she will actually earn from an investment denominated in another currency.  Even a high nominal return would not be attractive if one expects the denominating currency to depreciate at a similar or greater rate and erase all economic gain.  On the other hand, if the exchange rate is expected to appreciate the realized gain would be greater than what the nominal interest rate alone would indicate and the asset looks more attractive.
There is also likely to be a significant safe-haven effect behind some capital flows.  This is really just another manifestation of the balancing of risk and reward by foreign investors. Some investors may be willing to give up a significant amount of return if an economy offers them a particularly low risk repository for their funds. In recent decades the United States, with a long history of stable government, steady economic growth, and large and efficient financial markets can be expected to draw foreign capital for this reason.
The greenback is trading at a 12-year high against the euro and 8-year high versus the Japanese yen. This strength is, in many respects, a sign that the economy in the United States is much healthier than Europe, Japan and many other parts of the world. The strengthening of the USD in recent times has caused some element of volatility in the currency markets across the globe and almost all emerging markets' currencies have been affected on this score as they have tended to depreciate.
The US Federal Reserve has withdrawn the QE completely on the premise that the economy is picking up and that unemployment levels are low and within acceptable limits. This indicates that the economy is going to record a healthy growth rate from 2015 onwards. Also, interest rates are expected to increase in mid-2015 with the Fed tracking the inflation numbers.
Quantitative easing meanwhile continues to be dominating the economies of Japan and the euro region with China is also showing signs of easing rates. Any kind of affirmative action to revive an economy is taken to mean a weak economy and by implication a weak currency. This has propped up the USD which appears to be the strongest currency today.
Diverging central bank policy has created a perfect launch pad for the dollar to move higher, particularly against the euro. The Fed is expected to push interest rates higher in the next several months, while the European Central Bank embarked on a quantitative easing bond buying program recently. Some analysts expect the Fed to hike rates in September. The currency-weakening moves by the SNB, ECB and others across the globe have spurred talk about a renewed currency war as countries adopt a beggar-thyneighbor policy to spur growth.
Generally, the financial health of a country, as measured by deficits and debt and forecasts of deficits and debt accumulation, plays an important role in driving the relative currency valuation of a particular country. Countries that have chronic deficits and growing debt burdens ultimately end up in a weaker position in the foreign exchange markets, albeit sometimes with considerable lag times.
The present strength of the dollar is temporary and can also be seen as the penultimate stop in a flight to safety. When the next financial crisis unfolds as it surely will gold, precious metals and even structured alternatives like bitcoin are likely to be the next and last stop.
Predicting the path of the dollar is always a problematic endeavor.  Economic fundamentals predict that the dollars near-term path will broadly reflect the resolution by international investors of an ongoing balancing of risk and return.
Economic growth in the United States in 2014 showed signs of recovery and this may have translated into an increase of the expected return on dollar assets. In addition, the Fed is expected in mid-2015 to increase short-term interest rates. In contrast, both the euro area and Japan have demonstrated that they have firmly established economic contractions underway, and they have currencies that are not expected to appreciate. These changes suggest that the expected yield advantage of dollar assets has been strengthened. If so, this presents foreign investors, with an already strong need to diversify into dollar assets of an attractive sustained and safe rate of return. This change in incentives could be sufficient to induce a significant move away from yen and euro assets.
The US dollar is expected to appreciate over the near term against major convertibles. The reason for this is mostly down to a global monetary policy divergence between the U.S and the rest of the world. With the EU and Japan fighting deflation using QE, they are inadvertently propping up the Dollar.
This appreciation of the Dollar though due in a small part to stronger US growth is at the most part an inflated effect of deflated global economy. A disorderly adjustment is probable, but not inevitable.

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Oil Price Fall: Supply, Demand and Outlook

Following four years of relative stability at around $105 per barrel (bbl), oil prices have declined sharply since June 2014 and are expected to remain low for a considerable period of time. The drop in prices likely marks the end of the commodity supercycle that began in the early 2000s.
The sharp fall in oil prices since June 2014 is a significant but not unprecedented event. Over the past three decades, five other episodes of oil price declines of 30 percent or more in a seven-month period occurred, coinciding with major changes in the global economy and oil markets (Figure 1). The latest episode has some significant parallels with the price collapse in 1985-86, which followed a period of strong expansion of supply from non-OPEC countries and the eventual decision by OPEC to forgo price targeting and increase production.
According to the World Bank, the recent plunge in oil prices has been driven by a number of factors: several years of upward surprises in the production of unconventional oil; weakening global demand; a significant shift in OPEC policy; unwinding of some geopolitical risks; and an appreciation of the U.S. dollar. Although the relative importance of each factor is difficult to pin down, OPEC’s renouncement of price support and rapid expansion of oil supply from unconventional sources appear to have played a crucial role since mid-2014. Empirical estimates also indicate that supply (much more than demand) factors have accounted for the lion’s share of the latest plunge in oil prices. Although the supply capacity of relatively high-cost and flexible producers, such as the shale oil industry in the United States, will need to adjust to lower prices, most of the underlying factors point to lower oil prices persisting over the medium-term, with considerable volatility in global oil markets (World Bank, 2015).
The decline in oil prices will lead to significant real income shifts from oil exporters to oil importers, likely resulting in a net positive effect for global activity over the medium term. A supply-driven decline of 45 percent in oil prices could be associated with a 0.7-0.8 percent increase in global GDP over the medium term and a temporary decline in global inflation of around 1 percentage point in the short term.
Over the medium term, oil prices are projected to recover from their current lows, but will remain below recent peaks and witness considerable volatility for a couple of years. The pace of the recovery in prices will largely depend on the speed at which supply will adjust to weaker demand conditions. Given that OPEC, for now, appears to have relinquished to its role as swing producer, US shale oil producers, with their relatively short production cycles and low sunk costs, may see the greatest adjustments in the short term. In the longer term, adjustment will take place from both conventional and unconventional sources through cancellation of projects. While supply is likely to be curtailed, demand is expected to pick up, along with the expected recovery in global activity and in line with broader demographic trends.  However, predictions on the evolution of oil markets remain highly uncertain. Commodity prices, including oil, tend to be volatile, making forecasting prone to errors. For oil, the unpredictability is further amplified by the possibility of heightened geopolitical tensions and a sudden change in expectations regarding OPEC’s policy objectives. Over the long run, physical (geological) constraints should put upward pressure on the real price of oil, although technological advances could slow the increase.

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