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.
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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