Kwachamania - What's the story with the Kwacha?

News of the Kwacha’s recent  travails  has been has been spreading thick and fast – it has lost 16.2% year to date closing at ZMK6.4 per $US yesterday. Zambia’s economy grew by 6.5% in 2013 with key drivers being: Transport, storage and communications (27.1%), construction (24%), community, social and personal services (17.4%), financial institutions and insurance (13.7%), manufacturing (8.2%), and mining (5%). This is despite a 7.4% drop in agricultural output (which is expected to increase in 2014). Inflation remained in single digits, closing the year at 7.1%. There was a merchandise trade surplus of US$1.4bn in 2013. Despite the recent fiscal deficit concerns and ratings/outlook downgrades, outlook for growth remains positive. So what’s behind the recent Kwacha slide?

US Fed Tapering

The US Fed  quantitative easing program  which was aimed at stimulating the US economy had pumped a lot of liquidity into global markets at historically low rates (cheap money). Global investors felt more adventurous than usual and splurged on emerging and frontier markets like Zambia (Case-in-point; over-subscription of Zambia’s $750m debut Eurobond in 2012 with a yield of 5.565%). So, when the US Fed started to  cut back  on its quantitative easing program to the tune of $10bn a month, naturally global investors started to become more cautious with their money and in many cases, pull back investments (risk-off trades). This also led to an appreciation of the US dollar against most currencies. Zambia didn’t help its risk perception by having a higher than forecasted budget deficit in 2013 driven by increased spending on public sector wages. Ghana and Nigeria’s currencies have also been impacted for similar reasons.

Recent Drop in Copper prices 

China is the world biggest consumer of copper.  Negative news  was recently released which could potentially adversely affect copper demand. This news has led to a sharp decline in copper prices – LME copper for 3 months delivery closed yesterday at $6,430 per metric tonne. Copper remains critical to the Zambian economy and accounted for about 67% of export earnings in 2013. As a result, sharp declines in copper are a red flag for the Zambian economy and have a strong correlation to Kwacha movement:

Source: IB Times

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High dollar demand

The Kwacha declined 4.9% against the dollar in 2013. The following statement from the Bank of Zambia governor sums up one of the major reasons for this:

”Largely owing to increased economic activity following Governments’ investment in infrastructure development as well as the rise in foreign investment inflows, the merchandise imports bill increased by 16.5% to US 9,234.8 million Dollars in 2013. The rise in imports was mainly explained by an increase in import bills associated capital goods.”

Dollar demand has continued to increase and has been very high in Q1 of 2014 as a consequence of the sharp rise in imports. There has been a significant drop in the Q1 trade balance figures since the end of January. Exporters are holding on to their forex in order to ride out the Kwacha decline.

Combine all these factors plus traders betting on further declines and you get a sharp decline over a short period of time.

Risks

- Inflation (higher prices for oil procurement and various imports – including higher school fees for those kids studying abroad!)

- More expensive to service external debt 

The Forex market is the epitome of a 'Zero-sum Game' - Zambian exporters will be quite pleased because their goods will be more competitive on the global stage where as importers will be feeling the pinch (which they'll eventually pass on to the consumer)!

Bank of Zambia has already raised the reserve ratio to 14%, increased the policy rate to 10.25% (which will have a delayed reaction) and pumped $178m to help stabilize the Kwacha (and pledged to do more should the need arise). They don’t have enough foreign reserves to expend on protecting the currency (which would deplete the already less than satisfactory foreign reserves). They might have to bite the bullet and see where the chips fall over the next few months. This was always going to happen at some point with our economy lacking diversification away from copper. The sooner more Zambians start to take advantage of the vast opportunities at their doorstep, especially in Agriculture, the more diversified the economy will become - the government is merely a facilitator!