'Mystery' of the Falling Kwacha

By Caesar Cheelo and Thulani Banda

On 18th October, 2015 Zambia united in response to President Lungu's appeal to fast and pray for forgiveness and reconciliation. Many prayed for the country to receive relief from the recent social and economic woes, including the continuously depreciating Kwacha.

To the disappointment of many, the Kwacha, which had closed at ZK11.70 per US dollar the Friday before fell by 2.6 percentage points to ZK12.01 per dollar the Monday after Prayer Sunday. How could this happen after all the earnest prayers?

Some blamed the Clergy for failing to exorcise the demons possessing the Kwacha. A few felt it was the Almighty's way of saying, “My children, you can figure this out; it's neither rocket science nor a generational curse on your currency”.

Indeed, Kwacha depreciation is really not a mystery, although this may come as a shock to some people. The currency has been depreciating for some time now. Between January 2008 and September 2015, the Kwacha cumulatively fell by more than 108% against the US dollar. In 2015 alone it shed 51% against the US dollar; weakening by 31.5% even against the Rand which was also in trouble in 2015.

Solutions to most problems rest in first understanding their root causes. The persistent Kwacha decline stems from a combination of real sectors structural constraints, declining confidence in the economy and external factors. What does this mean?

Firstly, Zambia's continued copper export dependency – with copper accounting for 74% of total annual average export earnings during 2000-2014 – signifies an historic inability to diversify exports. As such, the country's currency suffers whenever copper prices wane. After years of high copper prices, which cumulatively increased by 57% and 14%, respectively, during January 2005-Decemeber 2007 and January 2008-December 2009, prices have seen a substantial (35%) cumulative decline between January 2010 and August 2015. With, inter alia, falling mining revenues, the Kwacha depreciated significantly.

Without any direct influence on copper prices or on Zambia's economic diversification performance, first-line currency defender the Bank of Zambia (BOZ) has been rightly cautious in intervening in the foreign exchange market. Despite complaints that the Central Bank was not taking sufficient action to stop the Kwacha's “free fall”, BOZ remained resolute to building up international reserves and only intervened in the market when required to smoothen sizable short-term volatilities. Allaying the mounting public pressure was the right policy stance since the root causes of the depreciation are structural not monetary.

Secondly, Zambia's structural imbalance affects the balance of payments (BOP), which confounds the depreciation. In 2015, the BOP position deteriorated underpinned by a widening current account deficit as both traditional and non-traditional exports declined significantly (imports also declined, though at a slower pace). The current account balance widened to US$305.9 million in the second quarter of 2015 compared to US$83.6 million in the first quarter, largely because of the poor performance in goods and services balances and primary income account. To reiterate, the lack of sufficient and diversified exports depletes export earnings to pay for imports; this depreciates the value of the Kwacha.

Finally, falling confidence in the economy has led to an outflow of foreign currency as investors sought to avoid the risk of losing their money. Falling confidence has come from political or economic factors, fueled uncertainty and speculation, and ultimately pushed persistent capital outflows and currency depreciations.

The World Bank's Ease of Doing Business shows that after consistent improvements in rankings from 101st place in the world in 2008 to 80th place in 2011, Zambia's position fell precipitously since 2011. By 2015, the business environment had declined markedly relative to other economies leaving Zambia at 111th place in the world. Also, in 2015, Fitch Group rated placed Zambia in category B on its long- and short-term foreign and local currency credit ratings. Standard & Poor's and Moody's, respectively, rated Zambia as B and B2. On the Trading Economics system, Zambia's performance score was 30. In combination the four ratings placed Zambia in the highly speculative category of countries in 2015. Eroded confidence and a speculative run on the Kwacha in the third quarter of 2015 were decisive sources of the currency's sharp depreciation during that period.

The lesson here is therefore that heavy interventions and exchange controls by the Central Bank would fail to arrest the Kwacha's deterioration. Zambia needs short- and long-term policy reforms that foster fiscal prudence and stability, create diversified exports, enhance the business environment, and restore confidence in the economy; economic restructuring towards dynamic, higher productivity, higher value-added, diversified and internationally competitive activities are imperative. As long-term measures, these promise to improve export performance and increasing foreign exchange earnings, thus restoring the value of the Kwacha and arresting the depreciation over time.

In the short-term, however, considering that “faith without works is dead”, Zambia must pray, but must also take pragmatic actions beginning with considering a return to IMF BOP support programmes. This should be well calculated, with the authorities establishing a well-researched and well-consulted negotiation position.

The authors are researchers at the Zambia Institute for Policy Analysis and Research (ZIPAR).
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