by Thulani Banda
Over the past week, Zambian's have observed with pleasant bewilderment the happenings in the foreign exchange market. Throughout 2015, the kwacha had fallen significantly against the dollar. However, approaching the end of April 2016, there seems to be life in the kwacha after all. It is now trading below K10 per dollar for the first time since September 2015. While this is welcome news, caution needs to be taken as there still remain risks in both the global and domestic economic environment which could potentially undermine a sustained recovery.
Recall the slump in the kwacha last year? Who could forget the year when our beloved currency became the globe’s worst performer? A number of reasons for the depreciation were advanced. One view, heard from government and the central bank, focused on the global economic context. Copper prices fell over 41% by March 2015 from its 2011 highs on account of bleak Chinese economic performance and outlook.
Given that the Chinese slowdown continues, the kwacha’s recent bounce back may seem surprising. There are, however, a number of reasons for the recovery.
The first is the modest rise in commodity prices. Three months into 2016, while the Chinese slowdown is still a concern, things are looking up for commodities. Copper and oil gained 10.86% and 1.30% respectively between January and March 2016. This has contributed to gains in the value of currencies in commodity exporting countries like Zambia.
The second cause is the increased flow of capital into emerging markets like Zambia. This is happening because investors are seeing declines in predicted returns in developed economies. For example, in October, 2014 the United States Federal Reserve (the Fed) ended its expansionary monetary policy (known as ‘quantitative easing’) on account of positive growth in the US economy and a threat of inflation. A further decision to hike benchmark interest rates in 2015 wreaked havoc in emerging market and developing country economies as investors moved capital back to "safe bets" in developed countries.
However, more recent economic uncertainties in Europe and the continued Chinese slump have made the Fed more cautious. Doubt now hangs over possible US interest rate increases this year. This has weakened the dollar leading to appreciating currencies around the world. In addition, negative interest rates in parts of Europe and in Japan make for too low returns for capital to remain in developed countries.
The search for better margins has led to higher risk taking which means returning some investment back to developing markets. This flow of capital is seen in the recent jump in turnover at the Lusaka Stock Exchange. In addition, Zambia’s total Treasury bill sales by end of March 2016 were 30% higher than their December 2015 levels. So, as capital returns, currencies appreciate as foreign currency supply improves.
A third explanation for the recovering kwacha is that mining firms in Zambia have been converting ‘dollars’ to meet their tax obligations as their financial year ends. This tends to increase foreign currency supply thereby relieving pressure off the local currency, albeit temporarily.
Having explained the causes of the recent Kwacha appreciation, it is important to note that significant risks still linger. For instance, growth in emerging markets is projected to weaken. This means currencies may take a hit, especially if countries such as Russia and Brazil remain in recession. In addition, China will continue with reforms aimed at re-orienting its economy from export-led to a domestically driven one. Therefore, no significant improvement in commodity demand is expected from there. US economic growth is also expected to be relatively better than its developed country counterparts, so the dollar is likely to remain stronger than other major currencies. Hence, the gains being experienced now could be reversed later in 2016 as speculative capital shifts back to the US market as the risks in emerging markets persist or even become pronounced.
On the domestic front, high inflation poses a challenge for smooth kwacha recovery. This is despite a reduction to 22.2% in March. Monetary policy is likely to remain tight and in consequence, interest rates will still be high. Despite a surge in copper price in the first quarter of 2016, Zambia’s trade deficit – when the value of imports outstrips that of exports - increased by over 190% to K683 million in February 2016. This indicates a potential increase in demand for foreign currency.
Furthermore, fiscal pressures still persist as reported by the International Monetary Fund mission in March. For these reasons, in addition to other structural concerns about Zambia’s economy, growth shall remain low thereby posing risks for the kwacha.
The threat of the kwacha’s depreciation remains real and it is important that government continues to pursue important structural, fiscal and monetary reforms if it is to eke out a sustained recovery. Whereas the recent appreciation is good news, we must be cautious and not lose sight of the broader economic challenges the country still faces.