Since 2014, the Zambian Kwacha has been in perpetual decline against the US Dollar, albeit with isolated episodes of appreciation. And now, Covid-19 has deepened the Kwacha’s long-standing depreciation. The Kwacha was trading for the US Dollar at K13.08 on 2nd September 2019 and depreciated by 49% to K19.56 as of 2nd September 2020.
The depreciation of the Kwacha has garnered public interest given the exchange rates’ link to other economic variables such as inflation. The discussions have centred on the root causes of this depreciation and what can be done to resolve the challenge. There is some consensus that the depreciation of the Kwacha emanates from real sector structural constraints, declining confidence in the economy and external factors. These factors can be distinguished as either short-term (declining confidence and external factors) or long-term (structural constraints) fluctuations that may or may not stem from the financial markets and therefore may be addressed either through short-term monetary policy interventions or demand longer-term structural interventions.
Zambia relies heavily on copper exports which account for a staggering 70% of export earnings. As such, the Kwacha responds to forex earnings which are dependent on copper prices and domestic copper production. Therefore, the country’s currency tends to suffer when forex earnings decline. Likewise, the Kwacha is affected by the actions of the large exporting firms (such as mining companies) as to where they deposit and hold their export earnings.
The Kwacha is also influenced by demand for foreign exchange necessitated by imports of petroleum products and agricultural inputs, among others. This creates pressure on Kwacha cover against foreign currency to pay for imports thereby leading to depreciation.
Overtime, the declining confidence in Zambia’s economy has led to an outflow of foreign currency as foreign holders of Government securities divest from the domestic market thereby reducing forex inflows. According to BOZ statistics, non-resident holdings of locally issued securities declined by 7.7% from 677.6 million US Dollars in the fourth quarter of 2018 to 625.5 million US Dollars in the fourth quarter of 2019. Declining confidence has largely been fueled by economic factors such as Zambia’s high debt levels and recurrent fiscal deficits.
Besides, the Government has become a key player in the forex market arising from its demand for US Dollars required for monthly interest payments on debt and this tends to contribute to depreciation.
Externally, the unprecedented Covid-19 pandemic has led to low supply and high demand for U.S. Dollars, and low investment amid global uncertainty. This has translated into a depreciation of the Kwacha among many other currencies.
Since the performance of the Kwacha affects price and financial market stability, it remains a primary concern for the Bank of Zambia which is mandated to maintain price and financial market stability. To the Bank’s credit, positive efforts have been made in recent years to stabilise the Kwacha, although temporarily. As a short-term measure, BOZ forex operations have tended towards reducing depreciation pressures through the sale of foreign exchange. For instance, in July 2020, BOZ intervened with 16 million US Dollars. In 2019, BOZ tightened Kwacha liquidity by raising the policy rate to 11.50% which partially quelled demand for foreign exchange, as a secondary effect. BOZ also raised the statutory reserve ratio to 9% with statutory reserve requirements on both local and foreign currency liabilities on a daily basis as opposed to weekly compliance. These monetary operations have targeted short-term volatilities in the exchange rate with some level of success achieved in arresting short-term volatilities.
Thus, to arrest the tenacious depreciation of the Kwacha, in the long-term, the Government must address Zambia’s deep-rooted structural disparity that has manifested itself in a mono-economy still heavily reliant on copper mining. The Government must expedite diversification of the country’s export base towards sectors such as Agriculture, Manufacturing and Tourism as espoused in the 7NDP and other policy documents. This will ensure a multiplicity of sources of foreign currency thereby arresting depreciation overtime.
Also, BOZ must assess the impact of financial practices by large firms and how they influence the forex market to strengthen its interventions aimed at curbing these practices.
From a fiscal policy angle, the Government must work to reduce its debt service costs to decrease its demand for foreign currency which depreciates the Kwacha. Specifically, in the short term, the restructuring of the country’s debt is paramount as it will reduce interest payments. In the long term, the Government must prioritise fiscal adjustment through containment of capital expenditure which persistently widens the fiscal deficit and leads to further borrowing.
In conclusion, the exchange rate remains a significant variable in Zambia’s economy. Hence, the persistent depreciation of the Kwacha continues to pose economic challenges. Going forward, a combination of short term and long-term measures must be used to arrest the perpetual depreciation of the Kwacha. This way, the Kwacha can be redeemed and consequently the economy insulated from the shocks arising from the Kwacha’s depreciation.
By: Shimukunku Manchishi
The author is a researcher at the Zambia Institute for Policy Analysis and Research (ZIPAR). For details contact: The Executive Director, ZIPAR, MNDP Complex, Cnr John Mbita & Nationalist Roads, P.O. Box 50782, Lusaka. Telephone: +260 211 252559. Email: info@zipar.org.zm