Why current inflation in Zambia makes treasury bill Investments attractive.

THIS article aims to breakdown the linkage between the current inflation and yields on treasury bills. Zambian paper has for while being offering healthy yields in the 1-year making them Africa’s most attractive given the level of inflation.

Inflation explained

Inflation is defined as the general rise or fall in prices over a period usually expressed as a percentage. It is sometimes referred to as the cost of money when expressed as a percentage. Money carries with it purchasing power that determines how many items of value can be equated to it. If a sum of cash today can afford one 20 packets of milk hypothetically and a year later decreased the number of packets to say 15 packets, the we say inflation has risen. The reason behind this analogy would be that inflation – also called consumer price index (CPI) – will have corroded the value of money with time. In the Zambian case, fuel prices were hiked recently because oil prices on the international market have edged higher making it costly to import the commodity. Because it is paid for in dollars the exchange rate then plays a key factor in converting the dollar cost of crude to Kwacha terms. The Energy Regulation Board has to then make periodic adjustments to the fuel price based on the importation cost of fuel. In the previous case, they decided to raise the price of fuel because Oil was trading higher on the international market. Oil has been rising because the OPEC countries agreed to restrict production so as to force the price up towards $USD70/bbl. to help oil exporters make more revenues from crude exports. Crude producers depend on oil for foreign exchange revenues the same way Zambia depends on Copper for 75% of our export revenues.

So when fuel was adjusted higher, transport operators in Zambia adjusted their prices higher to factor the change and as a result food prices also edged higher as a consequence. This took a month to reflect in the inflation numbers because the effects lag by a month hence the 100bps only reflecting now. Inflation has increased to 7.1% from 6.1% previously and is the highest number reported in 14 months hence the 14-month high analogy in the previous article.

Treasury bill yields currently high in the 1-year

Treasury bills are government investments of a short term nature with maximum duration of 1 year. The Bank of Zambia being borrowing agent of the government manage treasury bill sales every 2-weeks where they offer ZMW950-million to the market. In the last treasury bill sale held on 29 March Thursday the BOZ were able to raise ZMW1,127- million representing a higher appetite than on offer by 9% (Bid cover of 1.09) a full subscription.

Treasury Bill auction results . Bid cover ratio was 1.09 with the Bank of Zambia raising ZMW1,127million of the ZMW950million on offer.

Of this ZMW1,127-million sold, 74% was for 1-year treasury bills a pattern determined by the attractiveness of the investment tenor. Suffice to say if you buy 1-year treasury bills you will earn a return of 17.5%. Another attractive outcome of the auction on Thursday is that if lock up your cash in 273- day or 9 -month treasury bill investment you will earn yourself 13%. So players are now faced with an option to buy 273 – day investments at 13% or 364 -day at 17.5% depending on investment appetite.

Attractiveness of investment in relation to inflation

Return on investment also called ROI is what every investor looks to determine whether or not to make critical decisions. However other factors come into play such as inflation. Why? This is so because a nominal yield should be adjusted for inflation to calculate a real yield which is what the premium compensation for taking risk in investment is exactly. Bear in mind that inflation corrodes value. Therefore in simple financial mathematical formulae:

Real Interest yield (ROI) = Nominal yield – inflation rate and in the case of the 1-year treasury bill for Zambia which is paying 17.5% the real yield translates to 10.4% (= 17.5% -7.1%).

The 10.4% represents the real return on investment after the 17.5% is adjusted for inflation. This premium is what makes the treasury bill attractive. The next time to want to decide whether or not to invest, always match the annual nominal yield to the level of annual inflation to determine whether the spread/ premium or difference is not only positive but wide enough. The higher the yield and lower the inflation the more attractive the investment asset.

Term structure of Kwacha interest rates comparing the 15 March and 29 March.

That is the reason why current inflation in Zambia at 7.1% makes treasury bills Investments attractive at 13% (9-months) and 17.5% (12-months). The compensating premiums are still very health. Globally, investors are always looking for these kinds of assets and this will explain why offshore players flock to Zambia to buy treasury bills and bonds currently.

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