BOZ still has latitude to cut interest rates, credit spreads still wide

The Bank of Zambia monetary policy committee is on 16 May expected to announce the benchmark interest rate after two days of deliberations. Four (4) out of (6) economists surveyed expect the central bank to cut rates a further 50 -75 points after weighing the commercial banking stress posed by the stock of non-performing loans at 13% in excess of the prudential 10% regulatory limit at a time when the state targets bullish growth. The remaining (2) were of the view the BOZ will leave rates unchanged, a decision that will price in the upside risks to inflation on horizon to be fueled by rising crude prices on the New York Mercantile Exchange – NYMEX weighed against the recent currency slide. Credit spreads above the benchmark rate have widened over 1,420 basis points (A basis point is defined as a percentage point – 1bp = 0.01 such that 1,420 equates to 14.2%). Infact credit spreads are far wider currently than when the policy rate was 15.5% (its peak in the December 2015 to February 2017 period of tight monetary policy). See graph below depicting the regression analysis of the widening credit spreads rising at a velocity of 46% per unit of time measured in months.

Source: ZBT Technical Analysis Desk. The graph is regressed over a 2.5 year period with credit spreads in basis points being the dependent variable and time being the independent variable. R squared – coefficient of determination is 0.65 showing a strong goodness of fit test relationship.

Average lending rates currently oscillate around 24.1% (14% above the current 9.75% MPR) and have shown a very slow declining pace compared to the quantum of benchmark rate cuts. The regression tests show that ALRs are falling at a very slow pace measured by the gradient of the ALR curve slope (-0.0041) versus that of the BPR slope (-0.0087). See graph below showing the regression of and interest rate graphs.

Source: Bank of Zambia website fortnight statistics.

The BOZ has since  February 2017 embarked on expansionary monetary policy with the aim of stimulating private sector growth which had been penalized due to high interest rates. The MPR has been trimmed 5.75% to 9.75% while more liquidity was injected into the system through a 13.5% loosening in the statutory reserve ratio to 5%. However even with these aggressive and significant policy measures, the requisite intimacy with fiscal policy is still weak. The Ministry of Finance is currently on fiscal consolidation path that targets to correct current misalignment’s in the medium term.

“Commercial banks willingness to lower interest rates is elastic to central bank policy rate stance -only – and as such our analysts see a high chance of a 50bps rate adjustment in tomorrow’s announcement. However an unchanged stance cannot be ruled out which could signal that the regulator has priced -in cost push inflationary pressures that could brew from potential fuel price adjustments mirrored in the fast rising crude price on the NYMEX,” Business Times Lead Analyst said in a research note. Though a naïve assumption but first time ever Zambia introduced the policy rate was at 9% and our technical analysts see that level as a ceiling that could dictate the additional latitude the BOZ has to ease rates, he said.

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