market sentiment is extremely bearish with high upside risks to inflation as the kwacha flirts with new psychological highs
The currency in Africa’s second largest copper hots spot, Zambia is trading at a 27-month low. The kwacha has been on a weakening streak since sentiment started to dwindle following the copper producer’s debt concerns earlier in the year. Last the local unit traded at levels above K11.01/USD was in June 2016. The kwacha has year to date (YTD) shaved off 9.925% in value.
The Zambian currency market has been masked by dollar scarcity following waned sentiment as a result of asset sell off pressure exacerbated by a strong US dollar following trade wars between the top two global superpowers (US and China). This has caused an emerging market currency rout. The dollar index has been strong at levels of 94.5 currently after flirting with highs of 96.9 (13-month high) a few weeks ago making US treasuries very attractive and forcing asset sell-off in emerging markets including Zambia.
Global markets have started to price-in Donald Trump’s threats to impose additional tariffs on China which in turn is expected to retaliate.
Zambia having been classified as being in ‘high risk of debt distress’ by the IMF and World Bank in May this year has caused investor jitteriness that has many offshore players sit on the fence. This has been to the extent that maturities in kwacha treasury bills and bonds are not being rolled over at all.
Zambia’s dollar bond spreads have widened significantly to over 1,430-bps surpassing Mozambique with a record of default. Credit default spreads have been used to proxy investor sentiment which has steeply declined over the last few months.
Scarcity of dollars
There is a looming shortage of dollars in the Southern African nation to match demand hence manifesting in kwacha depreciation. With the low reserve levels of US$1.82-billion (as at 30 June reported by the Bank of Zambia) the copper producer has little ammunition to defend the local unit. The state has entered into an agreement with key mines to swap mineral royalty tax obligations with dollars for the purpose of shoaling reserves. This has however deprived the market of the usual and predictable dollar to kwacha conversion cycle to fund tax payments between the 15-25 of each month. This cycle ideally gives support to the kwacha but hasn’t been the case starting last month when the tax authorities (Zambia Revenue Authority) paid the mines a VAT refund in excess of K385-million (US$38-million) which the mines used to absorb the mineral royalty tax obligations at the expense of the usual conversion cycle.
With the mining agreement to swap dollars for mineral royalty tax obligations, very little conversions are being observed to effect the market and as such the kwacha has been on a sliding trajectory reaching all-time lows of K11.03/US$. Aside from the mines, there have been very little flows from other sectors of the economy to cushion the scarce dollar contagion.
Effects on the economy
A weak kwacha is inflationary in nature and will exert pressure on the consumer price index (CPI). Zambia’s August inflation rose to 8.1% (a 21- month high) breaching the BOZ target band of 6-8%. Upside risks to inflation remain high from a weak currency and elevated crude prices in excess of USD77.7 bbl. A rapidly depreciating currency has historically caused speculative pricing effects impacting food pricing component of CPI. Pump prices of fuel could easily spiral upwards anytime to ripple into cost push inflationary effects.
On the downside the kwacha depreciation matched to the rand that has been battered by a mixture of factors ranging from political to global effects, is a potential conduit for import inflation from South African. Zambia’s import basket weighs 33% of SA goods. Inflation is expected to soar 50-bps -75-bps in the month of September.
Currency effects could potentially transmit further to the government debt market pushing treasury bill higher than the current elevated levels of 14-20.5%.
Forecast for the week
Should the Bank of Zambia not intervene by selling dollars to ease pressure, the kwacha is will levitate north of K11/USD possibly ending the week at highs of K11.35/USD.
More analysis on Zambian kwacha