Kwacha appreciation: The implications for Zambia

By Pelekelo Liswaniso

Is the appreciation of the Kwacha a “fluke”, a political motivation or as a result of changed economic fundamentals? This is the million-dollar question posed to Dr Denny Kalyalya, deputy governor – operations at the Bank of Zambia (BOZ) during a lecture at the American center in Lusaka recently.

Dr Kalyalya explained that one factor largely unobserved is that over the years, there has been continuous and fundamental changes in the economy generally and particularly to the operating environment in the foreign exchange market.

The continuous change with respect to authorities’ commitment to a comprehensive economic reform program culminated in reaching the enhanced Highly Indebted Poor Countries (HIPC) Initiative in April 2005 whose effect has had a major spill over effect.

Dr Kalyalya who was speaking at the Zambia Fulbright-Humphrey Alumni Association (ZFHAA) lecture reviewed the background to the development of the Zambian foreign exchange market, economic developments and explained the recent appreciation of the Kwacha and the implications for Zambia.

ZFHAA is an association of Zambian scholars trained in the United States of America that aims at developing a network of graduates of the Zambian American Center for Education and Cultural Exchange (ZACECE)- Fulbright program.

The association is committed to public service through first –rate multidisciplinary competence of its members and their presence in Academia, and many public and private institutions. Dr Kalyalya, who is an economist at BOZ, is an alumnus of the Association.

Not long ago in 2004 Zambia’s external debt was a staggering US $ 7.1 billion but has now been reduced to less than US$500 million.

Dr Kalyalya pointed out that it was important to understand that improved macroeconomic management is an essential criterion in reaching HIPC noting that macroeconomic management in Zambia has remained on course since June 2004.

Furthermore, in 2005, there was the implementation of the fiscal and monetary policy and money supply growth was kept under check at 0.4 per cent while domestic budget deficit was at low levels in many years at 1.9 per cent of Gross Domestic Product (GDP).

Reaching the Completion Point under HIPC Initiative unlocked disbursements of budget and balance of payments support from Zambia’s cooperating partners.

He said US$ 155 million was received in 2005 of which 58 per cent was in the fourth quarter of the year.

The country’s profile and attractiveness to foreign investors also improved resulting in US$120 million recorded foreign portfolio investments in government securities at the end of December 2005. A total of US$264 million investment pledges were also recorded last year.

Dr Kalyalya noted that other recent economic development included debt service, which reduced dramatically. For instance, IMF debt service due was US$251.1 million but the IMF provided US$238.9 million relief under the enhanced HIPC Initiative and resulted in net payment of US$12.2 million.

“Total debt service in 2005 to various bilateral and multilateral non-IMF creditors amounted to US$133 million,” Dr Kalyalya explained.

Other recent economic developments included the record high copper prices and continued improvement in non-traditional exports (NTE’s) performance, which largely contributed to the overall improvement in merchandise exports in 2005.

Giving a breakdown of exports, he said, in 2005 there were: US$2,186 million; in 2004: US$1,779 million and in 1983: US$1,052 million. Dr Kalyalya said there were also a number of green and brown mines coming on stream.

In addition, following the resolutions of the Gleneagles G8 summit, Zambia qualified to the Multilateral Debt Relief Initiative (MDRI) resulting in 100 per cent cancellation of the multilateral debt owed to the IMF, World Bank and the ADB. The IMF delivered a total of US$581 debt relief in January 2006.

“It is clear from the above that the supply of foreign exchange on the market has been largely higher than the demand for it, particularly during the second half of 2005,”he said.

Also confirming this is the growth in foreign currency deposits at commercial banks saying in June 2005: US$436 million was deposited while in December 2005: US$551 million was deposited.

Dr Kalyalya pointed out that underpinning the operations of the foreign exchange market is a system of dealership, which was introduced in 2003 with the aim of broadening and deepening the market.

The system has so far performed well in promoting transparency in pricing and information flow so that the exchange rate at all times reflects the underlying market conditions.

“The system is anchored on a code of conduct that conforms to international standards. We have two-way quotes without advance knowledge of whether the customer would be buying or selling foreign exchange,” he said

Pointing out the implications for Zambia, Dr Kalyalya said the attainment of HIPC Initiative Completion point indicates that prudent and forward-looking macroeconomic management is possible in Zambia.

“Inflows of foreign currency to take advantage of interest rate differentials between Zambia and other jurisdictions is indicative of the confidence outsiders have in us as an economy,” he said, adding that the system of dealership in the foreign exchange market also allows the foreign exchange rate to reflect the underlying market conditions.

The decline in Zambia’s debilitating external debt stock from US$7.2 billion in December 2005 to less than US$500 million after delivery of HIPC Initiative and MDRI relief has triggered an improved sovereign rating and motivated higher private sector investment.

Dr Kalyalya said Zambia has now joined the league of progressive nations and unfortunately subject to the unenviable but inevitable scrutiny of every policy announcement and socio-economic developments.

The exchange rate of the Kwacha against the US dollar is increasingly becoming sensitive to developments in global commodity markets particularly copper.

He said the exchange rate of the Kwacha against the US dollar will increasingly reflect developments in the global commodity markets and influenced less by developments in domestic markets.

Another implication is that market participants’ now have a better appreciation of the issue of competitiveness particularly the role played by exchange rate fluctuations and the need to implement market based solutions devised by market participants themselves and not direct government intervention.

Dr Kalyalya stressed that there is an urgent need to develop new products and services that would offer some measure of protection to individual market players.

The Central Bank, he said, stands ready to collaborate with other market participants, as was done in the period leading to the introduction of the current system and to develop the system further to better manage currency volatility.

“On the question of competitiveness of our exports, emphasis needs to be placed on increasing productivity and adopting superior management techniques and systems for production and supply chain management”

There is need to use the available resources or emerging opportunities made possible by the appreciation judiciously, (since appreciation has come with increased supply and availability of foreign currency, low inflation and declining lending interest), to expand further our production frontiers, Dr Kalyaya said adding:

“The irony therefore, is that given the right mindset, a strong currency environment can stimulate exports with greater sustainability.”