Anatomy of a Depreciating Currency – Why the Kwacha tumbles

There has been continued concern over the depreciation of the kwacha. The local currency has seen most of its value eroded, and most FX analysts fear that it could depreciate further. On 1st June 2018, the currency closed at 10.3 against the USD. Historically, the kwacha hit its lowest point in November 2015, when it was trading at 13.9 against the greenback. Almost like déjà vu, we are witnessing a week by week depreciation, having crossed over its ‘new psychological barrier’ of 10 kwacha per USD, the kwacha shows no signs of halting its downward trajectory. The currency has been besieged by both endogenous and exogenous forces, as well as other idiosyncratic factors, as such it is more likely that the local currency could close the second quarter between 11.0 and 12.0 to the USD due to the following factors:

Continued Dollar Bull Run

The greenback has continued to appreciate against most of the global currencies with emerging markets (EM) taking most of the hit. HSBC predicates an upward break out for the dollar in 5 to 10 percent range against other currencies. The continued strength of the dollar against global currencies has been backed by many recent developments. The dollar index (USDX) which tracks the value of the greenback against a basket of other major fiat currencies (Fiat money is currency that a government has declared to be legal tender, but it is not backed by a physical commodity) is now up by 2.5 percent over last two weeks and has hit its peak since the start of the year.

Geopolitical landscape and oil prices

As I last wrote in my article (“Continued upward surge in fuel in 2018”), giving a prognostication about the rise in oil prices, $80/barrel is finally here. Since the beginning of the year it was anticipated that global oil price will rise in order to price in the supply cut by OPEC and other non-OPEC countries. The situation has been compounded further by the recent geopolitical events that have unfolded in US-Iran nuclear deal. The Trump administration pulled out of the nuclear deal and as a consequences OPEC third largest producer will cut its daily oil production giving a further squeeze on the supply. This will subsequently cause the local currency to depreciate further as purchasing power parity will dictate that we will need more kwacha per single unit of the greenback to import oil.

US Bond and stock market rally

Trump-O-nomics has seen a rally in both the bond and stock markets. The treasuries yield curve has not showed any signs of flattening and capital has continued pour into the 2 year US bonds, simultaneously the equities have also been booming with the S&P 500 rising by more than 3000 points since the start of the year. This phenomena has sucked out capital from Emerging Markets (EMs), as evidenced with the depreciation of the Turkish Lira and the Brazilian Real. Unfortunately the Kwacha has not been spared, until a period of this rally ends we are likely to see further depreciation.

Zambian Domestic Debt Market

As a consequence of the above exogenous factors, the local debt market has seen most of its off-takers being local players. The May 2018 bond auction saw most of the debt being taking up by local commercial banks and pension houses, chief among them being NAPSA. About a total of USD 5bn of the country’s domestic debt 83% is held by domestic players and 17% by offshore market participants. This has limited the levels of forex in the market and the resultant effects being the continued depreciation of the kwacha.

Trade Balance Deficit

The central statistical office reported a trade balance deficit for the month of April, standing at K 1,812.9 million. This implies a negative current account on the balance of payment at the Bank of Zambia. With negative current account on the Balance Of Payments (BOP), the central bank has little wiggle room to effect currency sterilization. Currency sterilization is a procedure where a central bank uses some of its forex reserves to control the depreciation of the domestic currency. Coupled with dwindling central bank reserves that stand at $1.8bn, BOZ has its hands almost completely tied.

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