There wasn’t so much fanfare from bank square on 19th February 2020 as the Bank of Zambia decided to keep its policy rate unchanged at 11.5% at its first policy rate meeting of the year. The reserve ratios on kwacha and foreign deposits were also unchanged at 9%. The rising inflationary pressures which is now pegged at 12.5% for January 2020 was cited as a major factor in arriving at the decision. Projections show that inflation risks will remain elevated in the medium term. Many Market players who had predicted a rate hike of at least 50 basis points (0.5%) were left surprised by the move; however, they were relived as liquidity pressures have been biting in the market.
The other important dimension considered was the country’s growth prospects, after recording the worst GDP growth rate in over a decade at 2.3%, the Bank of Zambia were sure that they would do some harm to the economy with further tightening. Therefore, instead of moving north (tightening) and risk dampening the growth rate further, or moving south (loosening) and risk opening the inflation ‘Pandora’s box’, our man at BOZ stayed still; a classical limbo.
This comes after our man at BOZ, Dr. Denny Kalyalya, an accomplished Economist and a former World Bank Group executive director had a very busy fourth quarter in 2019 going all out in ensuring no stone was left unturned in the pursuit of market stability and reining in inflationary pressures.
The overnight lending facility (OLF) was increased by an incredible 1000 basis points (10%) stunning many market players who did not see the move coming. In November, the Bank of Zambia would increase the monetary policy rate by 125 basis points to 11.50% further putting a lid on the liquidity tap. However, the Kwacha kept losing ground and inflationary pressures although contained for a while were bubbling underneath like hot magma ready to explode at any sign of misstep.
In November, the Kwacha was only behind Chiles’s Peso in the world’s worst-performing currencies index according to Bloomberg currency index. The BOZ would, therefore, strike yet again, increasing the statutory reserve ratios on Kwacha and Foreign currency deposits by 400 basis points from 5% to 9%. They would further reduce the reporting and compliance requirements for the reserves, from weekly to daily effectively cutting the lag that allowed smart treasury moves in the market that in their view was distorting the money supply. The market panicked and for a while, the Kwacha’s race to the bottom was halted, but not so for inflation and other debt vulnerabilities that were volatile enough to give Kalyalya sleepless nights.
The BOZ governor would face some criticism from some mainstream Economists who accused him of worsening the country’s growth vulnerabilities with his contractionary monetary policy stance. The country then was grappling with an energy crisis with power cuts of up to 15 hours long, drought and serious debt vulnerabilities, it would go on to record the worst growth in over a decade with GDP growing a meager 2.3% in 2019. Chibamba Kanyama, a renowned economic commentator and former IMF executive showed concern that Kalyalya was been put in a tight corner by the “weak” fiscal side of the government such that his monetary moves which were ideally supposed to be effective and cure a patient were now proving to be ineffective massage sessions.
It’s the opinion of this article that our man at BOZ faces a very tricky conundrum in which it will be very difficult to navigate alone. He will definitely need his partner at the fiscal headquarters, Ministry of Finance, to pull out a remarkable economic turnaround. This is so because what Zambia is facing is not normal inflation as a result of abnormal monetary expansion. Zambia is facing a stagflation, a very tricky situation in which inflation will rise even when growth is falling and the monetary authorities are putting a lid on liquidity.
In the case of normal inflation with a classic basic definition of too much money chasing few goods, the solution is simple; simply trigger a monetary contractionary policy to suck out excess money in the economy. This reduces people’s disposable incomes and in turn, puts a dent on consumption, the reduced consumption it is assumed will make the general prices of goods to self-correct downwards. Although this puts a serious dent on GDP growth, it solves every central banker’s biggest nightmare; runaway inflation, which is like a cancer to an economy.
But with stagflation, this move is not sufficient simply because inflation is triggered by a cocktail of factors and the major one being the cost-push phenomenon. Inflation will, in this case, be rising due to an increase in the cost structure of industry. In Zambia’s case which imports the majority of goods and services; this increase in cost structure is as a result of the massive depreciation of the kwacha which has lost 48% against the dollar year-on-year as at 1st March 2020 according to the Bloomberg currency index.
Ideally, a monetary contractionary policy is a very powerful tool which also solves the depreciation of a currency as well. This is so because you are making one currency scarce relative to the other. However, the Kwacha is defying all economic textbook theories and has continued its race to the bottom. The answer is simple, other things are not equal and Zambia has been caught up in precarious debt position which the International Monetary Fund has advised could become unsustainable sooner rather than later. The Euro bonds on the international markets have tumbled as there are more sellers than buyers and the result of this is the fall in bond prices and rise in yield. On the local market, the inverted yield curve is now the new normal. The inverted yield curve happens when investors see more vulnerabilities in the short than long term therefore demand a higher yield in the short term relative to the long term, an anomaly in Economics. As it stands, investor sentiment is at a low and most of them are on the fence turning their backs on Africa’s second biggest producer of copper and the dollars are simply not trickling in hence the depreciation.
It should be noted that Kalyalya has been on this road before, back in 2015, the Kwacha showed the same vulnerabilities it is now showing and inflation was threatening to let loose. He navigated the tricky position gracefully like a true professional he is. But there is just a sense that this one is different simply because other factors like debt vulnerabilities have manifested and come to the fore and made the situation trickier. This is therefore not an indictment against monetary policy or Denny Kalyalya. It is a submission that factors on the ground have changed and therefore need a tweaking of approach altogether. “When facts change, I change my mind – what do you do sir”? are the immortalizing words of John Maynard Keynes, a British economist who revolutionized the field of Macroeconomics.
It is the opinion of this article that Kalyalya needs to reach out more to his former deputy, now turned Boss at the Ministry of Finance. What is needed at the moment is coordination of efforts between the BOZ and Treasury to get the country out of this conundrum. A system I simply refer to as “whole of government” approach, monetary and fiscal policy in perfect sync like two experienced and talented tango dancers. The market is expectant that these two can dance tango and wow the crowd considering their time together at the BOZ. Is our man at the BOZ therefore in a limbo? He will be if he decides to go at it alone. Concerted coordination on the other hand will dramatically improve the odds of a turnaround and will be mutually beneficial rather than the zero-sum isolation game that is currently prevailing.
Katandula Chitika is an Economist and Writer. The views expressed in this article are solely mine and do not represent the views of my employer, church and any other organization I am affiliated to. Contact me on katandula.chitika@fizambia.com