… The MPC Decision
In its maiden 2022 sitting, the Monetary Policy Committee (MPC) of the Bank of Zambia kept the Monetary Policy Rate (MPR) unchanged at 9% according to a communique circulated on February 16, 2022.
The Central Bank notes that the decision was informed by projections of continued deceleration in inflation, with the potential of sliding back into the 6-8% target range in 2023. The removal of energy subsidies and a potential poor crop harvest remain upside supply side threats to inflation which could make policy formulation under the forward-looking inflation targeting framework difficult. Against all odds the central bank kept rates unchanged when majority of analysts expected an upward adjustment given the current state of domestic and global macroeconomic conditions. In our reaction, we provide a perspective that attempt to shed light on the decision made by the Bank of Zambia.
… Is the MPC Justified to Take this Stance?
Our view is that the decision is well aligned with the current forward-looking monetary policy framework of Inflation Targeting Lite. It is important to note that monetary policy is only effective in containing inflation if it is demand-driven, but current developments with impact on future inflation outlook suggest that many of these are on the supply side.
Although consumer demand has seen an improvement in recent months, it still remains relatively weak and fragile, considering that the economy is recovering from a contraction that saw many firms shed jobs in 2020 and the majority of H1 2021. Further the pandemic uncertainty and the lingering default cloud means that investment spending is currently subdued and therefore remains of little concern as far as inflationary pressures are concerned. Additionally, elevated fiscal deficits, that have been a major concern in recent years, are likely to start narrowing significantly based on IMF’s spending disciplinary guidance, tied to the imminent $ 1.40 billion ECF. Finally, money supply has been on a southward growth path for the past one year to a pandemic-era low, thereby ruling out the “more money chasing few goods” narrative.
Given the above environment, it is our considered view that maintaining the monetary policy rate at 9% was the right decision by the MPC. This is in addition to our forecasts that agree with the projected continuation in inflation climb down (see RHS of Figure 1 above). Details of factors informing our inflation outlook and associated risks can be found in our December 2021 economic report available here.
… but What about the Risks from the Energy Subsidy Removal and Potential Poor Crop Harvest?
There are key upside risks that the Central Bank has clearly highlighted and notable among them are the removal of subsidies on fuel (under implementation) and electricity (migration to cost reflective tariffs was waiting for the now completed cost of service study), as well as a potential poor crop harvest linked to the unfavorable rain precipitation.
With regards to the removal of fuel subsidies, prices for crude oil have, since the last revision in domestic pump price, escalated and currently sit north of $ 90 per barrel amid heightened geopolitical tensions between Russia and the US over reported intentions by Russia to invade Ukraine.
However, it is important to note that most of the upside risks to price developments in Zambia such as the ones above are supply-side factors and, as such, monetary policy does not have significant potency in containing them. While we appreciate that hiking interest rates can help in attracting offshore investors whose inflows have the potential to support the exchange rate which feeds into inflation, we are cognizant that results may not be guaranteed. This is because advanced economies and less risky emerging markets have embarked on monetary policy tightening (UK, Brazil, Russia, New Zealand, Singapore, South Korea and South Africa are among economies that have done so already) in response to mounting inflationary pressures and thus making assets in those economies more appealing compared to our already in default status.
… Does this Stance Have Benefits?
There are a number of advantages that we can associate with the stance taken by the MPC. Firstly, at household level, this stance means that the debt burden has remained unchanged from the pricing perspective at the time that recovery in household income remains subdued. Second, this move is likely to give room to the cost of credit to moderate, considering that inflationary pressures have significantly come down from 2021 peak levels; credit risk is subsiding (save for a January blip, economic conditions have improved in recent months) and profit margins on government securities have significantly been squeezed (likely to force lenders to direct lending to private sector). The foregoing are conditions that are likely to improve private sector credit access for financing productive undertakings, thereby support growth prospects. Thirdly, keeping the MPR tad means that yield rates on government securities can be kept at current levels or even falling further down and thus enabling government to access relatively cheaper credit on the domestic market.
… Conclusion
The decision by the MPC to keep the Monetary Policy Rate unchanged during the February 2022 sitting is welcome, considering that fundamentals as far as aggregate demand is concerned are currently in sound shape with no possibility of going out of hand in the next two years. Upside risks to the downward trajectory exist but key ones are sitting on the supply side of the problem and, as such, cannot be addressed by an interest rate hike. Among the positives associated with staying the policy rate, include maintaining household debt burden from the pricing perspective, possibility of encouraging private sector credit growth as well as enabling government to borrow cheaply on the domestic credit market.