–Republished with permission from the author.
… The Decision
At its Q2 MPC meeting, the Bank of Zambia (BoZ), moved to further ease monetary policy rate 125 bps to a record low of 8% coming from a 225-bps policy rate chop at its Q1 meeting. Never in the history of the benchmark interest rate framework which started in 2012 has BoZ undertaken such a huge pace of monetary policy easing in a single half of the year. This only speaks to the depth of the strain that economic activity is currently under having been in the contraction zone for the past seventeen months. Such a protraction of trouble in the economy also reflects evidence that the current turmoil is not COVID-19-created but only amplified. However, the central bank had to sacrifice, yet again, its price stability mandate which has suffered supply side shocks (food shortages and energy price increases) and currency weaknesses. As of July, Zambia’s inflation rate stood at 15.8%, above the 6-8% target range by 7.8 percentage points.
… Why the Policy Rate Cut Sequel?
Primarily, this move is meant to shore up aggregate spending in the economy by reducing the cost of credit especially to the private sector (firms for investment and households for consumption). The domestic credit market has been dominated by the public sector (government borrowing) while credit extension to the crucial private sector leaves much to be desired. For example, commercial banks’ credit growth to government accelerated to 17.3% in Q2 from a paltry 1.3% in Q1 2020 while that to the private sector shrunk by 4.3% from a 10% growth.
From where we stand, there are other reasons that might have influenced the decision to cut the benchmark interest rate. The first is the misalignment between the monetary policy rate (MPR) and the O/N interbank rate where, as per the operational framework, the latter is supposed to be kept close to the MPR. However, we have recently noted that the former continues to drift lower and getting closer to the lower boundary of the (now former) 8.25-10.25% policy corridor. This state of affair limits the extent to which the Bank can continue with its liquidity injections which it has been undertaking as a measure to ensure financial system stability. We believe this action gives bank of Zambia more scope to continue on its balance sheet expansion path.
The current monetary policy stance also works in favor of government by reducing its cost of borrowing on the domestic market. After all, and realistically speaking, fiscal authorities only have the domestic credit market as a go-to place because its current external debt exposure limits its ability to borrow on the international market. In recent years, the government has increasingly turned to the domestic market as access to international diminish. For example, government’s stock of domestic debt has nearly doubled in the past two years.
…This Action is a Good Move But……
Similar to a view we advanced when the central bank cut the monetary policy rate earlier in May, there are a wide range of hurdles that may impede the effectiveness of the current move as far as stimulating credit growth to the private sector is concerned. First, the operating environment for private sector firms remains very troubling such that credit risk high and expected to remain elevated and will limit credit growth to the private sector. This problem actually manifests itself in the observation that credit growth in June was down to 0.44% (only credit to government recorded positive growth) in June from 1.82% in May despite BoZ having deeply cut the MPR on May 20 as earlier mentioned. Besides, there is something we can pick from the low uptake of ZMW 10 billion stimulus package (only 11% of this amount has been disbursed as of August 14) that is exclusively meant for private sector players.
Second, government’s heavy presence in the domestic market is not likely to help matters much especially that lenders are also preferring packing their money in government paper owing to the low default risk they carry. We expect government appetite for credit on the domestic market to actually grow bigger in view of shriveling revenue collections. Third, the current of levels inflation indicate squeezed real lending rates and will therefore make it difficult for lenders to effect a significant slash to their lending rates. Actually, the policy rate chop may prove to be significant opposition to inflation deceleration through effect on the depreciation of the Kwacha (offshore players are likely to resort to limit their exposure to Zambian assets owing to low returns) which is already under pressure having gapped to ZMW 18.87/19.12 (on the interbank) by close of business on August 19 from around ZMW 18.22/18.27 two weeks prior.
Finally, the move to trim the interest rates also poses a threat on the availability of loanable funds in the credit market. It is common knowledge that deposit rates in Zambia’s financial sector are largely discouraging because they attract a penalty of negative real rates and the current inflation situation has a telling story on this. As a result, banks and other deposit taking institutions may find it difficult to attract private savings thereby weighing on their liquidity positions which are supposed to be advanced to the private sector. It is important to remember that the current liquidity levels in the market are largely being driven by injections from the central bank. However, BoZ may take a relatively more relaxed approach in fear of fueling inflation amid subdued economic activity.
… Main Takeaway
In the collective, the quickened easing of monetary policy undertaken by the central bank so far this year speaks volumes in terms of its concern for growth at the expense of price stability. Ideally, the preferred situation is a robust economic activity pulse in an environment of stable prices. Partialling COVID-19 out, we are aware that the current difficulties in which the economy finds itself is a myriad of factors including tight fiscus and environment challenges and maybe around for a while. In our view, although these actions are expected, the mere fact that policy measures seem to have neglected price stability suggests fiscal dominance is at as play. Nevertheless, the stance by the central bank is welcome but a number of pitfalls stand in the way of its potential. All in all, we can only continue to echo the longstanding and growing voice of fiscal spend restraint as indicated by the Governor in his presentation.
About the Authors
Gerald, Patrick and Chewe are economists at ZANACO, Zambia’s biggest indigenous bank. However, the comments, the opinions and conclusions reached are solely those of the researchers and do not represent the opinion of ZANACO, its employees or the Board.