Tuesday, November 3, 2015

Zambia raises rate 300 bps after jump in October inflation

   Zambia's central bank raised its policy rate by 300 basis points to 15.50 percent in a move aimed at anchoring inflation expectations in single digits following a surge in October inflation.
    It is the first rate rise this year by the Bank of Zambia, which raised its rate by 275 basis points in 2014 and in August raised the reserve ratio by 400 points and continued to tighten liquidity conditions to support the weak kwacha currency.
    In addition to the rate hike, the central bank will also lift the caps on lending rates and "stands ready to take appropriate monetary policy measures to support macroeconomic stability."
    Zambia's inflation rate jumped to 14.3 percent in October from 7.7 percent in September, with the central bank saying this was largely due to the pass-through from the depreciation of the kwacha, higher prices of refined petroleum products, a revision of fees and fines, and a high production costs induced by power rationing that led to the use of more expensive power from diesel generators.
    The kwacha has been falling since September 2014, hit by a fall in copper prices due to lower growth in China. China is the main buyer of copper from Zambia, Africa's second largest copper producer.
    More recently, the kwacha has also been hit by worsening sentiment due to power rationing, a weak mining sector, and fiscal and current account deficits.
    The kwacha was trading at 12.57 to the U.S. dollar today, down 49.2 percent this year.

    The Bank of Zambia issued the following statement:

"The Monetary Policy Committee (MPC) held its meeting on 2nd November, 2015. The MPC considered developments in the global and domestic economies during the third quarter of 2015 and the outlook for the fourth quarter. The MPC also decided on the monetary policy stance aimed at achieving the inflation objective and to support macroeconomic stability. 

The Committee observed that the trend of weak growth in the global economy evident in the second quarter of 2015 was sustained during the third quarter of the year. The International Monetary Fund (IMF), in its October 2015 World Economic Outlook (WEO) Update revised global growth downwards to 3.1% in 2015, 0.2 percentage points lower than the July WEO Update. Growth prospects remain uneven as output in advanced economies is expected to pick up slightly while activity in emerging markets and developing economies is projected to further slowdown, maintaining the deflationary pressure on commodity prices. Over the third quarter, the average prices for copper and crude oil (Dubai) continued on a downward trend, falling to US$5,267.0 per metric tonne (mt) and US$49.9 per barrel from US$6,057.0 per mt and US$61.4 per barrel, respectively.

As was noted in the August 2015 Monetary Policy Statement, the prospects for interest rate increase in the USA during the year continued to shift investor preferences in favour of US dollar denominated assets and further supported the strengthening of the US dollar. With this prospect on the horizon and the further slowdown in the Chinese economy, it is expected that the currencies of emerging markets and developing economies will remain under pressure as investors realign their portfolios.

The Zambian economy is currently facing significant challenges, with deterioration in the external environment similar to what was experienced during the global financial crisis of 2007/8. This has been compounded by domestic shocks related to the significant reduction in energy supply, fiscal pressures and adverse sentiments.

The Committee is cognisant of the urgent need to diversify the economy that will require measures to support investment and growth in key sectors, such as agriculture, energy and manufacturing. Monetary policy coupled with fiscal consolidation will be critical in anchoring macroeconomic stability. The fiscal deficit target for 2016 of 3.8% of gross domestic product (GDP) announced by the Hon. Minister of Finance in his 2016 Budget Address to Parliament represents a significant step towards anchoring macroeconomic stability.

At its previous Meeting in August 2015, the MPC kept the policy rate constant, having raised the Statutory Reserve Ratio in April 2015 to 18% from 14%. During the third quarter, liquidity conditions in the banking system rose reflecting increased Government spending and the net maturity of Government securities. The Bank of Zambia, therefore, heightened its open market operations and kept the interbank rate just above the upper policy rate band of 14.5%.

The average overall annual consumer price index (CPI) inflation was 7.4% in the third quarter, 0.3 percentage points higher than the second quarter average of 7.1%. Inflation ended higher at 7.7% in September 2015, up from 7.1% in June 2015. Food price inflation edged higher to an average of 7.9% in the third quarter from 7.1% in the preceding quarter. However, quarterly average non- food price inflation declined to 6.7% from 7.0%. The increase in inflation was largely attributed to the pass-through from the sharp depreciation of the Kwacha exchange rate, increase in pump prices of refined petroleum products, revision of fees and fines, and the high production costs induced by increased power rationing, which led to the use of more expensive power from diesel generators.

Excess liquidity in the banking system increased substantially in the third quarter due to net Government spending as well as maturity of Government securities.

The high liquidity level raised reserve money by 8.7% to K13.5 billion at the end of September, depressed demand for overnight lending facility funds, and pushed the Treasury bill and Government bond composite yield rates lower by 1.6 and 0.3 percentage points to 21.7% and 23.5%, respectively. While the value of funds raised through Government securities auctions jumped 20.3% to K4.0 billion, the outstanding balance of Treasury bills and bonds (at face value) fell 2.0% to K25.5 billion.

To contain the liquidity build up and attenuate inflationary pressures, the Bank of Zambia heightened its open market operations.

Broad money (including foreign currency deposits) increased by 26.3% to K46.6 billion in the third quarter largely due to the rise in deposits. The expansion in deposits to K42.0 billion (and increase of 28.2%) reflected valuation effects owing to the sharp depreciation of the Kwacha against the US dollar in the third quarter. Foreign currency deposits rose by 9.4% to about US$1.8 billion while Kwacha deposits marginally increased by 0.7% to K20.9 billion. Growth in domestic credit slowed down further in the third quarter to 2.7%, mainly due to a decline in lending to Government that fell by 52.9%. Lending to the private sector, however, rose by 22.0% in the third quarter from 1.2% in the second quarter.

The average lending rate for commercial banks rose marginally to 20.8% at end-September from 20.4% at end-June. Similarly, the average savings rate (ASR) for amounts above K100, and the average 30-day deposit rate for amounts exceeding K20, 000 marginally rose to 3.30% and 6.6% from 3.28% and 6.4% over the same period, respectively.

With the rise in inflation, real lending rates declined. The average real lending rate decreased to 13.1% in September from 13.5% in June 2015. Similarly, the real average 30-day deposit rate for amounts above K20,000 declined to -1.1% from -0.7% while the real ASR for amounts exceeding K100 declined to -4.4% from -3.8% in the second quarter.

The Kwacha came under severe pressure in the third quarter. Factors behind this were weak copper prices induced mainly by declining growth in China, the main buyer and consumer of copper; and adverse sentiments relating to power rationing, developments in the mining sector (prospects of job losses and scaling down of operations and reported loss of interest from investors), fiscal and current account deficits; and general performance of the economy.

Consequently, the Kwacha depreciated sharply by about 60% against the US dollar to end the quarter at K11.9800/USD. The Kwacha also weakened by an average of about 51% against the British pound sterling, euro and South African rand to end the quarter at K18.2334/GBP, K13.4435/Euro and K0.8679/ZAR, respectively.

The current account deficit widened further in the third quarter to US$401.0 million from US$305.9 million recorded the preceding quarter on account of higher import related service payments and the increase in income on equity payments by foreign owned enterprises.

The deficit on the balance of goods narrowed to US$14.0 million from US$91.0 million recorded in the preceding quarter due to a higher growth in goods exports relative to imports.

Preliminary data show that an overall balance of payments surplus of US$716.0 million was recorded in the third quarter against a deficit of US$27.8 million in the second quarter mainly as result of the receipt of the third Eurobond proceeds. 

The Hon. Minister of Finance in his 2016 Budget Address announced a reduction in the planned fiscal deficit to 3.8% of GDP from a projected 6.9% of GDP in 2015. Achieving this sharp fiscal consolidation will help to anchor macroeconomic stability, and ease domestic financing requirements and funding pressures. This will therefore also support the conduct of monetary policy.

In arriving at the decision, the Committee took into account the inflationary developments in the third quarter and the inflation outturn of 14.3% in October, 2015. The October outturn has pushed inflation into double digits, largely reflecting the sharp depreciation in the exchange rate as witnessed in recent months.

Keeping inflation expectations anchored in single digits is critical to maintaining our targeted macroeconomic objectives and in particular steering inflation towards the 2016 target. To this end, the MPC decided to further tighten monetary policy by raising the Policy Rate to 15.5% from 12.5%. In addition, to allow for better functioning of the credit market, the MPC decided to lift the caps on lending rates. Both measures take effect immediately.

The Bank of Zambia will continue to monitor domestic and external developments and stands ready to take appropriate monetary policy measures to support macroeconomic stability.

The next MPC Meeting will take place in February 2016. "



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