Zambia holds rate, won’t hesitate to act to ensure stability

February 12, 2015

By CentralBankNews.info
    Zambia’s central bank maintained its policy rate at 12.50 percent but warned that it “will not hesitate to take appropriate monetary policy measures that ensure macroeconomic stability while safeguarding the nation’s growth objective” before the next meeting of its policy committee in May.
    The Bank of Zambia, which raised its rate by 275 basis points in 2014, said it inflation was on a more favorable trajectory of inflation compared with its meeting in November but a deterioration in the external environment and a widening of its balance of payments deficit suggested that it should maintain its current policy stance.
    Zambia’s inflation rate has been trending down to 7.7 percent in January from a 2014-high of 8.1 percent in November and 7.9 percent in December, but is projected to remain “at elevated levels” in the first quarter of this year relative to the bank’s 7.0 percent inflation target.
    The variables that the central bank can control, such as domestic credit and money supply, suggest less inflationary concerns going into 2015 and the government’s continued deficit reduction is also expected to contribute to a stable economic environment.
    But the projected slowdown in China, the major buyer of Zambia’s copper, will have a negative impact on Zambia’s export earnings and thus the exchange rate and inflation.
    “The worsening external environment also presents a challenge to the Central Bank’s ability to accumulate foreign reserves required to mitigate exchange rate volatility,” the bank said.
    That negative, however, will be mitigated by lower oil prices and potentially lower government expenditure on oil imports.

    The Bank of Zambia issued the following statement:
   

“The Monetary Policy Committee (MPC) met on 11th February 2015, to consider developments in the domestic economy over the fourth quarter of 2014 and to decide on the Policy Rate. At the meeting, the MPC also reviewed developments in the global economy and their implications on the domestic economy and the Central Bank’s ability to achieve its primary objective of maintaining price stability.

GLOBAL ECONOMIC DEVELOPMENTS
The global economic recovery remains fragile and uneven, with important implications for the domestic economy through developments in commodity price trends and global trade and financial flows.The January 2015 IMF World Economic Outlook estimates the global economy to have grown by 3.3% in 2014 and for growth to expand to 3.5% in 2015. Growth in 2014 was mainly driven by developments in advanced economies, which as a region grew by 1.8% from 1.3% in 2013. In the advanced economies, growth was largely attributed to the United States, which grew by 2.4% from 2.2% in 2013. Economic growth in emerging market and developing economies slowed down to 4.4% in 2014 from 4.7% in 2013,largely on account of low domestic demand and reduced investment, with growth in China estimated to have slowed down to 7.4% in 2014 from 7.8% in 2013. Growth in the Sub-Saharan Africa region is also estimated to have slowed down to 4.8% from 5.2% over the same period.
In the fourth quarter of 2014, commodity prices continued to decline sharplyunderpinned by lower growth rates in emerging markets, especially China. In this regard, average crude oil prices declined by 25.1% during the fourth quarter to US$75.2 per barrel from US $100.4 per barrel recorded during the third quarter of 2014. In January 2015, crude oil prices continued to decline and averaged US$49.0 per barrel. Copper prices were also on a downward trend during the last quarter of 2014, declining by 6.1% to an average of US$6,572.5 per metric tonne from US $6,996 per metric tonne in the third quarter. At the beginning of 2015, copper prices have continued to decline, and averaged US $5,803.6 per metric tonne in January. In addition to the decline in commodity prices, there has been an overall strengthening in the US dollar, reflecting a flight to safety by investors as well as the brighter prospects for economic growth in the United States of America.

MONETARY POLICY
Monetary policy was tightened further during the fourth quarter of 2014 as inflation was projected to remain at elevated levels relative to the targeted 7.0% end-year inflation for 2015. In this regard, the Bank of Zambia Policy Rate was raised by 50 basis points to 12.5% at the MPC meeting held in November 2014.The tightening in the policy stance also helped to mitigate exchange rate volatility following a marked deterioration in the external sector, largely attributed to declining copper prices and the reversal of global financial flows. Following the upward adjustment in the Policy Rate, the Bank continued to manage liquidity conditions in the market through open market operations in a manner that ensured that the interbank rate remained within the Policy Rate corridor throughout the review period.

INFLATION
Inflation continued to stabilise during the fourth quarter though at elevated levels relative to the inflation targets for both 2014and 2015.The annual rate of inflation averaged 8.0%, marginally higher than the average of 7.9% recorded during the third quarter of 2014. In terms of end-period developments, inflation was recorded at 7.9% in December 2014, up from 7.8% in September2014.The inflation outturn of 7.9% at the close of the fourth quarter was 1.4% and 0.9% above the 2014 and 2015 end-year targets of 6.5% and 7.0%, respectively.
During the fourth quarter of 2014, food inflation remained elevated and closed the period at 7.5%, up from 6.9% recorded in September 2014 while non-food inflation slowed down to 8.4% from 8.8% over the same period. The increase in food inflation, despite the bumper harvest recorded during the year, is largely a reflection of higher transportation and production costs following the upward adjustments in fuel pump prices earlier in the year and the increase in electricity tariffs in the middle of the year. With regard to non- food inflation, the relative stability in the exchange rate, moderation in money supply and domestic credit growth, as well as the reduction in fuel pump prices in December 2014 all contributed to the downward trend. In January 2015, annual inflation slowed to 7.7% from 7.9% in December 2014, mainly on account of the decline in non-food inflation to 8.0% from 8.4% while food inflation declined by a marginal 0.1% to 7.4%.The fall in non-food inflation was mainly due to the reduction in fuel pump prices effected in January 2015.

DOMESTIC MONEY MARKET AND GOVERNMENT SECURITIES
Overall liquidity conditions continued to improve in the money market in the last quarter of the year relative to the third quarter, despite the increase in the BoZ Policy Rate in November. Net Government spending coupled with the provision of short-term liquidity by the Bank of Zambia through open market operations, early in the quarter, resulted in increased money market liquidity and a fall in the short-term interest rates. In this regard, the overnight interbank rate declined from an average of 15.6% in the third quarter to an average of 11.6% in the fourth quarter.
However, despite the improvement in liquidity conditions in the money market, liquidity remained concentrated in a few banks, and this consequently impacted negatively on demand for Government securities. Demand for Treasury bills weakened in the fourth quarter. This was reflected in the reduction in the subscription rate to 52.4% compared to 122.5% recorded in the third quarter of 2014.Te absence of foreign investors in auctions also contributed to low demand for Treasury bills as non-residents preferred to liquidate Treasury bills at maturity. In this regard, non-resident holdings of Treasury bills declined by 7.5% to K1.5 billion at the close of the fourth quarter. In January 2015, non-resident holdings of Treasury bills continued to decline, falling to K1.4 billion at end-January 2015.
The demand for Government bonds remained relatively stable, with a subscription rate of 92.5% compared with a subscription rate of 91.9% in the third quarter. In addition, non-resident holdings of Government bonds rose slightly to K1.2 billion at the end of the fourth quarter from K1.1 billion at the close of the preceding quarter. The overall reduction in foreign portfolio holdings of Government securities is a reflection of the global outflows of foreign capital from emerging and developing economies as growth in advanced economies picks up and the US dollar strengthens.
As a result of under-subscriptions recorded on Government securities auctions, yields rates generally trended upwards. In this regard, the weighted average Treasury bill yield rate closed the fourth quarter at 18.8% from 18.5% at the end of the third quarter while the composite bond yield rate increased to 21.0% from18.9%.ThenominalstockofoutstandingGovernmentsecuritiesincreasedby6.7%toK22.3billionat end-December compared with K20.8 billion at end-September 2014. In terms of the proportion, Treasury bills represented 48.9% of the total outstanding Government securities at face value while outstanding bonds were 51.1%. Foreign investors accounted for 14.8% of the total outstanding Government securities, compared to 13.5% at the end of the third quarter of 2014.

DOMESTIC CREDIT, BROAD MONEY AND INTEREST RATES
During the fourth quarter, both domestic credit and money supply continued to grow, a reflection of the continuing easing of liquidity conditions and a steady recovery from the sharp contraction in credit and money supply growth earlier in the year. Domestic credit increased by 12.1% to K31.9 billion in December 2014 from K28.5 billion in September 2014, slightly lower than the growth rate of 14.8% in the preceding quarter. The growth in domestic credit was mainly due to lending to the Government and households, which increased by 47.9% and 5.7%, respectively while lending to public enterprises declined by 12.1%. On an annual basis, domestic credit rose by 11.3% in December 2014 compared to 10.9% in September 2014. This was mainly explained by a rise in credit to households and private enterprises, which increased by 32.6% and 17.8%, respectively. However, lending to Government fell by 11.3%.
Broad money increased by 4.0% to K34.9 billion in the fourth quarter, up from the increase of 2.9% recorded during the third quarter. This growth was on account of a 19.8% increase in net domestic assets attributed mainly to lending to the Government. Net foreign assets, however, fell by 7.0% on account of a decline in gross international reserves by 6.7%. On an annual basis, broad money increased by 12.3% in December 2014 compared with 16.1% in September 2014. The growth was largely explained by the 27.9% expansion in net foreign assets as net domestic assets declined by 1.2%. The end-2014 broad money growth was also in line with the projected growth for the year, and the Bank has less inflationary concerns from growth in broad money going into 2015.
During the period under review, the commercial banks’ average lending rate rose to 20.5% in December from 19.3% in September 2014. The increase reflected the upward adjustment of the Policy Rate in November 2014 as well as the continued rise in Treasury bill yield rates. However, the average 30-day deposit rate for amounts exceeding K20,000 edged down to 6.6% from 6.7%. Similarly, the average savings rate for amounts above K100declined to 3.4% from 3.6% in September 2014. With regard to real interest rates, the real average lending rate for commercial banks’ rose to 12.6% in December from 11.5% in September 2014. However, the real average 30-day deposit rate for amounts above K20,000 and K100 declined to -1.3% and -4.5% from -1.1% and -4.2%, respectively.
The level of activity at the stock market continued to be on an upward trend in the fourth quarter, with market capitalisation rising by a further 5.6% compared to an increase of 1.0% recorded during the third quarter of 2014. However, the All Share Index marginally declined by 0.9%. The participation of non- residents also declined during the period under review as reflected in a reduction in net foreign portfolio inflows to US $0.8 million from $17.4 million in the third quarter. In this regard, non-residents purchased a total of US $3.0 million worth of stocks against sales of US $2.2 million.

FOREIGN EXCHANGE MARKET AND THE EXTERNAL SECTOR
During the fourth quarter, the performance of the Kwacha against major foreign currencies was mixed as the Kwacha depreciated against the US dollar while appreciating against the pound sterling, the Euro and South African rand. In this regard, the Kwacha depreciated by 1.9% against the US dollar to close the quarter at K6.37 per US dollar compared to the level of K6.26 per US dollar at the close of the third quarter. The depreciation of the local currency was due to a stronger US dollar on the international market, deterioration in the external sector performance, and the reduction in the supply of dollars on the domestic market. This was in addition to the relatively lower copper prices on the global markets that had a negative impact on domestic foreign exchange market sentiment.
Overall, the supply of foreign exchange on the market declined during the quarter under review compared to the previous quarter. The reduction in the supply of foreign exchange was reflected in reduced sales of foreign exchange to commercial banks by the public, mining companies and foreign banks. In line with the objective of minimising volatility in the foreign exchange market, the BoZ sold a total of US$182.0 million to support the market in the fourth quarter, up from sales of US $69.1 million during the preceding quarter. The Bank also purchased US$34.0 million from the market compared to total purchases of US $85.0 million during the third quarter.
The Kwacha, however, appreciated by a further 2.0% against the pound, though this was lower than the appreciation of 4.8% recorded in the third quarter.The Kwacha also strengthened against Euro and rand by 2.1% and 0.7% compared to appreciations of 7.3% and 5.7% recorded during the third quarter of 2014.
External sector performance continued to deteriorate during the quarter under review with preliminary data indicating that the overall balance of payments deficit widening to US $152.9 million from US $125.0 million recorded during the third quarter of 2014. The widening in the deficit was mainly driven by unfavourable performance in both the current and financial accounts. The current account deficit widened to US $213.4 million from US $57.8 million on account of a decline in the trade surplus as well as a widening of the services and primary income deficits. During the quarter, the surplus on the trade balance declined by 21.0% to US $342.7 million from US $433.7 million recorded the previous quarter, explained by a decline in merchandise exports. Merchandise export earnings fell by 3.7% compared to the 4.5% increase recorded during the preceding quarter.The decline in export earnings is mainly explained by a contraction of 7.8% in copper export earnings following a decline in export volumes and averaged realised copper prices. However, non-traditional exports grew by 13.6%, partly reversing a downward trend noted for most of 2014. This growth was due to the increase in export earnings of products such as burley tobacco, gemstones, machinery and appliance parts, copper wire, maize and maize seed, soaps and detergents as well as fresh fruits and vegetables.

FISCAL POLICY
Preliminary data indicate that the Government continued to make steady progress with respect to fiscal consolidation. The fiscal deficit for the fourth quarter of 2014 was 10.1% lower than programmed. As a percentage of the projected gross domestic product (GDP), the deficit was around 1.3%. During the quarter, total revenue and grants were 16.3% lower than programmed, with all the revenue categories falling short of the targets. Consequently, total expenditure was also 11.7% below the fourth quarter projection.
For the year, preliminary data indicate that the deficit is estimated to be 4.8% of GDP, thus 0.7 percentage points lower than the programmed 2014 deficit of 5.5% of GDP. The estimated end-year fiscal deficit is a reflection of the Government’s efforts aimed at fiscal consolidation through the containment of expenditures.

INDICATORS OF ECONOMICACTIVITY
In the fourth quarter, selected indicators of economic activity monitored by the Bank suggest increased output in some sectors of the economy while output in other sectors declined. In the agriculture sector, the stock of maize grain held by the Food Reserve Agency rose by 6.9% to 1,346,344 metric tonnes at end- December 2014 on account of additional domestic purchases following the record bumper harvest. Similarly, rice stocks rose by 24.6% to 2,613 metric tonnes at end-December 2014 due to local purchases.In the manufacturing sector, production of clear beer, soft drinks and packaged mineral water rose by 2.6%, 18.8% and 71.1%, respectively. In the construction sector, production of cement increased by 14.4% to 459,387 metric tonnes. However, in the energy and tourist sectors, electricity generation and international passenger arrivals at the country’s four international airports declined by 2.3% and 13.8% to 3,472,374 Megawatt hours and 151,017 passengers, respectively.
Preliminary figures regarding overall GDP growth suggest that non-mining output grew strongly at close to 7.0%. However, output in the mining and quarrying sector is estimated to have contracted by around 1.4%, pulling down the overall GDP growth to 6.0% in 2014 compared with 6.7% in 2013. Growth in non-mining output was largely driven by the following sectors: transport, storage and communications; construction; financial institutions and insurance; agriculture, forestry and fishing; wholesale and retail trade; and community, social and personal services.

THE BANK OF ZAMBIA POLICY RATE
In the first quarter of 2015, inflation is projected to remain at elevated levels relative to the 7.0% target for the year. However, the MPC noted the recent downward trend in inflation from 8.1% in November to 7.9% in December 2014 and 7.7% in January 2015, with non-food inflation being the main driver of the downward trend. This development is partly a reflection of the monetary policy measures taken during the course of 2014 as well as the reduction in fuel pump prices.
However, the deterioration in the external sector continued in the fourth quarter of 2014 and the situation seemed to be worsening at the beginning of 2015. The projected slow-down in China, the major consumer of commodities, including copper will impact negatively on the country’s external performance with particularly adverse effects on the exchange rate and consequently inflation. The worsening external environment also presents a challenge to the Central Bank’s ability to accumulate foreign reserves required to mitigate exchange rate volatility. However, these external challenges are likely to be mitigated by the downwardtrendinoilpricesandpotentiallylowerGovernmentexpendituresonoilimports.
The MPC’s overall assessment is that inflation is on a more favourable trajectory toward the end-year target of 7.0%, than was the case at the November MPC meeting. Key variables on which the central bank has an influence, such as domestic credit and money supply, suggest less inflationary concerns going into 2015. The continued consolidation of the fiscal position by the Government is also expected to contribute to a stable macroeconomic environment going forward. However, the external environment and the recent deterioration in the external sector performance suggest that the current monetary policy stance should be maintained to mitigate potential external shocks. Consequently, the MPC decided to maintain the Policy Rate at the current level of 12.5%.The MPC’s expectation is that this policy stance will help in entrenching the gains achieved on the inflation front so far while at the same time continuing to support the Government’s growth objective.

The next MPC Meeting will take place on 12th May, 2015. Before that date, the MPC will continue to monitor developments in the financial sector and the broader economy, and will not hesitate to take appropriate monetary policy measures that ensure macroeconomic stability while safeguarding the nation’s growth objective.”

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