Whats Up Kwacha - Fundamentals?

Dr. AM Chibumba CFA

1 FUNDAMENTALS
Its funny how no one wants to explain whats happening to the Kwacha apart from the often quoted its
all a Global Phenomenon. So after running a few numbers I thought I should start the debate going using
what I hope is laymans language. So Ill first try to explain a few technical terms.
In economics, they (economists) often talk about fundamentals. These are the building blocks of
economic theory and try to explain whats happening in the economy. You can think of fundamentals
like the foundation of a building.
The usual suspects are GDP which in reality is GDP growth rate or think of it as how profitable is our
Zambia bizness, then two very similar concepts budget deficit which shows if the government is
spending more than its collecting as tax revenues and grants and the current account balance of payments
which shows whether more money is coming into Zambia than is leaving, inflation that shows if prices
are increasing or decreasing and interest rates or the local cost of money.
Now trying to juggle all these different measures of how the economy is doing is quite complex so let me
try to unpack the relationships.
We usually think of GDP as a measure of economic performance. Is our economy doing well (GDP growing)
or not (GDP falling)? In our case our GDP has been chugging along at about 7% for the last 10 years or so
a good positive thing. Now depending on which numbers you want to accept, the forecast due to lower
copper prices, ZESCO issues that is slowing down manufacturing, agriculture and services then the
expectation is that GDP will be between (3.5% - 5%) in 2016 and about 5% this year. So basically we can
expect our economy to earn less than in previous years but to still grow. What this means for us is that
money will not be as available as before, some people will lose their jobs as businesses close and generally
we will feel like we dont have as much money as before even if we are still earning the same amount of
money. The reason this is happening, aside from the increase in prices, is that the slowdown in our
economic growth means money is not going around our economy as fast as it used to. We say that there
is less liquidity. This will happen in an economy when there is a slowdown regardless of whether the
currency devalues or not. I will use an example to show liquidity.
Suppose that you earn a basic pay of K3,000 per month and work on average 20 hours overtime that pays
K1,000 giving you a total monthly income of K4,000. Then, because there is no power (ZESCO), your
employer cuts overtime. You now earn only K3,000 per month. Not quite broke but earning less than
before. You have less money to spend so you are less liquid.
Now what most of the other Usual Suspects do is actually to influence liquidity. So if interest rates
increase, then it becomes more expensive for you and I to borrow to buy cars, houses or make other
investments. So we spend less and we invest less because the cost of borrowing is too high especially
since we cannot rely on the overtime pay. Likewise if inflation increases, prices go up. So if mealie meal
. AM Chibumba CFA 2015

goes up from K60 per 25 Kg bag to K90, since I and my family must eat, we continue to buy the 4 bags per
month at K90/bag. So our essential spending increases from K240 per month to K360 per month. So just
from mealie meal alone I have K120 less to spend each month. If we add up all the increases in prices on
essential spending food, transport, housing, medical you can see that the price increases can soon
consume all my pay and leave me with nothing extra to spend. Basically increases in inflation and interest
rates leave me with less money to spend on non-essential items. This extra money to spend is what is
called Discretionary Expenditure. Its also the extra money that I can use to make savings deposits
into the bank. And it is these Savings that can be used by someone else to make investments by
borrowing from the bank. So if we are not saving because essential expenditure is very high, then in
general our economy cannot make investments. And if our economy cannot make investments then our
economy cannot grow.
The budget deficit affects liquidity in a different way. When the government is spending more than it
collects as taxes, it needs to find money for this extra expenditure. It mostly does this by borrowing from
the domestic markets and also from international markets (Euro Bonds). When GRZ borrows from the
domestic markets, its basically mopping up our savings in the banks and pension funds. This leaves less
money for the banks to lend to the rest of the economy and has the effect of pushing up interest rates. If
the banks realize that GRZ is running an excessive budget deficit they view this as an increase in the risk
of GRZ defaulting or creating inflation and so demand higher interest rates for this additional risk. Since
the interest rate banks charge to GRZ are the lowest risk for our economy, it means that interest rates
that we pay will also be higher than what GRZ is paying. So budget deficits may create inflationary
pressure and an increase in credit risk the risk that GRZ will default and both these effects will result in
an increase in interest rates. In general, running a budget deficit for a short period of time is reasonable
and most countries aim to have a balanced budget over 5 years as opposed to a balanced budget year on
year. Where it becomes a problem is when a government runs a habitual budget deficit year on year as
this eventually becomes unsustainable.
Understanding the current account balance of payments and how it affects liquidity is a bit more tricky.
The money that leaves Zambia leaves as foreign exchange (USD, GBP, EUR, RMB etc). This money belongs
to other countries. We get this money by exporting our products to other countries. When the money
leaving Zambia is more than what we are getting from our exports, then we have a problem with our
current account because we need to find this extra foreign money. What the Bank of Zambia does is keep
Reserves of foreign money. They use the Reserves to balance out the money leaving Zambia and what
is coming in from exports. And as long as BOZ can manage the Reserves in such a way that an imminent
shortage of foreign exchange cannot arise, then this balancing out activity should have no impact on the
exchange rate. But obviously if month by month more money continues to leave Zambia than what is
coming in from exports then the Reserves will start to decrease and this will put pressure on the
exchange rate. This is what has happened now. The question the markets are asking is Will Zambia be
able to earn enough foreign exchange to maintain its current account balance? Not even Einstein or
Galbraith could answer this question as it depends on a lot of factors that it is not possible to forecast.
And if you dont know what is going to happen next, the prudent thing to do is to hedge you bets. So you
get as much foreign exchange as you can whilst the opportunity is there and this will put pressure on the
exchange rate as is happening now. The other unanswered question and which surprisingly the Fundis

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have not asked is Under the current fundamentals is the Kwacha cheap (undervalued) or expensive
(overvalued)? I will attempt to answer this in my next opinion.
What the exchange rate does is to affect inflation. When the Kwacha devalues, as it has now, our imports
become more expensive because we must pay more Kwacha for the same Dollar. If an importer was
paying K50 to buy shampoo at $10 today he must pay K110. When he sells that today it will be at a much
higher price than K110. Higher prices means increased inflation and we know how that affects liquidity.
So this is why these fundamentals are important to understanding what is happening in our economy!

. AM Chibumba CFA 2015

Whats up Kwacha Valuation

Dr. AM Chibumba CFA

Valuation is always tricky. It depends on many things and is not an exact science. One of the best ways
of looking at the value of the Kwacha is by looking at Relative Valuation. What we mean by Relative
Valuation is that we can compare it with other similar things. For example, if you want to buy a house in
Chalala you can ask questions such as how many bedrooms, does it have an ensuite bathroom, what is
the floor area etc etc. Once you have these parameters then you can use them to compare with other
houses in Chalala that are of similar size. What you cannot do is take a 2 bedroom flat in Chalala and
compare it with a 4 Bedroom house in Chalala. Similarly you cannot compare a 4 bedroom house in
Chalala with a 4 bedroom house in Kabulonga. Relative valuation requires comparing like with like.
So if the Kwacha has been the worst performing currency this year, then the questions we should be
asking are:
a. To what extent is this due to global factors?
b. Are there specific factors that have made the Kwacha perform worse than its peers?
So what we have to do is first find the Kwachas peer group and then line up the Usual Suspects as
comparators. This is not as easy as it sounds because finding a peer group is no easy feat.
The ideal country would be Chile except that Chile today is not just the largest copper producer, but also
a large exporter of lots of other goodies including manufacturing and services. But we can include it in
the mix whilst noting that it has a significantly more diversified economy than Zambia. Other countries
that we can consider include Ghana, similar economic profile basically gold and agriculture, Uganda
agriculture, Kenya Agriculture and Manufacturing and also our second largest trading partner, South
Africa Commodity based, diversified economy and our largest trading partner and Nigeria oil based
economy. Not exactly like Zambia but incorporating similar characteristics. If Zambias fundamental
economic variables were like the average of this peer group, then we would expect that its currency
performance would also be the average of this peer group. If this is not the case, then there must be
some exceptional economic drivers specific to Zambia that are perceived to be either more positive or
more negative for its economic outlook. This will in turn influence the exchange rate either positively
(Kwacha appreciation) or negatively (Kwacha devaluation).
Before I tabulate the comparators, we know that the Kwacha has been the worst performer. So for now
we should focus on whether the fundamentals support this view. If the market is correct then Zambias
fundamentals MUST be outside the range for these economies. If this is not the case then ON THE BASIS
OF FUNDAMENTALS ALONE the Kwacha is either undervalued (cheap) or overvalued (expensive).
Since Bloomberg has been reporting on this the most I decided to use their economic and currency data.
The other reason for doing so is that Bloomberg is the major trading platform for Global Bonds so the data
that they keep is used by the international markets when they perform their own relative valuation.
The Chart below shows the performance of the Kwachas and its peers over the last year.
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Key: UGX Uganda, KES Kenya, NGN Nigeria, ZAR South Africa, TZS Tanzania, CLP - Chile
The column on the right shows the relative devaluation of all these peer currencies against the USD. And
as you can observe the Kwacha is by far the worst performer with devaluation at about 89% whilst the
other currencies have devalued from 14% (Chile the Copper King) to 38% (Uganda Agriculture Country).
Also note that before March 2015, the Kwacha basically behaved like its peer currencies. So this gives us
a pointer in terms of working out what has happened after March 2015. Just note this!
Table 1 below shows the usual suspects for the peer countries over the last 5 years. In terms of
performance GDP, Zambia has clearly been one of the best performers historically. It has also maintained
a fairly healthy current account balance and budget deficit position compared to its peer group. And until
recently, its budget deficit has been

. AM Chibumba CFA 2015

Table 1: The Usual Suspects

Zambia
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)
Uganda
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)
Tanzania
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)
Kenya
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)
South Africa
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)
Chile
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)
Nigeria
GDP
Budget Deficit (% GDP)
Current Account Balance (% GDP)

2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Average Stress
6% 6% 6% 6% 8% 7% 7% 7% 7% 5%
7% -1%
2% -1% -1% 0% -1% -2% -3% -7% -6% -9%
-2% -7%
-8% 1% -7% -8% 4% 7% 0% -3% 1% -5%
-1% -4%
5% 6% 7%
-2% -2% -1%
0% -4% -2%

6%
-7%
-5%

5%
-2%
-7%

0%
-5%
1%

7% 7% 7% 7%
7%
-2% -1% -5%
-4% -12%
-6% -8% -9% -12% -9% -8% -12% -11% -10% -11%

7%
-5%
-9%

0%
-7%
-2%

6% 7% 2%
-2% -3% -3%
-2% -2% -4%

3% 5% 5% 5% 5%
-4% -5% -4% -4% -4%
-7% -6% -7% -12% -10%

5%
-8%
-3%

5%
-9%
-8%

5%
-4%
-6%

1%
-5%
-2%

5% 5% 3%
1% 1% -1%
-3% -5% -7%

-2% 3% 3%
-5% -4% -4%
-7% -4% -2%

3%
-4%
-2%

2%
-5%
-5%

2%
-4%
-6%

2%
-4%
-5%

3%
-3%
-5%

-1%
-1%
-1%

4%
7%
-2%

-2%
-4%
-3%

6%
1%
-1%

4%

2%

-3%

-3%

2%
1%
-1%

4%
2%
0%

-2%
-1%
-1%

5% 6% 5% 6% 8% 7% 6% 6%
-1% -1% 0% -3% -2% -2% -1%
7% 18% 19% 38% 33% 6% 12% 11%

6%

6%

7%

5%
8%
5%

7%

3%
5%
4%

5% 5% 7% 3% 6%
-1% -3% -3% -2%
-8% -7% -9% -11% -12%

5%
-5%
-8%

6%

5%
0%
2%

6%
1%
2%

4%

4%
-3%
3%

6% -2%
-2% -1%
16% -14%

reasonable and better than its peer group. Even the current levels of the fundamentals is not significantly
different from its peers. The Kenyan economy, for example, has exactly the same current levels of
performance for these parameters and yet the Kenya Shilling has only devalued by 15%. So all in all,
compared to its peers, there is nothing in the Fundamentals that would explain the poor performance
of the Kwacha. This in turn MUST mean that THIS IS NOT A GLOBAL PHENOMENON. In fact, if we
average out the devaluation of its peers as a proxy, then at most ONLY 25%, of the devaluation of the
Kwacha can be explained by GLOBAL PHENOMENON. The rest is SPECIFIC to Zambia and you can see it
from looking at the column I have labelled Stress. Just observe how far Zambias current fundamentals
are away from the historical average. Further note that all two of fundamentals (budget deficit and
balance of payments) are significantly away from the historical average. In fact, in this peer group, Zambia
is the only country that has more than one fundamental far from the historical average. This is what may
. AM Chibumba CFA 2015

be spooking the market and this is what the market wants sorted out. Their thinking is simple. Zambia
does not have recent experience of juggling a stressed economy. How is Zambia going to handle a budget
deficit and current account deficit in a contracting economy? Right now the markets cannot see GRZ
providing a solution because, even if they knew how, NEXT YEAR IS AN ELECTION YEAR!
So in summary! The fundamentals of the Zambian economy at present does not support a devaluation
beyond 25% i.e. based on fundamentals the exchange rate should be between K9/$1 to K10/$1.
What has happened is that the markets have perceived rightfully or wrongly that Zambia has specific risks
above and beyond its peers and it is these perceived risks and not the economic fundamentals of Zambia
that is driving the exchange rate. Understanding these perceived risks is the first step to restoring
confidence in the Kwacha and bringing it back to it correct levels. The budget will be the first occasion for
GRZ to either reinforce these perceived risks or negate them. If it (GRZ) reinforces these perceived risks
through a budget that does not address core issues such as the budget deficit, export promotion to reduce
the balance of payments deficit then the markets will interpret this as confirmation of their perception
and accordingly increase the perceived risks. The worst position to be in is to result in a situation that will
require IMF intervention sometime next year an election year. If on the other hand the budget is
disciplined, then we can expect some short-term pain but early relief within a 6 to 12 month period. In a
strange way we are back at that 1974 moment when Ba Andrew Kashita increased prices to balance the
budget and after a few near bread riots President Kaunda backed down. Had we taken the pain then, we
may have avoided the 20 year recession even with low copper prices.

. AM Chibumba CFA 2015

Whats Up Kwacha The problem with

shocks
Dr. AM Chibumba CFA

It has always amazed me how something can be both good and bad with just small changes. Take an
electric shock. Most of us have watched movies when someones heart stops and the bip bip bip on the
monitor just goes beeeeeeeeeeeeeeeeeeee.. or flatlines as they say. Then all these medical people
come around stick things on someones chest and someone shouts clear an electric shock is applied
and after a few tries we get the bip bip bip sound again. Someone has just come back from the dead
courtesy of an electric shock. What you might have not seen unless you watched The Green Mile is
seeing someone strapped onto an electric chair and getting fried to death. Amazing how just changing
how an electric shock is administered can have such contrasting effects. Strange as it may seem, shocks
to the economy are very similar to administering electric shocks. The significant difference is that
economic shocks are sometimes out of our control and at least the two electric shocks I have quoted are
fully under our control. But I want you to focus on the nuance of the electric shocks. In one case a person
lives, a good shock, and in the other a person dies, a bad shock. The only difference between the two
electric shocks is how they are administered that is what I mean by nuance.
Economic shocks can also be controlled and we have a living example of that. In the early 2000s Zambia
was battling with high interest rates and no solution of what to do about it. An idea was proposed to
reduce GRZ issuance of T-Bills. After much procrastination, about 2 years following the proposal, BOZ
finally got the green light to attempt the shock. Dr. Kalyalya was Deputy Governor and is fully aware of
how that shock was applied. GRZ reduced issuance of T-Bills around 2005/6 and suddenly the banks found
that they had no easy place to put their cash. In typical Zambian fashion the response from the market
was that GRZ was not disciplined enough to keep out of the T-Bill market. Well after about 6 months of
GRZ behaving interest rates dropped from 35% to about 25% and over the next year to below 15%. The
funny thing was that the shocks was not GRZ stopping to borrow from the domestic market. The real
shock was taking away an easy market for banks to make money and basically forcing them to lend to the
real economy i.e. bricks and mortar and stuff that creates wealth. And we trundled away nicely like that
until GRZ started borrowing heavily again in 2011. This is what Dr. Magande means when he says the PF
government has reversed all my hard work. But thats just one part of the story.
On the other hand now as in the 1970s, an external shock basically resulted in low copper prices. The
differences between now and the 1970s is that then we owned the mines and oil prices were increasing.
Now we own nothing, mines are foreign owned, and oil prices are falling. The good thing now is that we
dont own the mines so, in a real economy, this would only affect the mining sector and maybe trigger
economic challenges in other sectors. And at 10% of GDP and contributing only 2% of taxes, mining is too
small to be an issue especially when we dont own the mines because the losses will be to the owners of
the mines. Falling oil prices should also have been good for us except for the dodgy way we buy fuel that
makes it expensive. But that is in a real economy. In Zambia, the MINES ARE EVERYTHING. They earn the
largest amount of foreign exchangePARDON! Can someone please tell me how much of that foreign
. AM Chibumba CFA 2015

exchange actually ends up in Zambia!!! And by the way, how much money do they borrow from the
Zambian economy? Let us add up some numbers before we arrive at conclusions. The only thing I can
tell you is that if the mines brought back the odd $5 billion in metal sales that they make to Zambia, the
Kwacha would be the strongest currency in the world. Since its not Im not convinced that even 50% of
the money from copper sales comes back to Zambia. And this is where we have the biggest problem for
our exchange rate.
Now you have to forgive me because Im doing some number gymnastics but bear with me without
numbers. First let us ask who suffers the most if the mines close? Yes we would lose some jobs and some
foreign exchange. But at 10% of GDP and adding a multiplier of 3 then let us say we lose 30% of our GDP
growth. Thats only 2.1% loss of growth so a change from 7% to just under 5%. Something like what is
happening now. My point is that this will not kill our economy. The tricky bit is understanding the financial
issues for domestic suppliers and banks if the mines went belly up. It could be that domestic suppliers
and banks are too exposed to the mining sector and as a result when the mines go bankrupt, it affects
their suppliers and banks. The real issue is the banks because they would lose their capital and have
nothing to lend to us and that would really slow down the economy beyond the 10% of GDP that
constitutes the mines. In fact, given that most of our banks are foreign owned, their owners might not be
able to recapitalize our domestic banks so real trouble for us. So mostly foreigners, shareholders in the
foreign owned banks exposed to the mines and shareholders in the mines would suffer. The bankrupt
mines would be bought by other investors for significantly lower prices and these new owners would be
able to make money and re-employ the miners made redundant by the mines going belly up. So not
something that we should fear too much especially if it frees up the 300 MW of power for manufacturing
and export and gets us out of those dodgy Investment Protection and Promotion Agreements that we
stupidly signed with the mines. Now that is a restructure that the IMF and World Bank should be pushing
for!
Second, knowing that you have some power over GRZ and their sensitivity and fear of losing jobs in the
mining sector in an election year, what is the best action as mine owner that you could take? Well as a
mine owner I fully understand that I have the most to lose. So if I am to survive I need to know how to
limit my losses. A 50% devaluation of the Kwacha makes all my Kwacha loans and Kwacha expenses
cheaper by 50% since all my earnings are in Dollars. So even if copper prices have dropped 50%, my
Kwacha costs have also dropped by 50% because of devaluation. Whether I make money or not will
depend on the ratio of my Kwacha costs to my Dollar costs. The more Kwacha costs I have the better for
me. Given the external debts owed by mines to their international lenders, procurement of materials
mostly not made in Zambia chances are mines have a bigger dollar exposure than Kwacha exposure. So
if as mine owner I am to survive a drop in copper prices, I want the Kwacha to devalue as much as possible
because this will minimize my Kwacha cost. I can use the Kwacha devaluation to buy time until copper
prices start to rise again. Of course this also assumes that salaries will remain the same and if that happens,
effectively it is the Zambian citizen who is paying for this. So could it be that the mines are collectively
administering an economic shock to us to manage their profitability by pushing for Kwacha devaluation?
Now Im not suggesting that this is their plan. But clearly an external shock was administered to the
mining sector and they have to respond to it somehow if they are to survive that is the nuanced response.
Its just a hypothesis. But whatever the case is, as key players in the foreign exchange markets their
actions should be closely monitored.
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GRZ also has a partial interest in devaluation. Those Eurobonds will buy more Kwacha and they can pay
salaries, contractors etc etc. using 50% of the Eurobond money and keeping the rest as reserves. The
challenge for GRZ is that those same Eurobonds are now strangling them because as the Kwacha devalues,
the Eurobonds lose value and this pushes up interest rates that GRZ can borrow from international
markets. This in turn pushes up domestic interest rates because international interest rates are supposed
to be lower than our domestic interest rates and must remain that way because our inflation is higher.
So the next Euro Bonds GRZ wants to issue will be even more expensive and our domestic interest rates
will increase because of this and costs are going to go up because inflation has increased and interest
rates will have to rise again because of higher inflation and all this happening when the mines are not
exactly out of our economy but definitely not bringing in as much foreign exchange as they are taking out
so we cannot be sure that GRZ will have the foreign exchange to pay its international obligations.
So I hope you get the picture. We could be entering a devaluation spiral. We have a balance of payment
deficit so we borrow from international markets. Our currency devalues, inflation increases, interest rates
increases, the economy contracts so GRZ has less tax money so the budget deficit increases and GRZ has
to borrow more money so interest rates increase and inflation increases and .
You might also ask the question, if the mines have devaluation as their nuanced response for survival
given the external shock of falling copper prices, what is GRZ nuanced response to all this? And if the
markets cannot see this nuanced response what impact will this have on the Kwacha exchange rate?

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10

Whats Up Kwacha Surviving Shocks

The quick and easy way out of exchange rate volatility is simply to exit and get a different and less volatile
currency. But this is not easy because, as Zimbabwe has learnt, they dont print the United States Dollar.
So their liquidity and hence growth is entirely driven by how many additional dollars they can bring in
so that means increasing exports.
As a citizen and home owner I know that if the Kwacha devalues and I price my house in Kwacha then it
will become cheaper for someone with Dollars to buy. So since I dont want that to happen, the logical
thing for me to do is to price my house in dollars. That way I preserve the value of my house. This simple
approach has the additional advantage of slowing down asset sales because most people will not want to
part with their dollars. So it will also have the effect of slowing down asset price inflation. Your and my
house cannot increase in value as fast as before because we are now pricing in dollars that are increasingly
rare. So at some point even the dollar prices for property will have to fall. But this will preserve your
house value for longer than if you accept Kwacha and it devalues.
Now this simple solution is not advocated by BOZ because it makes the Kwacha redundant and that after
all is what they are supposed to be managing. But an interesting observation might be that Zimbabwe
like most of the countries in the Eurocurrency still have Central Banks. Their mandate is just different. So
a switch to pricing in Dollars is not necessarily a bad thing. What it does do is limit the ability of foreigners
to buy Zambian assets cheaply. This is why most estate agents changed from pricing in kwacha to pricing
in Dollars. Its the smart thing to do.
The problem is that this approach also renders a devaluation ineffective because basically you and I have
ignored it and said We dont care! We know the real value of our assets in Dollars and since nothing
fundamental has changed, why should the value change?
But these are not questions that The World Bank and IMF want us to ask. Definitely your response is
exactly what they do not want and here is why. If we continue pricing our assets in Kwacha, they will
become cheaper for foreigners to buy who will then bring in the foreign exchange to fill the current
account deficit. At least this is the theory of exchange rate devaluation. This will stabilize the Kwacha but
in the process you and I will become beggars. We will end up owning even less of Zambia than before the
devaluation so you can forget about empowerment. No one asks why on earth foreigners would want to
buy property in Zambia to help it balance its current account and they definitely cannot tell you for how
long foreigners will continue to buy Zambian assets to balance the current account. This sounds nice in
theory but in practice what will happen is that those Zambian who earn Dollars and some strategic
investors will buy us all out. So wealth will end up being even more concentrated than before. But for
the IMF and World Bank, devaluation will sort out one major issue. It will limit the loss of wealth of
shareholders in the mines and foreign owned banks basically Europeans and Americans. And that
reduces the stress in those economies.
But the nice thing about shocks is that anyone with enough leverage can apply them. So hers a test for
our resilience. Suppose we are all to decide not to buy imported products where a Zambian equivalent is
available. For example I only buy Yoyo snacks because they actually taste better than all the imported
. AM Chibumba CFA 2015

11

equivalents. If we all did this then we would effectively shock the market. The shops carrying foreign
products would find them slow moving and start cutting their prices even under the current devaluation
because these goods might expire. In addition they will reduce their stocks of these imported goods. This
will in turn reduce the import bill and reduce pressure on the Kwacha. So just our consumer habits alone
can trigger a market shock and its effect will actually be much greater that what GRZ and BOZ can possibly
do. This is something within our control, and is something we should consider if we want the Kwacha to
stabilize and perhaps strengthen a little bit. The fact is that BOZ and GRZ are restricted in what they can
do because of international treaties/agreements that we absent mindedly signed either under duress or
otherwise. We as consumers are not bound by these treaties so let us vote with our money and give it a
try for say 3 months. If it works then we continue for a further 3 months. Hopefully during this time our
local manufacturers will have responded and started to improve on their quality and pricing so that we
can definitively move away from some imported products. This will also stabilize and consolidate our
existing manufacturers and create jobs for us and prop up the Kwacha and preserve our purchasing power.
So not a bad deal for us. Its a simple decision for us to make stop buying foreign products.
So after our budget what is likely to happen? We know that GRZ must go for another Eurobond. They
will likely be told, like Ghana, that the market appetite for such a bond is low unless you can get a
guarantee. So we will have to go to the IMF and World Bank to get our guarantee and then GRZ will get
a reasonable interest rate. But the IMF and World Bank guarantee will come with strings attached. Is
devaluation on the agenda? Reduction of the budget deficit? Increase in Taxes? All of these actions
might sound good but must we go through devaluation to get to that?
When Im lost and troubled over Zambia, I pray and think of South Korea. I remember South Korea after
years of success nearly going bankrupt in the late 1990s. I remember how the South Korean citizens took
their gold, jewelry and other valuables and GAVE them to their Central Bank to enable their country to
pay its debts. So now I shall once again be praying that one day Zambians shall love Zambia the way
South Koreans love South Korea and that we can rise up and say no to another Eurobond that just might
take us over the edge and as consumers apply our own shock.

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Whats up Kwacha Beyond Survival

Dr. AM Chibumba CFA

We now know whats in the budget and the surprising thing is that with only a few exceptions, the core
message has been missed. The Fitch report was perhaps the most surprising and probably most revealing
for the things it omitted.
Now I know that the guys at Fitch are very good at counting and checking budgets out so I cannot accept
that what I view as a flawed analysis was due to a rush job. Basically Fitch said that GRZ will not be able
to raise the additional revenues because .. well they dont trust ZRAs effectiveness to increase revenue
collection. Whilst this might be true, let us also look at the reality on the ground. For example, this was
not an expansionary budget in real terms. The fact is most GRZ expenditure is US Dollar based. So if thats
correct then the budget in real terms contracts from about $7.4 billion in 2015 to $4.7 billion in 2016. By
any measure this is a huge drop in government spending and would be seen as a very responsible position
to take. IT IS A RESPONSIBLE STEP IF GRZ CAN STICK TO THAT BUDGET TARGET. Fitch chose not to
mention this. The second fault in Fitchs presentation is that they ignore the impact of devaluation on
Government revenue. Our imports are USD based and the devaluation alone increases the collectable
duties on these imports by over 25%. So increasing ZRA tax and duty collections by an additional 4% (from
about 16.6% to 20.4%) in total is not only feasible, but practically achievable just from devaluation effects
on cost of imports alone. ZRA actually does not have to do more than they are currently doing to achieve
this increased tax collection.
Now Fitch may argue that with a contracting economy and reduced foreign exchange inflows and
continued levels of imports will mean that the balance of payments will remain in deficit and that this
alone will stress the Kwacha towards further devaluation. Now this I can accept. However, if you accept
this position, basically we get another year of imports like last year, then you cannot deny that tax
revenues will go up.
The alternative scenario is that imports will decline because traders will be more cautious about their
ability to increase prices. In any event, reduced imports allows traders to push up prices if demand remains
the same. So it is in the best interest of traders to reduce imports to minimize their exposure to exchange
rate movements. If this happens then the level of imports will decline and therefore the likelihood is that
the balance of payments deficit will decline, meaning that pressure on the exchange rate will reduce.
The scenario of imports increasing is also unrealistic because in USD terms GRZ expenditure has drastically
declined. So where will the money to support these imports come from?
Clearly the driver for devaluation under the current budget is not there and Fitch know this. So the only
possible explanation for any driver for devaluation based on fundamentals is not there. This leaves only
the about $1.3 billion GRZ wants to raise from external sources as the remaining suspect.
What we know about GRZ Euro bonds is that they have lost a lot of value since the first bond issue. This
was issued at about 5% interest rate and as far as I know this is a fixed rate. This means that for the
duration of the life of this bond it will continue to pay only 5% interest. The next bond issues pays about
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8.5% and the latest bond was issues at 10.25%. The reason that the interest payment has gone up is that
rightly or wrongly the markets thing that the credit risk, the risk that GRZ will default on its Euro Bond
obligations, has increased. The interesting thing though about bonds, is that with the increase in GRZ
yields on its Euro Bonds, they have actually become cheaper. This means that if we could find enough
money to buy back these bonds, we could pay significantly less USD dollars than the money that we got
for these bonds. Roughly, the face value of GRZ Euro Bonds has dropped from about $94 for each face
value of $100 to about $87 per $100 face value. What this means is that although GRZ borrowed about
$3.2 billion, GRZ only needs about $2.7 billion to buy back these bonds. Basically when interest rates
increase, bond prices fall. So someone please give us the $2.7 billion we buy back these bonds and exit
the Euro Bond markets that we are clearly not ready for.
Now you have to consider this increase in GRZ Euro Bond yields in light of what has been happening
elsewhere. It was generally accepted until a few weeks ago that interest rates in the US will start to
increase. However, what everyone usually forgets is that the USA is still the worlds largest exporter of
commodities. Yes they are! And imagine how the fall of commodity prices has impacted the US economy.
The current thinking is that because of this fall in commodity prices, it is now unlikely that the US will
increase interest rates. They have a very good application of economic practice. Its called the Federal
Reserve Act a basic law that compels the US Governments and Federal Reserve Bank to behave always
in a manner that supports Growth and Opportunity. That is why, for example, they reduced interest rates
and kept them low since the 2008 Global Economic Crisis. Besides, like here, next year is also an election
year in the US so no way that the Democrats will want to go into an election during a recession created
by increasing interest rates to balance out either a budget deficit or balance of payments deficit. So there
is no chance of USA interest rates increasing. What this means is that pressure for yields to increase,
especially on emerging markets bonds like the Zambia Euro Bond, should reduce. So we have to ask again
what the impact of a fourth GRZ Euro Bond will be and how the market will take that.
I think what Fitch could not say is that they think that it is highly unlikely that the international markets
will welcome a GRZ Euro Bond without some sort of credit enhancement. They then postulated that the
credit enhancement can only come from the World Bank and IMF. Then they extrapolated, like I did
previously, and arrive at a conclusion that the measures that the Word Bank and IMF would demand in
order to provide the credit enhancement and support the balance of payments deficit will require
additional devaluation of the Kwacha beyond the current levels and possibly further reductions in GRZ
expenditure. The prospects then for Zambia would become grim and we would probably end up in a
recession. That would then explain the credit downgrade.
So obviously the issue for the economic Fundii to address is how we access this $1.4 billion without having
to go to the IMF and World Bank. Clearly if we do this then we are out of the woods for this year. But
what happens next year? Do we still go back to the international markets or hope that the mines will start
behaving? Clearly what is required is a serious re-think of our economic structure. One way or another
we will need to find a way of increasing non-traditional exports in the medium term, reducing on imports
in the short-term and basically making our economy more domestically driven. For you who might think
this is something simple, recall that this is exactly what President Kaunda tried to do all the time he was
fighting colonialism. The only difference now is that we are just starting the fight against economic
colonialism. President Kaunda won the political war but lost the economic one. There is no guarantee
that we too can win this new economic war. But at least we should go down fighting!
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