The Kwacha andExchange Rate Policy

Based on a study supported byThe International Growth Centre (LSE & Oxford)

John WeeksProfessor EmeritusUniversity of Londonhttp://jweeks.org

Major points

The Kwacha:1 Over the last several years the short run variation

in the Kwacha was low.

2 Nominal depreciation in recent months continues a longer trend dating back to late 2009.

3 Since late 2009 nominal depreciation resulted in a relatively stable & constant “real” exchange rate.

4 The depreciation trend is similar to that in other countries of the region over the same period.

Bank of Zambia

1 Operations in foreign exchange markets have reduced variation of the Kwacha.

2 Reducing variation is asymmetrical, more effective to slow appreciation (reserves increase) than to reduce depreciation (reserves decrease).

3 Further reduction in variations would require a large increase in reserves, plus information on foreign exchange flows that BoZ cannot know or predict (private sector foreign exchange management).

Major policy implications

1 Short run variations in the Kwacha are small and do not require policy intervention beyond the usual market operations of BoZ.

2 The depreciation trend has resulted in a relatively constant real exchange rate and should not be a cause of concern.

3 The current level of BoZ reserve holding is slightly below IMF guidelines, requiring accumulation.

SUMMARY

Unlike during some moments over the last 20 years, the Kwacha exchange rate is not now a problem requiring a substantial policy shift by the BoZ or the government, and this allows for necessary reserve accumulation.

Elaborations on

- the “Dutch Disease”

- BoZ “intervention”

- a “strong” and “weak” Kwacha

- appropriate exchange rate in the context of copper’s role in the trade account

- nominal exchange rate “stability”

Flow chart: The nominal Kwacha

Monthly nominal exchange rates with 4 currencies, percentage deviations from average, 2005.01-2014.02 (increase is a depreciation)

-40

-30

-20

-10

0

10

20

30

40

2005.012005.042005.072005.102006.012006.042006.072006.102007.012007.042007.072007.102008.012008.042008.072008.102009.012009.042009.072009.102010.012010.042010.072010.102011

.012011

.042011

.072011

.102012.012012.042012.072012.102013.012013.042013.072013.102014.01

US$ (.148)

UKP (.094)

Euro (.158)

ZAR (.137)

4 exchanges rates to US$, 2010.01-2013.12, percentage deviation from 2010.01 (coefficient of variation in legend)

0

5

10

15

20

25

30

35

40

45

2010.02

2010.04

2010.06

2010.08

2010.10

2010.12

2011.02

2011.04

2011.06

2011.08

2011.10

2011.12

2012.02

2012.04

2012.06

2012.08

2012.10

2012.12

2013.02

2013.04

2013.06

2013.08

2013.10

2013.12

Zambia (.053)

Kenya (.055)

Uganda (.075)

Tanzania (.056)

Monthly real exchange rates with 4 currencies, percentage deviations from period average (set to 0), 2005(Jan) -2013(Aug)

-30

-20

-10

0

10

20

30

40

50

60

2005.012005.042005.072005.102006.012006.042006.072006.102007.012007.042007.072007.102008.012008.042008.072008.102009.012009.042009.072009.102010.012010.042010.072010.102011

.012011

.042011

.072011

.102012.012012.042012.072012.102013.012013.042013.07

USD (.148)

UKP (.191)

euro (.141)

ZAR (.162)

Percentage difference in real exchange rate compared to period average, 2011.07-2013.09

-4

-3

-2

-1

0

1

2

3

4

2011.07

2011.09

2011.11

2012.01

2012.03

2012.05

2012.07

2012.09

2012.11

2013.01

2013.03

2013.05

2013.07

2013.09

The mild trend of nominal depreciation in the Kwacha is consistent with external indicators.

Stability of the real (PPP) exchange rate suggests an overall stability of the balance of payments.

Monthly US$ trade balance without re-exports, 2003.01-2013.11, US$ mns

-150-125-100

-75-50-25

0255075

100125150175200225250275300

2003.01

2003.08

2004.03

2004.10

2005.05

2005.12

2006.07

2007.02

2007.09

2008.04

2008.11

2009.06

2010.01

2010.08

2011.03

2011.10

2012.05

2012.12

2013.07

Monthly percentage point spread, Zambian 91 day T-Bills & US Federal Funds Rate, deviations from period average, 2003.01-2013.11 (averages in legend)

-15

-10

-5

0

5

10

15

20

25

30

2003.01

2003.07

2004.01

2004.07

2005.01

2005.07

2006.01

2006.07

2007.01

2007.07

2008.01

2008.07

2009.01

2009.07

2010.01

2010.07

2011.01

2011.07

2012.01

2012.07

2013.01

2013.07

Zambian 91 day T-Bill (9.4)

Zambian 24 month bond (15.1)

Sources of Kwacha variation

and BoZ operations

Quarterly trade balance without re-exports & coefficient of variation, 2000.1-2013.4* (US$ mns)

-400

-300

-200

-100

0

100

200

300

400

500

600

2000.1

2000.4

2001.3

2002.2

2003.1

2003.4

2004.3

2005.2

2006.1

2006.4

2007.3

2008.2

2009.1

2009.4

2010.3

2011.2

2012.1

2012.4

2013.3

coef var = -0.53

coef var = 2.00

2005.4

Estimation of the BoZ effect

Causal variables:1 trade balance (ratio of exports to imports)

2 domestic and foreign interest rates (percentage point spread

3 BoZ foreign exchange operations (US$)

4 Kwacha value in previous period

Changes in Kwacha/US$ rate by quarter, actual and without estimated BoZ effect, 2006.1-2013.3(number of Kwacha)

-1500

-1250

-1000

-750

-500

-250

0

250

500

750

1000

2006.1

2006.3

2007.1

2007.3

2008.1

2008.3

2009.1

2009.3

2010.1

2010.3

2011.1

2011.3

2012.1

2012.3

2013.1

2013.3

Actual change (aveage* = 250)

w/o BoZ (average* = 415)

Summary

I estimate that during 2006-2013 BoZ operations reduced the variation in the Kwacha from 9.2% of its quarterly value to 5.5%.

Why not by more?

Limits set by reserve holdings and the inherent instability of mineral prices.

Policy conclusions

1 The Kwacha has been relatively stable by both nominal PPP measures over the last two years, partly due to BoZ participation in the forex market which are appropriate and effective.

2 Going beyond exchange rate stabilization to medium term exchange rate management could undermine the goals of growth, diversification and exchange rate stability itself.

Policy conclusions (continued)

3 The exchange rate does not appear to be an effective instrument to alter the relative price of tradables to non-tradables in either the short or medium term.

4 As a result, in Zambia the exchange rate is not an effective instrument to foster competitiveness of non-copper exports, though it may be a part of a diversification strategy.

Suggestions

1 The instability of the global copper price implies that serious consideration be given to creation of a “copper fund”, for medium term exchange rate management & revenue smoothing.

2 Closer monitoring of foreign exchange flows from copper requires action by BoZ’s partners in relevant ministries (ZRA, MFNP and Ministry of Mines).