In a Country Report on Zambia published this week, the IMF team led by Outgoing Mission team for Zambia Tsidi Tsikata, the Washington based institution says the manner in which the Bank of Zambia has responded to has implemented its monetary policy has threatened financial stability.
The IMF states that the Monetary Policy Rate which is set by the Bank of Zambia has lost its aspiring role in the country’s Monetary Policy Framework.
In April 2012, the Central Bank took the first step towards modernizing its Monetary Policy Framework when it changed its operational procedures.
It formally shifted its operational procedures from targeting monetary aggregates or quantities to interest rates when it introduced the Policy Rate and established an informal interest rate corridor, set at ± 2 percentage points around the Policy Rate.
Following that decision, the operational target of Monetary Policy changed from reserve money to the overnight interbank rate.
Initially, Monetary Policy aimed at maintaining the 30-day moving average of overnight interbank rate close to the Monetary Policy Rate and within the corridor, but soon afterwards the moving average was reduced to 5 days.
Currently, the BoZ aims at maintaining the 5-day weighted average overnight interbank rate within the policy corridor.
But the IMF says the implementation of the monetary policy faced several challenges, which have hindered the modernization of the Monetary Policy Framework.
“The main underlying rationale for introducing the MPR was to mitigate the cost of credit. Although the introduction of the Monetary Policy Rate in Zambia was in line with similar measures taken by other African Central Banks modernizing their Monetary Policy Frameworks, the decision was taken within a context of the BoZ trying to exert greater control over lending rates,” the paper acknowledged.
“Indeed, less than one year later the BoZ introduced a ceiling on commercial banks’ lending rates,” it says.
The IMF stated that the ceiling did not produce the expected results and was removed in November 2015, along with several other Monetary Policy measures taken by the BoZ in an attempt to stabilize the kwacha during a sharp depreciation episode.
“In the first two years following the introduction of the Monetary Policy Rate, the BoZ kept the overnight interbank rate within the (wide) policy corridor 95 percent of the time. When the overnight interbank rate went outside the corridor, deviations from both bounds were relatively small and short-lived. The Monetary Policy Rate has lost its aspiring role in Zambia’s Monetary Policy Framework,” it charges.
It adds, “In an interest-rate framework, the Monetary Policy Framework plays a central role by clearly signaling the Monetary Policy stance. It also conveys, in a forward-looking framework, the CB’s assessment on future economic developments. In addition, by being much less volatile than under a MTF, it enhances policy signals, increasing the efficiency of the MP.”
The IMF says the frequent discrepancies between the Monetary Policy Rate and the Over Interbank Rate blurs policy signals making Monetary Policy opaque, harms the transmission mechanism of Monetary Policy and undercuts the credibility of the new operational framework.
“In addition, although under these circumstances interbank rates reflect better monetary conditions, they cannot perform properly the role of a meaningful reference rate, as they become very volatile and unpredictable. MP in Zambia appears to be trying to achieve multiple and often conflicting objectives,” it says.
The IMF also charges that one key reason behind the “policy rate smoothness problem” seems to be that the BoZ appears to face constraints on its ability to adjust its PR.
It says there is evidence that the difficulties faced by BoZ to adjust fully the Monetary Policy Rate reflect public and political concerns over the cost of credit and, therefore, growth.
“While the monetary authority sets the MPR, market conditions determine the interbank rate, which “transfers” to commercial banks the ownership of high interest rates. This kind of constraint is not unique to Zambia and is common in many other countries, and evinces the importance of operational independence. The lack of a coherent MPF not only causes unintended consequences, but also some of them are precisely what the CB is trying to avoid in the first place.”
It notes, “Despite the success so far in stabilizing the ER and inflation, the policy response created several distortions and unintended consequences, with large economic costs that could have been largely mitigated.”
“Some of them are, Credit growth has collapsed and lending rates have soared. Liquidity risks, funding costs and lending rates soared following the liquidity crunch created by November’s 2015 MP reaction. Consequently, credit growth plunged, as it has been restricted to prime clients, conflicting with BoZ’s objective of containing borrowing costs and increasing the supply of credit, harming financial inclusion and development.
It says the Monetary Policy response has threatened financial stability.