Why Zambia’s foreign reserves are dwindling, kwacha depreciating, while copper prices are sky high: Pres. Lungu holds the key to Kalyalya’s conundrum.

By Kalima Nkonde

President Lungu’s renewal of the contract of Bank of Zambia Governor Dr. Denny Kalyalya should be applauded by independent and keen observers of the Zambian economy as the man, has done a sterling job at the Central Bank regarding monetary policy which has not been sufficiently complemented by fiscal policy measures and executive action.

The initial appointment and subsequent renewal of the contract of the Governor is a clear demonstration that if appointments to key positions are made on merit, Zambia’s economy can easily takes off. The President deserves great praise on this and it should be testimony to the fact that when he does the right thing and makes an informed decision, like he also did regarding the removal of street venders he will win supporters among independents and objective Zambians and thereby build a better legacy.

Improved economic indicators at risk

Dr .Kalyalya has presided on the reduction of inflation from a high of about 21% to a low of 6.1%; stabilization of the exchange rate from $14 to a dollar to below $10; reduction of the policy rate to 9.75% and the statutory reserve rate to 5% and tried to urged the powers that they quickly conclude the IMF deal to help the country with the balance of payments situation which was very fragile when he took over in 2015 but three years on, the deal is not yet on the table mainly due to political delays initially and now IMF is playing hard ball having discovered hidden Chinese debt.

In their Country review statement of 2017, the IMF Executive Board commended Zambia for the improved economic indicators but warned that these gains were precarious and could easily be lost if decisive fiscal action was not taken.

“The near-term outlook for the Zambian economy has improved in recent months, driven by good rains and rising world copper price. The economy was in near-crisis from the fourth quarter of 2015 through most of 2016, reflecting the impacts of exogenous shocks and lax fiscal policy. Executive Directors welcomed the recent improvement in Zambia’s economic outlook. However, Directors noted that domestic and external risks pose significant challenges. They advised the authorities to take advantage of the current favorable conditions and implement decisive and prudent macroeconomic policies and reforms to place public finances and debt on a sustainable path, build international reserves, increase the economy’s resilience to shocks, and achieve higher and inclusive growth”.

However, due to lack of sufficient complementary reforms on the fiscal side, all these gains are now under serious threat where inflation on the upward trajectory and standing at 7.4%; the kwacha is now above the K10 threshold to a dollar and foreign reserves are an eight year low. The low foreign reserves apart from foreign debt are now one of the major economic challenges facing the country and like all economic indicators, it is connected to other factors that are not in the Governor’s control but other arms of government under the President’s control.,

Status of foreign reserves and the kwacha value

Zambia’s foreign exchange reserves were estimated at $2.4 billion in April, 2017 but as of February, 2018, Zambia’s foreign exchange reserves stood at US1.867 billion which is roughly two months of import cover. This is a drop of approximately 29% in less than a year. This is a massive drop and this explains the governor’s concern. This deterioration in the forex reserves is already being reflected in value of the kwacha. In July 2017, the kwacha hit an all time high of $8.90 to a dollar and currently it is about $10.30 to a dollar which is 16% depreciation in a twelve month period.

In February, 2018, during a press conference, the Central bank governor, Dr. Denny Kalyalya bemoaned the low level of foreign reserves.

“Right now, the reserves are not too good for our own comfort. It is a bit tricky; when trying to build reserves through purchases from the market, we have to weigh the impact on the overall market because I think it its still quite fragile. Right now, the reserves are not too good for own comfort- we are talking of $2.1 billion as at the end of December last year – which is close to three months import cover. Our own target is to get to beyond four and if we have to reach the SADC target, its six months of import cover. Copper prices are rising but you see continued reduction in reserves; it’s tricky,” The Governor lamented.

The Governor statement was couched in diplomacy and did not outline why the reserves are low despite the copper prices rising for fear of offending the appointing authority and the powerful forces of mining houses who are the major contributors to the low level of reserves by either commission or omission. This article tries amplifying on the Governor’s concern by explaining to the public the factors affecting the low level of reserves and consequential current depreciation of the kwacha.

While the lay may not understand the importance of having reasonable foreign exchange reserves, and may just ignore the current status, the reality is that low foreign currency reserves affect every Zambian. It is one of the major determinants of the value of the kwacha and if the kwacha depreciates as it is doing now – and Zambia being import dependent – all prices of goods and services will sooner rather than later start going up like in 2015.

IMF deal collapse effect.

The uncertainty surrounding the IMF deal has resulted in the loss of confidence by investors in Zambian economy resulting in the reduction of portfolio investors who were bringing in their foreign currency to Zambia prior to the decision by IMF to put the deal on hold due to the ‘hidden’ debt. It is fair to say that most Zambians do not appreciate that the improved economic figures especially the stable kwacha, happened during the period when Government and IMF were involved in negotiations with the latter providing technical assistance thus boosting investor’s confidence in the Zambia’s economy and its prospects. Foreign investors had confidence that the management of economy under an IMF programme will be better as the current administration is viewed by many independent experts as indisciplined managers of the economy.

According to the African Confidential Magazine, the IMF deal is unlikely this year given that the IMF visit to Zambia is in September, 2018,

“The Ministry insiders say the gap between the IMF’s view and the government’s is too wide for a programme to be possible this year. The Fund’s next mission is not until September, which is far off, given the urgency of the country’s problems. Mwanakatwe is trying to persuade officials to visit in June, the month before the $56 million tranche of payments on Eurobonds is due. But it is Zambia that has to make the first move, by sending a strong signal to the IMF that it will stop borrowing”, the publication said.
The cost of not moving ahead with an IMF deal can clearly be seen in the performance of the country’s Eurobond. According to Bloomberg, Zambia’s Sovereign bonds are the worse performing in the World but until recently, Zambia’s yields, were among the highest of any sovereign in the Euro market, helping to attract investors

“Investor concerns about Zambia show no sign of abetting. Investors are losing hope that President Edgar Lungu’s administration will agree on a bailout with the International Monetary Fund, which says the country is at “high risk of debt distress”. Yields on the southern African copper producer’s 2027 Eurobonds have risen to 10 percent for the first time in almost 18 months. Zambia’s dollar securities are the worst-performing in the Bloomberg Barclays Emerging Markets USD Sovereign Bond Index, which includes more than 70 countries,” Bloomberg said recently.

Zambia’s perceived economic risk has therefore gone up This environment has resulted in the drying up of inflows of both short term and long term inflows of foreign exchange thus the affecting the level of foreign exchange reserves.

Ballooning foreign debt servicing

The other factor that is affecting the low level of reserves is the excessive foreign borrowing by government which the governor lightly alluded to also. Zambia’s foreign debt is so high that at the moment debt, servicing it is eroding foreign reserves substantially. In 2011, Zambia was spending 5% of revenue of serving foreign debt but now it is 22%. In terms of external debt servicing from March 2017 to February 2018, Government has spent US$ 552,832,166 in servicing the growing external debt. Zambia’s foreign debt has increased from $7.2 billion in June, 2017 to $9.1billion, an increase of 26% according to government’s own figures. The June edition of African confidential states that there is another estimated $8billion in the pipeline for Chinese contracted project finance which has not been included in the current foreign debt figure of $9.1 billion.

Mines excessive foreign exchange retention

The Copper price was $4,695 in May,2016 and it is now about $6,900 per tonne which is an increase of 47%. The prices even hit $7,215 on the London stock exchange in December, 2017. The question is why are our reserves low when copper prices have been increasing in the past two years? The reality is that although copper prices are going up, the foreign exchange earned is mostly retained by mines in their off shore accounts abroad and therefore the supposedly 70 % of exports earnings coming from copper is illusory and just there in theory. The foreign currency that mines retain is above 40% and so there is very limited correlation between copper prices and our foreign exchange reserves. This is confirmed by an International Monetary Fund (IMF) in one of their country report.

“Care is needed with the interpretation of the export shock in the case of Zambia. Given that not all the copper export proceeds return to the country because most mines are foreign owned. Staff estimates that at least 40% of exports do not return to the country.” The IMF report noted.

Foreign contractors

The PF administration’s penchant and preference of foreign contractors in awarding major contractors for whatever reason, is a major contributing factor to the depletion of our foreign currency reserve. The case in point is the $3billion Euro bonds where the country was just a conveyor build for the money that was borrowed. The bulk of it came and left the country through foreign contractors, especially Chinese and little remained to contribute to economic multiply effects.

Other factors

The country’s excessively liberal import regime and having an import oriented economy is does also contribute to depletion of foreign reserves. Zambia imports the majority of goods and services that the country consumes and this does put a strain on the country’s reserves. We literally make nothing. At the moment, there is mushrooming of Chinese mall/ shops which are all dependent on importing Chinese goods using the scarce foreign exchange with no added value to the economy whatsoever apart from denying Zambian traders who used to go to China to buy goods in order to earn their a living.

The Bank of Zambia’s excessive participation in the foreign exchange market in order to protect the kwacha by pouring in foreign currency on the market mainly dollars from the reserves when the demand for the dollar is high does reduce our foreign reserves does contribute to the depletion of foreign reserves.

How foreign Exchange reserves can boosted

The solutions to the low foreign reserves do not lie with the Central bank alone but also the Chief Executive of the country, the President. He has to be have an interest and getting involved by ensuring that the other arms of government do carry out their bit to contribute to the objective of having sufficient reserves and protecting our currency, the kwacha. The economic cluster ministries like Finance, Commerce, Mining, Agriculture and Tourism ought to find ways of sorting out the low level of foreign reserves.
The causes of the low foreign reserves as outlined are varied and their contributions/ weight are for the researchers at Bank of Zambia, UNZA, ZIPAR and Ministry of finance. It should, however, be pointed out that the solutions to the problem can be categorized as short term, medium term and long term

The short term solutions should include conclusion of the IMF deal, the cancellation of foreign debts in pipeline and the attendant projects, administrative action on unnecessary imports by working with business associations, imposition of restriction on licensing Chinese retail malls most of which are not contributing to tax and employment but exporting jobs and forex. The conclusion of IMF deal is crucial for boosting reserves. Zambia through the $3billion Eurobond is vulnerable to international capital markets. It may also help to consider internationally respected Zambian economists like Dr. Caleb Fundanga or Ngandu Magande as finance Minister to instill confidence to the markets.

In the medium term, the Government should start engaging Mining houses by progressively reducing the amount of foreign currency they bank abroad so that they start bringing it to Zambia and bank in their foreign currency accounts here. The arrangements were made over 25 years ago when such concessions were fine as the conditions at that time permitted. They needed huge retentions for paying for Plant and machinery, spare parts, raw materials, debt servicing, dividends and expatriate salaries. Some of these components no longer apply. The retentions have been used as conduits of illicit financial flows as they are almost impossible to monitor. This partly explain why almost all mines have been making losses for over 20 years without shareholders revolting in their home countries as they do receive dividends while not paying income taxes in Zambia.

Zambia has made too many concessions with the mines on taxes, its time we acted tough on some of these issues. Khama and Mogae did it in Botswana with De-beers with relocation of diamond processing from London to Gaborone; Kabila just did it with royalty taxes. President Magufuli has just implemented far reaching mining reforms of mining act in Tanzania. The Mining houses in these countries never left! In Zambia, we treat Mining houses like eggs; it is time we called their threat of closing the mines, bluff. The will not leave with the prices so high and expected copper boom in the future given the impending electric car revolution.
The Mines should also be engaged to influence their captive suppliers of spares and other requirements to re- located from abroad and set up shop in Zambia like it was in the past where support industries to the mines were located on the Copperbelt and in the process transferred skills, technology, provided employment and paid taxes.

In the long term, the well know solution of export diversification policies of promoting non traditional exports, promotion of tourism, import substitution policies and value addition through the manufacturing industry. Zambia should also consider obtaining reasonable equity stakes from the foreign mining houses so that we start sitting on their boards and if we dribbled through tax avoidance, we can at least participate in dividend payments.

CONCLUSION

It is crystal clear from the analysis that the possibility of Zambia relapsing into an economic crisis like in 2015 is very real as the trend in some of the key economic indicators like inflation, exchange rate, level of reserves, the level of public debt and Zambia’s Euro bonds being the worse performing in the world with interest (yield) at 10% and having lost value 11% this year alone, all provide sufficient evidence. The President as the Chief Executive of the country needs to take bold and decisive action now. The President has boasted several times that he has a lot of power.

“I have a lot of power but I don’t want to abuse it. We only use power when there is necessity to use power,” he said when addressing Supporters in Ndola in April this year.

The message to the President is that this is the necessary time to use those powers in the interest of the economy and the Zambian people. He has made bold decisions in the past that negatively affected ordinary Zambians such as the removal of subsidies on fuel and agricultural inputs and the removal of vendors from the streets. It is time he made decisions that are in the best interests of Zambians not the powerful local and foreign interests or based on narrow political considerations of the next election. No Zambian will be negatively affected by cancelling debts in pipeline or reducing miner’s foreign currency retentions.

The following are some of major decisions that he needs to take using his Presidential powers: One, cancel all the foreign debts in pipeline as well as the supporting major projects; two, reduce Miners’ percentage of foreign exchange retention and three, implement strict fiscal discipline in the management of the country’s finances and lead by example.

One of our major diseases as Zambians including the current administration is that we fail to anticipate problems or if we do, we fail to take action prior to the event taking place. The mindset and management style of fire fighting has cost us dearly economically. It is important that the President takes action now before it is too late

The writer is a Chartered Accountant by profession and a financial management expert. He is a retired, independent and non partisan commentator/analyst. He has lived in the diaspora in England, South Africa and Botswana for over 25 years.