Fitch Solutions Group Ltd, a UK affiliate of Fitch Ratings has projected that the Bank of Zambia (BoZ) will implement further monetary tightening over the coming quarters in an effort to contain inflationary and exchange rate pressures.
In a note, Fitch also forecast that the Central Bank will hike its policy rate by 50 basis points (bps) to 10.75% by end-2019, before raising it again to 11.25% in 2020.
It however said while greater-than-expected kwacha weakness could trigger a more hawkish response from the BoZ, more aggressive monetary loosening in developed markets than they currently anticipate could ease pressure on the BoZ to tighten in the short term.
“We at Fitch Solutions expect that the Bank of Zambia (BoZ) will implement further monetary tightening over 2019 as the pass-through effect of kwacha depreciation will keep inflation elevated over the remainder of the year. While the kwacha has pared back some of its losses since falling to an all-time low of ZMW14.1/USD on May 17, it has lost 28.5% of its value against the dollar in the year to date due to fragile investor confidence in Zambia’s debt market,” it said.
It noted that continued exchange rate weakness over the coming months will feed through to most components of the consumer price index, keeping price growth elevated.
“Moreover, food price inflation, which climbed from 7.7% y-o-y in February to 9.3% in July, will continue to rise as drought weighs on crop yield prospects for the year. Against this backdrop, we expect that headline inflation, which reached 8.8% y-o-y in July, will remain above the upper bound of the Bank of Zambia’s (BoZ) 6.0-8.0% target range. This will motivate the BoZ to raise its policy rate by a further 50 basis points (bps) by end-2019, following a previous 50 bps hike in May, bringing the rate to 10.75%.”
In 2020, Fitch says it expects that the BoZ will enact another 50 bps hike in the face of sustained inflationary pressures and declining foreign reserves.
“We forecast average annual inflation will rise slightly from 8.3% in 2019 to 8.5% in 2020. Increased electricity charges-deferred in May – are likely to come into effect over the coming quarters given the need for utility firm Zesco to move towards more cost-reflective tariffs, thus driving higher inflation next year,” it said.
“Moreover, we do not expect significant progress on fiscal consolidation over the short term and see the kwacha weakening further in 2020, keeping imported inflation elevated. That said, our Oil & Gas Team now forecasts Brent prices to fall from USD67.0/bbl in 2019 to USD65.0/bbl in 2020, which, compounding the base effects of sharp currency depreciation this year, will overall limit the extent to which inflation accelerates in 2020.”
It added, “Furthermore, we expect that rising public external debt will continue to weigh on the country’s stock of FX reserves, which declined from USD1.6bn at end-2018 to USD1.4bn in June 2019. We believe that above-target inflation and the need to attract foreign investment to support reserves will press the BoZ to raise the policy rate again next year, to 11.25%.”
Fitch also notes that Zambia’s foreign reserves will continue to decline.
“That said, concerns over muted GDP growth will limit the scope for more aggressive tightening over the coming quarters. We forecast real GDP growth will slow from 3.7% in 2018 to 1.5% in 2019, and while we expect it to rebound to 3.1% in 2020 – due to a likely return to positive growth in the mining and construction sectors – this remains well below its 2010-18 annual average of 5.2%.”
It says it believes that the central bank will adopt a cautious approach to raising interest rates given a weak macroeconomic backdrop.
“Moreover, a dovish turn in developed markets monetary policy will limit the BoZ’s need to tighten more aggressively to keep interest rates attractive. We nonetheless highlight risks to our interest rate forecasts.”
It says a significant deterioration in investor sentiment towards Zambia remains a possibility, particularly if the government shows only limited signs of fiscal restraint over the coming quarters.
Fitch says this could weaken the Kwacha more than we currently anticipate, leading to higher inflation and a sharper decline in FX reserves, thus posing upside risks to our interest rate forecast.
“On the downside, should the US Federal Reserve implement more aggressive cuts than we currently expect this could ease pressure on the BoZ to tighten in H219 given the potential for a short-term rally in emerging market assets.”