The Monetary Policy Committee, at its February 13-14, 2023 Meeting, decided to raise the Monetary Policy Rate by 25 basis points to 9.25 percent. The decision was underpinned by the projection that inflation will increase and remain above the target range over the forecast horizon.
In a statement released on February 15, Bank of Zambia Governor Dr. Denny H. Kalyalya noted that “the decision to raise the Monetary Policy Rate was not an easy one, but it was necessary to address the potential upside risks to inflation.”
Inflation declined, but pressures build up
Inflation continued to decline in the fourth quarter of 2022, albeit at a slower pace. Average overall inflation fell to 9.8 percent from 9.9 percent in the third quarter. The decline arose from non-food inflation, which reduced to 6.8 percent from 7.4 percent, largely due to the lagged pass-through from the appreciation of the Kwacha against the US dollar. Nonetheless, food inflation increased to 12.1 percent from 11.8 percent, mainly driven by higher prices of bread and cereals.
In January 2023, inflation declined further to 9.4 percent from 9.9 percent in December 2022. This follows the dissipation of base effects across a number of items in the Consumer Price Index basket.
However, over the forecast horizon, inflation is projected to increase and remain above the 6 – 8 percent target range. This is in sharp contrast to the earlier projection in November 2022 that showed that inflation would return to the target range in the first quarter of 2024. Inflation is now projected to average 11.1 percent in 2023 compared to the November 2022 forecast of 8.5 percent. In 2024, inflation is forecast to average 10.1 percent.
According to Dr. Kalyalya, “the recent rapid depreciation of the Kwacha against the US dollar, the anticipated increase in electricity tariffs to cost reflective levels, and the possible reduction in maize production due to, among other factors, adverse weather conditions and crop infestation by Fall Armyworms” are among the factors contributing to the elevated inflationary pressures. He added that “the continued tightening in global financial conditions and negative sentiments arising from the protracted debt restructuring negotiations (and more so the uncertainty over the treatment of the non-resident holders of Government securities), working through the exchange rate channel, are also projected to add to inflationary pressures.”
Pressure on the Kwacha to add to inflation
After a cumulative appreciation of 10.0 percent in the previous two quarters, the Kwacha depreciated by 4.3 percent against the US dollar to an average of K16.71 in the fourth quarter of 2022. The depreciating trend in the Kwacha has persisted in 2023, with the Kwacha trading at K19.33 per US dollar as at February 14.
Dr. Kalyalya noted that “low foreign exchange supply, particularly from the mining sector, amidst high demand by market players for various purposes, including critical imports of fuel, medicines, and agricultural inputs, are among the key drivers of the depreciation.” He added that “foreign financial institutions, that had typically been suppliers of foreign exchange, are now more pronounced on the demand side as they are divesting from the domestic market. This is principally due to tighter global financial conditions, negative sentiments associated with the protracted debt restructuring negotiations and uncertainty around the treatment of non-resident holders of Government securities.”
In addition to the increase in the Monetary Policy Rate, the Bank of Zambia Governor also announced the decision to raise the statutory reserve ratio on commercial banks’ deposit liabilities by 2.5 percentage points to 11.5 percent as an additional measure to minimize exchange rate volatility.
Dr. Kalyalya emphasized that the current depreciation of the exchange rate has far-reaching effects on inflation and overall macroeconomic stability. He stated, “The assessment is that if left unchecked, the current depreciation of the exchange rate has far-reaching effects on inflation and overall macroeconomic stability.” He added, “Therefore, it was necessary to take additional measures to address the vulnerabilities emanating from the foreign exchange market.”
The Bank of Zambia Governor also explained that the recent rapid depreciation of the Kwacha against the US dollar, the anticipated increase in electricity tariffs to cost reflective levels, and the possible reduction in maize production due to adverse weather conditions and crop infestation by Fall Armyworms are some of the factors underlying the forecasted increase in inflation. The continued tightening in global financial conditions and negative sentiments arising from the protracted debt restructuring negotiations (and more so the uncertainty over the treatment of the non-resident holders of Government securities) are also projected to add to elevated inflationary pressures.
Dr. Kalyalya noted that some effects of the uncertainty surrounding the issue of NRHoGS are already being felt on the local currency. He stated, “The foregoing factors remain potential upside risks to the inflation outlook.”
Current account surplus declines sharply
The Monetary Policy Committee also observed that the current account, which had recently been robust, has now weakened with adverse implications on the foreign exchange market. Exports fell by 6.2 percent to US$2.7 billion owing to lower copper and gold earnings as realized prices fell. Imports grew by 4.8 percent to US$2.2 billion, mainly driven by an increase in intermediate and capital goods, mostly fertilizers, machinery, and equipment. The current account surplus declined sharply to US$18.3 million in the fourth quarter of 2022 from US$245.0 million in the previous quarter. This was largely driven by a significant reduction in net merchandise exports and an expansion in the services account deficit.
The Bank of Zambia Governor expressed optimism that the current measures would help stabilize the foreign exchange market and reduce inflationary pressures. He stated, “The Committee remains confident that the current monetary policy stance is appropriate to support the Bank’s objective of achieving and maintaining price and financial system stability. The Bank will continue to monitor economic developments and stands ready to implement further measures as necessary to address any emerging risks to price and financial system stability.”
Domestic credit growth more than double
In December 2022, domestic credit growth more than doubled to 18.7 percent year-on-year, with 10.1 percentage points accounted for by the private sector. The expansion in private sector lending contributed to stronger growth in money supply, which grew by 24.5 percent in December from 13.3 percent in September. However, lending rates remained sticky at 25.0 percent.
While economic activity moderated in the fourth quarter of 2022, in the medium-term, domestic growth prospects are optimistic, underpinned by the anticipated recovery in the mining, agriculture, and construction sectors. In addition, the financial and insurance, information and communications, wholesale and retail trade sectors will continue to support growth.
The Committee is aware of the implications of the upward adjustment in the Policy Rate and the recent increase in the statutory reserve ratio on credit and money supply growth, lending rates, and economic activity. However, taking these measures was deemed necessary to avoid amplifying the adverse impact of the current depreciation of the exchange rate on inflation, which would have negatively affected the aforementioned variables and macroeconomic stability in general.
Preliminary data indicates a further reduction in the cash fiscal deficit in 2022 to 8.1 percent of GDP from 9.0 percent in 2021. The deficit is projected to continue on a declining trend over the 2023-2025 period, due to expected improvement in revenue performance, improved fiscal management underpinned by expedited external debt resolution, and essential structural reforms, particularly in the energy, agriculture, health, and education sectors.
The Committee reaffirmed its call for continued effective implementation of fundamental structural reforms, including diversification of the export base, and adoption of climate change mitigation measures supportive of a stable exchange rate necessary to achieve low and stable inflation.
Decisions on the Policy Rate will continue to be guided by inflation forecasts, outcomes, and identified risks, including those associated with financial stability and debt restructuring.
The next MPC Meeting will take place on May 15 and 16, 2023.