Some commenters following the local currency's gyrations have made the point that the Kwacha's performance this year is not exclusively a Zambian thing. Other African currencies are also feeling the pressure of China's possible slowdown and/or monetary policy developments in the US. So I decided to compare the Kwacha's performance against the performance of a selected number of African currencies - chosen because they are usually invoked by many as comparison currencies for the Kwacha. I have also included the performance of the Chilean Peso given that Chile, just like Zambia, is vulnerable to a slow-down in copper demand. (Readers are encouraged to do this comparison exercise for as many currencies as possible). The results of this exercise for the period 31st January 2015 to September 4th 2015 are in Figure 1 below.
Figure 1
What is clear from Figure 1 is that the Kwacha has depreciated the most when compared to the Naira, Chilean Peso, Kenyan Shilling, Ghanaian Cedi, Rand and Ugandan Shilling. The Kwacha has depreciated by about 50% over the period January 2015 to early September 2015. Only the Ugandan Shilling comes close with a depreciation rate of around 30% over this period.
What is clear from Figure 1 is that the Kwacha's rate of depreciation this year has exceeded that of comparison currencies, not by a little but by quite a substantial margin. In other words, other currencies are also depreciating, but the Kwacha's rate of depreciation is exceptionally high. This suggests that there might be domestic factors over and above the external ones that are responsible for this. The country is currently facing substantial power outages that are going to negatively impact the economy. Further, the large and widening fiscal deficit has raised uncertainty about its sustainability and how it's likely to be funded.
The combination of all this is likely preventing new investors from channeling foreign exchange our way and/or causing those with investments in Zambia (stock market, local bond market, local real estate market, etc...) to divest away from Zambia.
Further, there is the business of servicing our external debt obligations. The country's total stock of external debt has risen by about 4 times since 2011 (in September 2011, external debt stock stood at US$1.6bn. As at September 2014, external debt had risen to US$4.7bn. This doesn't include the recently issued US$1.25bn Eurobond). As you all know, external debt service payments have to be made in foreign currency.
Perhaps, the Kwacha's worse than average performance this year is due to the fact that, unlike other Central Banks, the Bank of Zambia (BoZ) has been unwilling to use precious foreign reserves to "defend" the currency. That is, everyone is facing pressure with their currencies but other Central Banks, unlike BoZ, have been throwing fire power at the problem. I doubt this is the case though, precisely because the Central Bank has in actual fact been using reserves to try and stabilize the exchange rate whenever necessary (see the discussion around Figure 3 below).
Another graph that I decided to look at was the long-term performance of the Kwacha, over, say, a 4 to 5 year period. The results of this exercise are presented in Figure 2 below.
Figure 2
The figure shows the Kwacha/US dollar exchange rate from the first quarter of 2011 (11q1) to the second quarter of 2015 (15q2). What is clear from the figure is that the Kwacha has mostly been depreciating over this period. For instance, the average exchange rate for the first quarter of 2011 was K4.76 to the dollar. By the second quarter of 2015, this had increased to about K7.41 to the dollar.
Countries often hold foreign exchange reserves in the same way that households hold savings - a cushion for a "rainy day". Since we pay for imports in foreign currency, we want to hold a chest of foreign currency so that we can still continue to import things in the event that inflows of foreign currency dwindled to zero. (This is why a country's foreign exchange reserves are often reported in "months of import cover"). But sometimes, a country's Central Bank might use some of this bounty to intervene in the foreign exchange market. If a country's currency is facing pressure, the Central Bank might then draw down its stock of reserves by releasing US dollars into the forex market in exchange for local currency. This immediately increases the supply of dollars and reduces the supply of the local currency and hopefully the exchange rate stabilizes. This is precisely what the Bank of Zambia is reported to have done last week.
But over a longer time horizon, what does Zambia's stock of foreign reserves look like especially when viewed through the lens of a depreciating Kwacha? In Figure 3, I report the quarterly Kwacha/dollar exchange rate from quarter 1 2011 to quarter 1 2015 (essentially data from Figure 2 without q3 2015) along with the country's stock of foreign exchange reserves over the same time period [1]. The exchange rate is represented by the blue bars and reserves by the orange line.
Figure 3
In general, the country's stock of reserves, measured absolutely, has grown over the period covered. For instance, the average stock of reserves for quarter 1 2011 was US$2.1bn. By quarter 1 2015, this had increased to US$2.8bn.[2] But looking at the beginning and end obscures a lot of action in between. Looking at the figure closely, one notices that reserves did grow from US$2.1bn in q1 2011 to US$3.3bn in q4 2012, only to be drawn down to US$2.4bn at the end of q2 2013 (I have marked this period with an arrow in the figure). This was likely a result of a US$900mn attempt by BoZ to stabilize the currency. A similar story can also be seen for q2 2014 where reserves, which had built up to US$3.5bn, were drawn down to USD2.7bn by q1 2015 (again marked with an arrow). This was likely another attempt (this time worth US$800mn in reserves) by BoZ to stabilize the currency ("likely" being an important word, here). Notice that at both time periods, the draw down in reserves coincided with an uptick in the height of the blue bars (i.e. coincided with a depreciation of the currency).
So if the draw downs in reserves have been a response to a depreciating currency, how would one judge the performance of this strategy?
My parting thoughts are really to say that economists care less about the level of the exchange rate than whether it is stable. We want a stable exchange rate much more than we want a "high" or "low" one. This is because stability is really important for long term planning.
Footnotes
[1] The Bank of Zambia has not yet reported the stock of foreign exchange reserves for q2 of 2015.
[2] But I don't know whether in "real" terms our stock of reserves has indeed increased. To figure this out, I'd have to compute how much of import cover our reserves covered in q1 2011 against how much they covered in q1 2015. (This would require a little bit more looking around on the CSO website to figure out the quarterly dollar values for imports. Feeling slightly lazy to do that so perhaps somebody else might help?). My priors, however, suggest that we are likely covering less import cover now than before simply because, even though reserves have grown, imports have also likely grown and perhaps at a rate faster than the rate of growth in reserves. But I stand to be corrected.
