Sunday 27 May 2018

In praise of Denny Kalyalya

On September 28, 2015, the Kwacha slipped 20% against the US dollar. It had started the day trading at K10 to the dollar and closed at K12. At some point during the day, some bureaux de change were quoting rates as high as K15 -- a reflection of that day's panic, confusion and speculative buying (my sister, who cares little for finance, called in the afternoon asking if dollars were a good investment). This was the biggest single day drop in 14 years.

That day's events were a culmination of the currency's very weak performance from the beginning of the year. Between January and September of 2015, the Kwacha's value had reduced by more than half against the US dollar making it the worst performing currency in the world.

Given Zambia's heavy reliance on imports, prices of goods and services began to rise at an alarming rate not long after September. After registering single-digit inflation for much of the post-HIPC era, the annual inflation rate reached 14% in October 2015 from 7% that January and by year's end it was just above 20%. The inflation rate had tripled in a single year!

As 2016 was starting, the expectation was that the Kwacha would continue its free-fall and along with it prices of goods and services would go through the roof. After all the country was in the midst of a catastrophic fiscal crisis and potentially divisive presidential elections were slated for the second of half of the year.

Unexpectedly, the Kwacha's wild gyrations of 2015 stopped in 2016. Granted, there was a slight depreciation in January with the local currency starting the year at K11 to the dollar. But by year's end the Kwacha had actually gained closing at K9.

As for inflation, it peaked at 22% in March of 2016 and thereafter began a slow and steady decline. By October the inflation rate was back to single digits, at 8%, and has been in single digits ever since.

The turnaround of 2016 was nothing short of miraculous. Had the country carried on with the pattern of inflation seen at the end of 2015, food prices would have doubled by 2018!

But calling it a miracle would render the turnaround inexplicable and that would be the furthest thing from the truth.

Even though the originator of the crisis of 2015 was far away at the Ministry of Finance, the job of putting out the fire was placed at the foot of the Central Bank. In February of 2015, president Edgar Lungu announced the appointment of Dr. Denny Kalyalya as the new governor of the Bank of Zambia. Dr. Kalyalya would be taking over from Dr. Michael Gondwe, whose short tenure at the bank had been underwhelming.

No sooner had Dr. Kalyalya settled into his new role than the bottom fell out of the Kwacha. The local currency, whose job it was for him to defend, was now the laughing stock of many across the world.

Dr. Kalyalya and his team correctly diagnosed that the proximate cause of the Kwacha's problems was a chronic shortage of US dollars on the local market stemming from "flight-to-quality" concerns. Consequently, the Central Bank engaged in one of the most audacious interventions in the foreign exchange market in Zambia. The evidence for this is in the dramatic draw-down of the country's reserves between January and December of 2016 (see the blue line in the figure below).

Reserves went from US$2.9billion in January to US$2.3billion in December -- a decline of some US$600million in a space of 12 months! Half way into the year (about July), the Kwacha somewhat stabilized (see the orange line in the figure below) and the Central Bank slowed down the rate at which reserves were being depleted.

Note: Forex Reserves (blue line) and Exchange Rate (orange line), 2016
                             Source: Bank of Zambia

What about inflation? Given Zambia's reliance on imports, inflation was always going to be tamed once stability in the foreign exchange market had been re-established, something that Kalyalya and team succeeded in doing in the latter part of 2016. But it must have occurred to the Central Bank that upward pressures on inflation were also the result of excess Kwacha liquidity in the domestic money market. That is, some upward pressure on prices was due to excess demand in the economy.

Consequently, the Central Bank in November of 2015 hiked the Bank of Zambia Policy Rate, the rate that influences access to credit in the wider economy, from 12.5% to a record high of 15.5% and kept it at that level throughout 2016. The rate hike immediately followed the emergence of double digit inflation in October of 2015.

By October of the following year, the Central Bank's interventions had borne fruit and the inflation rate slowed down to a much more respectable 8%. In February of 2017, after being comforted that inflation had been tamed, the Central Bank began a process of reversing their "tight money" policy and reduced the Policy Rate to 14% and subsequently to 12.5% in May.

In addition to the interventions outlined above, Dr. Kalyalya has successfully used "softer" measures such as holding regular and transparent press briefings to communicate the bank's future course of action  (technically known as providing "forward guidance"). This is in a bid to reduce policy uncertainty.

The interventions outlined above were certainly not without their costs. Foreign exchange reserves are not free and the hikes in the Policy Rate must have drastically affected the ability of businesses, particularly SMEs, to obtain credit. But there was a general sense of armageddon in the dark days of late 2015 and early 2016 and the heroic efforts by Dr. Kalyalya and his team brought the country back from the brink.

Knowing that the origination of the crisis was in the Ministry of Finance, Dr. Kalyalya has openly castigated government on their reckless and uncoordinated borrowing and spending policies, showing unusual independence of thought by a public servant in Zambia.

In a country where there is currently wide-scale erosion of public institutions, it is a wonderful thing to see that there are still a few good men and women who are doing the job that the people of Zambia pay them to do.

Dr Denny Kalyalya (Center) in a jovial mood after a meeting at State House