The Bank of Zambia wishes to take this opportunity to update the public on recent developments in the foreign exchange market and the measures that have been taken to stabilize the recent instability in the Kwacha. As a result of additional measures implemented on May 30, 2014, the exchange rate has shown signs of stability over the past week.
Let me first of all state that Zambia’s economic fundamentals remain sound. It is our view that the rate of depreciation of Kwacha witnessed over the past few months is not consistent with economic fundamentals.
Early this year, the Central Statistics Office revised the GDP numbers for the year 2010, to take into account the changes in the economy since 1994. Based on these revised GDP numbers, in 2013 the economy registered growth of 6.7%. It is anticipated that growth will remain above 6.0% in 2014 and even higher over the medium term.
As we have indicated before, the prospects for the mining, agriculture, construction, manufacturing and tourism sectors are all bright. We expect these sectors to continue being strong drivers of growth and this is being supported by the strong investment in the transport and energy infrastructure that the Government is currently undertaking.
Our mandate at the Bank of Zambia is to achieve price and financial system stability. For the year 2014, our inflation objective is to attain an end-year inflation target of 6.5%. From the beginning of the year, inflation has generally been on an upward trend with the annual inflation rate rising from 7.1% in December 2013 to 7.8% in May 2014. Factors contributing to these inflationary pressures include the depreciation in the exchange rate from the third quarter of 2013, higher food prices during the lean period between October 2013 and March 2014 prior to the crop harvest and the increase in fuel prices.
More recently, the announcement that electricity prices are likely to be raised, will also add to inflationary pressures. Having said this, we are confident that the increased investment in the electricity sector supported by economic tariff rates will bring the benefit of higher exports and more stable power supply, which ultimately will support export diversification, exchange rate stability, greater productivity in industry and lower inflation.
We are all aware that inflation is a corrosive influence on any economy and mostly hurts the poorest. The depreciation of the exchange rate is a strong driver of inflationary pressures and is, therefore a threat to the achievement of our inflation objective. Some of the factors that have contributed to the depreciation in the exchange rate include but are not restricted to: a noticeable reduction in the supply of dollars to the market, particularly from the mining sector, which accounts for the bulk of foreign exchange supply.
Over the first quarter of 2014, we also noticed deterioration in the current account balance to a deficit of US $260.7 million from a surplus of US $28.7 million in the fourth quarter of 2013. The deterioration was largely accounted for by higher service payments. Over the fourth quarter of 2013 and into the first quarter of 2014, there has also been a significant build-up of liquidity. This liquidity has supported demand for foreign exchange – and has ultimately led to the measures taken to tighten monetary policy. Developments in the international financial markets have also impacted on the Kwacha, as the strengthening of the dollar has led to a corresponding weakness in the Kwacha through financial flows.
It is because of the importance we attach to maintaining low inflation, that the Bank of Zambia has taken strong measures to address the rising inflation trend and the instability in the foreign exchange market by significantly tightening monetary policy. In March 2014, the Monetary Policy Committee raised the BoZ policy rate by 50 basis points to 10.25%. The statutory reserve ratio was also increased to 14.0% from 8.0%, to help address the high liquidity levels in the market. In April, we announced a further increase in the policy rate to 12.0%.
On May 30, 2014, the Bank of Zambia took further measures to tighten monetary policy by increasing the rate on the overnight lending facility to 10 percentage points above the policy rate from 6 percentage points. Further, the Bank has widened the application of statutory reserves to include Government deposits and Vostro accounts held by foreign financial institutions. The Bank of Zambia will also now require Banks to comply with statutory reserve requirements on a daily basis and not on an average basis as was previously the case. In addition to these measures the Bank of Zambia has also intervened in the foreign exchange market to improve supply of foreign exchange. This is in line with its policy of managing volatility in the exchange rate, rather than targeting a specific level of the exchange rate.
With the measures we have taken, we have seen some stabilization in the exchange rate over the past few days. We will remain alert to ensure that we achieve our objective of a flexible and market-determined exchange rate that reflects market fundamentals and promotes macroeconomic stability.
In addition to measures taken to tighten monetary policy, we have also had in-depth discussions with stakeholders in the financial sector. These discussions have focused on the foreign exchange market in general and the operations of the interbank market in particular. It is clear that working with the banking sector, there is a need to improve the efficiency of the foreign exchange market by eliminating the structural rigidities that have emerged. Some of these rigidities include the concentration of sources of supply, and the lower sales of foreign exchange, particularly by the mining sector.
The Bank of Zambia will continue to address the key structural constraints in the financial sector. We are confident that efforts to develop our financial markets and make the interbank foreign exchange market more efficient, coupled with the continued strong growth in non-traditional exports, will promote a diversified supply of foreign exchange and help achieve greater resilience in the foreign exchange market.
In conclusion, we wish to assure the general public that the Bank of Zambia and the Government are committed to maintaining macroeconomic stability and ensuring that the year of our golden jubilee becomes a stepping stone towards inclusive growth.