5 Key Factors Driving the Fall in The Kwacha

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In September 2020, the Zambian Kwacha hit the 20 Kwacha mark. The fall in the value of the Kwacha has been gradual. From 2015 till now, the Kwacha has continued to depreciate. What are the key issues driving the fall in the Kwacha against major currencies? Trevor Hambayi, an Economist and Development Analyst, shares his insights on the key factors driving the fall in the Zambian Kwacha.

The first and most significant factor affecting the Kwacha is that Zambia’s’ sovereign debt (foreign debt) is almost 90% to its Gross Domestic Product (GDP). The high percentage of debt to GDP is inconsistent with international standards, requiring that debt does not exceed 60% percent of a country’s GDP.  Zambia’s’ euro bond payment in terms of yields has been due in the last few weeks. The government needs to make a payment of 180 million dollars of the Eurobond payments. And the government is trying to find hard currency to pay this debt. The dollar demand is a lot higher because the government needs a huge chunk of hard currency.

This demand in hard currency is driving the pressure on the exchange rate. You see this trend from the last time Zambia’s’ payment was due in March 2020. There was so much pressure for the country to find foreign currency to cover the Eurobond payments during this period, resulting in the Kwacha’s depreciation.

The second key factor is that we do not generate enough revenue from Zambia’s’ minerals’ exports, which has reduced the hard currency needed to cover Zambia’s’ needs. Additional pressure on Zambia’s’ reserves comes from the fact that we are importing more than we are exporting. This imbalance also contributes to the performance of an exchange rate.

The third factor relates to international perceptions around investment in Zambia’s’ capital market. Investors in Zambia’s treasury bills and bonds have been liquidating their assets and taking these resources out of the country, resulting in capital flight and further putting pressure on the exchange rate.

What is the relationship between the performance of the countries’ currency and the inflation rate?

Depreciation in a currency directly affects the interest rate and inflation rate. Zambia is an import-dependent country, so when the exchange rate goes up, it means that inflation (the price of commodities will also increase by that proportion). When inflation rises by the exchange rate proportion, it means that you require more money to buy the same kind of item. The rise in the inflation rate also affects the interest rate and results in more expensive capital costs.

The depreciation in the Kwacha results in a general loss of income to a business. If someone owed you ten thousand Kwacha last month and then there’s a depreciation in the Kwacha, you find that in real terms, the value of that 10 000 Kwacha has reduced by that increase depreciation in the Kwacha. So you lose income for any that you had generated.

The fall in currency also increases business costs because the exchange rate increase means that most goods in the country will increase.

You will have a decreased purchasing power for the same amount from your general income, so if you were earning ten thousand Kwacha last month, you would be buying fewer things this month from the same ten thousand Kwacha.

If you're an import-based company, the same fact applies. The value of your dollar for the things you import increases, so you will have to increase the price of your goods or services for you to maintain the same kind of profit. 

The effect of a depreciating currency on business

The effect of a depreciating currency on business is that it makes it very unpredictable for you to price your goods or services. You have to continually increase your prices depending on fluctuations in the exchange rate, affecting your market and customers.

If you do not increase that price, you will suffer an exchange loss because you’ll be selling your goods at less than the value you’re expecting.

As a business, there are three options that you can consider;

  1. First, you must be thinking about generating an income stream, which is in hard currency. You can only do this by actually exporting your goods and commodities; this reduces your business's exposure to a fluctuating exchange rate. As a small entity, it is not easy for you to export. The easiest way to do this is to partner with specific organizations that are working towards this. The Cross-Border Traders Association (CBTA) and the Zambia Association of Manufacturers (ZAM) are some of the entities working towards exporting. You need to partner with them.
  2. Besides creating an export base, you can use financial instruments to hedge against the fall in the Kwacha.
  3. You could also save money in a foreign currency.

How about export diversification? Could it be the key to stopping the Kwacha from falling further?

The issue around export diversification has been talked about since 1971 when we had the economic crash. But as a country, we have not done enough to encourage exports out of the country. There are many things to consider for the export industry to grow outside minerals.

  • Many countries export goods to Zambia because we have created an economy that does not protect Zambia’s’ own. For you to export a product to South Africa, you would have to pay high export tariffs. These tariffs restrict imports to South Africa. After all, they're also producing the same product. Imported products must be more expensive than locally produced products. However, some imported products are cheaper than locally produced goods because importation charges are not significant to deter imports.
  • Secondly, Zambia has not provided incentives to the manufacturing sector to produce goods for export so that their products are cheap for them to compete in the international market.
  • The third one is that we also have not created the platform under which we can export. The Chinese are not the largest exporting country in the world. Still, small entities or SMEs manufacture most of the products they export. The Chinse government supports these SMEs to produce goods. There's a centralized place where they take these products for export. When these SMEs consolidate their production units, they meet the quantities that are required to export. We have not created these platforms for Zambia’s’ small entities to produce. When you get an export order, it would be so large that you will not be able to meet as a small entity, but if there are many of you producing the same product, you'll meet the export requirements.
  • Lastly, in terms of export, we also do not have export finance; you need funding for you to be able to buy the products to export before you receive your payment.

For the local SMEs, those who don’t export and maybe don’t even import raw materials or products from outside the country, how should they understand this foreign currency movement?

For a local business, whether you import products or not, your cost of business will still rise because most of the companies you buy from import some of the products or materials that you use. Generally, when the Kwacha depreciates, the price of fuel also increases. With the increase in fuel comes a general rise in goods and services, resulting in increased production costs.

What can you do as a small business that imports products from South Africa from China? How can you implement measures that do not adversely affect you?

You can do certain things to hedge yourself if you’re a small business, and you are trading a particular product. You want to be able to import the goods that you need for the year simultaneously so that they come into the country at once. You’re going to buy the goods at the same price and use the stock over the year without getting concerned about changes in the exchange rate.

But for you to be able to do this, you need to have access to trade finance, providing you with working capital for your goods.

You could ask your bank to lock in a certain amount of money at a specific rate. Locking in an exchange rate for a future purchase of a currency is called a futures agreement. The bank agrees to sell a certain amount of foreign currency for you to be importing your goods at an amount that is approved, so you know exactly how much you are going to spend.

To do this, you must have an evident focus on what income you’re going to generate because that kind of money that you need to do this is that it needs to be borrowed money, and you have to service every month.

From a business perspective, that is a challenging position. It is challenging for any business to thrive because the success you’ll have this month could be wiped out next month.

As a business entity, you can take some measures to mitigate the rise in the currency, such as hedging your business by creating an export base. But the company will have to work towards adapting itself to the prevailing economic environment.  There’s very little that you can do.

Do we have financial institutions that can lend to a small business that wants to buy in bulk to hedge against foreign currency movements?

The actual reality is that the financial institutions are there, but they’ve got no interest in supporting the SMEs because of the risks involved.

Firstly, the conditions that they are going to give you will be so stringent to meet. For instance, they want you to have clear cash flows. And they want landed property as collateral. Besides, you will have a very high-interest rate to pay, which is a floating rate making it very difficult for you to plan.

There are very few options other than the fact that you have to work towards having organic growth. Organic growth means that you, as a business, are trying to generate revenue from your own business and reinvesting it back into your business until you get to a point where you have the resources to grow. Still, the critical aspect is that it doesn’t matter how small you are as a business; you need to have savings.

It will help if you put away savings to build your capital base. If you continue on this strategy, you’ll reach a point where you have the resources that will support you. Savings also put you in a better position to negotiate with the financial institution to give you the funding you need to import raw materials.  It makes it a lot easier for your financial institution to support you.

What should the government do to address the fall in the Kwacha?

The government has to address the fall in the Kwacha by managing macroeconomic factors, thus creating an economic environment conducive to business.

The government needs to create that economic environment by managing Zambia’s’ national debt and ensuring that they cover the aspects around the liquidity in the market so businesses can get resources to invest in the industry for the economy to start growing.

Managing these macroeconomic issues will increase GDP and Zambia’s’ reserves, giving us a better trade balance in terms of a surplus from the exports of minerals and non-traditional exports because our results determine our pressure. These measures will create a balance that ensures that there is no volatility in the exchange rate. That is only the only way businesses will be able to thrive under this kind of economic environment.

Who’s responsible for ensuring we have a vibrant manufacturing industry that is export-based? Is it the government, or are entrepreneurs accountable for creating these businesses?

The ideal situation is that the private sector should drive the economy. The government should have no space in the private sector in terms of business; this is the biggest challenge that we’ve had in the last five years. Zambia’s’ economy is now crashing because the government does not have any resources. What has happened is that because the government is the leading player in the economy, but they do not have resources, has now affected the country’s economic performance.

If the government were restricting its responsibility to managing the economy’s policy issues, the effect of the fall in the Kwacha would not be the same even if the government didn’t have money because the economy would still be running driven by the private sector.

We must move this paradigm to ensure that the private sector drives the economy. Suppose the private sector drove it. In that case, it also makes it very attractive for the government because an economy driven by the private sector allows the government to get taxes from the economy. Now that the government has been running the economy and the economy has crashed, the government has no place to collect taxes because the economic players have also crashed with the government’s strategy.

Key Insights:

  • You should start thinking about generating an income stream, which is in hard currency. You can only do this by actually exporting your goods and commodities; this reduces your business’s exposure to a fluctuating exchange rate.
  • Besides creating an export base, you can use financial instruments to hedge against the fall in the Kwacha.
  • You could also save money in a foreign currency.

“When inflation rises by the exchange rate proportion, it means that you require more money to buy the same kind of item” 

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When inflation rises by the exchange rate proportion, it means that you require more money to buy the same kind of item.

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