12/01/2024
Navigating Zambia’s New Export Framework: Money Market vs. FX Market
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Original Article: https://www.linkedin.com/pulse/navigating-zambias-new-export-framework-money-market-vs-onyambu-rlcxf%3FtrackingId=pbmSujrwQraNLadlq6xvPg%253D%253D/?trackingId=pbmSujrwQraNLadlq6xvPg%3D%3D
I. Introduction
Discussions surrounding Zambia's new export framework have raised questions and need clarification on its impact on everyday life. The introduction of this framework has generated significant buzz, leaving many people wondering about its real implications.
Understanding the nuanced differences between various market types is crucial, not just for professionals but also for the general populace. The recent changes, particularly the new export framework, have blurred the lines between the money and foreign exchange (FX) markets. Frequently mentioned, these terms seldom receive explanations that connect to everyday experiences.
The money market, typically associated with simple deposits and transfers, and the FX market, known for its currency exchange complexity, serve distinct yet interconnected roles in our financial system. However, misconceptions abound as many conflate the two, leading to misguided expectations and analyses.
For instance, consider the Zambian local banking sector, where corporations and individuals hold substantial amounts, slightly above $3 billion, in foreign currency deposits. This figure, while impressive, does not necessarily signify active participation in the FX market. Why? Because these funds often remain within dollar-denominated accounts, merely shifting from one account to another without undergoing the critical process of currency exchange - a hallmark of the FX market.
This column aims to demystify these markets, dissecting their functions, interactions, and the impact of recent policy shifts. By doing so, we aspire not only to clear the fog of confusion but also to provide clear, understandable insights into how these financial mechanisms affect our economy and, by extension, each of us.
II. Understanding the Money Market
The term 'money market' often conjures images of a bustling exchange of currencies and sophisticated financial dealings. However, in Zambia, the reality of the money market is both more straightforward and more nuanced, encompassing short-term borrowing and lending, individual Kwacha savings, and the dynamics of dollar deposits.
The money market primarily serves as a short-term borrowing and lending hub where businesses, including local companies and large corporations, access funds for immediate operational needs. For example, a Zambian business might take a short-term loan to finance inventory purchases or manage cash flow during slower sales. These loans are often in the form of overdraft facilities or short-term credits, which are essential for the smooth operation of businesses. They provide the necessary liquidity for companies to thrive and grow.
For individual Zambians, the money market typically involves interactions through savings in Kwacha. These savings, such as fixed deposits, are crucial as they offer individuals a safe place to store their funds while earning interest. When individuals deposit their savings in banks, these funds become a part of the money market. Banks can then use these deposits to extend short-term loans to others, creating a cycle that benefits both savers and borrowers.
In recent years, we have seen a significant increase in dollar deposits within the banking sector primarily due to two main factors: individuals and corporates converting Kwacha to dollars due to concerns over currency depreciation and companies earning in dollars choosing not to convert these earnings into Kwacha. The rise in dollar deposits, from an average of $2.4 billion in 2020 to an average of $3.3 billion in 2023, highlights a growing preference for holding savings in dollars. These funds, some initially converted through the FX market, often circulate within dollar-denominated accounts without re-entering the FX market for conversion back to Kwacha.
As such, Zambia's money market is an integral part of our financial system, catering to businesses and individuals. It facilitates short-term financial needs and savings while reflecting broader economic trends, such as currency stability concerns and strategic financial decisions by individuals and corporations. Understanding this interplay is vital to grasp the intricacies of our economy and the choices that shape it.
III. Exploring the FX Market in Zambia
The Foreign Exchange (FX) market in Zambia, while seemingly a complex financial concept, has direct and tangible effects on the daily lives of its citizens. This market, where currencies trade, and their values fluctuate against each other, is integral to our nation's economic fabric, particularly given our dependence on imports.
At its core, the FX market facilitates currency exchange, crucial for international trade and investment. For instance, a Zambian exporter dealing in copper receives payments in US dollars but needs Kwacha for local operations. Here, the FX market enables the conversion of dollars into Kwacha. Similarly, a Zambian student studying abroad in the UK would convert Kwacha into British Pounds for tuition and living expenses. These direct interactions with the FX market impact businesses and individuals alike.
The interconnected nature of the FX market and everyday expenses becomes evident when we look at global oil prices. Despite a global decrease in oil prices by about 14.9% since September 2023, the Kwacha's depreciation against the Dollar by approximately 25.9% over the same period has negated potential benefits. As a result, the cost of importing oil rises, increasing transportation costs and, subsequently, the prices of goods and services in Zambia.
Our trade relationship with South Africa further illustrates this point. With about a third of Zambia's imports coming from South Africa, the Rand's 54.6% increase against the Kwacha over the last seven months has made these imports more expensive. This inflationary pressure directly affects the cost of living for Zambian citizens.
Additionally, the Kwacha's significant depreciation from 17.025 to 26.125 against the Dollar has a broad impact, especially on goods priced in Dollars. This depreciation contributes to the increasing cost of imports, adding to the overall inflationary trends in the country.
While the average individual might not engage directly with the FX market, its influence permeates everyday life. From the cost of fuel to the price of imported goods, the strength and stability of the Kwacha in the FX market play a critical role. Understanding this market is vital to grasping how international currency trends can impact everything from national economic policies to the price of daily necessities in Zambia.
IV. Zambia's New Export Framework and Its Implications
Zambia's economic landscape is witnessing a significant shift with introducing a new export framework. This policy change aims to bolster economic stability but has also sparked a wave of misconceptions, especially regarding its impact on the foreign exchange (FX) and money markets.
The crux of this new framework is the redirection of export proceeds. Previously, Zambian exporters, such as copper mining companies, often kept their dollar earnings in foreign banks. Under the new system, mining companies must deposit these dollars in local Zambian banks before further action.
A common misunderstanding is that this influx of dollars into local banks will automatically increase FX conversions, stabilizing the Kwacha. Just because these dollars are now in Zambia's banking system does not mean they will be immediately, or even eventually, converted into Kwacha.
For instance, consider the scenario of a mining company in Zambia that exports copper, earning millions of dollars. With the implementation of the new export framework, the mining company now deposits these earnings into local Zambian banks. However, the presence of these dollars in the local banking system does not automatically lead to increased foreign exchange (FX) conversions. Typically, these funds remain in their original dollar form, contributing minimally to the FX market dynamics because these companies have established financial practices and operational needs that dictate their currency usage.
Mining companies, a significant source of the dollar influx, must pay taxes in dollars. This requirement ensures that a substantial portion of their dollar earnings does not undergo FX conversion, influencing the overall flow and conversion of foreign currency in the economy. Furthermore, while these companies convert some of their dollars into Kwacha for operational costs like salaries or supplier payments, this practice is not new. The frequency and volume of such conversions under the new framework will likely stay the same unless there is a measurable increase in their production capacity. As production expands, the need for more local services and supplies could increase FX conversions. Until then, the new export framework may not significantly alter the current patterns of currency conversion.
Meanwhile, the role of VAT refunds is crucial. The Zambia Revenue Authority typically pays these refunds in Kwacha, reducing the need for mining companies to convert their dollars. Additionally, short-term Kwacha facilities and FX swap options provide alternative means for these companies to meet their Kwacha needs, further reducing the necessity for conversion.
Interestingly, similar confusion arose with the central bank's decision to buy gold locally. While this policy aimed to boost gold reserves more conveniently, it inadvertently reduced the need for mining companies to convert foreign currency gold export earnings into Kwacha.
While the new export framework ensures greater transparency and channels more of the export earnings into Zambia's local banking system, the economy's fundamental currency conversion process remains the same. The taxation requirements for mining companies remain unchanged; they continue to pay taxes in US dollars, and these effectively get redirected to the Bank of Zambia (BOZ). This crucial aspect means the influx of dollars into local banks does not automatically translate into increased conversions into Kwacha by the BOZ.
Furthermore, it is crucial to recognize that simply rerouting export earnings into local banks does not equate to an increase in dollar tax payments. The current mining taxation policy has not changed; hence, the dollar amounts paid in taxes remain largely consistent, within a range dependent on prevailing copper prices and output. The BOZ's involvement in the FX market and its decision on when to introduce these dollars remains the critical determinant of the market's dollar supply. Significant changes in tax payments, which could substantially affect international reserves and subsequent actions in the FX market by the BOZ, would require either changes in the mining taxation policy, a substantial increase in copper prices, or a measurable boost in mining production. This understanding is vital to accurately assess the impact of the new export framework on Zambia's economy and currency market.
V. Investment, Trade Practices, and Their FX Impact
After examining the direct implications of the new export framework and its limitations in Sections III and IV, let us shift our focus to specific sectors like mining and fertilizer manufacturing. Understanding how investment and trade practices within these sectors impact the FX market is critical to grasping the full scope of our economic challenges and opportunities.
Investment in the Mining Sector: Analyzing the FX Conversion Dynamics
In Zambia's economy, the mining sector, particularly copper mining, is not just an industrial giant but also a significant player in the foreign exchange (FX) market. Understanding how investments in this sector impact the FX market requires a nuanced view, especially regarding the mode of payment and capital sourcing.
A significant investment in the mining sector, often announced in millions of dollars, typically creates a surface-level perception of an economic boon. However, the immediate impact on the FX market depends on how investors utilize this investment and the currency chosen for transactions.
Consider a foreign company announcing an $80 million investment in a Zambian mine. Suppose investors use this investment to acquire offshore-sourced assets, like imported machinery or foreign expertise. In that case, it likely limits the immediate impact on Zambia's FX market because these expenditures typically occur outside Zambia, involving minor to no currency conversion within the local market.
Conversely, if investors use this investment to acquire locally sourced assets or services, the potential for FX conversion increases but is still not guaranteed. The determining factor here is the payment mode. If investors pay for these local assets or services in dollars, the recipient in Zambia might choose to hold onto these dollars. Given the relative ease of accessing short-term Kwacha facilities from local banks, the recipient may opt for such facilities instead of converting their dollars. This preference is particularly prevalent when monetary policy is not stringent, allowing for easier borrowing in Kwacha.
For example, a local supplier to the mining operation, paid in dollars, might avoid converting these dollars to Kwacha. Instead, they could engage in FX swaps or borrow Kwacha, relying on their dollar reserves as security. This approach enables them to meet their local currency needs without triggering a currency conversion.
The scenario changes if there is a mandate or requirement to pay for local goods or services in Kwacha. In such cases, there is a higher likelihood of FX conversion, as the recipients of these payments would need to convert their incoming dollars to meet their local currency obligations. This requirement could stimulate activity in the FX market as more entities convert foreign currency to Kwacha.
Nevertheless, over the medium to long term, capital investments in mining can significantly boost production, beneficially affecting export proceeds as the mine increases copper sales internationally. This increased production, however, depends on the pace of investment and the speed of transforming that investment into enhanced production capacity.
For instance, consider a new investment into a mine in a challenging terrain. Depending on factors like the geological complexity or the technology used, ramping up production could range from a brisk 6-month period to a more prolonged timeline of 2-3 years.
Furthermore, it is again essential to remember that mining companies currently pay taxes in USD to the Zambia Revenue Authority (ZRA), which then converts the USD to Kwacha with the Bank of Zambia (BOZ). However, these dollars only impact the FX market when the BOZ actively sells them. This lag between investment and increased export proceeds to the BOZ's FX sales from tax receipts adds another layer of complexity to understanding the total economic impact of mining investments.
These intricate dynamics highlight the importance of looking beyond just the immediate pronouncements. The long-term economic influence of mining investments, including increased production capacity and the subsequent flow of export proceeds and tax payments, play a crucial role in shaping Zambia's FX market and overall economic health. However, it is vital to understand the nuances regarding how they relate to the FX market.
Local Production and Payment Currencies
A critical aspect of Zambia's economic dynamics, which often goes unnoticed, is the currency used in transactions, especially in local industries like fertilizer production. This choice of currency has far-reaching implications for the FX market and the broader economy.
Zambia has made commendable strides in boosting local production, particularly in sectors like fertilizer manufacturing. This progress is crucial for economic independence and stability. However, if the financial transactions do not align with the local economy's needs, the benefit of such local production can be undermined.
Consider a local Zambian fertilizer company that has successfully shifted to predominantly domestic sourcing of inputs. Ideally, this move should reduce reliance on foreign currency, as most of their expenses are now in Kwacha. However, the expected pressure alleviation on the FX market will not materialize if these companies continue to receive dollars for their products.
For instance, a large agricultural firm contracts this local fertilizer company for an annual supply. If the payment currency agreed is in dollars, the transaction, despite being entirely local, adds an unnecessary burden on the FX market. The agricultural firm, earning in Kwacha, would need to convert significant sums into dollars, adding demand pressure on the FX market.
In contrast, mandating such transactions in Kwacha would simplify the process for local companies and reduce the demand for dollar purchases. Reintroducing policies like Statutory Instrument 33 (SI33), mandating local payments in local currency, can facilitate such a shift. Such a policy ensures that the benefits of local production strengthen the local economy and reduce unnecessary strain on the FX market.
Therefore, the currency used in internal transactions is not just a matter of convenience but a strategic economic decision. Zambia can better harness its domestic industries' growth to bolster the national economy and stabilize the local currency by encouraging or requiring local transactions in Kwacha.
VI. Strategies for Encouraging Currency Conversion
At this juncture, recalling our earlier exploration of the new export framework and its limited immediate impact on FX conversions, it becomes clear why additional strategies are necessary to encourage currency conversion in Zambia. While the framework sets a stage for greater financial transparency, proactive measures to stabilize the Kwacha remain imperative.
Tightening Monetary Policy
One approach we suggested at Canary Compass is the aggressive tightening of monetary policy. This strategy aims to make the Kwacha scarce, thereby increasing its value. When Kwacha becomes more challenging to obtain, those holding foreign currency deposits, such as dollars, may find it more appealing or necessary to convert their holdings into local currency.
For instance, imagine a scenario where a local business can quickly and easily access short-term Kwacha loans to meet its operational costs. If the central bank tightens monetary policy aggressively, such as a significant hike in the statutory reserve ratio, these loans become less accessible or more expensive. The business, holding dollar reserves, might then be compelled to convert some of its dollars into Kwacha, thus actively participating in the FX market and potentially bolstering Kwacha's value.
Implementation of a Conversion Clause
Another strategy could be the introduction of a conversion clause in certain financial or trade transactions. While currently not in practice, this clause would mandate the conversion of a portion of foreign currency earnings into Kwacha. Such a policy could directly increase FX market activity, particularly dollar liquidity within the FX market. However, the feasibility and desirability of this approach need careful consideration, as it may have implications for investor confidence and the broader economic environment, particularly under an IMF program.
Mandating Local Currency for Domestic Transactions
A more direct approach would be reinstating policies like Statutory Instrument 33 (SI33), which requires all domestic transactions in Kwacha. This policy would force companies and individuals earning in foreign currencies to convert their earnings for local use.
This approach was previously implemented in Zambia and showed potential in encouraging currency conversion. For example, if a mining company is required to pay all its local suppliers and taxes in Kwacha, it would need to convert a significant portion of its dollar earnings, thus actively participating in the FX market and supporting the Kwacha.
Each of these strategies carries its own set of benefits and challenges. The key is finding a balanced approach that encourages currency conversion, supports the Kwacha, and maintains a stable and attractive environment for local and international investors.
VII. The Silver Lining
As we have discussed the nuances of the new export framework and the established financial practices of mining companies, it is evident that immediate changes in FX conversion patterns may not be on the horizon. However, a 'silver lining' in recent economic developments might offer a short-term reprieve and a potential reversal of the current trend, which has seen the Kwacha lose over 50% against the USD over the last seven months.
A significant factor in this optimistic outlook is the recent disbursement from the International Monetary Fund (IMF) in December, amounting to about $187 million. This influx of foreign currency has provided the Bank of Zambia with additional resources to support the currency market more effectively. Following the IMF disbursement, the central bank took a proactive stance in January by selling a substantial amount of dollars - estimated between $140 million to $150 million. This strategic move has significantly reduced the dollar demand backlog, which we now estimate is around $100 million. By actively supporting the FX market, the central bank has dismantled a significant portion of the demand pressure, exerting a downward force on the Kwacha.
If the central bank continues this approach and successfully eliminates the remaining dollar demand backlog, it could be a critical catalyst for reversing Kwacha's depreciation trend. This potential reversal would not stem from the export framework's implementation but from the central bank's deliberate actions in the FX market.
VIII. Conclusion
In light of our discussions, introducing the new export framework, a significant step towards financial transparency does not inherently transform the currency conversion landscape as some might have expected. Instead, it becomes evident that long-term Kwacha stability hinges on broader economic reforms and sustained efforts to enhance Zambia's FX market structure, as we outlined in our article https://www.linkedin.com/pulse/strengthening-fx-market-structure-kwacha-stability-in-depth-dean-n-qgdnf%3FtrackingId=vogrGa09S3yGxmmwkIhqOQ%253D%253D/?trackingId=vogrGa09S3yGxmmwkIhqOQ%3D%3D . These reforms, encompassing policy changes and market practices, are pivotal in creating a more resilient and dynamic financial ecosystem. As such, the path to enduring economic health lies in immediate policy adjustments and a strategic reshaping of our FX market architecture to foster stability and growth.
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Dean N Onyambu is the Executive Head of Trading at Opportunik (OGF), a CIMA-licensed fund for Africans and diasporans (https://opportunik.com/), and is a co-author of Unlocking African Prosperity (https://opportunik.com/whitepaper/unlocking-african-prosperity). Passion and mentorship have fueled his 15-year journey in financial markets. He is a proud former VP of ACI Zambia FMA (https://www.linkedin.com/company/aci-zambia-financial-markets-association/) and founder of mentorship programs that have shaped and continue to shape 63 financial pros and counting! When he is not knee-deep in charts, he is all about rugby. His motto is exceeding limits, abounding in opportunities, and achieving greatness.
For more insights from Dean, you can follow him on LinkedIn (https://www.linkedin.com/in/dean-n-onyambu/), X (https://twitter.com/InfinitelyDean), or Facebook (https://www.facebook.com/dean.onyambu).
Picture Source: World Bank, 2014: "Zambia's Exports are Growing and Diversifying, but They Could Do Better."
