INFLATION TARGETING: A HIT OR A MISS?

The Minister of Finance and National Planning – Honourable Situmbeko Musokotwane, has been on a consistent track preaching growth and creation of employment ever since his appointment. True to his word, it was no surprise to see his Budget for 2022, themed “Growth, Jobs and Taking Development Closer to the People”. Despite his boundless enthusiasm, his wards at the Central Bank, adopted a contractionary fiscal policy stance by raising the monetary policy rate (MPR) by 50 basis points, from 8.5% to 9% at the meeting held on 23rd November 2021. Was this pronouncement the right one for a country that has been projecting itself to grow? The policy stance seems amiss!

Generally, monetary policy is either contractionary or expansionary. A contractionary policy serves to lower spending by making it more expensive to borrow money as the case is by increasing the policy rate. On the other hand, an expansionary policy aims at increase spending by businesses and consumers by making it cheaper to borrow. In addition to modifying the interest rate, a central bank may buy or sell government bonds, regulate foreign exchange (forex) rates, and revise the amount of cash that the banks are required to maintain as reserves. All in all the responsibility is to balance economic growth and inflation.

A contractionary monetary policy increases interest rates in order to slow the growth of the money supply and bring down inflation. The Bank of Zambia (BOZ) has set their monetary policy stance on “Inflation Targeting” or price stability, by increasing the MPR. BOZ stated that the increase will help arrest inflationary pressure anticipated to arise from the foreseen possible increase in fuel pump prices, electricity tariffs and the emergence of new waves of COVID-19, which could disrupt supply chains and trigger price increases. They stated that this will ultimately feed into the goal to drive inflation to single digits in 2022 and achieve the 6-8% target range by mid-2023 as stated in the 2022 National Budget.

Whilst the MPR stance defends a likely situation in the future, it does not take into consideration the current situation of the country. Indeed, economic growth in the second quarter of 2021 was at a record high of 8.1%, last seen over 7 years ago. However, this growth is a once off growth that is likely to be wiped away in the second half of the year, due to factors such as inadequate electricity and the now increased interest rates.

Increased interest rates will slow economic growth and even increase unemployment though often seen as a necessary tool to keep prices in check. Examples are usually given of economies such as the United States of America where, in the early 1980s, the Fed raised its benchmark interest rate to a record 20% because inflation was hovering in the double digits. The immediate impact of the high rates was a recession, though the move eventually managed to bring inflation back to the desired range of 3% to 4% only after few years.

Clearly, the contractionary monetary policy stance is contrary to the desire expressed by the current Minister of Finance. He especially recognized the high unemployment rate among the youth in Zambia who comprise more than half of the population.

Indeed, with the youth unemployment rate in 2020 standing at 22.63% and a tad higher that the overall unemployment rate at 12.17%, he has a right to be worried about this unemployment weight he must carry on his shoulders. Additionally, he took office when the country continues to face risks of inadequate growth due to the slowdown caused by the effects of the COVID-19 pandemic. Therefore, ZAM’s expectation was that the monetary authority would opt for an expansionary monetary policy aimed at increasing economic growth and expanding economic activity to align with the Government’s chief financial officer’s policy direction for 2022.

Economic growth should have been aided by the monetary authority’s reduction of the interest rate to promote spending money and making saving unattractive. The increased money supply in the market would have worked to boost investment and consumer spending. The lower interest rates would have especially served to encourage businesses and individuals to get loans on favorable terms and spend in the economy. Many economies around the world have held onto this expansionary approach since the 2008 financial crisis and now more so during the COVID era. But we are told this will result in inflation.

A pressing concern for the manufacturing sector is that the lender of last resort seems to miss that the major source of inflationary pressure has emanated from a depreciated Kwacha ie that inflation in Zambia has been mainly from the cost push source other than the demand pull type especially that jobs elude people. In an import dependent economy like Zambia, expensive inputs and imports on account of a more expensive Kwacha has propagated imported inflation. Thus, the solution to inflation lies not in the interest rates, but in the exchange rates.

Moreover, the possible increases in fuel pump prices are likely to be higher should the exchange rate not be kept in check. While demands for cost reflective electricity tariffs continue to be made, the country is yet to be given the results of the Cost-of-Service study investigating the pricing mechanism of electricity by ZESCO to ensure that electricity is efficiently priced.

Not only has the inflation targeting monetary policy stance failed to understand the times (COVID era), but it also fails to recognize the policy direction given by the Minister. The rate should have been lowered to encourage growth while dealing with factors that are leading to the depreciation of the Kwacha. While a longrun solution, the Government needs to continue to support development of local value chains which will allow for increased sourcing of local inputs and reduce import dependence, while enhancing export capacity, to cure the demand and supply of forex.

At BOZ’s disposal are other monetary policy tools, and in this case in the short term the Central Bank needs to utilise more open market operations to stabilise and lower the dollar to kwacha exchange rate in order to curb this imported inflation, evidence in the higher costs of manufacturing inputs and finished goods and cure the root causes of inflation other than the symptoms.

Moreover, the Cost-ofService study should be finalized as the important study is cardinal in providing information which will show how efficient our power utility is being run and what the cost reflective rate of electricity tariffs ought to be in Zambia for both domestic and commercial use.