EAZ ad­vises state on hedg­ing credit risk ef­fects…

• Zam­bia to strengthen man­u­fac­tur­ing ca­pa­bil­i­ties to de­crease im­port in­fla­tion • EAZ lauds re­cent MOU for Mwinilunga honey to sell in China

Zambian Business Times - - FRONT PAGE -

Rat­ing agency Moody’s In­vestor Service ear­lier said a strength­ened United States (US) dol­lar meant an in­crease in the credit risk of sev­eral emerg­ing mar­kets due to cur­rency de­pre­ci­a­tion. A Moody’s re­port said a strong dol­lar would also lead to a drop in for­eign ex­change re­serves of coun­tries such as Ar­gentina, Ghana, Mon­go­lia, Pak­istan, Sri Lanka, Turkey and Zam­bia.

“Coun­tries with large cur­rent ac­count deficits, high ex­ter­nal debt re­pay­ments and sub­stan­tial for­eign-cur­rency...

Rat­ing agency Moody’s In­vestor Service ear­lier said a strength­ened United States (US) dol­lar meant an in­crease in the credit risk of sev­eral emerg­ing mar­kets due to cur­rency de­pre­ci­a­tion. A Moody’s re­port said a strong dol­lar would also lead to a drop in for­eign ex­change re­serves of coun­tries such as Ar­gentina, Ghana, Mon­go­lia, Pak­istan, Sri Lanka, Turkey and Zam­bia.

“Coun­tries with large cur­rent ac­count deficits, high ex­ter­nal debt re­pay­ments and sub­stan­tial for­eign-cur­rency govern­ment debt are most ex­posed to the im­pact of a stronger US dol­lar,” Moody’s Global Man­ag­ing Di­rec­tor of the Sovereign Risk Group Alas­tair Wil­son said.

Brazil, China, In­dia, Mex­ico and Rus­sia are the least vul­ner­a­ble as they are less de­pen­dent on ex­ter­nal cap­i­tal in­flows, the re­port said.

From the above what does this en­tail for Zam­bia?

The United States dol­lar has ral­lied to a 13 - month high of 96.7 amidst spec­u­la­tion fu­elled by the trade wars be­tween the world’s top two economies namely US and China. Surely when ele­phants fight, the grass suf­fers, so emerg­ing mar­kets have taken a ‘knock’ with cur­ren­cies com­ing un­der pres­sure from stronger dol­lar strength. Post Trumps elec­tion the US econ­omy has un­der­gone a se­ries of in­tense macroe­co­nomic in­ter­ven­tions and mon­e­tary pol­icy tight­en­ing which has given the green­back par­ity strength that has made dol­lar de­nom­i­nated as­sets such as trea­suries and stocks, very at­trac­tive caus­ing as­set sell – off rip­ple ef­fects in emerg­ing mar­kets to in­clude African na­tions (A sell-off is the rapid sell­ing of se­cu­ri­ties such as stocks, bonds, ETFs, com­modi­ties or cur­ren­cies). A stronger dol­lar fun­da­men­tally en­tails, com­modi­ties com­ing un­der pres­sure to wane the demand for as­sets such as cop­per, crude, gold, plat­inum and other in­dus­trial com­modi­ties. Be­cause emerg­ing mar­ket economies are ‘Dutch dis­eased’ (Overde­pen­dence on one or two com­modi­ties for ex­port rev­enues), ex­port pro­ceeds then de­cline. The au­topsy of a plum­met in pro­ceeds of ex­port rev­enues then trans­lates to in­suf­fi­cient cover for fis­cal pro­grams man­i­fest­ing in bud­get deficits which African na­tions choose to plug with ex­ter­nal bor­row­ing to bridge the gap. An­other con­se­quence of low ex­port rev­enues due to a de­cline in com­mod­ity prices is a weak build-up of for­eign ex­change re­serves for im­port cover pur­poses.

The case of Zam­bia

Africa’s sec­ond largest cop­per pro­ducer, Zam­bia, de­pends on the red metal for over 75% of its ex­port rev­enues. A stronger dol­lar would en­tail a lower cop­per price that would have the net ef­fect of im­pact­ing the ex­change rate be­cause the mines will not re­alise suf­fi­cient dol­lar pro­ceeds from cop­per ex­ports which could, to some ex­tent, sti­fle con­ver­sions (dol­lar to kwacha to meet lo­cal cur­rency obli­ga­tions such as wage bills or tax pay­ments). It must be borne in mind that the mines are the largest sup­pli­ers on the cur­rency mar­ket to the ex­tent that the play­out in the in­dus­trial com­modi­ties mar­ket man­i­fests in cur­rency volatil­ity (ap­pre­ci­a­tion or de­pre­ci­a­tion swings). An econ­omy can have all the dol­lars in the world but ex­change rate is only a func­tion of the por­tion con­verted to the dol­lar - kwacha rate is the price at which con­ver­sion takes place. Cop­per had a bullish run in the first half (H1:2018) flirt­ing with highs of USD7,250 a met­ric ton as news of the elec­tric car hit the mar­ket. Elec­tric cars need cop­per wiring to trans­mit elec­tric charge. How­ever, un­cer­tainty then gripped the met­als mar­ket af­ter the US and China roiled into a trade war that saw the dol­lar strengthen, forc­ing in­vestors to off­load risky as­sets to re­place them with dol­lar de­nom­i­nated as­sets. As a con­se­quence, cop­per has shaved off sig­nif­i­cant value to trade at near 1 – month lows of USD5,926 a met­ric ton.

For Zam­bia, this means lower pro­ceeds from cop­per ex­ports. Be­cause cop­per is a barom­e­ter for global eco­nomic growth, a lower price will sig­nal weaker growth prospects for Zam­bia which then prices into cop­per pro­duc­ers’ dol­lar as­sets (Eurobonds) to widen credit de­fault spreads to push yields higher.

(Credit de­fault spreads mea­sure the credit risk of a coun­ter­party such that wider spreads sig­nal de­te­ri­o­rat­ing po­si­tion and nar­row spreads re­flect stronger pos­i­tive credit po­si­tion). It has been tech­ni­cally proven that Eurobond yields cor­re­late neg­a­tively with un­der­ly­ing com­mod­ity prices. ( Zam­bian dol­lar bonds will cor­re­late with cop­per prices; An­gola, Nige­ria and Gabonese Eurobonds will cor­re­late with crude oil prices etc.). Depend­ing on the me­chan­ics of each na­tion, lower com­mod­ity prices (due to stronger dol­lar) then ide­ally should trans­late into weak build-up of for­eign ex­change re­serves and as such im­port cover is jeop­ar­dised. Nige­ria and An­gola lost most of their for­eign ex­change re­serves when the price of crude plum­meted sig­nif­i­cantly from highs of USD110/bbl. to just un­der the teens at USD32/bbl. This was in part the rea­son why the oil de­pen­dent na­tions is­sued Eurobonds. Why this is a source of con­cern is be­cause re­serves are viewed as fi­nan­cial am­mu­ni­tion to bal­ance cur­rency sta­bil­ity when an econ­omy is ex­posed to vul­ner­a­bil­i­ties such as ex­ter­nal shocks. How­ever, burn­ing re­serves is very costly. Zam­bia is sit­ting on USD1.82bil­lion of for­eign re­serves and any ex­ter­nal shocks would threaten sta­bil­ity of this cover thus far.

What can Zam­bia do to mit­i­gate the ef­fects?

Much as the ef­fects of dol­lar strength is sys­temic to emerg­ing mar­kets and African na­tions, di­ver­si­fi­ca­tion through build­ing man­u­fac­tur­ing ca­pa­bil­i­ties is strongly ad­vised. The big­gest chal­lenge is to start build­ing this ca­pa­bil­ity with fore­sight of a rainy day so as to be hedged from ex­ter­nal shocks. The im­pact of global mar­kets how­ever tends to hit economies that are more pos­i­tively in­te­grated into the global fi­nan­cial sys­tem such as South Africa, Kenya, Nige­ria and Ghana which sup­pos­edly have duel list­ings in cap­i­tal mar­kets in ad­di­tion to hav­ing more liq­uid as­sets such as bonds that are listed on in­ter­na­tional in­dexes such as the JPMor­gan emerg­ing mar­ket bond in­dex - EMBI’s etc. These na­tions eas­ily catch flue when the west coughs. Illiq­uid­ity has proven to be a nat­u­ral hedge against global tur­bu­lence ben­e­fit­ting na­tions like Zam­bia. How­ever, man­u­fac­tur­ing ca­pa­bil­i­ties then tend to pro­mote lo­cal in­dus­tries to the ex­tent that im­ports are re­duced thereby curb­ing im­port in­fla­tion. If Toy­otas were man­u­fac­tured in Zam­bia and sold in Kwacha, there would be no need to buy dol­lars to im­port these brands from Ja­pan. But be­cause man­u­fac­tur­ing ca­pa­bil­i­ties are weak in Zam­bia, dol­lar demand will re­main high as ci­ti­zens con­tinue to im­port goods from out­side. Ex­cess dol­lar demand is the sole rea­son for pres­sure on the Kwacha. Zam­bia needs more ex­ports of prod­ucts to earn for­eign ex­change to com­pen­sate po­ten­tial loss of ex­port pro­ceeds from cop­per. This has been the big­gest hur­dle for the Min­istry of Com­merce and Trade in fail­ing to close tan­gi­ble deals that would foster forward trade be­tween Zam­bia and its peers or glob­ally. It is for this rea­son that trade bal­ances are neg­a­tively widen­ing. The re­cent MOU to al­low Mwinilunga honey to sell on Chi­nese shelves is a wel­come move but we need more than just honey out there.

(Forward in­te­grated trade refers to get­ting Zam­bian prod­ucts on in­ter­na­tional shelves). Pro­ceeds could be max­i­mized through value ad­di­tion of metal pro­cess­ing which is a so­lu­tion that has been on the ta­ble for decades. The likes of Neelka­nth ca­bles have smelt the cof­fee and have started to add value to cop­per by man­u­fac­tur­ing wires.

Other con­sid­er­a­tions in­clude hedg­ing through short dated (3-months to 6-months) forward ex­change con­tracts for busi­nesses that would like to se­cure dol­lars in a cur­rency volatile en­vi­ron­ment. These will al­low for lock­ing in of ex­change rates in ad­vance for trans­ac­tions to hap­pen in the future. How­ever, it is a dry point of con­struc­tion that the Zam­bian mar­ket has a lim­ited ar­ray of de­riv­a­tive in­stru­ments to man­age cur­rency risk due to ei­ther re­stric­tive cen­tral bank li­censes or lack of tech­ni­cal ex­per­tise to man­age cur­rency and in­ter­est rate risk through in­ter­est rate swaps, con­tracts for ex­change or ex­otic prod­ucts.

From a credit per­spec­tive, lend­ing may need proper match­ing with cash flows, i.e. dol­lar loans must be matched with ho­moge­nous cash flows or kwacha loans should be ab­sorbed by lo­cal cur­rency cash flows to mit­i­gate cur­rency risk con­cerns. Cross cur­rency as­set - li­a­bil­ity mixes must be care­fully thought out with resid­ual risk ap­pro­pri­ately hedged.

Mutisunge Zulu is an Econ­o­mist and Na­tional Sec­re­tary Eco­nom­ics As­so­ci­a­tion of Zam­bia.

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