VAT and Corporate Tax Net Offs, Asset Selloff, Dollar Fetish and Business Pulse Rise Weaken Kwacha

THE Kwacha, Zambia’s currency has come under pressure in the last two months emanating from various factors key of which are tax - net offs, asset selloffs and rise in business pulse. As at 26 Nov the Kwacha was trading for ZMW9.8/USD after breaking the ZMW10/USD barrier in intraday trading on 25 Nov.

VAT and Corporate Tax Net Offs

It’s time for corporation tax payments as Q3 earnings for corporates have been reported. However taxation payments are made in Kwacha which ideally should push demand for the local currency higher. For corporates that earn in dollars, this time is characterized by massive conversion of dollars to fund Kwacha tax payments. This time it’s an interesting paradox as some big corporates that usually sell dollars for Kwacha to meet tax obligations are owed Value Added Tax - VAT refunds. The government owes VAT refunds in excess of $400million which is paid out in Kwacha. So instead of actual conversions taking place the tax authorities are netting off the VAT refund with the tax due from the corporates. This has the net effect of dampening Kwacha demand the market experiences when corporate tax payments are due. This quarter will not see as much Kwacha demand for tax payments as the bulk of payments will netted off VAT refunds. This is the biggest source of pressure on the Kwacha.

Asset Selloff

Most investors that took positions on Zambia on the back of a potential International Monetary Fund - IMF deal have exited positions due to weariness of the wait. It’s a “sheep sheep come home we are afraid of the lion’” type of scenario where investors were lured into taking positions with an IMF package in their minds by for 8 quarters this has not happened. Investors then decided to sell off their position in bonds and are converting the proceeds to dollars and then repatriating the funds offshore. With Gold and Copper at 3yr peaks most rational investors would rather lock in cash holdings in these assets. This process has put the Kwacha under pressure by default. This trajectory was observed starting August after the expected board meeting would approve Zambia’s $1.3billion package but in vain. The Ministry of Finance shifted goal posts to October – last month – when the World Bank and IMF had their annual meetings. However what came out of the sideline meetings was that Zambia’s debt profile needed attention before the IMF would even table a package. This news has continued to price in the markets causing more weariness in the investor. One thing we are cognizant of is that Zambia has never tabled a package discussion and the nation still grapples with meeting the criteria which can only be ticked off after debt concerns are dealt. It’s interesting that the dollar debt (Eurobonds) credit spreads have not widened as much as offshore holders are more excited about a copper price over $7,000 metric ton that anything else. Suffice to say news about a deteriorating debt profile priced in the Eurobonds but was overshadowed by a bullish copper price which is too good to be true against all odds. So the asset selloff is source tow of pressure on the Kwacha.

Dollar Fetish

Ministry of Finance has released funds towards a number of agriculture projects which most recipients converted to dollar pushing dollar demand higher. On 25 Nov we reported that the Ministry of Finance released a total of ZMW 515million aimed at settling Food Reserve Agency payments owing and the E-voucher farmer input support program. These moneys are supposed to fund availability of agriculture inputs for the farming season. The Ministry paid out ZMW 115million towards FRA settlement of payment in reserve food purchasing chain and has a financing plan to pay out another ZMW 85million in a fortnight. Earlier the Ministry disbursed ZMW 400million a few days ago towards the e-voucher program for farmer input support to ensure smooth management of affairs concerning input supply management.

Business Pulse Rise

September Purchasing Managers Index – PMI for Zambia was at a 31month high of 52.5 (a PMI of above 50 represents an expanding economy while that below 50 signals contraction), a vivid indication that the economy is growing as Zambia targets 4.3% in 2017 and 5.1% in 2018. The nation has many projects that are expansionary in nature that have fueled importation of raw materials which have to be funded in dollars. With a portion of the budget allocated towards road construction we are likely to see more imports of raw materials which will fuel dollar demand to ultimately put more pressure on the Kwacha. The fact that Zambia is an importer makes dollar fetish higher. It may sound absurd but growth in the Zambian economy which is a net importer means higher dollar demand to fund imports.

Medium Term View of Kwacha

The Kwacha is expected to weaken further to above ZMW10/USD over the next 1 week however may have some of its pressure absorbed from demand for Kwacha treasury bills and bonds whose yields are expected to somewhat tick upwards. With copper trading higher at current levels, dollar supply should normalize in the remaining quarter of 2017.