Fundanga explains cause of weakening kwacha

Fundanga explains cause of weakening kwacha
Written by Fridah Zinyama
Wednesday, March 11, 2009 5:02:19 PM

BANK of Zambia governor Dr Fundanga has said the weakness of the local currency is a consequence of increased risk aversion to emerging and developing economy financial assets.

According to Dr Fundanga, the supply of foreign exchange by foreign portfolio investors for the purchases of kwacha financial assets such as government securities and domestic company equities has significantly declined, with most non-residents preferring to liquidate their investments and externalising the foreign exchange.

“The consequence to this is the volatility in the exchange rate of the kwacha against other major currencies,” he pointed out.

The kwacha is currently trading at between K5, 625 and K5, 645 per US dollar.

Dr Fundanga explained that the response of the Bank of Zambia has been to significantly increase supply of foreign exchange to the market, in recognition of this supply shock as well as the global uncertainty in the prospects for commodity prices and the mining sector in particular.

“In addition, the financial sector exhibited an additional demand for kwacha liquidity related to the global financial crisis, which was reflected in persistent shortfalls in government securities tenders during the half last year,” he said.

Dr Fundanga said the central bank responded by rebalancing the use of its monetary policy instruments with a greater weight placed on foreign exchange sales.

“Associated with the exchange rate volatility is the pass-through effect of the depreciation of the kwacha against major currencies on domestic inflation,” he said. “A depreciation of the kwacha against major currencies tends to cause inflation to increase.”

Dr Fundanga explained that reflective of this principle, annual inflation increased to 16.6 per cent in December, 2008 from 14.2 per cent in September 2008.

“This outturn was above the 8.9 per cent inflation recorded in December, 2007 and the increase in inflation was in part explained by the pass through effects of the exchange rate of the kwacha against major currencies as the effects of the global financial and economic crises unfolded.

The country's inflation rate has since reduced to 14 per cent but there are fears that the volatile exchange rate might contribute to its increase again as Zambia is a net importer of goods.”