Zambia's Currency Tumbles -- and With It, Reserves

UNCLAS LUSAKA 000218 SENSITIVE SIPDIS E.O. 12958: N/A TAGS: ECON EFIN ZA SUBJECT: Zambia's Currency Tumbles -- and With It, Reserves ¶1. (SBU) Summary. In recent months, the Bank of Zambia (BoZ) depleted one-third of its foreign exchange reserves in its attempts to "dampen volatility" of the precipitously depreciating Zambian Kwacha. Central bank foreign reserves have fallen to 900 million, which covers about two months of imports. In February, the IMF proposed a USD 200 million loan to Zambia to provide a cushion against sharp movement of the currency. The BoZ says it remains committed to a floating, market-determined exchange rate and it continues to "target reserves." End Summary. ¶2. (SBU) Declining world metals prices, brought about by the global economic crisis, has had a severe impact on Zambia's mining sector, which accounts for close to three-quarters of the nation's export earnings and ten percent of formal sector employment. This, combined with an overall reduction in foreign direct (and portfolio) investment, has dealt a devastating blow to the Zambian Kwacha, which has fallen over fifty percent in the past six months, from 3500 K/USD in late September 2008 to over 5600 K/USD by late-March ¶2009. Many agree that the strength of Zambia's currency, which generally correlates to the price of copper, is unlikely to rebound until copper and cobalt prices recover. ¶3. (SBU) Fearing a run on the Kwacha that would devastate Zambia's consumer-dependent economy and the government's efforts to contain inflation (hovering around 15 percent),the BoZ has intervened in the currency market. Over the past four months it has expended approximately one-third of its foreign currency reserves. On March 25, BoZ Deputy Governor assured DCM and Emboff that the central bank continues to support a market-determined exchange rate, but will intervene to dampen volatility. He acknowledged that exporters prefer a weak Kwacha, in contrast to the more numerous and vocal importers' groups, and that it is impossible to please all sectors of the economy, save that less volatility and increased stability will serve everyone. The Deputy Governor lamented that Zambia's terms of trade had deteriorated significantly, contributing to a current account deficit that necessitated the central bank's intervention. ¶4. (SBU) In February, the BoZ began negotiating a USD 200 million loan from the IMF. An IMF representative assured Emboff that the BoZ is not seeking to strengthen its currency, but rather to "cushion" against large fluctuations. They also point to the benefits of a weak currency to Zambian farmers whose produce prices have become more competitive in foreign markets. Despite press reports that World Bank opposes the loan, the World Bank country representative clarified that he supports acquiring debt to restore foreign exchange reserves to the equivalent of three months of imports. He recommended caution, however, in the acquisition of debt and the use of foreign currency reserves to prop up the Kwacha. The BoZ Deputy Governor is also reticent about taking on this new debt: "We do not want another HIPC situation," he said. BOOTH