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