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Zambia's Currency Hit by Inflation, Default

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Zambia's inflation rate has soared since January 2018 when it was 6.2% and June 2019 when it was 8.6% hammering the value of the kwacha.

Inflation is hurting Zambia's currency at a time when a rise in the commodities market should be boosting the value.  "There's no easy way out here really."

A rise in commodity prices would normally be a boon for Africa's second largest copper producer, but that is not the case in Zambia these days where the country's currency, the kwacha, has fallen dramatically against the dollar as the result of rising inflation, high debt and a recent default on a portion of the country's bond obligations.

The Zambian kwacha, a currency that is usually heavily influenced by global commodity prices, fell 50.27% against the dollar in 2020 (see chart below), the worst devaluation for the currency since the commodities crash in 2015.  The decline is particularly troubling considering the fact that global commodities rose 13.9% last year and 20% in the fourth quarter. 

But, while the global commodities market was regaining its footing after pandemic-induced losses suffered early in the year, Zambia's economic situation was worsening as the result of a mountain of debt and rising inflation so strong that it easily over-powered what has become a booming copper market. 

In terms of currency volatility, a key stress indicator, Zambia was the world's fourth largest hot spot in 2020 with a currency volatility of 10.27% behind only Venezuela and its beleagured currency at 28.4%, Haiti at 23% and the tiny African nation of Seychelles at 11.87%.  In 2015, Zambia was the world's major hot spot with a volatility rate of 19.29%.

Inflation is not Zambia's only problem, however, as in November the country missed a $42.5 million bond payment essentially defaulting on $3 billion in dollar-denominated debt that was borrowed as part of a series of bond offereings that took place between 2012 and 2014 just before the commodities market tanked in 2015.

Since the default, which occurred around November 13th, the kwacha has fallen from a value of 20.913 to the dollar to 21.62 at the close of business on Friday, February 12th, a decline of 3.4% in only three months.  For the year, the kwacha is down 2.1% (see nearby graph).  The currency's biggest decline came in August of last year when Zambia's President Edgar Lungu suddently replaced the head of the country's central bank, the Bank of Zambia. 

Just this week, the Bank of Zambia raised its benchmark interest rate 50 basis points to 8.5% in an effort to slow the runaway inflation and stabilize the currency.  In January, the bank began purchasing gold from the country's gold mines as a way of increasing its international reserves. 

The runaway inflation and ensuing default are a huge blow to a country that was trying to take the next step in the development process.  "Successive governments went through a lot of blood, sweat and tears to establish the country as a credible borrower," said Bradford Machila, an opposition politician, as reported in the Financial Times.  To end in default in just a few years is a "massive embarrassment and a huge source of anger."

Much was made of Zambia's second forray into the bond market in April 2014 when $1 billion was raised in a single day for one of the poorest countries in the world at a yield of 8.625%, a hefty price tag compared to the 5.625% yield in the country's first bond offering in September 2012.  "Zambia's fiscal outlook has deteriorated since their last bond issue," Max Wolman, a fund manager at Aberdeen Asset Management told the Wall Street Journal.

Zambia's total debt is approximately $12 billion with approximately $3 billion owed to China.  The China Development Bank has agreed to a six-month delay in debt repayments, but the exact terms and structure of the Chinese loans have not been made public.  "Zambia should come clean on its Chinese public and private debt," said Steve Hanke, a monetary policy expert and economics professor at Johns Hopkins University, as reported in The Africa Report.  "Zambia has been playing with smoke and mirrors on its Chinese debt, and its other creditors are rightfully fed up."

Zambia is expected to turn to the International Monetary Fund (IMF) for relief but there is no guarantee of reaching a bond restructuring agreement.  "There's no easy way out here really," said Robert Besseling, executive director of risk consultancy EXX Africa, as reported to CNBC.  "I mean Zambia needs to continue to balance the priorities of international bonds versus commercial credits, versus Chinese project finance loans and World Bank and African Development Bank loans and see which ones are the most important."