Caleb M Fundanga: Global financial and economic crisis and its effect on
the Zambian economy
Speech by Dr Caleb M Fundanga, Governor of the Bank of Zambia, to the SADC Group of
High Commissioners and Ambassadors Meeting, Lusaka, 9 July 2009.
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Chairperson
Your Excellencies High Commissioners and Ambassadors from SADC Resident in Zambia
Distinguished Guests
Ladies and Gentlemen
It is a great honour and privilege to be invited this afternoon to share Zambia's experiences
given the unfolding global financial and economic crisis. In discussing this topic, I will begin
by highlighting, albeit briefly, the origins of the current global economic crisis. I will then
underscore the effect of the crisis on the Zambian economy before I look at the policy
responses, the challenges and then conclude.
Origins of the crisis
As Your Excellencies are already aware, the genesis of the current global economic crisis
has been traced to the collapse of the sub-prime mortgage market which started between
2002 and 2006. This was when lending to the household sector in the United States of
America (USA) was growing at a rate far beyond that of the broader economy (i.e. growth in
GDP). The rising delinquencies in the subprime mortgage market triggered turbulences in the
subprime mortgage - backed securities market leading to a financial crisis which quickly
spread to other advanced economies.
Subsequently, the financial crisis created a recessionary economic environment in which
global trade, stock market indices, and commodity prices, such as copper and cobalt,
declined significantly. The global financial and economic crises thus negatively impacted on
economies around the world by adversely affecting trade and investment flows and the price
of key export commodities.
To respond to this crisis, several actions are being taken at global level by the major
economies to address the root causes and the effects of the global financial and economic
crises. These are fiscal and monetary policy stimulus measures aimed at boosting global
consumption and investment demand in an effort to avoid a significantly sharper global
contraction than that which has already occurred. Measures typically entailed reduction of
interest rates, tax cuts and increased Government spending in form of bail-outs of strategic
institutions and in some cases virtual nationalisation. Concrete steps are also now being
taken to reform the regulatory and supervisory frameworks governing the financial sector.
Further, increased resources have been provided to key multi-lateral institutions such as the
IMF and the World Bank. These institutions have also been mandated to play a central role
in leading the global response to the crisis and evaluating the efficacy of the various
measures that are being implemented.
Impact of the global economic crisis on Zambia
The Zambian financial sector has so far not been directly adversely affected by the credit
crunch as reflected in the continued stability of the banking sector with most banks being
adequately capitalized and the inter-bank market operating as before. This is mainly due to
the sector's limited integration into the international financial markets. Further, our financial
sector had no exposure to toxic assets, which led to the credit crunch in most developed
markets. However, the current global financial crisis, with the subsequent global economic
recession, has adversely affected Zambia, like most global economies, mainly through:
reduced revenue earnings from mineral resources; job losses, particularly in the extractive
industry; lower foreign capital inflow (both foreign portfolio investment (FPI) and foreign direct
investment (FDI)); rising domestic inflation driven by pass-through effects of the depreciation
in the exchange rate of the Kwacha against major currencies; and declining number of
foreign tourists.
Revenue earnings from mineral resources
As you may know, Your Excellencies, Zambia, like many African countries, relies heavily on
commodity exports. This has made the country more vulnerable to the global downturn. The
global financial crisis and the plummeting commodity prices on the international market have
negatively affected Government revenue. The global economic recession has resulted in a
reduction in world demand for copper, which in turn, has led to the precipitous fall in copper
prices. Copper prices at the London Metal Exchange (LME) fell from highs of US$8,980 per
tonne in July 2008 to as low as US $2,812 per tonne in December, 2008. The dramatic
decline in the price of copper has entailed reduced earnings from copper exports by mining
companies and subsequently reduced earnings for the Government from mineral royalties
and corporate taxes from this source as well as falling income taxes from employees in the
mining and related sectors.
The reduced earnings for the mining sector may translate into lower investments and
production. Further, some mining companies, which were carrying out exploration works,
have suspended these activities. Ultimately, all this lead to job losses in the country's
extractive industry, leading to lower income tax revenue. In addition, the downturn will reduce
Government's capacity to develop the much needed infrastructure as it may have to
scaledown its capital expenditure in line with lower realized revenue.
Loss of employment
In the real sector of the economy, the impact of the crisis has been reflected in the scaling
down of production or the closing down of some mining operations due to low copper prices.
This has had the inevitable consequence of loss of jobs. However, following the reopening of
some mines, the situation has slightly improved.
External position
The declining earnings from copper exports adversely affected Zambia's balance of
payments position. For instance, during the fourth quarter of 2008, the overall balance of
payments deficit widened to US $177.6 million from US $120.6 million recorded the previous
quarter. Merchandise export earnings declined to US $909.8 million from US $1,206.7 million
realised in the third quarter of 2008 following a sharp reduction in metal export earnings.
Metal export earnings declined by 23.1% to US $711.7 million in the fourth quarter of 2008
from US $925.6 million the previous quarter. Metal export earnings at US $575.8 million in
the first quarter of 2009 were 49.8% lower than the US $1,147.2 million recorded in the
similar period last year. A slide in both copper and cobalt export earnings owing to lower
prices accounted for this outturn. Nonetheless, it should be noted that commodity prices on
the international markets recently have been edging upwards. If this trend is sustained,
Zambia's external position may improve accordingly.
Foreign capital inflow
Your Excellencies, the global financial crisis has led to the decline in the foreign portfolio
investment inflows as investors reduced their exposure to emerging market instruments. The
risk aversion towards emerging markets has led to a reduction in foreign portfolio inflows and
holdings in Zambia's Government securities. This has resulted in a net outflow of foreign
portfolio investment since funds that mature are not being rolled over and funds coming in
have be en scaled down. For example, the foreign investor's total holding of Government
securities has reduced from K1,054.7 billion in the third quarter of 2008 to K446.2 billion by
the second quarter of 2009. Similarly, the flow of foreign investments at the Lusaka Stock
Exchange has switched from a net inflow of US$2.5 million during the period January to May
2008 to a net outflow of US$8.5 million in the same period this year.
Exchange rate volatility and domestic inflation
The global financial meltdown has caused a contagion effect to our foreign exchange market
and has led to volatility in the exchange rate of the Kwacha against major currencies. This
unfavourable development is partly a consequence of reduced earnings from copper exports
arising from the fall in copper prices as reflected in the lower supply of foreign exchange on
the market by mining companies. For instance, the supply of foreign exchange to the market
by mining companies has declined by 35.7% to a monthly average of US $62.4 million in the
first half of this year from an average of US $97.0 million in the last half of 2008.
Further, the weakness of the local currency is a consequence of increased risk aversion to
emerging and developing economy financial assets, as stated earlier, attributed to the
deepening global financial crisis. In this regard, the supply of foreign exchange by foreign
portfolio investors for the purchases of Kwacha financial assets, such as Government
securities and domestic company equities, has significantly declined, with most
nonresidents preferring to liquidate their investments and externalising the foreign exchange.
The result of this is the volatility in the exchange rate of the Kwacha against major foreign
currencies. In the last quarter of 2008, the Kwacha depreciated by 26.9% to trade at an
average of K4,394.76/US$ (BoZ mid-rate) from an average of K3,462.00/US$ in the third
quarter.
It should also be noted that the depreciation of the Kwacha against major currencies partly
contributed to higher inflation, particularly as Zambia remains dependent on imports for a
wide variety of consumer goods as well as inputs for domestic production. Further, this
unfavourable development has a strong role in shaping inflation expectations.
Tourism
Apart from mining and related companies that are affected by the effects of the global
recession, tourism has also been negatively impacted. The number of foreign tourists is
anticipated to decline owing to financial problems and credit crunch their countries of origin
are facing.
Availability of credit
Perhaps the most challenging effect of the global financial crisis, especially for developing
countries like Zambia, is its impact on private sector investment. Between 2006 and 2008
credit to the private sector grew strongly (at an average of 45.6% per annum), largely driven
by the expansion of consumer credit and the strong growth in the domestic economy. An
immediate consequence of the financial and economic crisis has been a curtailment of credit
lines and a slow-down in FDI flows. In 2009, domestic credit is expected to slow down as
financial institutions adopt more conservative lending practices and tighten their lending
standards. In addition, the deterioration in corporate and household balance sheets is now
being translated into higher non-performing loans (NPLs) as a percentage of total assets in
the banking sector (from 6% in mid-2008 to 10% in May, 2009 - an increase of 67%.). The
deterioration in NPLs is now across all the past due loan categories.
Policy response
In responding to the crisis, the Government is taking steps to maintain macroeconomic
stability and continue encouraging investments that will lead to diversification of the economy
and safeguard vital social services. Further, the Government is actively engaging new
investors to take over the running of the closed mining operations as well as negotiating with
the owners of the bigger mines on modalities of continuing with operations at the mines to
forestall further job losses. The 2009 Budget has prioritised infrastructure development with
the view to opening investment opportunities for diversification, particularly in agriculture,
tourism, and manufacturing sectors. Some specific measures include the following:
Agricultural sector:
Increased allocation of funds to the sector for livestock development and creation of at least
one disease-free livestock zone, Farm Block infrastructural development and irrigation
projects. Further, the value added tax on selected agricultural equipment and spares, has
been zero rated as incentive to increase agricultural production and productivity.
Tourism sector:
In order to diversify the economy and attain broad based economic growth, Government has
increased the allocation to the sector to improve access to the Northern Tourism Circuit
(infrastructural development in Mbala and Kasaba Bay). Further, Government will embark on
the development of a new world class tourism area in Livingstone, and step-up the
development of road infrastructure in key national parks namely, Luangwa and Kafue.
Manufacturing:
In order to expand the manufacturing base, Government is promoting the establishment of
Multi-Facility Economic Zones (MFEZ) on the Copperbelt (Chambishi), and Lusaka (Lusaka
south and east) provinces by providing for fiscal incentives and quality infrastructure
development in the budget. The construction of the Chambishi MFEZ has already
commenced. Further, the budget reclassified and re-categorised certain manufacturing
materials with the aim of lowering customs duty rates.
Mining sector:
In light of the adverse impact of the global economic crisis on the mining sector and with the
view of easing these effects, the Zambian Government introduced tax concessions, which
included removal of the windfall tax, increasing capital allowance to 100 percent as an
investment incentive, and reduction of customs duty on Heavy Fuel Oils.
As the Central Bank, we have continued to monitor and review developments in the foreign
exchange market and provide prudent support when necessary in order to dampen
excessive volatility in the exchange rate and safeguard the recently achieved
macroeconomic stability. To this end, the Bank has been a net seller of foreign exchange to
banks. However, the Bank's interventions are limited given the global extent and magnitude
of the crisis.
In addition, the Bank has enhanced its vigilance and interaction with the domestic financial
system to ensure adherence to its supervisory guidelines and to enhance information flows
between banks and itself. Accordingly, the Bank also introduced measures to ensure that
financial market players under its supervision provide detailed information on their foreign
exchange transactions.
Further, the Bank has continued to reinforce the regulation and supervision of the financial
sector. Effective surveillance of the financial market entails adopting appropriate risk
management policies and procedures that will ensure that financial institutions do not
undertake excessive risks that may increase the vulnerability of the country to external
shocks.
Challenges
Maintaining macroeconomic stability is critical to sustaining economic growth in
Zambia. The challenge is how to sustain stability and mitigate falling domestic demand
within the constraints posed by increasingly scarcer external financial inflows. This has to be
done in the context of implementing policies consistent with medium-term stability and
development goals.
The second challenge relates to mitigation of the vulnerability of the Zambian economy
to the adverse external shocks. We will have to closely monitor capital flows and adopt
supervisory policies that will ensure a sound and stable financial system. The pursuit of
policies that promote macroeconomic stability is also important to ensure that the domestic
economy remains attractive to both domestic and foreign investors for the long-term growth
and development of the economy.
One of the unfolding lessons of the current crisis is the need for greater transparency in the
transactions players in the financial markets undertake, particularly, with respect to
offbalance sheet transactions. We will therefore be acting to ensure that market players provide
us with detailed information on their transactions. In addition, we will continue to work
towards strengthening and developing our financial markets as well as encouraging
competition and efficiency.
Prospects for 2009 and beyond
Your Excellencies, going forward, it remains important to accelerate diversification of the
economy as a way to mitigate the effects of a prolonged global financial crisis. Currently,
there are enormous business opportunities which still lie unexploited in Zambia in virtually all
sectors of the economy. It is important that we continue reducing the cost of doing business,
in conjunction with the private sector, in order to improve investments in various sectors of
the economy. The agriculture sector, for instance, remains underdeveloped despite the
country possessing large tracts of arable land, adequate water and relatively good weather.
This is one sector where the country can easily take advantage of its comparative
advantage.
The achievement and maintenance of a low and stable inflation rate, preferably single digit,
therefore remains key to promoting investment, enhancing business planning and confidence
in the economy, maintaining external competitiveness and stabilising people's incomes. In
the medium-term, Government continues to pursue market and structural reforms in
partnership with the private sector with the view of consolidating the gains so far attained for
sustained economic growth and development.
Despite the adverse effects of the global economic meltdown, there are still prospects for
appreciable economic growth in 2009 and the years ahead. GDP growth is expected to be
led by growth in agriculture; construction; financial services; manufacturing; transport and
communication; and wholesale and retail trade.
Conclusion
In conclusion, we all agree that Zambia remains vulnerable to effects arising from the
ongoing global financial crisis, particularly if it is prolonged. We hope that the actions that most
affected countries, led by the US and the EU, have taken would help cool down the financial
crisis and bring back the much needed confidence in the financial systems.
For its part, the Bank of Zambia continues to closely monitor global developments and
always stands ready to intervene in the local financial market with a view to prevent any
systemic risks that may have negative effects on macroeconomic gains achieved thus far.
Once again, Your Excellencies let me thank you most sincerely for this opportunity to
discuss the challenges Zambia is facing in view of the current global economic crisis.
I thank you.