The Zambian Kwacha to Recover on Steadily Rising Investor Sentiment

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Tuesday, October 25, 2016/ 2:18pm /BMI Research

BMI View: The Zambian kwacha will trade sideways through to year-end and will appreciate modestly over 2017. While elevated inflation will offset improving trade dynamics over the rest of 2016, leading to range bound trade, loose developed market monetary policy will drive capital inflows and will see the kwacha strengthen over 2017.

Short-Term Outlook (three-to-six months)
After a significant sell-off in 2015, we expect the kwacha to remain largely range bound through the remainder of 2016. The currency has stabilised this year, after depreciating by 41.7% against the US dollar in 2015, and will average ZMW10.35/USD over 2016.

We believe that imports of food and electricity will abate in the months ahead as improving weather conditions raise domestic agricultural production as well as power supply and this will see the country's net exports improve.

However, while inflation will begin abating in the months ahead (see, 'Cooling Inflation Will Keep Rates On Hold', August 25), price growth will remain in double digits through end-2016 and will counter improving domestic trade dynamics.

This being the case, we expect the kwacha to trade between ZMW9.40/USD and ZMW11.41/USD over H216.

Long-Term Outlook (six-to-24 months)
We believe that gradually rising foreign direct investment (FDI) into Zambia as well as lower for longer developed market interest rates will support a modestly higher average exchange rate over 2017.

We forecast the kwacha to appreciate by 1.5% over 2017 and average ZMW10.20/USD over the same period, compared with an average exchange rate of ZMW10.35/USD in 2016.

While investors will remain wary, generally business friendly government policies will drive an uptick in capital flows in the months ahead. Frequent revisions to the country's mineral tax policies over 2015 – mining taxes were changed three times over the period – led to a weakening of investor sentiment but policies have subsequently been revised in order to support profitability for copper mining firms.

The new copper mining tax policy, which is linked to global copper prices, will see investor sentiment recover, albeit gradually. Indeed, in April Glencore announced that it plans to invest USD1.1bn into the mining sector over the next several years.

In addition, the gradual uptick in global copper prices in the years ahead will encourage mining firms to expand operations and boost output. As such, rising capital flows will drive demand for the kwacha upward and will see the currency strengthen over 2017.

Additionally, the likely agreement between the Zambian government and the IMF for a support package will raise investor sentiment in the months ahead and boost the local currency.

We believe the deal will support the government's weak fiscal position and will assist in keeping its high external debt load sustainable. Public external debt has risen from 6.5% of GDP in 2010 and we forecast that it will reach 31.5% in 2016 due to lower fiscal revenues and persistently high expenditures, in the run up to the August elections.

Investor sentiment will therefore strengthen on the back of the IMF deal, due to improving debt sustainability, with rising capital flows putting upward pressure on the kwacha over the next year.
Increasing global investor search for yield, as developed market monetary policy remains loose, will see capital flows into Zambia rise and will further support the kwacha.

The Zambian kwacha will benefit as interest rates in developed markets remain low and monetary easing in the Eurozone continues in the wake of the UK's decision to leave the European Union (Brexit) in June (see, 'ECB Policy: Looser For Longer', August 3).

In addition, the kwacha will receive support as improved domestic food and power supply temper inflationary pressure over 2017.

Risks to Outlook
While the government has implemented more business friendly mining tax policies, continued uncertainty surrounding Zambia's mineral policies presents potential downside risks to our forecasts.

Significant upward revisions to the country's mining taxes would see increased capital outflows and a substantial sell-off of the kwacha, as experienced over 2015

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