The global financial crisis in Zambia: the commoditycurrency

The global financial crisis in Zambia: the commoditycurrency link By Elva Bova PhD candidate SOAS, University of London Presentation outline Overvie...
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The global financial crisis in Zambia: the commoditycurrency link By Elva Bova PhD candidate SOAS, University of London

Presentation outline Overview of the Zambian economy: copper dependence the copper boom the copper bust

The Zambian Kwacha as a commodity currency: some evidence: cointegration EGARCH analysis

how the forex market works in Zambia: Exchange rate regime Mine ownership

Policy question: what policy mix for commodity shocks in developing countries, given the new context of: -liberalisaed foreign exchange markets - privatised commodity sectors - open capital flows - comovement of commodity prices

Copper dependence 

Zambia is ranked as 163 out of 179 in the UN’s HDI. 64% of the population below poverty line in 2006 (Oxfam2009)



Copper production:



constitutes < 60% of total exports; contributes to 70% of the foreign exchange; contributes to 10% of the GDP in 2006 (refining of metals included[1]) (CSO 2008);  the sector as a whole employs 60,000 people, i.e.10% of the total workforce (Chambers of Mines), as opposed to 70% of agriculture  



Historical notes: nationalised in the early 1960s, in 1972 public companies were grouped under ZCCM.  In the 1990s, the country opted for privatisation due to high losses in the mining sector (poor investments in the 1980s, low prices in the 1990s)  After years of negotiation, ZCCM was finally split in seven units in 2000, each belonging to a transnational corporation  The Government of Zambia retained 15% share through ZCCM-IH de jure but not de facto 

The boom 2003-July 2008 •Copper price: 1,800 10000 US$ MT (2002) 8000 8,000US$ MT (2006) 6000 •Copper production: 25,000 MT (2002), 4000 2000 52,000 MT (2006) •Trade balance 0 positive but very volatile U S $ p er M T

250 200 150 100 50 0 -50 -100 2003m 01 2003m 05 2003m 09 2004m 01 2004m 05 2004m 09 2005m 01 2005m 05 2005m 09 2006m 01 2006m 05 2006m 09 2007m 01 2007m 05 2007m 09 2008m 01 2008m 05

U S $ M illio n s

Copper prices and trade balance (2003-2008)

Trade balance

Source: IMF-IFS

Copper prices

Macro-adjustment in the early 2000s Political stability  Economic stability (reduction of inflation through fiscal adjustment)  Privatisation reform in the copper sector (increasing FDIs)  Portfolio flows since 2005  Aid and debt relief 

GDP growth Gross Domestic Product (1990-2007) 8 6 4 2 0 -2 90 91 92 93 94 95 96 97 98 99 00 01 02 03 04 05 06 07 19 19 19 19 19 19 19 19 19 19 20 20 20 20 20 20 20 20 -4 -6 -8 -10

GDP % growth

Source: WB-WDI

GDP per capita % growth

The copper bust: July 2008-2009 10000 8000 6000 4000 2000 0

tradebalance Source: IMF-IFS, IMF-DTS

copper prices

U S$ per M T

250 200 150 100 50 0 -50 -100

20 06 20 m 01 0 20 6 m 04 06 20 m 07 0 20 6 m 10 07 20 m 01 0 20 7 m 04 0 20 7 m 07 07 20 m 10 0 20 8 m 01 08 20 m 04 08 20 m 07 08 20 m 10 09 m0 1

US$ M i llio n s

Copper prices and trade balance (2006-2009)

Copper production: 35,000 October 2008, while 52,000 in 2006 Trade balance: +US$ 160 mil in June; - US$30 mil in Nov Mine closures: Chambishi in Oct 2008, 1,800 made redundant. 8,000 job losses registered in December 2008 from October (Oxfam 2009, ODI 2009)

Mining tax regime: the debate Changes in the taxation system prior and post the bust:  Mining code in 1995  Development agreements 2000 (Lungu & Fraser 2007), secretly signed by GoZ and companies, exemptions and deductions (royalty 0.6% vs. 2%, exp tax 25% vs. 35%, carrying forward losses for a period of 15-20 years)  The scandal 2007 and new regime in 2008 (Oxfam 2009): 9% predicted increase in gov revenues out of mines, not realised  January/May 2009 new concessions to the mines (Reuters), like removal of windfall tax

The currency 10000

6000

8000

5000 4000

6000

3000

4000

2000

2000

1000 0

20 0 20 0 m 0 0 1 20 0 m 0 0 9 20 1 m 0 0 5 20 2 m 0 0 1 20 2 m 0 0 9 20 3 m 0 0 5 20 4 m 0 0 1 20 4 m 0 0 9 20 5 m 0 0 5 20 6 m 0 0 1 20 6 m 0 0 9 20 7 m 0 0 5 20 8 m 0 08 1 m0 9

0

copper price

Source: IMF-IFS

ZKw to US$

ZK w per U S$

U S $ per M T

Zambian Kwacha and copper prices (2000-2008)

•Appreciation by 30% end 2005 [negative impact on non trad. exports- Weeks 2007, Weeks et al. 2008] •Nov 2008 depreciation by 40% [negative impacts on imports, mainly food prices]

The Zambian Kwacha as a commodity currency

Commodity currency as indicating a long run relationship between the commodity price and the currency [empirical literature Cashin et al. 2002; Chen and Rogoff 2002] Evidence on long run relationship: Cointegration analysis between ZKw and copper, through Johansen test proves the existence of a long term relationship with a lag of 4 months and a coefficient of 0.746177 (0.02486) between the ZKw and the copper price (see Annex) Evidence on short run volatility: Analysis of patterns of volatility through EGARCH to check for patterns of asymmetry in the volatility from positive and negative shocks. The theory of storage explains asymmetric volatility in the copper price: the copper price explains the asymmetric volatility in the Zambian Kwacha (see Annex)

The foreign exchange market •Explanation for the commodity currency behaviour in the Kwacha: how the foreign exchange market works Volume of transactions (purchases-sales)

Sep-08

May-08

Jan-08

Sep-07

May-07

Jan-07

Sep-06

May-06

Jan-06

Sep-05

May-05

Jan-05

-50000

Sep-04

0

May-04

50000 Jan-04

Million US$

100000

-100000 -150000 BoZ

Source: Bank of Zambia

Interbank

Bureaux

Others

Main players in the market (2007-2008): Foreign exchange sales

Foreign exchange purchases

350,000

200,000

300,000 150,000 U S $ '000

U $ 000

250,000 200,000 150,000 100,000

100,000 50,000

50,000 0

0 Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Foreign Bank

Mining

Agriculture

Wholesale and Retail

Source: Bank of Zambia

Q1 2007 Q2 2007 Q3 2007 Q4 2007 Q1 2008 Q2 2008 Foreign Bank Manufacturing Mining Transport and communications

A framework for the interpretation 1- The exchange rate regime: a market determined rate monetary target price stability objective

2- The ownership structure of the commodity sector largely private owned trans-national corporations minimum government share

The behaviour of the currency in cdcs is related to the exchange rate regime and the kind of ownership of the commodity sector. The latter provides a measure of the degree of revenues from mines that accrue to the government and it indicates the scope for fiscal policy response to commodity shocks.

BoZ Management Bank of Zambia transactions of forex (2004-2008)

J an Ma 04 yS e 04 pJ an 04 Ma 05 yS e 05 p-0 J an 5 Ma 06 yS e 06 pJ an 06 M a -0 7 yS e 07 pJ an 07 Ma 08 yS e 08 p-0 8

m i ll i o n U S $

100000 75000 50000 25000 0 -25000 -50000 -75000 -100000

sales to BOZ

Source: Bank of Zambia

purchases from BOZ

•Weeks 2007, little intervention from BoZ during the boom: fear of inflation 1. low monetary transmission mechanism 2.high pass-through, of 12% [especially on food prices, 20%] •During the bust, no too much intervention to avoid depreciation [reserves-non trad. Exports]

Ownership structure Largely privatised commodity sector. ZCCM-IH no dividends even despite the boom, due to accumulated debts Equinox

ZCCM-IH

J&W Holding Vedanta

Glencore

First Quantum Co-Africa

Source: anMbendi 2007

Tax revenues Revenues in Zambia (in ZMK) 8000 Billions

7000 6000 5000 4000 3000 2000 1000 0 2001

2002

2003

Mines taxes

Source: Zambian Revenue Authority

2004

Revenues

2005

Taxes

2006

Conclusive points 





Under a market determined rate and a highly privatized commodity sector, commodity shocks are passed on to the economy through the nominal exchange rate. A more managed exchange rate regime (in a countercyclical way) could be an option, as long as commodities do not exhibit co-movement, since Zambia is a large importer of commodities (oil and food) and as long as the country has large reserves Alternatively, an expansion of government shares into the commodity sector may provide more scope for fiscal policy’s intervention in a counter-cyclical way. [stabilization funds for example]

Open issues…. 

 



“I want you to know that the drop in metal prices has hit all hard in Zambia” Banda, President of the Republic of Zambia, “While our people here in Luanshya may have gone without food, your government has also been robbed of revenues in the form of taxes” (Reuters May 2008) Proposal to increase government shares Obiagel Ezekwesli WB vice president for Africa “the populist reaction is to say let’s take a stake, but do you want to risk capital in a sector where the private sector can take risks? (…) this is an industry better left to the private sector to run” (Reuters 23 April) Is it? Evidence from the GCC, Chile, Botswana, Canada, Malaysia..

Future research Fiscal management of commodity shocks (stabilisation funds)  Capital flows along the commodity price cycle 

Annex 

Johansen cointegration test

Series: LRER LCOP Unrestricted Cointegration Rank Test (Trace) Hypothesized

Trend assumption: Linear deterministic trend Lags 1-4 Trace

No. of CE(s)

Eigenvalue

Statistic

0.05 Critical Value

None *

0.170668

26.21973

17.49471

0.0009

At most 1

0.012930

1.704818

3.841466

0.1917

Trace test indicates 1 cointegrating eqn(s) at the 0.05 level

Normalized cointegrating coefficients (standard error in parentheses) LRER

LCOP

1.000000

0.746177 (0.02486)

Prob.

Annex

• EGARCH for price of copper Dependent Variable: RCOP

Method: ML - ARCH (Marquardt) - Normal distribution

LOG(GARCH) = C(1) + C(2)*ABS(RESID(-1)/@SQRT(GARCH(-1))) + C(3)*RESID(-1)/@SQRT(GARCH(-1)) + C(4)*LOG(GARCH(-1)) Coefficient

Std. Error

z-Statistic

Prob.

C(1)

-0.090670

0.029421

-3.081108

0.0021

C(2)

0.044417

0.009270

4.801923

0.0000

C(3)

0.017482

0.007100

3.427812

0.0006

C(4)

0.993381

0.002996

331.7942

0.0000

R-squared

-0.000082

Mean dependent var

0.000124

Adjusted R-squared

-0.001786

S.D. dependent var

0.013678

S.E. of regression

0.013669

Akaike info criterion

-7.784870

Sum squared resid

0.372770

Schwarz criterion

-7.773664

Log likelihood

7787.977

Hannan-Quinn criter.

-7.780777

Durbin-Watson stat

2.186347

Annex

• EGARCH for Zambian Kwacha Dependent Variable: KWACHA

Method: ML - ARCH (Marquardt) - Normal distribution

LOG(GARCH) = C(1) + C(2)*ABS(RESID(-1)/@SQRT(GARCH(-1))) + C(3)*RESID(-1)/@SQRT(GARCH(-1)) + C(4)*LOG(GARCH(-1)) + C(7)*PRICE Coefficient

Std. Error

z-Statistic

Prob.

C(1)

-0.723774

0.018910

-38.27718

0.0000

C(2)

0.270177

0.006060

41.28076

0.0000

C(3)

-0.043467

0.004712

-9.633682

0.0000

C(4)

0.977248

0.001176

813.7737

0.0000

C(7)

-12.64126

3.276087

-3.878647

0.0001

R-squared

-0.001611

Mean dependent var

7.63E-07

Adjusted R-squared

-0.002937

S.D. dependent var

0.001402

S.E. of regression

0.001404

Akaike info criterion

-10.69470

Sum squared resid

0.007978

Schwarz criterion

-10.68476

Log likelihood

16191.42

Hannan-Quinn criter.

-10.69112

Durbin-Watson stat

1.972379

References    

  



Cashin, P, L Cespedes, R Sahay (2002), "Keynes, Cocoa, Copper: in Search of Commodity Currency", IMF Working Paper n.223. Chen, Y C. and K Rogoff (2002), "Commodity Currencies and Empirical Exchange Rate Puzzles", IMF Working Paper n.27. Fraser A and J Lungu (2007), “For Whom the Windfalls. Winners and losers in the privatisation of Zambia’s copper mines”, www.minewatchzambia.com. Fynn, J and S Haggblade (2007), “Potential Impact of the Kwacha Appreciation and proposed Tax Provision of the 2006 Budget Act on Zambian Agriculture”, Food Security Project, Zambia National Farmers Union, Working Paper n.16. Green, D. “A copper-bottomed crisis? The impact of the Global Economy. Meltdown on Zambia”, Oxfam GB March 2009-05-29 OECD 2008, Zambian Economic Outlook Weeks, J., V. Seshaman, A. C.K. Mukungu, S. Patel 2007. “Kwacha Appreciation 2005-2006: Implications for the Zambian Economy”. Report prepared for the United Nations Development Program, Lusaka. Weeks, J. 2008 “Economics Effects of Copper Prices on the Zambian Economy: Exchange Rate Regime and Kwacha Appreciation”, paper presented at the International Workshop on Challenges and Prospects for Commodity Markets in the Global Economy, A Workshop in Memory of Alfred Maizels, 19th -20th September 2008.

Source: IMF-IFS CPI inflation rate

2008m09

2007m05

2006m01

2004m09

2003m05

2002m01

2000m09

1999m05

1998m01

1996m09

1995m05

1994m01

1992m09

1991m05

1990m01

1988m09

1987m05

1986m01

CPI inflation rate (1986-2008)

250 200 150 100 50 0

Source: BoZ, IMF-IFS Discount rate Exchange rate

2008m09

2007m04

2005m11

2004m06

2003m01

2000m03 2001m08

1998m10

1997m05

1995m12

1993m02 1994m07

1991m09

1990m04

1988m11

1987m06

1986m01

140 120 100 80 60 40 20 0 6000 5000 4000 3000 2000 1000 0 Kwacha per US$

Exchange and interest rates (1986-2008)

Capital account (1998-2007) 300

Millions US$

250 200 150 100 50 0 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 -50 portfolio flows

Source: IMF-IFS, BOZ

Direct investment

M illio ns U S $ (cur r ent)

Official Development Assistance (196-2002) 1000 800 600 400 200 0 1996

Source: OECD-DAC

1997

1998

1999

2000

2001

2002

Foreign Debt/GDP (2000-2007) 200 150 100 50 0 2000

2001

2002

2003

2004

2005

2006

2007

Revenues from the boom 20 20 19 19 18 18 17 17 16

8000 7000 6000 5000 4000 3000 2000 1000 0 2001

2002

2003

2004

Revenues as % of GDP

Source: WB-WDI

2005

2006 Revenues

B illion s of K w acha

Revenues as % of GDP in Zambia

Prior to the copper boom 1996-2002 

The reforms in the 1990s



More political and economic stability



Low copper prices and trade deficit

80 60 40 20 0 -20 -40 -60 -80 -100 -120

2500 2000 1500 1000 500 0

Trade balance Source: IMF-IFS

Copper prices

US$ per M T

3000

1996m01 1996m07 1997m01 1997m07 1998m01 1998m07 1999m01 1999m07 2000m01 2000m07 2001m01 2001m07 2002m01 2002m07

M illions US $

Copper prices and trade balance (1996-2002)

The behaviour of the Kwacha 

The foreign exchange market in Zambia



the main players



The Broad Based Inter-Bank Foreign Exchange market (introduced in July 2003) Commercial banks The foreign exchange bureaux market;

 

Additional flows Aid flows  Debt relief  FDI and portfolio flows 

1600 1400 1200 1000 800 600 400 200 0

19 96 19 97 19 98 19 99 20 00 20 01 20 02 20 03 20 04 20 05 20 06 20 07

Millions US$ (current)

Official Development Assistance (1996-2007)

Source: OECD-DAC

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