Effects of Monetary Policy on the Economy

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1 Bank of Zambia Effects of Monetary Policy on the Economy Speech at the ZACCI CEO s Breakfast Meeting By Dr Michael Gondwe, Governor-Bank of Zambia Intercontinental Hotel Lusaka 16 September

2 President of the Zambia Chamber of Commerce and Industry, Mr Geoffrey Sakulanda, Distinguished Guests, Ladies and Gentlemen, Let me just say ALL PROTOCOLS OBSERVED It is my privilege and honour to join you this morning at this important Breakfast meeting. On behalf of the Bank of Zambia and indeed on my own behalf, it is a pleasure to be part of this important platform for the captains of industry to share views on various issues affecting the business environment and the economy of our country at large. This platform also affords the business community an opportunity to share their views on various measures government has put in place to stimulate the economy. As a central Bank, we appreciate the exchange of views and sharing of experiences on the management of the economy as well as developments affecting the economy. Over the last 10 years, the country has registered relative macro-economic stability and appreciable economic growth reflected in: Positive real GDP growth and rising per capita incomes; Lower and largely single digit inflation, relatively stable exchange rate and downward trend in lending rates; Favourable external sector performance; and, Stability and growth in the financial sector. Growth in real Gross Domestic Product (GDP) has averaged 6.4% during the period 2004 to The economic growth has been broad-based, encompassing agriculture, mining, manufacturing, retail and trade; construction and tourism sectors. In 2014, the economy is projected to grow by at least 6.0%. The robust growth that the country has continued to register over the years has been a result of supportive fiscal and monetary policies that Government continues to implement as well as favourable developments in the global economy. This is in addition to strategic initiatives taken by the Government aimed at boosting economic development and reducing poverty levels. Ladies and Gentlemen As you may be aware, the Vision 2030 provides the country s broad macroeconomic objectives and targets that have to be achieved by This 2

3 vision, as you well know, is operationalised through five year development plans and annual budgets. In this regard, the national budgets outline the macroeconomic objectives to be achieved in each year and these include the growth target, employment, inflation and other macroeconomic objectives. The growth target is based on an economic program that spells out a number of assumptions for various economic variables that would support the targeted level of growth. Monetary policy, which is the responsibility of the central bank, contributes indirectly to attainment of the growth target by ensuring a stable money supply and favourable macroeconomic environment, while the Government is responsible for the implementation of fiscal policy. Macroeconomic stability, which encompasses inflation, real GDP growth, competitive exchange and interest rates, enables the private sector to thrive and develop the real sector of the economy. Through the economic program agreed with Government, monetary targets are spelt out and the Bank of Zambia s role is to design monetary policy consistent with economic growth and the inflation target. Thus, the Bank of Zambia s primary role in the economy is to contribute to macro-economic stability through price and financial system stability, necessary for investment and economic growth. Let me hasten to mention that macroeconomic stability is a necessary but not sufficient condition for economic prosperity. Hence, the private sector, to which most of the organisations represented here belong, remains the engine for economic growth through its investment and trade activities. I can assure you that we are here to facilitate your investments and trade transaction in the most efficient, least cost manner to meet the economic development aspirations of our citizens and the global community. Distinguished Colleagues Monetary policy in Zambia can generally be categorised into two periods, the pre-liberalisation period of 1964 up to 1991 and the post-liberalisation era of 1992 to date. Prior to 1991 monetary policy had multiple objectives without clearly defined targets and largely employed direct instruments for monetary control. Since 1991, monetary policy in Zambia has been directed at reducing and stabilising inflation. This objective has been achieved and we now have and intend to maintain a single digit inflation rate. In April 2012, the BoZ embarked on the modernisation of its monetary policy framework and the first step in this 3

4 regard was the introduction of the Policy Rate. The ultimate objective of the modernisation of the monetary policy framework is to adopt an inflation targeting monetary policy framework, with the Policy Rate as a key monetary policy tool as opposed to monetary aggregates. The introduction of the Policy Rate is aimed at enhancing the central bank s communication of its monetary policy stance as well as providing an anchor for inflation expectations. In addition, the Policy Rate helps the market to understand the commercial banks setting of lending rates on their credit products as it is used as a reference rate by commercial banks. Under the new framework monetary policy framework, the central bank s monetary policy decisions regarding interest rates have an obvious implication on interest rates in general and the availability of credit in the economy. It should, however, be noted that changes in the Policy Rate are mainly driven by the inflation objective of ensuring a stable macroeconomic environment buttressed by a low and stable inflation rate. A low and stable inflation rate will generally be associated with lower interest rates, which in turn will encourage households and businesses to borrow for investment purposes thereby boosting production levels in the economy. It is the increased production activities which spur the economy into growth and this is the motivation of the conduct of our monetary policy! Ladies and gentlemen Let me also use this opportunity to discuss the recent developments in the exchange rate system and the measures the Bank undertook to remedy the situation in recent months. The developments in the exchange rate in the first half of the year were an area of great concern to the Bank, which if not addressed, would have worked against our inflation objective for this year. In our view, the rate of depreciation of Kwacha which we witnessed was not consistent with economic fundamentals. The depreciation in the exchange rate was partly as a result of a noticeable reduction in supply of dollars to the market, particularly from the mining sector, which accounts for the bulk of foreign exchange supply. This reduction in supply was partly a function of the general weakness in copper prices. Over the first quarter of 2014, we also noticed a significant deterioration in the current account balance to a deficit of US $260.7 million from a surplus of US $28.7 4

5 million in the fourth quarter of The deterioration was largely accounted for by service payments. In addition, during the fourth quarter of 2013 and the first quarter of 2014, there was a build-up of liquidity in the banking system, which supported demand for foreign exchange. A combination of these factors resulted in significantly weaker exchange rate, which threatened the attainment of the 2014 inflation target. Given the importance the Bank attaches to maintaining price stability, measures had to be taken to address the rising inflation trend and the instability in the foreign exchange market by significantly tightening monetary policy. The tightening of monetary Policy was done through: Raising the BoZ Policy Rate from 9.75% in February 2014 to 12.0% in April 2014; Increasing the statutory reserve ratio to 14.0% from 8.0%, to help address the high liquidity levels in the market; Increasing the rate on the overnight lending facility by 10 percentage points above the Policy Rate from 6 percentage points; Interventions in the foreign exchange market to improve supply of foreign exchange; and, Application of statutory reserves to include Government deposits and Vostro accounts held by foreign financial institutions. In implementing these measures the Bank was cognizant of the impact that the significant tightening would have on the economy, but the primary objective was to support price stability by arresting the excessive depreciation in the exchange rate. I am pleased to say that the measures implemented have been successful in restoring relative stability in the foreign exchange market and in the financial sector in general. This has therefore given the Bank an opportunity to begin the process of easing the tight liquidity conditions in the market, mainly through the provision of liquidity under open market operations. I am sure you will agree with me that a stable exchange rate is good for the business community for their planning purposes; it is good as well for economic management for us and the Government. 5

6 Let me conclude by assuring you that the Bank of Zambia is committed to continue playing its role of maintaining macroeconomic stability and ensuring that the year of our Golden Jubilee becomes a stepping stone to prosperity for all. I wish you all success in your various businesses and urge you to take up your place of being the engine of growth of this prospering economy. On a different note, the African Export and Import Bank is holding two seminars in Lusaka; on Structured Trade Finance to be held from 4 th to 6 th November 2014 and Annual Factoring Workshop on 7 th November, I invite you to participate in at least one of the workshops and as you do so hold discussions with senior officials from Afreximbank to find out what financing would be available for your businesses. Zambia has not substantially utilised the financing resources of this institution. I therefore urge to take this opportunity to explore all the available financing avenues available to seek full benefits offered by Afreximbank. We shall share with you, the details of the seminars once Afreximbank have finalised arrangement. As I conclude, ladies and Gentlemen, allow me to once again thank ZACCI for this important forum. We commend you for this initiative and appeal to other similar umbrella mother bodies to create fora where we can share our views and explain developments on economic matters that affect all of us. I thank you for your kind attention. 6

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