SRR measure: BoZ’s wise balancing act

CENTRAL banks, including the Bank of Zambia (BoZ), have a crucial role to play in any given economies.
The most obvious one is the issuance of the local currencies, in the Zambian case the Kwacha and the Ngwee, since we still have 50N.
Relevantly, the Central Banks have to ensure the stability of the financial systems in their respective economies and monitor the performance of the local currency in relations to international currencies.
The monitoring of the performance of the local currency in relations to international currencies is with a view to intervene accordingly using various monetary policy instruments.
According to the BoZ, by selling or buying foreign exchange, the Central Bank ensures that the exchange rate is at levels that do not affect domestic money supply in undesired direction, through the balance of payments and the real exchange rate.
One of the instruments the Central Bank can use to indirectly intervene in the money market is the reserve requirement or the minimum statutory reserve ratio.
In that vein the BoZ last week announced a 2.5-percentage point increase in the minimum statutory ratio on both local and foreign currency deposits for banks to 11.5 per cent.
The measures which will take effect on Monday next week, include government deposits and those in vostro accounts which are accounts correspondent banks hold on behalf of others banks.
The vostro accounts are an essential aspect of correspondent banking in which the bank holding the funds acts as custodian for or manages the account of a foreign counterpart.
According to the Cambridge Dictionary the Statutory reserve ratio or reserve requirement is the minimum amount of money that a bank must keep, usually a percentage of the amount that it has lent at a particular time.
This instrument depends on the level of development of the economy, especially its financial sector.
The Central Bank may require deposit money banks to hold a fraction (or a combination) of their deposit liabilities (reserves) as vault cash and or deposits with it.
Increased fractional reserve, like the current move by the BoZ, limits the amount of loans banks can provide to the domestic economy and thus limit the supply of money in the economy.
The assumption is that deposit money banks generally maintain a stable relationship between their reserve holdings and the amount of credit they extend to the members of the public.
The BoZ has increased the statutory reserve ratio from nine per cent to 11.5 per cent as way of curbing value of the Kwacha from its current free-fall.
This is according to the circular dated February 1, 2023 released by Deputy BoZ governor Francis Chipimo and addressed to all heads of commercial banks.
Mr Chipimo says the measure is aimed at addressing the increased volatility in the exchange rate which intensified in December 2022 and has persisted well into 2023.
The measure is to safeguard stability of the foreign exchange market, particularly the value of Kwacha against the major convertible currencies like the United States (US) dollar.
External and internal pressure on the Kwacha has seen the value of the local currency breach the psychological mark of K19-per-dollar recently.
Dr Chipimo says the exchange rate has come under sustained depreciation pressure despite the Central Bank support to market through the sale of foreign exchange proceeds, mostly from mining companies, another instrument.
He notes that if not addressed, the trend has the tendency and potential to undermine the emerging stable macroeconomic environment in Zambia.
This is because currency depreciation presents major disadvantages ranging from making imported goods more expensive to causing the decline in local consumer buying power.
It also fuels inflation, while in the medium to long-term era it can also result in less efficient and less competitive domestic industries.
Indeed as an import-dependent country, Zambia’s economy will be greatly hurt by the nosedive in the value of its Kwacha.
On the other hand the BoZ is wary of the risks its current measure poses on the local economy.
As a layperson who has, however, been writing on these issues for some time now I can tell that one of the effects of the move is the rise in the cost of money (borrowing) from the banks.
This is because of the reduction in the supply of the commodity (money) coupled with the decrease in the economic activities locally.
In the long-run the move could negatively affect the projected economic growth rate.
However, like I always state, economic policies are about balancing and what the authorities want at a given time.
For now the BoZ has weighed the consequences of letting the Kwacha continue falling on one hand and the risks associated with its intervention on the other.
It has found that the economic benefits of intervention outweigh those for letting the Kwacha continue falling unabated.
“The Bank of Zambia is mindful of attendant risks to this action but deems the overarching potential benefits of stabilising the foreign exchange market at this point, outweigh perceived adverse risks to the economy,” Dr Chipimo says.
For finance expert Moses Mwale the measure taken by the BoZ is remedial and, therefore, commendable as it is in line with one of its objectives of ensuring pricing stability in the economy.
Mr Mwale says the move taken by the BoZ basically entails reducing the level of money supply by increasing the holding of a ratio of bank deposits out of circulation.
The situation means the amount available for use for lending by a commercial bank has reduced.
“This hopefully means that the lending to the public may not be affected. Inflation may reduce as less Kwacha cash shall be available,” he says.
Similarly, Trevor Hambayi, a financial analysis, commends the Central Bank for taking remedial action to be able to contain the continued depreciation of the Kwacha.
Mr Hambayi urges BoZ to work towards driving the double-digit gross domestic product (GDP) which he says is a more permanent solution than to reduce the reserve ratio for commercial banks.
He says that the country should work towards tilting the balance of trade towards a surplus by exporting more than what is currently being imported.
Out of interest, we will next week, look at some of the SRR for other developed and developing countries just to compare the levels.
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