Saturday, November 1, 2008

Standard Chartered economic assessment of the current political situation in Zambia

Source [Zambian Economist]

Zambia - A presidential by-election, Raziah Khan, Standard Chartered (On the Ground), Analysis:

The ruling MMD is set to choose its presidential candidate

The National Executive Committee (or NEC) of Zambia’s ruling Movement for Multiparty Democracy will meet on Friday 5 September to choose a successor to the late President Mwanawasa, who was buried earlier this week. According to the Zambian Constitution, a new election is due within 90 days of the death of the President. A presidential by-election has been scheduled for November. While the ZMK sold off, initially on the news of President Mwanawasa’s stroke in late June, and then again following the death of President Mwanawasa on the 19th August, we continue to anticipate further appreciation from current levels. The holding of new polls in November, naturally unanticipated at the time the Budget 08 was read in Q1, will in all likelihood require a supplementary budget. The authorities have already released ZMK 46bn to the Electoral Commission of Zambia in order to prepare for the forthcoming presidential by-election. Donors are expected to finance at least 50% of the cost, which should mean new inflows. The remainder will be financed from domestic resources. Moves earlier this year to impose a windfall tax payment on copper mining companies – revenue that had not yet been accounted for in the budget when the FY 08 deficit was forecast at -3.2% of GDP, should limit any fiscal deterioration. Although the new tax regime for mining companies, and the requirement to pay a windfall tax on copper earnings was made effective from the start of the current fiscal year in April, the grace period offered to mining companies on these payments only expired in the current quarter. Now, with elections due, greater urgency might be given to the mobilisation of domestic revenue. More mining-related flows and greater donor inflows in the near term should lend some support to the ZMK.

ZMK selloff somewhat overdone. Near term, fundamentals still support a lower USD-ZMK

In many respects, the sell-off already seen has been overdone. Investor fears over the risks to Zambian policy as a result of recent political developments may be unfounded. There are currently two leading contenders in the MMD presidential contest, the current acting President (and Mwanawasa’s appointed Vice President) Rupiah Banda who appears to be the front-runner, and Zambia’s Finance Minister, Ng’andu Magande; although in all it is thought that as many as 19 aspiring presidential candidates have emerged from the MMD, including two former Vice Presidents, Enoch Kavindele and Nevers Mumba, and the Health Minister, Brian Chituwo. Initially, there were some concerns that Banda’s status as a relative latecomer to the MMD might work against him in the leadership contest. (Banda,formerly a member of UNIP, the party run by the son of Zambia’s first President Kenneth Kaunda, had been offered the post of Vice President by Mwanawasa following the 2006 elections when he helped to switch support in Zambia’s Eastern Provinceaway from UNIP to the MMD). However, the subsequent endorsement of Rupiah Banda as presidential contender by the MMD in at least 8 of the country’s 9 provinces appears to suggest that Banda’s supposed ‘outsider’ status within the ruling party is now a non-issue. Finance Minister Ng’andu Magande would
reinforce economic continuity, but regardless of who wins the MMD nomination, it is unlikely that policy will change meaningfully. The final decision on the choice of the presidential candidate will be down to the 55 member National Executive Committee of the MMD when it meets on Friday. Some observers have suggested that the large number of presidential aspirants within the MMD signals deep divisions within the ruling party, damaging its electoral prospects. Others disagree, seeing the process as no more than the healthy exercise of Zambia’s democracy. For investors who note the macroeconomic stabilisation, improvement in external debt and GDP growth achieved in Zambia in recent years, it is policy continuity that is likely to matter most, and it is on this point that they will seek reassurance.

Between 2006 and the present: three key differences

In part, the currency volatility seen since late June (see chart 1) reflects some level of portfolio investor apprehension that the future course of policy might be subject to greater uncertainty. For many investors who remember the closely-fought election in 2006, when initial vote counting in Lusaka and the Copperbelt put the leftist Patriotic Front in the lead, the election poses an important risk event. Back then, the leader of the Patriotic Front, Michael Sata, had turned foreign investment in Zambia (and Indian and Chinese mining investment in particular) into a major political issue, playing on voter discontent with Zambia’s gains from the copper boom. Had he won the presidential election, Sata had at the time threatened to expel certain foreign investors from Zambia, even threatening at one point to switch official recognition from China to Taiwan. But much has changed since 2006, and the risk of any major policy upheaval has diminished considerably. First, with the election being held as soon as November, some would argue that the opposition has been caught on the back foot. There has been little time to mobilise, and an alliance of opposition parties to unseat the MMD appears – at this late stage – to be unlikely. (The different political views of the leftist leader Michael Sata, and the more centrist presidential contender Hakainde Hachilema also suggest that this would be a rather unlikely alliance). Second, it must be remembered that this is a presidential by-election, rather than a general election. The ruling MMD still dominates parliament. Although any new president would have the power to re-appoint the cabinet, he would still face an MMD-dominated parliament. As such, the government itself will not change significantly. Last, and perhaps most significantly, in terms of policy, there is no longer as wide a gulf between the current government and the opposition. While the opposition deliberately played on voter discontent with Zambia’s share of the copper windfall in the previous election, making strong gains on the copperbelt and in other urban constituencies as a result, the MMD government has since then itself moved to increase mining sector royalties and impose a windfall tax on mining companies, seeking to secure a greater proportion of copper-related revenue for Zambia. In doing so, the government had taken an important step towards neutralising the opposition. (Sata’s subsequent about-turn on the issue of mining sector taxation, claiming that the government had gone overboard with policy to the detriment of long term prospects on the copper belt, will also be recalled). Policy differences are no longer likely to be an important voter differentiator – it is how policy is implemented, rather than the policy itself, on which the various parties are likely to differ. In a short space of time, Zambia has seen an important maturing of its multiparty democracy. Political risk – at least to the extent that it might impact on policy - has receded meaningfully.

Currency trajectory – inflation may the more important risk

What then do we expect of the currency? With the publication of our September FX Strategy monthly (‘Rotation, rotation, rotation’), we recently revised our ZMK forecasts. The revisions – both our old and new forecasts – are set out in Table 1 below. While we still expect the ZMK to strengthen in the near term on the back of donor flows and the concerted effort that we now see underway to raise more domestic revenue ahead of the election, our revised forecasts take as their starting point both the recent sell-off that we haveseen in the ZMK (so any appreciation is likely to be from a higher level of USD-ZMK), and the rise in Zambian inflation. Whilst continued windfall tax flows this quarter should still be overriding, triggering ZMK strength in the near term, Zambia’s higher inflation rate – with CPI rising 13.2% y/y in August and set to go higher still – suggests that further currency gains beyond Q3 may be short lived. Although oil and food prices are expected to recede from current levels, it may be a while before this has a significant impact on Zambian inflation. In line with our outlook for regional southern African inflation, we would only expect the downtrend in Zambian CPI to begin in earnest next year, helped by the higher base, and a more aggressive effort at mopping up domestic liquidity. Until the end of the year at the very least, inflation is expected to continue to rise.

The resurgent USD, rising levels of risk aversion, and pressure on regional currencies such as the ZAR, may also weigh on the ZMK in Q4, which in any case – tends to exhibit seasonal weakness at the end of the year (there have been some exceptions, most strikingly in 2005, but Q4 currency depreciation has been the general trend). However, Zambian fundamentals remain positive overall. The commitment to macroeconomic stability is firm, and we expect that this will be reflected in rising interest rates, eventually adding to the currency’s yield attraction. With resolution of power sector constraints – and Zambia has recently taken important steps to make more of it vast hydroelectric potential – an important limitation on the expansion of copper production in the medium term should be removed. Although copper prices may weaken, reflecting softer industrial demand, Zambia may yet see a doubling of production on the copperbelt, its second in under a decade since 2000. While portfolio investors have reacted to near term perceived political risk, we caution that these fears may be overdone, and longer term, it is Zambia’s positive fundamentals that are likely to be overriding.