By BERNADETTE DEKA-ZULU (PhD Researcher-Public Enterprise)
DURING one of my post graduate studies in Economic Policy Management at the University of Zambia, I remember extensively delving in discussions around dynamics of the Bank of Zambia’s open market operations both in Public Sector Economics and Monetary Economics; the Statutory Reserve and its implications on the financial system and economic growth at large.
This bring us to the prevailing macro-economic fundamentals that is seeing Zambia witnessing a continuous depreciation of the Kwacha against major international currencies, especially the dollar which is heading towards K20.00 (per dollar).
Of the many key messages given by the current government to the general public, was the appreciation of the Kwacha, and that it was of top priority, hence, the general populace raising concerns on the current exchange rates.
Depreciation of Kwacha and the Economy
The depreciation of a currency may have positive or negatives effects depending on the developmental level of a particular country. The positive side of depreciation is that in an industrialised government, when a currency depreciates the price of imports increases and exports increase in value.
What this does is that most people would instead outsource locally the goods they would need, on the other hand, exports’ increase in value acts as an incentive to export more goods therefore the country gains from export income and intuitively value of the currency rises.
The negative effects come into play when the currency of a developing country like Zambia that has a less industrialised economy depreciates. In a less industrialised economy, when a currency depreciates since the economy is not industrialised the demand of certain goods remains intact and therefore only the prices rise causing a problem of inflation.
The depreciation of the Kwacha has had a significant impact on the country’s economy. The sharp devaluation of the currency has made imports more expensive, which has put pressure on the cost of living, particularly for the country’s most vulnerable citizens.
The devaluation of the Kwacha has also led to higher inflation, making it more difficult for businesses to raise prices and remain competitive.
A continued depreciation will weaken the domestic currency, making it harder for Zambians to buy imported goods and services. This has resulted in a decrease in consumer demand and a further decrease in economic activity.
What Government is doing about currency Depreciation? (BoZ statutory Reserve)
The Bank of Zambia runs to promote the financial and economic stability of the country. Economic scholar’s world over have highlighted that the guiding principle of the central bank is that it should act only in the public interest and for the welfare of the country and its citizens without regard to profit as a primary consideration.
Amongst many functions, the central bank manages the exchange rate and is responsible for maintaining the exchange value of the Kwacha.
The Bank of Zambia recently increased the minimum statutory reserve ratio by 2.5 percentage points to 11.5 percent from the current 9.0 percent, which is meant to address the increased volatility in the exchange rate and safeguard the stability of the foreign exchange market.
What is a Statutory Reserve?
A statutory reserve is a type of bank reserve that is required by a central bank, such as the Bank of Zambia. It is a minimum amount of money that commercial banks must keep in reserve to ensure that they have enough liquidity to meet their obligations.
Statutory reserves are part of the central bank’s monetary policy and can be used to influence the money supply in the economy.
The Bank of Zambia sets minimum statutory reserve requirements for commercial banks operating in the country, and these requirements can be changed according to the economic needs of the country and the performance of the banking sector.
The statutory reserve of a central bank can have a significant impact on the exchange rate of a currency. When a central bank increases its statutory reserve, the amount of money available for lending decreases, leading to a decrease in the money supply and a decrease in demand for the currency.
This decrease in demand will cause the currency to weaken against other currencies, leading to a decrease in the exchange rate. Conversely, when a central bank decreases its statutory reserve, more money is available for lending, increasing the money supply and increasing demand for the currency.
This increased demand will cause the currency to strengthen against other currencies, leading to an increase in the exchange rate.
Effects of an increased statutory reserve (lending rates and saving interest rates)
An increased statutory reserve has a variety of effects on the banking system and the economy as a whole. From the perspective of the banks, an increase in the statutory reserve means that they must hold a larger portion of their deposits as reserves.
This reduces the amount of money that banks can lend out and can make it more difficult for businesses to secure loans. It also reduces the amount of money that banks can use to invest in stocks and bonds, which can have a negative effect on the overall performance of the financial markets.
From the perspective of the economy, an increase in the statutory reserve can lead to a decrease in the money supply. This can lead to an increase in interest rates, which can make it more expensive for businesses and individuals to borrow money.
It can also lead to a decrease in consumer spending, which can have a negative impact on economic growth. Overall, an increase in the statutory reserve can have a range of effects on the banking system and the economy as a whole.
It can lead to a decrease in the money supply, higher interest rates, and reduced consumer spending, all of which can have a negative impact on economic growth.
Lending rates and savings interest rates
An increase in the statutory reserve rate will have a direct and significant effect on interest rates. When banks are required to set aside more of their deposits as reserves, they have less capital available to lend out to borrowers.
This leads to a decrease in the supply of capital and an increase in the cost of borrowing. As a result, interest rates will rise to reflect the increased cost of obtaining capital. Higher interest rates will incentivise savings, as people can earn a higher return on their deposits.
This, in turn, will increase the amount of capital available for lending, leading to a decrease in interest rates over time.
Impact on money supply
An increase in statutory reserve requirements will lead to a decrease in the money supply. Since the cost of borrowing has increased, less people will want to get loans at the same time an increase in the interest rates will encourage more to save. This will lead to less money in circulation.
Money supply and economic growth
A decrease in the money supply can have a significant impact on economic growth. When the money supply decreases, it reduces the amount of money available to people and businesses, making it more difficult for them to borrow, spend, and invest.
This can lead to a decrease in consumer spending and investment, which can have a significant negative effect on economic growth. Lower consumer spending and investment can lead to lower productivity, lower wages, and slower economic growth.
Additionally, a decrease in the money supply can lead to higher interest rates, which can further reduce consumer spending, reduce investment, and decrease economic growth.
How does the common citizen positively benefit from this?
An increased statutory reserve imposed by the Bank of Zambia may help protect the financial system by decreasing the amount of money available for lending and investment, as this helps to keep inflation low, which helps to keep the cost of living lower.
It also helps to ensure a healthy financial system, which can help to protect banks from large losses.
The increased statutory reserve imposed by the Bank of Zambia would also mean that banks would have less money available to lend out to individuals, businesses, and other organisations.
This could result in higher borrowing costs, making it more difficult for the common Zambian to access credit, or to borrow money for investments or other needs.
It could also mean that banks would be less likely to approve loan applications, further restricting access to credit. This could lead to less economic activity and slower economic growth, which could have negative impacts on the economy in general.
The increased statutory reserve has a direct and negative impact on a common citizen, as it reduces the availability of credit, increases the cost of borrowing, and limits their access to capital.
This, in turn, can impede economic growth and development, and make it difficult for individuals to access the resources they need to start or grow a business.
As a result, the increased statutory reserve has a negative impact on the Zambian population, and can make it difficult for them to achieve financial stability and prosperity.
Nevertheless, amid the dynamics discussed, we remain hopeful that the recent steps undertaken by the central bank will foster a positive outcome to the economy, in the long run. What are your thoughts? bernadettedekazulu@gmail.com
