BANK Of ZAMBIA PRESS RELEASE ON MONETARY POLICY Policy Rate Maintained at 15.5% The Monetary Policy Committee (MPO), at its meeting on 11 February 2016, decided to ‘maintain the Policy Rate at 15.5%. In arriving at this decision the Committee took a number of factors into account not least the effects of the current monetary policy stance, financial system stability, key drivers of observed inflation, and growth of the economy. The Committee noted that although the annual rate of inflation at 21.8% in January 2016 was significantly above single digits, previous measures to tighten ‘monetary policy and address volatility in the foreign exchange market are taking effect. This has contributed to the monthly inflation rates falling back sharply towards levels that are consistent with single digit inflation going forward. The current monetary policy stance is also reflected in liquidity conditions which are expected to remain tight over the first quarter of 2016. The MPC also noted that high food prices and other supply side shocks are playing a significant role in the high levels of inflation. However, these shocks are better addressed through a combination of measures, including structural and fiscal policies. The Bank of Zambia will continue to monitor domestic and external developments and stands ready to take appropriate monetary policy ‘measures to support and entrench macroeconomic stability. Inflation rose sharply over the fourth quarter of 2015 Annual overall inflation increased to 21.1% in December 2015, significantly higher than the 7.7% in September. The higher inflation in the last quarter of 2015 was mainly a result of the pass-through effects from the sharp depreciation in the exchange rate, high food prices, elevated production costs induced by power rationing, and the increase in electricity tariffs. Food prices, particularly for essential commodities, such as, maize, remain significantly above their five year averages. The global economic environment remained challenging Over the fourth quarter of 2015, the global economy was characterized by significant declines in commodity prices, weakening trade, declining capital flows, and volatility in financial markets as equity prices fell. Economic growth in advanced economies 1[Pagewas broadly as forecast, but emerging market economies registered a marked slowdown in growth. Copper and oil prices remained weak and dampened export earnings for many emerging and developing economies. As a result of these global developments, Zambia's current account deteriorated further, as export earnings declined largely due to depressed copper prices. Monetary operations reflected the tightening in monetary policy in November, 2015 Monetary operations were guided by the increase in the Policy Rate to 15.5% in November, from 12.5% previously and restricted commercial banks access to liquidity from the Bank of Zambia through the Overnight Lending Facility (OLF) to once a week. These measures were implemented in order to address rising inflation, dampen exchange rate volatility, and anchor inflation expectations going forward. As a result, the overnight interbank rate was allowed to trade above the Bank of Zambia Policy Rate corridor of +/- 2 percentage points of the Policy Rate, for much of the quarter. ‘The interbank rate also exceeded the Overnight Lending Facility (OLF) rate towards the end of the quarter, largely reflecting tighter monetary conditions. In light of reduced foreign exchange supply, particularly from the mining sector, that paused a risk to the smooth functioning of the market, the Bank of Zambia provided support to the foreign exchange market, amounting to US $294 million. Domestic financial markets characterized by tight liquidity, higher interest rates, low demand for Government securities, slower credit growth, and appreciation of the Kwacha with significantly reduced volatility In the interbank money market, the tight kwacha liquidity raised the traded volumes and the overnight interbank rate. Commercial banks increased their dependence on the Overnight Lending Facility (OLF) and re-discounting of Government secur The demand for Goverment securities fell during the fourth quarter. In the Treasury bill market, subscription rates fell to 32.5% from 87.0% in the third quarter. The subscription rates on Government bonds registered an even sharper fall to 4.0% from 87.0%. The decline in the holdings of Government securities was more pronounced in the banking sector, which reduced its holdings of Government securities by 19.3% to K66 billion in December 2015. However, the demand by other investors remained stable, with the amount of Government securities held by non-banks as a whole, fising by 1.5% to K107 billion at the end of the fourth quarter. However, participation of foreign investors declined due to the sharp rise in inflation and depreciation of the exchange rate of the Kwacha against the major traded currencies. Although the weighted average Treasury bill yield rate fell to 20.7%, the weighted average Government bond yield rate rose to 25.9% from 23.4% at the end of the 21Pagethird quarter. Commercial banks nominal lending and deposit rates also rose, following the increase in the Policy Rate and the removal of caps on lending rates. The average lending rate rose to 23.9% from 20.8%, whilst average savings rates rose only marginally. With the acceleration in inflation, all real interest rates declined sharply. Domestic credit contracted by 5.2% in the fourth quarter to K47,7 billion against an ‘expansion of 13.4% in the third quarter of the year. Foreign currency denominated credit fell by 11.7% to K9.6 billion as firms substituted foreign currency loans for Kwacha loans to mitigate rising currency risks induced by the volatility in the exchange rate. Broad money growth declined to 15% from 26.3% in the third quarter. In the foreign exchange market, the Kwacha stabilised following measures taken to tighten monetary policy, strengthen rules governing operations of the interbank foreign exchange market, and improve transparency regarding interbank and retail exchange rates offered by commercial banks. The Kwacha recovered from a low of K13.70 per US Dollar in September to K10.98 per US Dollar at the end of December, an appreciation of 8.6%, The Kwacha also appreciated against other major partner currencies, with particular gains made against the South African rand (18.7%. Economic activity remained constrained, whilst the current account and fiscal deficits widened further Preliminary data suggest that economic activity remained constrained in the fourth Quarter of 2015. For 2015 as a whole, GOP growth is projected at 3.6% compared to 4.9% recorded in 2014. The decrease in economic activity is mainly attributed to adverse weather conditions which ted to a decline in output in the agriculture sector and power rationing, which affected productivity in key sectors. In addition, the increase in fuel prices and the sharp depreciation in the exchange rate raised Production and transportation costs as well as the cost of inputs in general, External sector developments also contributed to lower growth, The current account deficit deteriorated to US $482.5 million from US $2945 million. Export earings declined by 7.2% to US $1.8 billion, while imports, on the other hand, rose by 0.4%, due to higher petroleum imports with the increased use of petrol and diesel generators as alternative source of power. For the year as a whole, the current account deficit widened to US § 767.7 million from a surplus of 581.2 million, However, the overall balance of payments recorded a surplus of US $ 432.3 million, reflecting the US § 1.25 billion Eurobond issuance. Intemational reserves stood at US $2,976. million at end-December 2015, representing 3.7 months of import cover. 3[PagePreliminary data indicate that the fiscal deficit at 2.9% of GDP, widened marginally in the fourth quarter. This reflected higher expenditures largely on account of the depreciation of the Kwacha against the major currencies relative to the budget projections, as well as higher subsidy payments, particularly in the agriculture and energy sectors. Revenues on the other hand were higher than projected. The implementation of the Treasury Single account is expected to contribute to improved fiscal management and thus support efficient implementation of monetary policy. Macroeconomic Outtook Challenging but Positive ‘The external sector is expected to remain challenging with modest global growth, with low commodity prices. On the domestic front, real GDP growth is projected to improve marginally in 2016, but to strengthen significantly thereafter. The adverse weather conditions and the continuing rationing of power are expected to continue to constrain growth. However, these constraints are projected to ease as additional power is brought on line and the worst effects of El Nifio recede. The Bank of Zambia currently forecasts annual inflation to rise further over the first quarter of 2016, stabilize over the second quarter, and to decelerate sharply from the third quarter onwards. In the first quarter of 2016, inflation is projected to average 21.6%, partly reflecting the persistent inflationary pressures from the fourth quarter ‘of 2015 and high food prices that typically characterize the lean period between October and April. Despite the elevated level of inflation in January, 2015, recent data suggest that changes in monthly inflation will return to average levels seen between January and September 2015, after the second quarter of 2016. The Bank of Zambia will continue to monitor domestic and external developments closely and stands ready to take appropriate monetary policy measures to support price and financial system stability, This is key to macroeconomic stability which is essential for growth and development. The next MPC Meeting will take place in May 2016. Issued by Denny H Kalyalya Governor February 12, 2016 4[Page