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Issues on the Zambian Economy Issues On The Zambian Economy Bank of Zambia THE BOZ READER, VOL.01, NO. 02 Issues On The Zambian Economy 2004 Bank Of Zambia THE BOZ READER, VOL.01, NO. 02 EDITORIAL COMMITTEE Richard K. Chembe, Economics Department, Bank of Zambia Patrick C. Mulenga, Economics Department, Bank of Zambia Mulenga J. J. Musepa, Economics Department, Bank of Zambia Ivan Zyuulu, Economics Department, Bank of Zambia Wilson Kaputula, Economics Department, Bank of Zambia Jonathan Chipili, Financial Markets Department, Bank of Zambia Anthony Musonda, Financial Markets Department, Bank of Zambia Chisala Kauta, Economics Department, Bank of Zambia Published by the Bank of Zambia Bank Square Cairo Road P.O. Box 30080 Lusaka Zambia http://www.boz.zm ISBN: 9982 - 870 - 00-9 Printed by Mission Press, Ndola - Zambia First Printed in August 2003 Copyright © 2003 Bank of Zambia All rights reserved. No part of this publication may be reproduced, stored in a retrieval system, or transmitted, in any form or by any means, electronic, mechanical, photocopying, recording, or otherwise, without the prior permission of the Bank of Zambia. CONTENTS PAGE Foreword i Macro-Prudential Analysis:Lessons for Zambia 1 Dynamic Model of Inflation Determination in Zambia 10 Relationship between Bank of Zambia (BoZ) Dealing and Commercial Banks Exchange Rates during the Auction Period 27 Fuzzy Analysis of the Zambian Consumer Price Index (CPI) 42 Learning and the Failure to Learn in Development Cooperation 52 Choice of Exchange Rate Regime: Has The Zambian Economy Performed Better Under a Floating Exchange Rate Regime? 72 Asymmetric Effects of Monetary Policy in Zambia: A Structural VAR Analysis 83 Effect of Stabilisation Policies on Macroeconomic Performance in Zambia 93 Foreword This is the second issue of the Bank of Zambia Reader Issues on the Zambian Economy, a publication aimed at providing national and international readership with analyses by economists and other social scientists in government, business, international agencies, academia and other research institutions. In addition, the Reader continues to contribute towards the creation of economic literature and exchange of views on theoretical, policy and practical issues on the Zambian economy. This issue has articles covering several topical subjects of current debate in the economy including: Macro-Prudential Analysis; Dynamic Model of Inflation Determination in Zambia; Relationship between Bank of Zambia (BoZ) Dealing and Commercial Banks Exchange Rates during the Auction Period; Fuzzy Analysis of the Zambian Consumer Price Index (CPI); and Learning and the Failure to Learn in Development Cooperation. Other topics are Choice of Exchange Rate Regime: and Asymmetric Effects of Monetary Policy in Zambia: A Structural VAR Analysis. We wish to thank the contributors of these articles to the Reader and hope that this will encourage other economists and social scientists to put their ideas to paper as part of their contribution to the wealth of ideas and literature on the Zambian economy through this publication. In addition, we wish to take this opportune time to invite comments or brief notes on the articles in this Reader. Further, articles are invited from researchers and writers on various topics that are relevant to the Zambian economy. In this regard, all correspondence should be channelled to the Director, Economics Department, Bank of Zambia, P. O. Box, 30080, Lusaka Zambia. Comments and articles can also be sent via e-mail to [email protected]. The views and interpretations expressed in this reader are those of the authors and do not necessarily represent the views and policies of the Bank of Zambia. All errors and omissions are entirely due to the author. Caleb M. Fundanga Governor Bank of Zambia December 2004 CHAPTER 1 Macro-Prudential Analysis: Lessons for Zambia Mwiza Mbewe1 Abstract Macro-prudential analysis is a relatively new area in financial system supervision. The paper presents a synopsis of the main attributes of the area, noting that one of its main features is that it adds an element of dynamism to the existing framework of supervision. Based on these factors several lessons have been drawn which should have a bearing on establishing the macro-prudential analytical framework in Zambia. In conclusion, it is noted that being a new area, there is still a lot of work that needs to be done in order to have an adequate analytical framework in place. 1. Introduction In the late 1990s, the world witnessed a series of financial crises; namely, the Mexican crisis of 1995, the Asian crisis of 1997 and the Russian crisis of 1998 (Davis, 1999). Notable traits of the crises were banking failures and currency depreciations in the affected countries. According to studies undertaken, a banking crisis can impose costs of 14% to 15% of gross domestic product (GDP) while the recovery process can take as long as 3 to 5 years (Davis, 1999). A banking crisis can also blunt the effectiveness of monetary and fiscal policies while, output and growth opportunities are foregone during the process (Borio, 2003). The literature identifies three categories of triggers which have often coincided at the beginning of a financial crisis. These are a worsening of the ability to repay loans which effectively lessens the capacity of the banking profession as regards credit risk management; a rise in real interest rates which induces most solvent borrowers to leave the market; and volatility in the asset market which reduces the protection enjoyed by banks against credit risk (Timmermans, 2001). Evidently, the triggers were such that they applied on a broad or macro basis and thus could not be said to distinctly apply to single financial institutions. Arising from this perspective and taking into account the importance of financial stability to macroeconomic performance, a relatively new element of financial system supervision has emerged. This element has been designated 'macro-prudential analysis'. In addressing the issues related to macro-prudential analysis, the paper is organised as follows: the next section presents an outline of the main attributes of macro-prudential analysis; the third section discusses the analytical methodologies utilised under macro- prudential analysis while the fourth section provides the lessons for the Zambian financial system. The fifth section concludes the paper. DISCLAIMER: The author is an Inspector in the Bank Supervision Department of the Bank of Zambia. The views expressed are those of the author and not necessarily those of the Department or the Bank of Zambia. The author thanks the Working Paper Discussion Forum of the Bank of Zambia and Herbert Poenisch for critical and useful comments. 1 2 THE BOZ READER-ISSUES ON THE ZAMBIAN ECONOMY 2. Main Attributes of Macro-Prudential Analysis According to Sundararajan et al (2002), macro-prudential analysis is 'the assessment and monitoring of the strengths and vulnerabilities of financial systems. This encompasses quantitative information from both financial soundness indicators and indicators that provide a broader picture of economic and financial circumstances, such as GDP growth and inflation, along with information on the structure of the financial system, qualitative information on the institutional and regulatory framework particularly through assessments of compliance with international financial sector standards and codes, and the outcome of stress tests.' Meanwhile, financial soundness indicators (FSIs), which supervisory authorities have long utilised, are defined as 'indicators compiled to monitor the health and soundness of financial institutions and markets, and of their corporate and household counterparts. FSIs include both aggregated information on financial institutions and indicators that are representative of markets in which financial institutions operate.' After substantial research and discussion with practitioners and academics, the International Monetary Fund (IMF) produced two sets of FSIs which are considered to be useful for the purpose of periodic monitoring, compilation and dissemination efforts by national authorities. The FSIs consist of a core set which basically relates to the deposit- taking industry through the utilisation of the CAMELS2 analytical framework and an encouraged set for additional deposit-taking indicators as well as data on other institutions and markets that are relevant in assessing financial stability the corporate sector, real estate markets and non-bank financial institutions (NBFIs) and the related markets. In identifying the core set of the FSIs, the IMF used six determinant criteria: focus on core markets and institutions; analytical significance; revealed usefulness; relevance in most circumstances (that is, not country specific); availability; and parsimony (that is, achieving the maximum information content with a limited number of FSIs). A notable feature that emanates from utilizing the two sets of FSIs - that is, the core set and the encouraged set - is that a one-size-fits-all approach is avoided. This provides a degree of flexibility in the selection of the indicators that are deemed to be most relevant to assessing vulnerabilities in country-specific circumstances. 2 capital adequacy, asset quality, management soundness, earnings and profitability, liquidity and sensitivity to market risk MACRO-PRUDENTIAL ANALYSIS: LESSONS FOR ZAMBIA 3 Box 1: CORE AND ENCOURAGED SET OF FSIS. Deposit-Taking Institutions Core Set Capital Adequacy Regulatory capital to risk weightedassets Regulatory Tier
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