Copper prices are headed for the longest slump in 20 years, on signs of weakening demand after manufacturing slowed in China and the U.S., the world's top metals consumers. The metal for delivery in three months on the London Metal Exchange slid as much as 0.3 percent to $7,000 a metric ton, the lowest intraday level since Dec. 4. Prices have lost 4.3 percent in this run of declines. (Source: Businessweek)
Factories in the U.S. expanded in January at the weakest pace in eight months, and a measure of orders declined by the most since December 1980, data from the Institute for Supply Management showed yesterday. In China, a purchasing managers' index fell to a six-month low last month as orders slowed.
Copper in London has slumped 15 percent in the past 12 months, partly as economic growth eased in China. Global supply will exceed demand by 385,000 tons this year, after a 45,000 ton surplus in 2013, and prices will "grind lower". About $2.9 trillion has been erased from the value of global equities this year as China's economy slowed and the Federal Reserve further cut stimulus on Jan. 29.
What does this all mean for Zambia? That depends on how long the slump lasts and where the prices might finally end up. Chile and other produces are pricing much lower copper prices. If they correct it should concern all of us because our economy suffers from lack of diversification and therefore not well positioned to withstand external shocks.
A significant slowdown in copper prices may affect us all in at least six ways. First, lower copper revenues means further depreciation of the Kwacha. Given the political pressure to keep the Kwacha reasonably stronger we are likely to see further erosion of foreign reserves. The Kwacha is currently falling, at the last check it stood at K5.6 per $1. Expect it to go further and the reserves to deplete along the way introducing other risks.
Secondly, further depreciation despite its benefit in improving competitiveness in some sectors carries significant inflationary risks. Zambia is currently experiencing its first trade deficit since 2009. It is very vulnerable to exchange rate movements as consumption of foreign goods increasingly continue to take a larger share of food basket. This will mean more costs to individuals on the poverty line.
Thirdly, at the firm level, the short term impact of weaker Kwacha is higher cost of imports for production! The elasticity of imports becomes crucial here, but needless to say, oil is a critical input for mining production costs, and a weak exchange rate, means higher domestic production costs for other sectors not least general transportation. This effector means the cost of doing business will rise.
Fourthly, higher government costs. A weaker Kwacha means GRZ debt repayments become dearer. And of course if it comes with further credit downgrades going forward the cost of repayments may be even higher. In general the cost of doing government business will become more expensive. Consider that GRZ funds it's embassies in foreign currencies and then there's all the many foreign travels, and other costs.
Fifthly, lower government revenues. The reduction in copper revenues will mean lower than forecast mining taxation revenues. This is a problem in terms of fiscal policy because it yet again means government will continue borrowing more abroad and at home than suggested. That again may point further to credit down grade from credit agencies as the deficit worsens. We already knew that Zambia's fiscal deficit is likely to get worse before it gets better. This may amplify that! And of course private sector credit may also further be crowded out from higher domestic borrowing, increasing private sector interest rates.
Finally, unemployment pressures may increase. The reduction in copper prices are unlikely to lead to immediate job losses, but it will put further pressure on some mining houses facing high energy and wage costs (e.g KCM). It is also possible that it will make new investments in less likely until prices re-adjust to a much higher medium to long term equilibrium. It largely depends on how severe the slump becomes.
These impacts are not set in stone. These are just potential risks and much depend on how worse the slump becomes and how those in government respond. The challenge for Zambia of course is that the economic folly of increasing wages and misguided foreign borrowing spree has already robbed us of much needed fiscal space to respond to any external shocks.
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Chola Mukanga | Economist | Writer
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