Forex Market Watch: Is The New Zambian Kwacha A Stronger Currency?

The rebased K2 which had been the K2000

  

I have to start by applauding Zambian economists, newspaper columnists and other related publicity showmen in their sovereign nation for never using the term "Revaluation" to describe the structural transition that the Zambian currency (Kwacha and Ngwee) went through for there is a huge difference between Revaluation and Rebasing/Redenomination/Recalibration of a currency.

 

• Currency Revaluation  - this is a deliberate upward adjustment in the official exchange rate established or pegged by government against a specified standard such as another currency or gold.

• Currency Rebasing           - involves dividing a currency unit by a set or proposed denominator. In this case the Zambian currency was rebased by dividing the banknotes by a 1000 denominator hence removing the three zeroes from the old K50000, K20000, K10000, K5000 and K1000.

The purpose of this article is to clearly explain the macro-economic effect of rebasing the Kwacha that became effective on 1 Jan 2013 which saw the slashing off of three zeros from their currency resulting in the issue of new notes. 

All price lists are quoted in both the old and the rebased figure

The extensive research I did on the subject matter shows that the main dilemma that people continue to face with these new bank notes is getting to understand what effect it had on the foreign currency exchange rate. For example if 5000 Kwacha (K) was needed to buy 1 Namibian Dollar (N$) before rebasing i.e exchange rate (K5000 : N$1)  and after the zeroes on the Kwacha were removed it became K5 : N$1 does this mean that the Kwacha has strengthened against the Namibian Dollar? It might seem so based on the reasoning that you now need fewer kwacha to purchase the same Namibian dollar. However this is not the case as I shall clearly explain the how and why in the simplest economic terms that every Harry, Dick & Tom can understand thereby delivering people from this popular misconception.

How the Kwacha is NOT worth more on the Forex market

Although money markets and forex traders such as banks always quote the exchange rates, they usually only quote one type of an exchange rate called the 'nominal exchange rate' which is the same as the one given in the above example. There are actually two types of exchange rates

1. Nominal Exchange Rate
2. Real Exchange Rate

 Nominal Exchange Rate

 This is simply the price of one currency in terms of the number of units of some other currency. This is determined by fiat (a formal or official authorization of a policy or sanction by government which is often arbitrary) in a fixed rate regime and by the market forces of demand and supply in a floating rate regime like the one prevailing in Zambia currently. 

Example

Take for instance the first hypothetical situation where the Kwacha to Namibia Dollar had been  

K5000 : N$1

When rebasing of the Kwacha took place, this forex rate would have changed to 

 K5 : N$1

 Let us imagine that you live in Zambia and you earn your salary in the local currency Kwacha. You then decide to buy a car that is being sold in Namibia at a price of N$1. Before rebasing, inorder to buy that car, you needed K5000 inorder to buy the sufficient Nam dollars (i.e N$1)  so that you can import your car. Now after rebasing you now need just a seemingly little K5 to buy the N$1 on the forex market so as to buy your Nam car.   

This is the reasoning that some people have adopted as justification of their claim that the Kwacha would have strengthened against the Namibian Dollar. 

When rebasing occurs, the only exchange rate that can verily determine the true exchange rate is the Real Exchange Rate. The Central Bank of Zambia is more concerned about this one than the nominal exchange rate. If this exchange rate reduces as a result of the rebasing then we can safely conclude that the Kwacha has grown stronger. But will it increase or decrease? Or even, will it change? Let us find out next.

Real Exchange Rate

This is an extension on the nominal exchange rate that takes into account the inflation differentials among the countries into account. In other words it takes into account the what money can overally buy in what economists call the purchasing power parity. Therefore inorder to calculate the Real Exchange Rate you need to collect information on the average price of goods in the two countries based on indicators such as the Consumer price Index (CPI) or the Gross Domestic Product Deflator (Calculation of these two does not fall within the scope of this article). Now suppose:

Average price of goods in Nam is N$17.5 

Average price of goods in Zambia is K65800

 Real Exchange Rate is determined by the formula:

RER  =  eP*

              P

 Where  RER   - the Real Exchange Rate

              e         - the nominal Kwacha to Nad exchange rate

              P*      -  Average prices of goods in Namibia

              P        -  Average prices of goods in Zambia

We are now going to calculate the RER before and after rebasing. Keep in mind that if the RER drops it means the Kwacha has improved in its value. If it increases, then it obviously points to the fact that the Kwacha has depreciated in value. If it remains unchanged then it signifies to us that there is no effect of rebasing on the exchange rate. Let us calculate given that 

  

 Before Rebasing

e    = 5000   

P* = 17.5  

P   = 65800     

 RER = 5000 x 17.5

                                                         65800

    =  87500

        65800

                                                  

                                                  = 1.33 (to two decimal places)

After Rebasing 

 e   = 5

P* = 17.5

P   = 65.8 

 

RER = 5 x 17.5

           65.8

  = 87.5

      65.8

= 1.33

Just from merely looking at the figures, we already have our answer. As you can see from the calculation, the Real Exchange Rate has not changed in response to the rebasing. It just kept at a constant 1.33. Therefore, its now safe to say:

 The Kwacha has NOT increased in value

Concluding Remarks 

In a publication on a website called 'Better Zambia' posted by a writer from the University of Zambia writing under the nom-de-plum 'Unza Narep' the writer makes ridiculous claims of how the transition was actually a 'Revaluation' of the Kwacha and that Zambian imports have become cheaper using the reasoning from his own analysis of the Nominal Exchange Rate rather than the Real Exchange Rate. He quoted an example that in our case of you buying the car from Namibia, the car would be K4995 cheaper!! Of course after reading this article you now understand that this is serious misinformation. 

So dear reader, next time you hear anyone talk like this again, pull them away from the crowd to avoid shaming them & tell them what you have learnt today. Tell them of the Real Exchange Rate and its unresponsiveness to currency rebasing. Until then..take care.

M'kos 2013