BANK Of ZAMBIA PRESS RELEASE ON MONETARY POLICY Policy Rate Maintained at 15.5% The Monetary Policy Committee (MPC), at its meeting on 11 and 12 May 2016, decided (o maintain the Policy Rate at 15.5%. The Committee noted that inflationary pressures appear to have peaked over the first quarter of the year with annual inflation ending the quarter at 22.2% and monthly inflation at 0.5% in March 2016. Further, in April annual and monthly inflation declined 10 21.8% and 0.3%, respectively. The slowdown in the inflation rate reflects mainly the relative stability in the exchange rate, which partially offset the effect of high production costs induced by power rationing, decline in the supply of some food items and the hike in taxes and customs duty on some non-food items. The Bank of Zambia forecasts annual inflation to decelerate in the remaining quarters of 2016, with a sharp decline in the fourth quarter of 2016 toward single digit levels. This is a significant improvement in the inflation outlook compared to the February MPC projection. The Committee noted that economic activity remained constrained, but the Government fiscal oulturn showed some improvement and the current account deficit narrowed. Domestic financial markets continue to be characterized by tight liquidity, higher imerest rates, low demand for Government securities and slow credit growth over the first quarter. However, liquidity conditions have eased somewhat in April and May, with an improvement in subscription rates on Government securities. As the Bank transitions to the new monetary policy framework, with a greater reliance on price signals, it has continued to rely on some quantitative measures to address extreme volatility in the foreign exchange market. The inlerbank rate may, therefore, be allowed 10 move outside the Policy Rate corridor reflecting these exceptional circumstances and adjustment back into the corridor is likely to be gradual. The Commitice looks to the consolidation of positive developments in inflation and fiscal adjustment as key triggers 10 considering adjustments to the Policy Rate going forward. Inflation rose moderately in the first quarter of 2016 Annual overall inflation increased moderately in the first quarter of 2016 to 22.2% in March 2016 from 21.1% in December 2015. The moderate increase in the inflation rate reflected mainly the observed relative stability in the exchange rate, which partially offset the effets of higher production costs induced by power rationing, lower supply of some food items, and the January 2016 increase in the taxes and customs duty on cigarettes and selected motor vehicles. Food inflation, although slowing, has kept overall inflation elevated, with food prices remaining above five year averages on account of adverse weather conditions that led toa significant reduction in regional supply and an increase in export demand for maize grain and maize products, The Committee also noted that in April 2016, there was a slowdown in annual inflation to 21.8%. On a month-on-month basis, the Committee noted that the inflation rate had fallen from 6.2% in October 2015 to 0.5% in March 2016 and declined further to 1[Page0.3% in April 2016. Sustaining the current trend in monthly inflation will assure the achievement of single digit inflation by the fourth quarter of 2016. The global economic environment remained challenging Over the first quarter of 2016, global economic growth remained generally subdued as the downside risks that limited growth in 2015 persisted, Uncertainty surrounding the sustainability of economic recovery in the Euro area and Japan, coupled with slowing growth in the United States, added further pressure to the global economy. Gross domestic product, ‘growth in China slowed down due to weaker investment growth as the economy continues to shift away from manufacturing to consumption. The slowdown in the Chinese economy has. reduced commodity prices, dampening export earnings for emerging and developing economies, including Zambia, that are dependent on commodity exports. Despite low copper prices, Zambia's current account deficit narrowed as the decline in imports outweighed the fall in exports, attributed mainly to the lagged effect of the exchange rate depreciation in the last half of 2015 Monetary conditions reflected the tight monetary policy stance taken since November 2015 As indicated in the February 2016 MPC Statement, the Bank of Zambia maintained a tight, monetary policy stance in the first quarter of 2016. The Policy Rate and the Overnight Lending Facility rate were kept at 15.5% and 25.5%, respectively. Access to the Oven Lending Facility window remained restricted to once a week and the statutory reserve ratio fon bank deposits was maintained at 18%, to help stem growth in Kwacha liquidity. As a result, the interbank rate rose to 26.9% at the end of March 2016, and remained above the upper bound of the Policy Rate corridor and the Overnight Lending Facility rate of 25.5%. The Bank did not deliberately undertake expansionary open market operations to bring the interbank rate down. This was in order to help contain the persistent and rapid depreciation of the Kwacha with its consequential adverse impact on inflation. The Kwacha depreciated by a modest 1.4% to K11.14 against the US dollar at end-March 2016. As the Bank transitions to the new monetary policy framework with a greater reliance on Price signals, it continued to rely on some quantitative measures to address the extreme volatility in the foreign exchange market, Accordingly, in the face of extreme volatility, the interbank rate was allowed to stay outside the Policy Rate corridor. Adjustments back into the corridor will depend on how quickly observed threats to inflation recede. Domestic financial markets characterised by tight liquidity, higher interest rates, low demand for Government securities, and slower credit growth Trading in the interbank market increased by 27.2% to K33.6 billion, reflecting mainly the concentration of liquidity in a few banks. Most banks continued to face constrained liquidity conditions despite a slight increase in the current account balance to K14 billion from K1.1 billion in the previous quarter. Net Government securities maturities accounted for the increase in the current account balance. Reliance on the Overnight Lending Facility and re- discount of Treasury bills reduced significantly as liquidity positions of banks improved. Participation of more non-bank financial institutions led to an increase in the subscription rate for Government securities during the first quarter. In the Treasury bills market, the 2|Pagesubscription rate rose to 58.1% from 32.5%. The subscription rate on Government bonds registered an even sharper increase to 38.1% from 4.0%. The outstanding stock of Treasury bills and bonds however, fell by 10.5% and 0.7% to K9.0 billion and K10.1 billion, respectively as maturities exceeded offers, enabling the Government to pay down part of its domestic debt. Participation of foreign investors, however, declined further. The decline was due to, among other things, risk aversion towards emerging and developing economies. Yield rates on Government securities increased further amidst relatively tight liquidity conditions. The weighted average Treasury bill yield rate rose to 27.4% from 20.7%, while the weighted average Government bond yield rate increased to 27.5% from 25.9%. Commercial banks’ nominal lending and savings rates generally rose. For instance, the average lending rate increased to 27.0% from 23.9% while the savings rate for amounts above K20,000.00 rose to 12.9% from 10.8%. The increase in interest rates is mainly in response to the rise in funding costs and inflation. With the moderation in inflation, all real interest rates picked up. After declining by 5.3% in the previous quarter, credit contracted by a further 3.8% to K45.8 billion in the first quarter of 2016. This was driven mainly by tight liquidity conditions, high funding costs, increased collateral requirements, and reduced risk appetite by banks. Broad money also contracted by 4.9% to K44.9 billion due to a decline in the net foreign assets of the Bank of Zam| Economic activity remained constrained, fiscal performance improved, and the current account deficit narrowed Preliminary data indicate that domestic economic activity remained subdued mostly due to a variety of factors including continued electricity shortages, cost and availability of credit, increase in the cost of production attributed to the higher cost of imported raw materials, and increased labour costs as employees worked outside regular hours to make up for lost production occasioned by load-shedding schedules. On the other hand, the current account deficit narrowed to US $168.6 million from US $482.5 million, as imports fell sharply relative to the contraction in exports. Imports fell by 23.0% to US $1.7 billion while exports declined by 10.5% to US $1.6 billion. The fall in imports is attributed to seasonal fluctuations in fertilizer requirements as well as the lagged effect of the depreciation of the exchange rate of the Kwacha against the US dollar. The drop in copper volumes and constrained domestic production largely accounted for the decline in export ‘earnings. The current account deficit was financed by the surplus on the financial account and the drawdown of foreign exchange reserves to US$2.6 billion at end-March 2016, largely to service external debt and pay for oil imports. This level of reserves represents 4.0 months of import cover compared to 3.7 months at end-December 2015. The higher import cover reflects a decline in imports in 2016. Preliminary data indicate that over the first quarter of 2016, Government registered a small fiscal surplus. The surplus was utilised on domestic and external debt amortisation. Macroeconomic outlook remains challenging in the short-term, but is more positive over the medium-term 3|PageThe extemal sector is expected to remain challenging with modest global growth and relatively low commodity prices in 2016. On the domestic front, real GDP growth is projected to improve marginally in 2016, but to strengthen significantly thereafter. ‘The continuing rationing of power is expected to ease as additional power is brought on line and the effects of El Nifio recede. The Bank of Zambia forecasts annual inflation to decelerate in the remaining quarters of 2016, with a sharp decline in the fourth quarter. This is a significant improvement in the inflation outlook compared (o the February MPC projection. In the second quarter of 2016, inflation is projected to average 20.3%, partly reflecting improved supply of food during the harvest season and relative stability in the exchange rate. The 9.7% forecast increase in maize output for the 2015/16 production season, announced in the recent crop forecast survey results, should assist in moderating food inflation. Inflation is projected to average 17.7% the third quarter and to decline further to an average of 8.7% in the last quarter. Underlying this inflation projection are relative stability in the exchange rate and expected fiscal consolidation. In addition, the Monetary Policy Committee noted, from survey data on business opinions and expectations, that businesses are expecting lower inflation over the second quarter of the year and increased investments a year from now. Survey data on credit conditions also indicate that credit constraints are expected to ease somewhat. 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. Price and financial system stability are key to macroeconomic stability, which is essential for economic growth and development. The next MPC Meeting will take place in August 2016 Issued by A Denny H Kalyalya Governor May 17, 2016 4|Page