The Treasury Bill rate has dropped to nearly 5.3 percent, the lowest ever experienced in Zambia in many years. Just four years ago in 2005, Zambia offered the highest interest rate in the world of over 19 percent and this triggered huge portfolio capital inflows into the country. It was this huge injection of foreign capital that led to a sudden appreciation of the Kwacha from K4, 850 at the time to K2, 900 per US dollar.
The drop in the Treasury bill rate as experienced now has shaken the market. A few weeks ago, the Bank of Zambia warned the rate would continue falling but the market took little attention thinking the projected government deficit as announced by the Minister of Finance and National Planning Dr. Situmbeko Musokotwane would require the government to increase its borrowings.

It was also anticipated at the time donors would not be forthcoming to fulfill their commitments. Now donors have come on board and the copper price is enjoying a high price on the international market. The foreign exchange reserves are now able to cover five months worth of imports, another high record in recent Zambian experience. The bottom-line is that government has enough money and does not need to borrow through the Treasury bills.

The interest rates are so low that they are not attracting foreign portfolio investors, something that has not been experienced in the last many years. This also explains why the exchange rate has still remained high despite a fall in Treasury bill rates. There is another downside to this development:

1. The private sector investors are now experiencing low returns on their investments. Pension funds, commercial banks and other institutional investors who had committed huge amounts of money in the Treasury bill investments are now reported to be considering foreign lucrative markets. Others are already investing in Kenyan and Tanzanian markets where the yields are much more favourable than Zambia. In addition, many investors feel they are unnecessarily penalized for their investments in Treasury bills. They have to pay separate handling charges of 2 percent to commercial banks and the Bank of Zambia respectively, 1 percent medical level and another 15 percent withholding tax. Given the drop in the TB rate, these penalties make investing in Zambia unprofitable.

2. Large companies that were seeking to raise money from Zambia for additional investments in various projects have withheld the initiatives in anticipation of a drop in lending rates. What comes out clear is that the Bank of Zambia has made a deliberate step to drop the interest rates. By cutting down Treasury bill rates, the commercial banks are expected to respond likewise. Unfortunately, the commercial banks are still resisting with some of them reportedly looking to external markets for investments. Companies are also not willing to borrow at the existing rates as there is no fundamental reason for banks to maintain interest rates at high margins when deposit rates have dropped and the inflation rate has equally dropped. This wait-and-see approach by the private sector will have some impact in investments for 2010. It is important for the Bank of Zambia not to simply focus on a policy instrument without investigating further why the banks are resisting dropping the interest rates. Focusing on TB rates alone may just harm market confidence and give the country a result that was not projected and planned.