EXECUTIVE SUMMARY

GOVERNORS MONTHLY MEETING WITH COMMERCIAL BANKS CHIEF EXECUTIVES

BANK of ZAMBIA

Bank of Zambia Boardroom

JULY 20101.0 INTRODUCTION This report reviews the Bank of Zambias implementation of monetary and supervisory policies and their outcomes during the month of June 2010, as well as real and external sector developments. The report also provides an inflation outlook for August 2010.

2.0MONETARY AND ECONOMIC DEVELOPMENTS IN JUNE 20102.1 MONETARY DEVELOPMENTS The focus of monetary policy in June 2010 continued to be the achievement of the end-year annual inflation target of 8.0%. To achieve this, the Bank of Zambia relied mainly on Open Market Operations and the auctioning of Government securities in order to maintain reserve money within the programmed growth path. This was complimented by prudent fiscal policy management. Consistent with this, overall inflation in June was programmed at 7.7% under the Extended Credit Facility arrangement, while the BoZ projection was 8.2%.

2.1.1 Inflation

During the month under review, the annual overall inflation rate decreased by 1.3 percentage points to 7.8% (May 2010: 9.1%). This was mainly on account of the fall in annual food inflation to 3.8% from the 6.5% recorded in May 2010. However, the annual non-food inflation rate rose to 11.8% (May 2010: 11.6%). Of the total 7.8% annual inflation outturn, food products accounted for 1.9 percentage points while non-food products accounted for 5.9 percentage points. The annual overall inflation outturn was 0.4 percentage points below the BoZ projection of 8.2% for the period.

Monthly food inflation declined to negative 1.6% (May 2010: negative 0.1%), due to the reduction in prices of various food items during the crop marketing period. Lower prices were observed on maize grain, breakfast and roller meal, rice, millet, sorghum, sweet potatoes, groundnuts, cabbage, tomatoes, onions, carrots, green beans, rape, Chinese cabbage, peas, dried beans, fillet steak, mixed-cut beef, T-bone, beef sausages, pork sausages, mutton and dried kapenta (Mpulungu/Siavonga). 2.1.2 Broad Money and Domestic Credit

Preliminary estimates indicate that monthly growth in broad money (M3), comprehensively defined to include foreign currency deposits, increased to 6.7% in June 2010 (May 2010: 2.6%). This outturn was mainly due to a rise in both Net Foreign Assets (NFA) and Net Domestic Assets (NDA). In absolute terms, M3 rose to K16,725.9 billion from K15,682.5 billion in May 2010.

The NFA edged up by 6.8% (May 2010:1.8% rise), contributing 2.6 percentage points to M3 growth. The increase in the NFA was mainly due to the depreciation of the Kwacha against the United States (US) Dollar in the month under review. Similarly, NDA expanded by 6.5% (May 2010: 3.1% rise), contributing 4.0 percentage points to M3 growth in June 2010. The developments in NDA reflected the continued growth in lending to the government with overall credit to the private sector (including public enterprises) contracting by 2.6% in the month under review. Excluding foreign currency deposits which increased by 13.3%, money supply increased by 3.3% to K10,714.1 billion in June 2010 (May 2010: 7.4% increase).

On an annual basis, M3 growth increased to 27.9% compared to a revised figure of 24.4% in May 2010. This performance was mainly due to the increase in NDA, as NFA declined. NDA expanded by 60.9% in the month under review and contributed 29.7 percentage points to M3 growth. On the other hand, NFA declined by 3.4% and contributed negative 1.7 percentage points to the M3 outturn. Excluding foreign currency deposits which increased by 18.6%, money supply increased by 33.8%.

Preliminary data for June 2010 shows that monthly growth in domestic credit, comprehensively defined to include foreign currency loans, was 3.3% (May 2010: 4.4%). In absolute terms, outstanding domestic credit was K13,337.2 billion (May 2010: K12,908.3 billion). The increase in domestic credit was due to the continued expansion in lending to government which grew by 14.2% and contributed 5.0 percentage points to domestic credit outturn in the month under review. On the other hand, credit to the private sector (including public enterprises) fell by 2.6% and contributed negative 1.7 percentage points to the domestic credit outturn in June 2010. Excluding foreign currency denominated credit, domestic credit growth was 1.7% in June 2010 (May 2010: 3.1%).

On an annual basis, domestic credit growth increased to 20.1% in June 2010 (May 2010: 14.9%). The outturn largely reflected the rise in credit to Government by 104.5%, which contributed 23.9 percentage points to annual credit growth. However, lending to the private sector (including public enterprises) declined by 4.9% and contributed negative 3.8 percentage points to annual credit outturn. Excluding foreign currency denominated credit, annual domestic credit growth fell to 26.2% (May 2010: 28.4%).2.1.3 Interest Rates

Commercial Banks Interest Rates

During the month under review, developments in the commercial banks nominal interest rates were mixed. The Weighted Average Lending Base Rate (WALBR) maintained its downward trend, falling marginally to 21.0% (May 2010: 21.3%). The Average Lending Rate (ALR) also fell marginally to 28.0% in June 2010 (May 2010: 28.2%). However, the 30-day deposit rate for amounts exceeding K20 million and the Average Savings Rate (ASR) for amounts above K100, 000 remained unchanged at 5.6% and 4.7%, respectively. Following the decline in inflation in June 2010, the ALR rose to 20.2% (May 2010:19.1%) while the real WALBR rose to 13.2% (May 2010:12.2%). Similarly, the real ASR for amounts above K100,000.00 and the real 30-day deposit rate for amounts above K20 million improved to close at negative 2.2 % (May 2010: negative 3.5%) and negative 3.1% (May 2010: negative 4.4%).

2.2 GOVERNMENT SECURITIES MARKET DEVELOPMENTS

2.2.1 Government Securities Transactions During the month under review, the demand for Treasury bills continued to be strong. Nonetheless, investors rate of subscription for Treasury bills was recorded at 104.3% (May 2010:126.8 %). In contrast, the Government Bond auction was undersubscribed recording a subscription rate of 77.4% (May 2010: 119.3%).

Out of a total of K400 billion worth of Treasury bills on offer, the market submitted bids worth K417.5 billion out of which K323.3 billion were successful. With maturities standing at K386.2 billion, a deficit of K44.6 billion was realized in Treasury bills, thereby decreasing the total bills in circulation by 1.7% to K4,288.6 billion (May 2010: K4,360.4 billion).

A total of K45.5 billion was sold at the monthly bond auction, in line with the tender invitation of K120 billion. With the periods total bond maturities amounting to K53.42 billion, the auction resulted in a deficit of K7.9 billion. Accordingly, total bonds in circulation declined by K96.4 billion to K5,311.5 billion at face value. 2.2.2 Yield Rate Movements

The composite yield rate for Treasury bills gained 68 basis points to close at 6.3%. In contrast, the composite yield rate for Government bonds lost 382 basis points to close at 9.5%.2.3 FOREIGN EXCHANGE MARKET DEVELOPMENTS2.3.1 Exchange Rate Developments

During the month under review, the Kwacha made losses against major trading currencies. The weakness of the Kwacha was due to lower copper prices, global risk aversion emanating from the debt crisis in the euro zone and the resulting broad-based strength of the dollar across the board.

Accordingly, the local currency depreciated by 3.5%, 3.6%, and 2.3% to settle at monthly averages of K5,122.9/$, K7,518.6/ and K664.8/ZAR against the US dollar, pound sterling and rand, respectively. Against the euro, the Kwacha depreciated slightly by 0.004% to close the month at K6,264.2/.

2.3.2 Volume of Transactions The volume of foreign exchange traded in the interbank market during the month of June increased to US$384.6 million (May 2010: US$356.3 million). Commercial banks made net spot sales of foreign exchange from the non-bank public in June of US$25.8 million, compared to net purchases of US$25.7 million in May. Commercial Banks net sales of foreign exchange to bureaux de change increased to US$21.6 million (May 2010: US$14.1 million).2.4 REAL SECTOR DEVELOPMENTS2.4.1Agriculture

Major Millers Maize Stocks The stock of maize grain held by major millers in the country rose by 15.9% to 45,336.7metric tons (mt) as at 29th June 2010 (May 2010: 39,093.2 mt). In terms of holdings by province, Lusaka contributed 26,094.7 mt (57.6%), Copperbelt 13,305.0 mt (29.3%), Southern 5,537.0 mt (12.2%), and Northern 300.0 mt (0.7%), respectively while Eastern province accounted for 100.0 mt (0.2%). Data on maize stocks from Central province was not available on the reporting date. 2.4.2 Mining Preliminary estimates show that copper output increased by 20.8% (May 2010: 3.1% increase) to 71,957.4 mt in June 2010 from the 59,542.8 reported in the previous month. Further, this output was 13.9% higher than the 63,142.0 mt produced in the corresponding month of 2009. On a year-to-date basis, production of finished copper at 377,265.4 mt was 11.2% above the output (339,372.5 mt) for the first half of 2009.

In addition, cobalt output rose by 13.5% (May 2010: 23.1% increase) to 847.4 mt during the month under review from 746.3 mt produced in May 2010. Further, this output was 139.2% higher than the 354.3 mt of output registered in June 2009. On a year-to-date basis, cobalt output rose by 111.5% to 4,160.8 mt from 1,967.6 mt produced during the first six months of 2009. 2.4.3 Manufacturing

During the month under review, production of cement by Lafarge Zambia Plc increased by 5.3% (May 2010:14.9% increase) to 66,641.0 mt from 63,276.0 mt the previous month. This level of output was 19.0% higher than 55,982.0 mt produced in June 2009. Production of milk by Parmalat Zambia Ltd fell by 2.l% (May 2010: 4.5% increase) to 2,504,388.0 litres from 2,557,642.0 litres in May 2010. However, this output was 5.2% higher than the 2,381,029.0 litres of milk produced in June 2009.

Production of clear beer by Zambian Breweries Plc increased by 26.8% in June 2010 (May 2010:11.3% increase) to 70,667.0 hectolitres from 55,749 hectolitres produced in the previous month. Moreover, this output was 50.6% higher than the 46,920 hectolitres produced in June 2009.

The production of soft drinks by Zambian Breweries Plc fell by 11.4% (May 2010:2.3% decrease) to 38,053 hectolitres from 42, 937 hectolitres recorded the previous month. However, this level of output was 59.9% higher than the 23,792 hectolitres recorded in the corresponding month of 2009.

During the month under review, output of opaque beer by National Breweries Plc declined by 2.1% (May 2010:10.4% increase) to 16,471,133.8 litres from 16,816,956 litres produced in May 2010. However, this output was 13.7% higher than the 14,486,812 litres of output recorded in the corresponding month of 2009.

2.5 EXTERNAL SECTOR DEVELOPMENTS2.5.1 International Trade

Preliminary data indicate that Zambias international trade performance during the month of June deteriorated marginally. The overall merchandise trade surplus narrowed to US $51.6 million in June 2010 (May 2010: US $52.0 million). This was on account of a rise in the merchandise imports bill which was higher than the rise in merchandise export earnings.

Merchandise imports grew by 1.5% to US $443.8 million in June 2010 (May 2010: US $437.2 million). The rise in import bills of commodity groups such as petroleum products (17.1%), fertiliser (11.2%), plastic and rubber products (4.6%), and iron and steel and items thereof (2.5%) explained this outturn.

Merchandise export earnings rose by 1.3% to US $495.4 million (May 2010: US $489.2 million). This followed an increase in metal exports, which was moderated by the decline in non-traditional export earnings during the month under review. Metal export earnings grew by 6.1% to US $398.5 million (May 2010: US $375.5 million). The increase was attributed to the rise in copper export earnings which outweighed the decline in cobalt export earnings.

Copper export earnings rose by 7.8% to US $374.1 million (May 2010: US $346.9 million), due to an increase in the export volumes by 14.4% to 60,455.55 metric tonnes (mt) (May 2010: 52,839.75 mt). The realised price of copper, however, declined by 5.8% to US $6,187.71 per ton (US $2.81 per pound) in June (May 2010: US $6,565.33 per ton (US $2.98 per pound)). The decline in the realised price reflected the slide in copper prices on the international market during this period.

During the same period, cobalt export earnings fell by 14.7% to US $24.4 million (May 2010:US $28.9 million), following a decline in both the export volumes and the realised price. Cobalt export volumes declined by 10.3% to 691.50 mt (May 2010: 771.33 mt). Similarly, the realised price of cobalt fell by 5.8% to US $35,263.26 per ton (US $16.00 per pound) (May 2010: US $37,415.26 per ton (US $16.97 per pound).

In the month under review, non-traditional export earnings declined by 14.8% to US $96.9 million (May 2010: US $113.7 million). This was largely explained by a decline in earnings associated with the export of cane sugar, burley tobacco, fresh flowers, cement & lime, fresh fruits and vegetables, electricity, and gemstones. An increase however, was recorded in the export of copper wire, electrical cables, gas and petroleum oils, and wheat and insulin.

On a year-to-date basis, Zambia recorded a merchandise trade surplus of US $632.5 million compared with a deficit of US $111.2 million recorded during the same period in 2009. An increase in merchandise export earnings, which outweighed the rise in the merchandise imports bill, explained this outturn.

During the same period (January to June), merchandise export earnings more than doubled to US $3,198.9 million from US $1,558.0 million recorded over the same period in 2009. This performance largely reflected the rebound in metal export earnings after the global economic crisis. Metal export earnings more than doubled to US $2,624.0 million from US $1,201.8 million recorded over the same period last year. This was largely due to the 77.5% rise in the average realised price of copper to US $6,625.35 per ton from US $3,732.66 per ton. The rise in global demand for metals resulting from the recovery from the global economic and financial crisis, explained this outturn. In addition, increased copper and cobalt export volumes contributed to the rise in metal export earnings.

Copper export volumes grew by 19.4% to 372,390.4 mt (January to June 2010) from 311,933.13 mt recorded over the same period in 2009, while cobalt export volumes more than doubled to 4,018.0 mt from 1,948.50 mt. Increased production arising from increased capacity utilisation at various mines explained this outturn.

Similarly, non-traditional export earnings rose by 61.4% to US $574.8 million (January to June) from US $356.2 million recorded over the same period in 2009. Increased exports of copper wire, cane sugar, cotton lint, burley tobacco, electrical cables, electricity, gasoil, gemstones, maize and wheat explained this outturn. Increased production of these products, coupled with an improvement in international commodity prices, following the recovery of most economies from the global economic crisis, explained this outturn. During the same period (January to June), merchandise imports grew by 53.7% to US $2,566.3 million from US $1,669.2 million recorded during the corresponding period in 2009. This was largely explained by a rise in import bills associated with such commodity groups as petroleum products, fertiliser, chemicals, plastic and rubber products, paper and paper products, iron and steel and items thereof, industrial boilers and equipment, electrical machinery and equipment and vehicles. Imports increased following the recovery of the economy from the impact of the global economic crisis.

2.6 FINANCIAL SECTOR DEVELOPMENTS

2.6.1 Overall Performance of the Banking Sector The overall financial condition of the banking sector in June 2010 was satisfactory. On aggregate, the banking sector was adequately capitalized and the liquidity position, earnings performance and asset quality remained satisfactory.

The banking sectors total assets increased by 4.0% to K20,703.3 billion as at end -June 2010, with the increase largely being funded by total deposit liabilities which went up by 5.8% to K15,394.7 billion. The sectors total assets continued to be dominated by net loans and advances and investments in Government securities at 35.5% and 22.3% respectively, (May 2010: 36.5% and 23.5% , respectively). The total liabilities and shareholders funds continued to be dominated by total deposits at 74.4% (May 2010: 73.1%).

The sectors aggregate capital adequacy ratios remained the same as in May 2010 at 19.6% and 23.1% and were well above the regulatory minimum ratios of 5% and 10%, for primary regulatory capital and total regulatory capital, respectively.

In the month under review, the asset quality of the banking sector was satisfactory, although the gross NPL ratio (a key indicator of the banks asset quality) marginally deteriorated to 15.2% (May 2010:15.0%). On the other hand, the net NPL ratio marginally improved to 3.4% (May 2010: 3.5%). The deterioration in the gross NPL ratio was largely on account of an increase in the gross non performing loans by K31.5 billion (2.5%). Further, the NPL coverage ratio improved to 80.4% (May 2010: 79.4%). The improvement in the net NPL ratio and the NPL coverage ratio was due to a proportionately higher increase in the allowance for loan losses which went up by K38.0 billion (3.9%) to K1,020.2 billion compared to the increase in the gross non-performing loans.

The overall earnings performance of the banking sector for the month under review improved slightly. The sectors total operating income increased by 1.7% to K253.1 billion mainly on account of an increase in un-realized trading gains and other non-interest income compared to the previous month. As a result, the sectors profit before tax increased by 17.0% to K34.5 billion (May 2010: K29.5 billion). However, the sector recorded a loss after tax of K0.6 billion (May 2010: K20.5 billion profit after tax).

The banking sectors overall profitability as measured by the return on assets and return on equity, was at 2.5% and 12.6% (May 2010: 2.5% and 13.2%), respectively.

The banking sectors liquidity position remained satisfactory, with the ratio of liquid assets to total deposits and short-term liabilities and the ratio of liquid assets to total assets increasing to 50.9% and 41.6% (May 2010:49.0% and 39.8%), respectively. 2.6.2 Developments in the Non-Bank Financial Sector2.6.2.1 Overall Performance of the Non-Bank Financial Institutions Sector The overall financial performance and condition of the NBFIs was rated marginal during the month under review. On average, the microfinance institutions and bureaux de change sub-sectors reported adequate capital, fair asset quality and liquidity position while the earnings performance was rated marginal. However, four leasing finance companies, one building society and one credit and savings institution had regulatory capital deficiencies.

2.6.2.2 Financial Sector Development Plan (FSDP) During the month under review, the FSDP Secretariat embarked upon finalising the work plans and budgets for the six working groups, whose Chairpersons and Vice Chairpersons were elected in the previous month. Working Groups are expected to meet monthly commencing June 2010 and the finalisation of work plans sets the ground for activities to commence in earnest under the FSDP Phase II.

2.6.3.2 Update on the Operations of Credit Reference System

Following the meeting that the Credit Reference Bureau Africa Limited (CRBAL) held with chief executive officers of banks and their credit staff on 2 June 2010, CRBAL has reported an improvement in submission of credit reports by the banking sector. The BoZ notes that CRB and BAZ are working together to resolve issues rose during the meeting.

The total number of reports searched by the banking sector increased by 5% to 4,113 (May 2010: 3,904). The total number of searches conducted by the banking sector also increased 353% to 158,822 (May 2010: 35,022). Meanwhile, the number of banks that submitted credit data to CRBAL during the month increased by 5 to 11 (May 2010: 6). The number of banks that searched the CRBAL increased by 2 to 15 (May 2010: 13).

2.7 DEVELOPMENTS IN BANKING, CURRENCY AND PAYMENT SYSTEMS 2.7.1 Performance of the National Payment System The volume and value of transactions processed through ZIPSS increased by 9.8% and 53.8% to 14, 326 (May 2010: 13,051) and K23,790 billion (May 2010: K15,468 billion) respectively. The volume and value of transactions on the four retail payment systems, namely Physical Interbank Clearing (PIC), Direct Debits and Credits Clearing (DDACC), Automated Teller Machines (ATMs) and Points of Sale (PoS), increased by 11.1% and 10.8% to 2,574,776 (May: 2,317,688) and K3,459 billion (May 2010: K3,121 billion) respectively.

The increase in volume and value of both the large value and retail payment streams is attributed to the commencement of the crop marketing season.

3.0INFLATION OUTLOOK FOR AUGUST 2010

Inflationary pressures in the month of August 2010 are expected to ease on account of the availability of carry-over stocks of various food items from the 2009/10 bumper crop harvest. However, this may be partially off-set by pass-through effects of the exchange rate depreciation of the Kwacha against the US dollar.

At the beginning of the year, a monthly inflation path for the year was drawn up, consistent with the end-year inflation target of 8%. Under this original path, the overall inflation projection for August 2010 was 7.6%, with food inflation projected at 3.2% and non-food inflation projected at 12.0%.

The BoZ overall inflation forecast, which indicates the estimated inflation outturn taking into account recent developments in the economy, projects the annual inflation rate for August 2010 at 7.0%.

4.0 ANNOUNCEMENTS AND AREAS OF CONCERN

4.1 Cheque Truncation The Bank is concerned about the little progress being made on the implementation of the Cheque Truncation project, which has taken rather too long. The Bank wish to appeal to BAZ once more to look into this matter and expedite the process.4.2 Handling of Captured Automated Teller Machines Cards (ATMs) The Bank is still waiting for banks to submit a finalised policy on handling of cards captured ATM cards for the consideration of the Bank. The Bank would therefore like to urge banks to conclude this matter urgently.4.3 ATM Transaction Charges

Once again, we want to take this opportunity to reiterate our concern over the issue of charges for cash withdraws on ATMs. For instance some banks have given a limit of K10 million for ATM transactions. To withdraw such an amount customers have to withdrawal 5 times and end up being charged for each withdraw. This is a structural matter which banks should look into as a matter of urgency. The publics outcry on the matter is testimony to that.4.4 Frauds At Atms And Point Of Sale Machines The Bank is keenly following the reported suspicious transactions on some customer accounts involving ATM and Point of Sale machines. The Bank wishes to urge banks to address this matter expeditiously in order to avoid loss of confidence by customers in this important payment method and reversal of gains the country has registered in the payment systems.

Banks should also ensure that they sensitise their customers on how they can protect themselves from falling prey to such fraud. 4.5 PARTICIPATION AT THE ZAMBIA AGRICULTURAL AND COMMERCIAL SHOW

The Bank was gratified with the high level of participation of banks at the just ended Zambia Agricultural and Commercial Show.

We believe that the public benefitted greatly from the information and materials shared in during the show. In particular we commend the initiative by the BAZ on sensitising the public on the issue of the credit reference services.4.6 WORKSHOP ON HOW BANKS DETERMINE LENDING RATES

The workshop on How Banks Determine Lending Rates will take place on August 10, 2010 at the Taj Pamodzi Hotel from 08:30 hours. As announced in the previous meeting, every bank is required to be represented at the Chief Executive Officer level and or Chief Finance Officer level. 4.7 Finscope Zambia 2009

Following the approval of the FinScope 2009 Survey Report by the FSDP Steering Committee, the results were officially launched to the public in Lusaka and Copperbelt (Ndola) on 27 July 2010 and 29 July 2010, respectively.

It is expected that going forward a series of industry-specific dissemination workshops will be held to highlight potential areas of intervention. Stakeholder groups amongst you, who may wish to hold such workshops, should engage the FSDP Secretariat to facilitate.

In a related development, during the Launch, the Hon Minister of Finance and National Planning reiterated Governments appeal for the provision of banking services in rural areas, in particular the provision of house loans to the civil servants to complement Government infrastructure development efforts. GOVERNORS MONTHLY MEETING

WITH CHIEF EXECUTIVE OFFICERS OF

COMMERCIAL BANKS

Figures for broad money and domestic credit are estimated.

This is the ratio of gross non-performing loans to total gross loans.

This is the ratio of net non-performing loans to net loans.

This is the ratio of the allowance for loan losses to gross non-performing loans.

This forecast is based on the Bayesian Vector Autoregressive model, depicting the exchange rate, money supply, fuel price and maize price as the variables that have the key information on the inflationary process. In addition, past trend analysis and judgment is an integral part of the forecast.

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