Copper Price and Exchange Rate Dynamics in Zambia

The kwacha/US$ exchange rate has fluctuated widely post-liberalization period, with large changes attributed to the copper price booms and bursts due to the significant contribution of copper to the Zambian economy. Copper mining is the major source of foreign exchange, contributing over 70% of total export earnings. Largely commodity-dependent economies are, however, vulnerable to commodity price fluctuations as principal commodity exports have a significant bearing on the overall performance of the economy. Thus, the copper price-kwacha/US$ exchange rate relationship is examined in the cointegration framework over the period 1994.1- 2012.4 against the background of mixed empirical evidence from previous studies. The analysis is augmented by examining the influence of endogenously detected specific events underlying copper price movements on the kwacha/US$ exchange rate. The estimation results reveal the existence of a long-run equilibrium relationship between the real copper price and the real kwacha/US$ exchange rate. A positive shock to the copper price shifts the kwacha/US$ exchange rate to a new equilibrium level. External factors underlying copper price movements tend to increase persistence in the volatility of the kwacha/US$ exchange rate. Nevertheless, the copper price has a weak short-run effect on the exchange rate. Monetary authorities should, therefore, closely monitor underlying movements in the copper price to ensure that external competitiveness of the economy is safeguarded and macroeconomic stability is maintained.