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Zambia: Staff Report for the 2013 Article IV Consultation

Author(s):
International Monetary Fund. African Dept.
Published Date:
January 2014
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Decade of Progress But the Economy at a Crossroads

1. Decade of progress. Zambia has achieved high, sustained growth—thanks to strong growth in copper production and prudent macroeconomic policies—and macroeconomic stability over the past decade, supported by two Extended Credit Facility (ECF) arrangements. During this period, Zambia received debt relief of $5.5 billion. Public debt was just over 30 percent of GDP at end-2012, of which about half was external debt. GDP per capita in PPP terms has almost doubled since 2000. However, poverty remains high (in 2010, an estimated 60.5 percent of the population was living in poverty and 42.3 percent in extreme poverty) and infrastructure needs to be improved substantially (Ex-Post Assessment update, 2011).

Real GDP and CPI

(Percent change)

Source: Zambian authorities.

2. Growth and inflation. Output grew 7.2 percent in 2012, supported by strong performance in agriculture, construction, and communication services. Growth is expected to decline to 6 percent in 2013, mainly owing to lower agricultural production. Inflation was slightly above the BOZ target of 7 percent at end-2012, and was 6.9 percent in October 2013, mainly driven by non-food inflation.

3. Fiscal developments. The government conducted fiscal policy prudently in recent years, and the 2013 budget targeted a deficit of 4.1 percent of GDP (broadly consistent with the 2012 Article IV recommendations), with significant increases in capital spending. However, the actual fiscal deficit for 2013 is projected to be roughly double the budgeted level, mainly as a result of significant overspending on recurrent items, primarily subsidies and wages.

4. External position. The current account was roughly balanced in 2012, but is expected to move into a deficit of 1.3 percent of GDP in 2013, despite rapidly growing non-traditional exports, reflecting lower copper prices and rising imports. FDI has been increasing in recent years, largely in mining. International reserves are increasing slowly, but remain low after sharp declines earlier in 2013. In January-April 2013, BOZ sold foreign exchange to offset depreciation pressures. The possible tapering of unconventional monetary policy in the U.S. has had little impact on Zambia’s Eurobond yields, but reflecting concerns about the Zambian economy, Zambia’s Eurobond spreads have during 2013 increased more than those of other African countries.

Spread to Benchmark for Selected Eurobonds

(Basis points)

Sources: Bloomberg, Fitch and S&P.

1/ S&P

2/ Fitch

5. Financial sector. The banking sector has grown steadily and remains profitable and well-capitalized. Private sector credit growth has started slowing down in 2013 from a rapid increase in the second half of 2012. Nonperforming loans declined to 8.2 percent of total loans in mid-2013 from 15 percent in 2010.

6. Past advice and recent reform measures. In line with earlier advice, the government recently made progress in structural reforms by curtailing fuel and agricultural subsidies (Box 1) and announcing a pension reform plan that will include an increase the pension age to 65 from 55 years. The authorities have also made progress in improving access to financial services, and the government increased BOZ’s capital substantially. BOZ has proceeded flexibly and gradually with the implementation of the increased capital requirement for banks. However, traction on PFM reforms, including on fiscal reporting and quality control, has been weak and the fiscal situation has deteriorated sharply in 2013.

Box 1.Subsidy Reform

Subsidies for fuel, maize, and agricultural inputs have in recent years been a source of significant budget overruns in Zambia. During 2010-13, these subsidies averaged close to 3 percent of GDP in total, of which only about one quarter was provided for in the original budgets. Aside from being difficult to manage, the programs have been widely criticized as being excessively costly and not obtaining good value for money.

To rein in expenditures and better target those in need, the Zambian government has embarked on a major subsidy reform. Retail fuel prices were raised in May 2013 by an average of almost 22 percent, eliminating a mounting subsidy and generating savings for the government of about 1.2 percent of GDP. Around the same time, Government announced that it would reduce the scale of the Food Reserve Agency’s operations and eliminate the difference between its buying and selling price for maize. Moreover, the price of fertilizer under the Farmer Input Support Program was doubled. While the reforms are still underway and the full savings are yet to be realized, the combined cost of the latter two programs is expected to be reduced to 1.0 percent of GDP in 2014 from 2.2 percent of GDP on average during 2010-13. In addition, starting from the 2014 budget, the authorities have decided to accurately reflect all maize-related activity on budget.

Along with the reduction of subsidies, government is scaling up social cash transfers to better assist the poor. The budgeted allocation to such transfers is being increased almost tenfold to K150 million in 2014 (about 0.1 percent of GDP) to provide some 143,000 of the poorest households with about $12 a month. This program will cover approximately 13 percent of those in extreme poverty, and for the average recipient household the transfer should boost consumption by 20 percent and eliminate almost half of the gap to the food poverty line. Government plans to extend the program nationwide over the coming years as delivery capacity is built up.

7. Political and business environment. Zambia’s score in the World Bank’s Doing Business Indicators has improved over the past decade, largely due to improvements in the ease of getting credit and enforcing contracts (Appendix I). Policymakers, however, have at times taken measures adding to costs of doing business and raising uncertainty about the policy direction. The government banned, in mid-2012, the use of foreign exchange in domestic contracts (creating problems for some externally-funded businesses, although these were reduced by a later exclusion of electricity projects from the ban); BOZ introduced caps on lending rates early this year; and the authorities recently adopted a new regulation to strengthen monitoring of foreign exchange transactions (adding to business costs, albeit limited by subsequent revisions of the regulation).

8. Medium-term outlook. The Zambian economy has high growth potential, with its substantial mineral wealth and largely untapped resources in agriculture, hydropower, and tourism. In light of the significant policy uncertainties, however, the medium-term outlook for growth and inflation is uncertain. Assuming front-loaded fiscal reforms leading to a medium-term deficit of 3 percent of GDP, and a business friendly policy environment, staff projects growth to remain at 7–8 percent and inflation to decline gradually to 5 percent. The proposed fiscal adjustment together with increased copper production and non-copper exports would improve the current account to roughly balance by 2018.

9. Risks. The balance of risks to growth is on the downside due to the uncertainties regarding the pace of fiscal adjustment and the investment climate. If the needed fiscal adjustment is delayed, the economy would be highly vulnerable to negative shocks, with low international reserves and rapidly rising public debt. In addition, the authorities might have difficulty mobilizing the needed deficit financing (Risk Assessment Matrix). Other risk factors include weather conditions, financial fallout from a reemergence of financial stress in the euro area, and trade and commodity price implications of a slowdown in emerging markets such as China. Greater exchange rate flexibility could help cushion against negative shocks, including disruptions to external financing and worsening of the terms of trade.

10. Authorities’ views. The authorities broadly shared staff’s assessment of the economy and outlook. They noted that steps had already been taken to contain the fiscal deficit, including by removing the fuel subsidy, and that further strong action would be taken in 2014 and over the medium term. They also emphasized their commitment to maintaining a business friendly environment, noting that the recent steps to tighten regulation were needed to strengthen monitoring of the economy and had already revealed some suspicious business activities.

Policies Going Forward

11. Government objectives. The government’s Sixth National Development Plan aims to make Zambia a prosperous middle income country with an economic program leading to inclusive growth. Large public investment, particularly on roads and electricity, will lessen key constraints to economic development. Moreover, a rural focus will support pro-poor growth and an ambitious target for job creation has been established.

12. Policy priorities. Preserving the economy’s hard won macroeconomic stability calls for a reduction of the fiscal deficit and increased international reserves. This will require mobilizing additional domestic revenue, realigning spending priorities, and creating fiscal space for infrastructure investment, while also maintaining a business environment that encourages job creation. At the same time, the targeted transformation of the Zambian economy requires fundamental administrative and institutional reforms to promote credible policy implementation, higher efficiency of public infrastructure investment, and deeper financial intermediation.

A. Fiscal Policy: Close the Financing Gaps and Realign Priorities

13. Developments in 2013. The fiscal deficit for 2013 is projected to reach 8.6 percent of GDP, assuming that the government implements planned fourth quarter spending cuts through reducing spending on goods and services (0.3 percent of GDP savings relative to the budget for the fourth quarter) and maintaining capital spending at least 0.5 percent of GDP below the annual budget. Virtually all categories of spending have deviated substantially from approved levels. The sharp increase in wages (45 percent, compared to the budgeted 9.1 percent),1 and the large overruns on subsidies—4.0 percent of GDP, compared to a budget of less than 0.7 percent—forced the government to make sharp cuts in goods and services, intergovernmental transfers, and capital spending. To finance the above-budget deficit, the authorities have increased issuance of Treasury bills, used part of the 2012 Eurobond proceeds that had earlier been transferred to SOEs for investments but had not yet been spent, and intend to borrow abroad via a syndicated loan.

14. There are risks that the fiscal deficit for 2013 will be higher than currently planned, if the authorities fail to implement the spending cuts discussed with the mission. This could lead to a substantial accumulation of arrears and/or reliance on central bank financing. In this regard, staff expressed concern about the recourse to central bank bridge loans, which are intended to assist with cash management but could—if not quickly repaid—constitute central bank financing of the budget.

15. The current fiscal stance is clearly unsustainable. Rating agencies have recently downgraded Zambia’s credit rating, citing sharply deteriorated government finances. Without a change in policies, government debt would rise in net present value from about 30 percent of GDP in 2013 to over 50 percent by 2018, with the debt financing predominantly recurrent expenditures.

PV of Debt-to-GDP Ratio

Source: IMF staff estimates

16. Proposed fiscal adjustment over the medim term. Discussions on the 2014 budget took place before the authorities had finalized their plans. Staff advised addressing the fiscal gaps and creating space for spending on infrastructure, health, and education by taking measures to boost domestic revenue and contain the wage bill and other recurrent expenditures. Given the small size of the domestic financial market, in line with earlier staff advice, net domestic financing should not exceed 1½–2 percent of GDP in the medium term, so as not to crowd out private sector credit. In addition, given limited debt management and project assessment and implementation capacities, as well as the limited availability of concessional financing, staff believes reliance on external financing should also be contained and gradually reduced. Thus, staff recommended reducing the fiscal deficit to 5 percent of GDP in 2014, in line with the MTEF approved by Cabinet in September, and gradually to 3 percent of GDP over the medium term. Given the recent fiscal slippages and to anchor the needed fiscal adjustment, staff stressed the importance of adopting, and then following, prudent budgets.

  • Long-term fiscal anchor. Staff proposed—and the authorities agreed—that fiscal policy should target a roughly unchanged debt to GDP ratio over the medium term. The proposed debt level is moderate but, considering the limited absorptive and debt management capacities, debt-financed additional spending is not recommended to maintain macroeconomic stability. To finance the needed investment in infrastructure, revenue measures are needed in addition to external borrowing. Moreover, maintaining fiscal space will be important given the economy’s dependence on copper and its volatile prices. In light of the expected increases in mining revenue over the medium term, the authorities will need to consider the implications of possible revenue volatility in conducting macroeconomic policy as well as the benefits of introducing a fiscal rule over the medium term.
  • Revenue measures. Staff encouraged the authorities to accelerate revenue mobilization and cautioned against any narrowing of the tax base. Staff proposed revenue measures of about 2.3 percent of GDP over the medium term through broadening the tax base (text box), based on the recommendations of the recent FAD tax policy mission. The authorities need to continue strengthening mining tax administration. Staff advised against raising the PIT tax free threshold, which the authorities were considering, noting that the threshold is already high at 3 times GNI per capita. The proposed tax measures together with rising mining revenue and improved non-tax revenue collection are expected to raise revenues by 5 percent of GDP over the medium term.
  • Rationalize the wage bill, which is projected to be 54 percent of domestic revenue in 2014. To mitigate this year’s large wage increase, staff supported the government’s plan to freeze wages in 2014 and 2015 and net recruitment in 2014, and further proposed reducing the wage bill to not more than 35 percent of domestic revenue over the medium term and eventually to not more than 8 percent of GDP. To achieve the medium term target will require very tight wage policy through at least 2016. To enhance budget predictability and contain the wage bill, multi-year wage agreements (for the period after 2015)2 and civil service reforms will be needed, including a review of staffing levels (Appendix III). In this context, the government has embarked on a multi-year civil service reform program that aims to strengthen the efficiency of the public sector by, among other things, introducing a performance management system, rationalizing the pay scale, and streamlining allowances.
  • Fuel subsidies. Staff welcomed the removal of fuel subsidies and stressed the importance of adopting an automatic pricing mechanism to avoid the recurrence of subsidies and to attract much needed investments in the area.
  • Maize marketing and fertilizer subsidies. Staff supported the authorities’ decision to reduce fertilizer subsidies and fully reflect the Food Reserve Agency’s (FRA) operations in the budget, and urged them to stick to the announced policy of limiting FRA activities to maintaining a modest strategic reserve. Additional reforms to support a larger role for the private sector, including the elimination of export bans, could help boost agricultural output and rural development more generally.
  • Pension system. The Public Service Pension Fund (PSPF) has accumulated pension arrears of an estimated 1.1 percent of GDP, and its annual funding is insufficient to prevent the accumulation of new arrears. Staff supported the government’s intention to reform the system (Box 2), including through increasing the retirement age to 65 from 55 years.
  • Capital spending and financing. Staff recommended a more gradual path of increase in capital spending, in light of capacity constraints, and limiting external borrowing for capital projects to what is needed each year rather than issuing a Eurobond adequate to cover the full cost of multi-year investment projects. In the case of the latter, the government must bear additional interest costs, and there will be a risk that the funds will be diverted to lower priority spending.
Staff Medium-Term Recommendations: Revenue Measures
Estimated impact over 2014–18
Harmonizing CIT rates/raising rates on low-tax sectors0.7 percent of GDP increase
Raising VAT rates by 1 percent and reducing exemptions0.7 percent of GDP increase
Lowering PAYE tax thresholds0.5 percent of GDP increase
Raising Excises0.5 percent of GDP increase

Box 2.Pension Reform

The public pension system in Zambia is complicated by the presence of three different schemes: i) the National Pension Scheme Authority (NAPSA), to which all new entrants to the formal sector since 2000 are mandated to contribute, ii) The PSPF for central government workers, and iii) The Local Authorities Superannuation Fund (LASF) for subnational government and public utility workers. The PSPF and LASF have been closed to new entrants since 2000. Moreover, pensions for all three funds are based on ultimately unsustainable benefit rules. And the PSPF and LASF have been running large deficits. The central government has been partially financing the deficit of the PSPF to slow down the pace of arrears accumulation, but the stock of PSPF arrears to pensioners are nevertheless expected to reach 1.1 percent of GDP by end-2013.

Supported by the finding of an FAD TA mission, staff recommended near- and medium-term measures to strengthen the sustainability of the pension systems including: i) transferring members of PSPF and LASF to NAPSA, which is currently in surplus, under a dual-benefit system, ii) raising the statutory retirement age from 55 to 65 gradually, (iii) reducing the current bias towards lump sum payments by lowering the commutation rate, introducing penalties for early retirement, and indexing benefits to inflation, (iv) raising the contribution rates of PSPF and LASF workers to the NAPSA rate of 10 percent, (v) strengthening collection capacity within NAPSA.

The authorities have announced their intention to put the public pension system on a sustainable footing, including by raising the retirement age to 65. However, the full details and timing of the reform are not yet available.

17. Proposed 2014 budget. Staff stressed that the proposed 2014 budget does not take sufficient steps to start addressing the large fiscal deficit. The budget submitted to Parliament in October calls for a deficit of 6.2 percent of GDP in 2014, above staff’s recommendation of 5 percent. The budget aims to increase domestic revenue by about 1.3 percent of GDP, mainly through nontax measures (including bringing revenue from FRA and other government agencies on budget, raising road tolls, and introducing a surcharge on money transfers). Contrary to staff’s advice, the budget proposes raising the PIT tax-free threshold to K3,000 from the current 2,200, which will generate a revenue loss of about 1 percent of GDP.3 The budget also proposes a wage freeze for 2014 and 2015, as well as a net recruitment freeze for 2014 and limits FRA activities to maintaining a strategic reserve.

18. In addition to the higher than desirable planned deficit, there are substantial downside risks to the proposed 2014 budget. Based on available information, staff estimates that revenue and spending policies in the budget would produce a deficit of 7.4 percent of GDP, about 1 percent of GDP higher than budgeted.4 Moreover, the proposed wage and hiring freezes will be difficult to achieve given opposition from unions. Even modest increases in wages and new recruitments could incur additional spending of 1– 1½ percent of GDP. To reduce the proposed deficit to 5 percent of GDP, staff recommended further measures (text box).5

Staff Recommendations: Fiscal Measures Additional to the 2014 Proposed Budget
Gain in Deficit Reduction
Refrain from raising the tax-free theshold1 percent of GDP
Starting to raise CIT rates on low-taxed sectors0.4 percent of GDP
Postponing some infrastructure projections0.4 percent of GDP
Reducing intergovernmental transfers0.3 percent of GDP

19. Authorities’ views. The authorities reiterated their commitment to ensure that the fiscal deficit for 2013 does not go beyond 8.5 percent of GDP. They will cut low-priority spending as needed to meet the deficit projection. Regarding the risks to the 2014 budget, the authorities reaffirmed that the government will stick to the proposed wage and net recruitment freeze and that additional measures will be taken as needed to meet the 2014 deficit target. Starting next year, revenues and expenditures of FRA and other government agencies will be monitored by the Treasury. Across the public sector, steps are being taken to strengthen governance and accountability, including new measures to improve procurement of petroleum and fertilizer.

20. While the authorities have not finalized their medium-term fiscal plans, they broadly agreed with staff’s recommendations to gradually reduce the deficit to 3 percent of GDP, net domestic financing to 1½–2 percent of GDP, and the wage bill to not more than 35 percent of revenues.6 They did not fully agree with the long-term target of a wage bill less than 8 percent of GDP, noting that the need to hire teachers, health care workers, and agricultural extension workers may make this impossible. In addition, while the authorities agree it will be important to eventually develop a fiscal strategy to insulate the budget from volatile copper revenues, they do not see this as an urgent need, in light of the fact that significant copper tax revenue remains some years in the future.

B. PFM: Step up Reforms to Support Fiscal Consolidation

21. Developments. The recent PEFA assessment found a deterioration in PFM, including reporting and quality control. Procurement practices have also deteriorated, with single-source contracts for some large projects. While the rollout of the Integrated Financial Management Information System (IFMIS) has continued, its implementation, as well as that of the Treasury Single Account (TSA), has been weak, and only release-based fiscal data are available. In addition, consolidation of financing data with the BOZ needs to be improved.

22. Staff stressed the importance of stepping up PFM reform to support fiscal consolidation and improve budget planning and implementation. Staff underlined the importance of (i) enhancing budget credibility and consistency between the National Development Plan, Medium-Term Expenditure Framework, and annual budget; (ii) improving fiscal data as well as forecasts by enhancing the macro fiscal framework; (iii) expanding the coverage of the TSA by closing line ministries’ accounts at commercial banks; (iv) improving collaboration between units at the Ministry of Finance, and with the BOZ, to produce fiscal data based on expenditures rather than releases; (v) strengthening IFMIS implementation and controls; and (vi) providing additional resources to the Accountant General’s Department to support these reforms.

23. Authorities’ views. The authorities agreed with the need to improve cash management and improve collaboration across ministry units and with the BOZ. They noted that, with TA from donors, they will be refocusing efforts in this area and have recently adopted a new PFM reform strategy. Progress has been slow in implementing the multi-donor funded Public Expenditure Management and Accountability (PEMFA) program prepared in 2010. They indicated that the recommendations of the November 2013 FAD mission will be used to further develop the reform program, including prioritization and sequencing, and will inform further strategic discussions with donors on support for PFM reform.

Infrastructure and government spending

Sources: World Economic Forum; WEO; and IMF staff calculations.

C. Improve Investment Planning and Maintain Debt Sustainability

24. Developments. Given infrastructure needs, the government is ramping up capital spending on roads, railways, and power over the medium term. With limited donor support, Zambia has begun tapping the Eurobond market to finance needed infrastructure.7 Selected municipalities and SOEs have proposed issuing sub-national Eurobonds totaling $4.5 billion (over 20 percent of 2012 GDP). Such issuances would likely require government guarantees.

25. Staff supported the Minister’s opposition to the proposed sub-national Eurobonds, and advised that, to the extent these projects are of national importance, it would be preferable to issue sovereign bonds, which should be budgeted and on lent to sub-national entities with proper monitoring. Any such borrowing should also be in line with (i) macroeconomic stability and fiscal/debt sustainability; (ii) project appraisal, management and monitoring capacity; and (iii) debt management capacity and strategy. In this regard, staff encouraged the authorities to request a voluntary update of the Debt Management Performance Assessment (DEMPA) conducted in 2011, as well as to request TA from the World Bank to assist in finalizing their medium-term debt strategy.

26. Debt sustainability analysis (DSA). Zambia’s external and public debt remains relatively low, and an updated DSA based on the authorities’ planned fiscal adjustment scenario continues to indicate a low risk of debt stress, despite higher borrowing envisaged than in the previous DSA (Attachment). Absent adjustment, however, the debt ratio would rise sharply, with the fixed primary fiscal balance scenario demonstrating clearly the need for fiscal adjustment.

27. Authorities’ views. The authorities broadly agreed with staff’s recommendations on the proposed sub-national Eurobonds as well as with the DSA results. They indicated that, to strengthen debt management, the International Debt Management Department will be restructured in tandem with a restructuring of the Ministry of Finance and stressed that Zambia will not fall into another debt trap, after receiving large debt relief in the 2000s.

D. Monetary Policy: Ensure Flexibility to Maintain Macroeconomic Stability

28. Developments. Inflation has in recent months remained at around 7 percent, above the BOZ’s end-2013 target of 6 percent, reflecting the removal of fuel subsidies, and inflationary pressure is expected to rise due to the large civil servant wage increases and reduction of maize subsidies.8 Following the elimination of fuel and maize subsidies, the BOZ increased the policy rate twice (25 bps each time) to 9.75 percent to contain inflationary pressure.9 Bank liquidity has been highly volatile. The BOZ has been under political pressure to lower lending rates and strengthen the kwacha.

29. Monetary policy framework. Staff welcomed the progress that the BOZ has made in transitioning from conducting monetary policy through targeting reserve money to conducting policy through the policy rate. However, more needs to be done, including strengthening understanding of the interest rate transmission mechanism, improving liquidity forecasting and management, and developing high frequency indicators of economic activity. Pending further progress in these areas, staff supported the BOZ’s intention to increasingly conduct monetary policy through the policy rate, while nonetheless seeking to keep reserve money and bank liquidity in check. Staff encouraged the BOZ to narrow the 400 basis point corridor in which the BOZ targets the interbank rate to strengthen the policy rate’s role as a benchmark for the pricing of longer-term and customer transactions.

Policy Rate and Overnight Interbank Rate

(In percent)

Source: Bank of Zambia.

30. Monetary policy stance. The significant fiscal policy changes this year greatly complicate the BOZ’s task of controlling inflation. Staff supported the authorities’ intention to implicitly increase their inflation target for end-2013 to 7.5 percent to accommodate the first round effects of the removal of fuel and maize subsidies (estimated at 1– 1½ percentage points). Staff emphasized the importance of continuing to tighten monetary policy, in order to resist the second round effects of the removal of subsidies and the inflationary pressure from the large civil servant wage increases.

Consumer Prices

(year-on-year percent change)

Source: Zambian authorities.

31. International reserves and exchange rates. The BOZ has started building up reserves slowly as the kwacha had appreciated in recent months, after losing reserves rapidly early this year during a brief (now ended) period of providing foreign exchange to finance oil imports. Given the economy’s vulnerability to negative shocks and the current low level of reserves (an estimate of 2.3 months of imports for 2013), staff advised the BOZ to allow more exchange rate flexibility and to continue to build up reserves in line with their medium-term target of 4 months of imports, using reserves to offset temporary exchange rate movements, but not to resist sustained depreciation pressures when they exist. Staff analysis suggested that the kwacha remains broadly in line with fundamentals (Appendix IV).

International Reserves

(US$ Millions)

Source: Bank of Zambia.

1/ Unencumbered reserves only.

32. Exchange restrictions. The authorities amended the BOZ Act and introduced new foreign exchange market regulations to strengthen monitoring of external transactions. LEG had judged that the initial version of the regulation on foreign exchange transactions violated Article VIII of the IMF’s Articles of Agreement:

  • On June 25, 2013, the Zambian authorities issued Statutory Instrument 55 of 2013, which regulates the monitoring of foreign exchange transactions and includes two measures that give rise to exchange restrictions subject to Fund approval under Article VIII, Section 2(a). The first exchange restriction arises from the requirement that a person making payments of dividends in foreign exchange provide a tax clearance certificate and evidence of payment of corporate or income tax. The second exchange restriction arises from the requirement that payments for royalties, management fees, technical fees, commissions or consultancy fees in foreign exchange be accompanied by evidence of corporate tax payments. Both measures give rise to exchange restrictions subject to IMF approval under Article VIII, Section 2(a) because they impose limitations on the availability of foreign exchange for the making of payments of current international transactions based on noncompliance with obligations that are unrelated to the proposed transaction.

33. The authorities have been working closely with the Fund staff to eliminate the exchange restrictions in the regulation, while maintaining their goal of strengthened monitoring. It is expected that the authorities will amend the regulation to be compliant with Article VIII before the Board meeting.

34. Authorities’ views. The BOZ acknowledged that moving to a policy rate-based regime is a transitional process. They noted that, utilizing the ongoing Norway/MCM TA, the BOZ will continue to develop all the structures necessary for the effective functioning of the policy rate as the main monetary policy tool. To improve liquidity forecasting, the BOZ plans to work together with the government to enhance the flow of information on government transactions. The BOZ stressed that to avoid a wage-price spiral, they are prepared to act to offset inflationary pressures from the large civil service wage increase, and noted the recent increase in BOZ’s budget for open market operations. The authorities agreed with the exchange rate assessment and acknowledged the need to further build up international reserves, but noted that they are reluctant to do so when the kwacha is depreciating.

E. Financial Sector: Address Structural Constraints

35. Background. The authorities are concerned about high lending rates and limited access to credit by SMEs, which prompted the introduction of caps on lending rates (Appendix V).10 The banking system is highly concentrated, with the top four banks’ assets amounting to about 60 percent of total banking sector assets. The banking system’s loan-to-deposit ratio is low at around 65 percent, indicating that the lack of bankable projects and borrowers is the main reason for limited credit delivery. The overall framework and practices for banking supervision are broadly compliant with the Basel Core Principles (Financial Sector Assessment Program Update, 2009).

36. Lending rate ceilings. Staff noted that international experience shows that lending rate ceilings—if they are binding—will distort credit allocation and restrict (rather than enhance) access to credit, particularly for SMEs. Since the lending rate ceilings were introduced early this year, market interest rates (as reflected in average Treasury bill rates) have increased more than two percentage points, while the ceilings have been increased only one half percentage point, making them increasingly binding. Staff advised that to reduce interest rates, efforts should focus on reforms to enhance competition in the banking sector, and help SMEs develop credible business plans. If the authorities are determined to maintain the lending rate ceilings, at the very least it will be important to adjust them in line with market rate increases. One way to achieve this would be to tie the ceiling to the average Treasury bill rate, rather than to the policy rate.

Treasury Bill Rates and Lending Rate Ceilings

(percent)

Source: Bank of Zambia.

37. Financial inclusion. Staff welcomed the authorities’ continued efforts to enhance financial services delivery by strengthening the Credit Reference Bureau, expanding bank branches in rural areas, and improving credit culture. The planned introduction of a unified collateral registry system, agency banking guidelines, and steps to improve land titling will facilitate credit provision and improve access to financial services particularly in rural areas. Staff noted that, combined, these measures are more likely to contribute to a reduced cost of loans for SMEs than the lending rate cap.

Zambia: Number of Bank Branches and Agencies

Source: Bank of Zambia.

38. Banks’ new capital requirement. To strengthen the balance sheets of banks, the authorities increased the minimum capital requirement.11 All but a few small banks are expected to meet the new requirements by the end of 2013. Given the rapid increase in private sector credit in the second half of 2012 and the new higher bank capital, staff supported the BOZ’s intensive banking supervision to assess a potential build-up in vulnerability and risks to financial stability.

39. Authorities’ views. The authorities noted that private sector credit has continued to increase since the introduction of the lending rate ceilings and that the nonbank sector is being restructured, including by marginal and inefficient nonbanks’ exit from the market. They indicated that BOZ is carefully monitoring developments in bank and nonbank lending, and has also asked a foreign consultant to conduct an in-depth study of the impact of the lending rate ceilings. The authorities noted financial inclusion as a policy priority. Given limited financial system infrastructure in Zambia, agent banking is being pursued as a low cost solution, particularly in rural areas.

F. Boosting Competitiveness and Inclusive Growth

40. Background. Over the last decade, Zambia’s competitiveness has been boosted by strengthened macroeconomic fundamentals and a supportive business environment. Zambia’s business environment remains favorable compared to other countries in the region, but weaknesses in infrastructure and human capital as well as the recently more interventionist regulatory approach and related uncertainty about the policy direction are impediments to continued progress. Moreover, while non-copper exports have increased rapidly in recent years, the country remains reliant on copper exports. To secure continued growth and diversification, Zambia will need to boost infrastructure and education, while maintaining a business friendly environment that inspires investor confidence

Minimum Wages

(2012/13 and private sector unless otherwise noted)

Sources: U.S. Department of Labor and WageIndicators.org.

41. Minimum wages. A sharp increase in 2012 brought the minimum wage in Zambia to about 1½ times per capita GDP. The private sector and NGOs noted that the high minimum wage is hampering the country’s competitiveness and formal employment.12 Moreover, some in government are considering pressuring private companies to match the new government minimum wage, which is roughly 4½ times per capita GDP and 2½ times the current minimum wage in the private sector. Minimum wages of this magnitude would inhibit job creation by driving many employers out of business and resulting in a sharp decline in both domestic and foreign investments. It could also lead to further reliance on informal sector jobs, where workers have less protection.

42. Authorities’ views. The authorities stressed that the government is ramping up capital spending on infrastructure to address key impediments to inclusive growth and competitiveness. They noted that the 2012 increase in the statutory minimum wage had been overdue as it had not been adjusted between 2006 and 2011, but also that views by some officials on extending the new government minimum to the private sector or introducing sector-based differentiation were their personal views, not the government’s.

G. Strengthening Statistics

43. While data provision needs improvement, especially on balance of payments and fiscal reporting, data are broadly adequate for surveillance. Efforts are ongoing to improve national accounts data with plans to rebase to 2010 by next year. However, gaps in balance of payments data remain in several areas including reinvested exporter earnings, trade in services, and the financial account (Informational Annex). Fiscal data is not robust due to weak data consolidation and limited classification harmonization across government institutions and the BOZ. Staff welcomed the authorities’ continued efforts to improve data quality and availability and recommended a data ROSC to fully assess Zambia’s data situation.

Staff Appraisal

44. The Zambian economy has performed well in recent years, with strong growth and modest inflation, and has high growth potential. The government has resolved to step up development by scaling up investment in infrastructure. However, this year has seen a substantial loosening of fiscal policy, leading to a large fiscal deficit.

45. The current fiscal stance is unsustainable. To address risks of large arrears accumulations and additional central bank financing in 2013, it will be important for the authorities to adhere to their plans to reduce low-priority investment spending, and contain goods and services spending. Staff recommends firmly addressing the fiscal slippages in 2014 and continuing to reduce fiscal deficits over the medium term. Medium-term reforms are required to contain the wage bill and recurrent expenditure, boost domestic revenue, and create fiscal space for infrastructure investment. Staff recommends reducing the fiscal deficit to 5 percent of GDP in 2014 and gradually to 3 percent of GDP over the medium term, and bringing down net domestic financing to 1½–2 percent of GDP a year to avoid crowding out the private sector.

46. The proposed 2014 budget does not take sufficient steps to begin addressing the large fiscal deficit. Staff estimates that the spending and revenue policies in the budget will produce a deficit of at least 7.4 percent of GDP, much higher than the recommended 5 percent. Staff cautions against the proposed increase in the tax-free threshold on personal income tax, which would further reduce the already narrow tax base. The government should take stronger revenue measures than budgeted and stick to the proposed wage and recruitment freezes, to contain the already excessive wage bill. Staff welcomes the government’s decision to remove fuel and maize subsidies, to limit FRA activities to maintaining a strategic reserve, and to fully reflect FRA revenue and expenditure in the budget.

47. Public financial management reform needs to be stepped up to support fiscal consolidation. Staff welcomes the authorities’ stated commitment to working with its partners to strengthen PFM, and urges the authorities to attach high priority to these efforts, especially on fiscal reporting and budgetary controls.

48. The progress made in transitioning to conducting monetary policy through the policy rate is welcome. However, more needs to be done, including strengthening understanding of the interest rate transmission mechanism, improving liquidity forecasting and management, and developing high frequency indicators of economic activity. Pending further progress in these areas, staff supports the BOZ’s intention to increasingly conduct monetary policy through the policy rate, while nonetheless seeking to keep reserve money and bank liquidity in check.

49. The BOZ needs to continue tightening monetary policy. The significant fiscal policy changes this year complicate the BOZ’s task of controlling inflation. Staff supports the authorities’ intention to increase their inflation target to accommodate the first round effects of the removal of fuel and maize subsidies. However, tighter monetary policy is needed to resist second round effects of the removal of subsidies and inflationary pressure from the large civil servant wage increases. Given the current low level of reserves, staff advises the BOZ to allow more exchange rate flexibility and continue to build up reserves in line with their medium-term target in order to limit the economy’s vulnerability to negative shocks.

50. Staff supports the authorities’ efforts to strengthen the financial sector and improve access to financial services. Staff recommends the elimination of the lending rate ceilings introduced early this year, which restrict access to credit, particularly for SMEs, and are becoming increasingly binding, or, at a minimum, tying the lending rate ceiling to the Treasury bill rate. To reduce lending rates, efforts should instead focus on reforms to enhance competition in the banking sector and address high business costs. The planned introduction of a unified collateral registry system, agency banking guidelines, and steps to improve land titling will facilitate credit provision and improve access to financial services particularly in rural areas.

51. Maintaining a good business environment is important for strong growth and economic diversification. Over the last decade, Zambia’s competitiveness has been boosted by strengthened macroeconomic fundamentals and a favorable business environment. However, regulatory changes in a number of areas have raised costs of doing business and created uncertainty about the policy direction. Moreover, wage increases that outstrip productivity would hamper the country’s competitiveness and job creation. Staff strongly advises against pressuring private sector employers to match the government’s new minimum wage, as this would significantly undermine competitiveness.

52. Staff recommends that the next Article IV consultation be held on the standard 12-month cycle.

Table 1.Zambia: Selected Economic Indicators, 2011–18
20112012201320142015201620172018
ActualProj.
Baseline scenario
(Percentage Change)
National account and prices
GDP growth at constant prices6.87.26.07.37.57.67.67.7
Mining−5.2−2.712.013.28.27.57.07.0
Non mining8.28.25.56.77.47.67.77.7
GDP deflator12.55.97.67.25.95.15.05.0
GDP at market prices (millions of kwacha)93,344105,983120,952139,113158,275178,864202,101228,462
Consumer prices
Consumer prices (average)8.76.67.17.06.05.25.05.0
Consumer prices (end of period)7.27.37.56.55.55.05.05.0
External sector
Terms of trade (deterioration -)4.4−12.5−3.91.4−0.8−1.0−1.3−1.1
Average exchange rate (kwacha per U.S. dollar)4.8615.147
(percentage change; depreciation -)−1.3−5.9
Real effective exchange rate (depreciation -)1−2.63.3
Money and credit (end of period, unless otherwise specified)
Domestic credit to the private sector28.237.010.018.018.220.420.620.7
Reserve money (end of period)6.851.4−9.618.018.018.117.517.7
Broad Money (M3)21.717.918.219.619.919.920.020.3
(Percent of GDP; unless otherwise indicated)
National accounts
Gross investment23.524.824.825.225.926.727.027.5
Government4.26.56.67.27.78.38.48.6
Private19.318.318.118.018.218.418.618.9
National savings27.124.923.424.525.526.527.027.6
Net lending(+)/net borrowing(-)3.70.1−1.3−0.6−0.4−0.20.00.1
Central government budget
Revenue21.722.720.922.022.523.123.824.8
Taxes19.318.217.216.917.618.319.320.2
Grants0.81.71.01.41.31.21.00.8
Other revenue1.62.92.73.73.63.63.53.7
Expenditure23.926.029.529.428.928.828.928.8
Expense19.719.622.922.221.220.620.420.2
Net acquisition of nonfinancial assets4.26.56.67.27.78.38.48.6
Fiscal Measures0.01.10.70.60.91.0
Net lending/borrowing2−1.2−2.7−8.6−6.3−5.7−5.2−4.2−3.0
Excluding grants−2.0−4.4−9.6−7.8−7.0−6.4−5.2−3.9
Net acquisition of financial assets2.42.0−1.50.70.20.20.40.4
Domestic2.42.0−1.50.70.20.20.30.3
Foreign0.00.00.00.00.00.00.10.1
Net incurrance of liabilities3.64.76.47.05.95.44.63.4
Domestic2.41.14.82.02.42.21.71.3
Foreign1.23.71.75.03.53.22.82.1
External sector
Current account balance3.70.1−1.3−0.6−0.4−0.20.00.1
(excluding grants)2.9−0.6−2.0−1.6−1.1−0.9−0.6−0.4
Gross International Reserves (months of prospective imports)2.82.72.32.52.83.13.43.8
Excluding FDI-financed imports3.33.12.62.83.23.53.84.2
Public debt
Total central government debt, net (end-period)20.124.230.333.034.936.236.535.6
External10.216.316.519.721.021.822.322.0
Stock of domestic debt, net9.87.913.813.313.914.314.213.6
Memorandum item: Gross national income per capita (US․)1,4081,463
Sources: Zambian authorities; and IMF staff estimates and projections.

Excludes Zimbabwe.

Including discrepancy between the above-the-line balance and below-the-line financing.

Sources: Zambian authorities; and IMF staff estimates and projections.

Excludes Zimbabwe.

Including discrepancy between the above-the-line balance and below-the-line financing.

Table 2.Zambia: Fiscal Operations of the Central Government, 2011–18(Millions of kwacha)
20112012201320142015201620172018
Prel.BudgetBaselineStaff Rec.BudgetBaselineBaselineBaselineBaselineBaseline
Revenue20,23324,09926,27125,31332,81631,61430,57435,66341,27248,08556,648
Tax18,01819,26021,61320,82225,69524,45723,46627,87832,80339,03946,244
Income taxes10,65510,27510,8879,96212,50510,78110,62712,50414,77418,00321,841
Value-added tax3,9734,7436,0166,2107,4808,0997,2258,80310,45612,29014,315
Excise taxes1,6652,2012,5962,5423,2223,2473,2633,8214,4155,1415,976
Customs duties1,7252,0412,1142,1082,4882,3312,3512,7513,1583,6064,112
Grants7141,7961,5251,1852,1982,0761,9842,0722,0911,9501,856
Budget support602755599599550533415492513522525
Project grants1121,0419265861,6481,5431,5691,5791,5781,4271,331
Other revenue11,5013,0423,1323,3064,9235,0815,1255,7136,3787,0978,549
Of which: Mineral Royalty8681,4591,9222,0372,5572,1862,5902,8953,1943,4984,481
Memorandum item: ZRA Revenues (Tax + Mineral Royalty)18,88620,71923,53522,86028,25226,64326,05630,77335,99642,53750,725
Expenditure22,26727,60031,21135,69039,89740,20640,86845,72451,58258,30765,894
Expense18,36420,75322,54427,66030,47730,46630,83733,53336,79641,32646,232
Compensation of employees7,4029,39311,05111,82615,40815,49715,49715,84316,11917,77119,592
Use of goods and services24,4804,6405,2054,8655,9895,7775,7777,0938,1469,45611,056
Interest1,0821,7372,0142,2313,6493,2773,6524,5315,1906,0346,696
Domestic1,0131,6361,5211,7412,6832,2502,6863,1623,3833,7334,034
691014934909661,0269661,3691,8072,3012,663
Subsidies2,8371,8948004,8501,5131,5131,5131,5261,5361,5451,555
Fertilizer support program8958405001,027500500500513523532541
Strategic Food Reserve (FRA)1,6743003002,3291,0131,0131,0131,0131,0131,0131,013
Fuel26875401,4940000000
Intergovernmental transfers1,3921,7292,7102,4232,8693,3863,3813,1163,4363,8434,306
Social benefits9778747651,4651,0491,0161,0161,4222,3692,6773,026
Other3195486000000000
Net acquisition of nonfinancial assets3,9026,8478,6678,0309,4209,74010,03212,19114,78616,98119,662
Of which: non-donor financed3,8434,9577,0516,5627,0737,6957,6959,49112,03014,23016,878
Gross Operating Balance1,8693,3463,727−2,3462,3391,148−2622,1304,4766,75910,417
Fiscal Measures0014961038103317522300
Statistical Discrepancy (-overfinancing)4925640
Net lending/borrowing−1,109−2,861−4,940−10,376−7,081−8,592−8,798−9,023−9,277−8,471−6,945
Excluding grants−1,823−4,657−6,465−11,561−9,279−10,668−10,782−11,095−11,368−10,420−8,801
Financing−1,109−2,861−10,376−7,081−8,592−8,798−9,023−9,277−8,471−6,945
Net acquisition of financial assets2,2462,143−1,8657651,079949240340821895
Domestic2,2462,143−1,8657651,079949240340531600
Currency and deposits52,1272,040−2,625−1300−130−130−13000
Loans0000000000
Equity and investment fund shares1191027608951,0791,079370470531600
Foreign00000000290295
Net incurrence of liabilities3,3555,0037,7757,8469,6719,7489,2639,6179,2917,840
Domestic2,2211,1155,7512,8752,9022,7723,7343,9083,5333,080
Debt securities2,7461,2623,5964,2053,5023,5024,4644,0383,5333,080
BOZ recapitalization390−1300−130−130−130
Loans−525−1471,765−1,200−600−600−600000
Foreign1,1343,8882,0244,9716,7696,9765,5295,7095,7594,760
Loans1,134282,0246101,2691,5321,1981,0621,2561,813
Budget support, gross1,23427012022400268262265265
Project loans, gross09711,2371,7761,5151,7761,8551,9172,0032,095
Other, gross001,3390000000
Amortization−99−1,212−673−1,390−246−244−925−1,116−1,012−548
Debt securities3,86004,3625,5005,4444,3314,6474,5032,947
Arrears financing7360
Memorandum items:
Net Domestic Financing594−9258,3763,0052,9022,9023,8644,0383,5333,080
Excluding Eurobond proceeds5,8512,9753,0022,8723,8644,0383,5333,080
Overall balance, excl. budget grants and mining revenue−6,806−7,685−14,580−12,039−13,544−13,632−14,506−15,593−15,850−16,439
Primary balance−27−1,124−8,145−3,432−5,315−5,146−4,492−4,087−2,436−249
Primary balance, excluding mining revenue−5,121−5,193−11,750−7,840−9,734−9,565−9,482−9,891−9,294−9,218
Mining revenue5,0954,0693,6054,4084,4194,4194,9905,8046,8578,969
Stock of domestic debt, gross14,16415,40921,34724,80323,14623,74327,12330,67733,86536,602
Stock of external debt, net9,55817,29219,95327,64725,95727,39133,18939,08045,13650,317
Sources: Zambian authorities; and IMF staff estimates and projections.

Includes royalties paid by mining companies.

Includes arrears payments for goods and services and other liability payments.

Includes financial restructuring.

The discrepancy largely reflects changes in the carryover of budgetary releases.

Includes eurobond proceeds collected in 2012 to be spent in 2013.

Sources: Zambian authorities; and IMF staff estimates and projections.

Includes royalties paid by mining companies.

Includes arrears payments for goods and services and other liability payments.

Includes financial restructuring.

The discrepancy largely reflects changes in the carryover of budgetary releases.

Includes eurobond proceeds collected in 2012 to be spent in 2013.

Table 3.Zambia: Fiscal Operations of the Central Government, 2011–18(Percent of GDP)
20112012201320142015201620172018
Prel.BaselineStaff Rec.BudgetBaselineBaselineBaselineBaselineBaseline
Revenue21.722.720.923.622.722.022.523.123.824.8
Tax19.318.217.218.517.616.917.618.319.320.2
Income taxes11.49.78.29.07.77.67.98.38.99.6
Value-added tax4.34.55.15.45.85.25.65.86.16.3
Excise taxes1.82.12.12.32.32.32.42.52.52.6
Customs duties1.81.91.71.81.71.71.71.81.81.8
Grants0.81.71.01.61.51.41.31.21.00.8
Budget support0.60.70.50.40.40.30.30.30.30.2
Project grants0.11.00.51.21.11.11.00.90.70.6
Other revenue11.62.92.73.53.73.73.63.63.53.7
Expenditure23.926.029.528.728.929.428.928.828.928.8
Expense19.719.622.921.921.922.221.220.620.420.2
Compensation of employees7.98.99.811.111.111.110.09.08.88.6
Use of goods and services24.84.44.04.34.24.24.54.64.74.8
Interest1.21.61.82.62.42.62.92.93.02.9
Domestic1.11.51.41.91.61.92.01.91.81.8
Foreign0.10.10.40.70.70.70.91.01.11.2
Subsidies3.01.84.01.11.11.11.00.90.80.7
Fertilizer support program1.00.80.80.40.40.40.30.30.30.2
Strategic Food Reserve (FRA)1.80.31.90.70.70.70.60.60.50.4
Fuel0.30.71.20.00.00.00.00.00.00.0
Intergovernmental transfers1.51.62.02.12.42.42.01.91.91.9
Social benefits1.00.81.20.80.70.70.91.31.31.3
Other30.20.50.00.00.00.00.00.00.00.0
Net acquisition of nonfinancial assets4.26.56.66.87.07.27.78.38.48.6
Of which: non-donor financed4.14.75.45.15.55.56.06.77.07.4
Gross Operating Balance2.03.2−1.91.70.8−0.21.32.53.34.6
Fiscal Measures0.00.01.10.70.60.91.0
Statistical Discrepancy (-overfinancing)41.00.6
Net lending/borrowing−1.2−2.7−8.6−5.1−6.2−6.3−5.7−5.2−4.2−3.0
Excluding grants−2.0−4.4−9.6−6.7−7.7−7.8−7.0−6.4−5.2−3.9
Financing−1.2−2.7−8.6−5.1−6.2−6.3−5.7−5.2−4.2−3.0
Net acquisition of financial assets2.42.0−1.50.50.80.70.20.20.40.4
Domestic2.42.0−1.50.50.80.70.20.20.30.3
Currency and deposits52.31.9−2.2−0.10.0−0.1−0.1−0.10.00.0
Loans0.00.00.00.00.00.00.00.00.00.0
Equity and investment fund shares0.10.10.60.60.80.80.20.30.30.3
Foreign0.00.00.00.00.00.00.00.00.10.1
Net incurrence of liabilities3.64.76.45.67.07.05.95.44.63.4
Domestic2.41.14.82.12.12.02.42.21.71.3
Debt securities2.91.23.03.02.52.52.8
BOZ recapitalization0.3−0.10.0−0.1−0.1
Loans−0.6−0.11.5−0.9−0.4−0.4−0.4
Foreign1.23.71.73.64.95.03.53.22.82.1
Loans1.20.01.70.40.91.10.80.60.60.8
Budget support, gross1.30.30.10.20.00.00.20.10.10.1
Project loans, gross0.00.91.01.31.11.31.21.11.00.9
Other, gross0.00.01.10.00.00.00.00.00.00.0
Amortization−0.1−1.1−0.6−1.0−0.2−0.2−0.6−0.6−0.5−0.2
Debt securities3.60.03.14.03.92.72.62.21.3
Arrears financing0.60
Memorandum items:
Net Domestic Financing50.1−0.96.92.22.12.12.42.31.71.3
Excluding Eurobond proceeds4.82.12.22.12.42.31.71.3
Overall balance, excl. budget grants and mining revenue−7.3−7.3−12.1−8.7−9.7−9.8−9.2−8.7−7.8−7.2
Primary balance0.0−1.1−6.7−2.5−3.8−3.7−2.8−2.3−1.2−0.1
Primary balance, excluding mining revenue−5.5−4.9−9.7−5.6−7.0−6.9−6.0−5.5−4.6−4.0
Mining revenue5.53.83.03.23.23.23.23.23.43.9
Domestic arrears payments0.40.40.50.20.30.30.20.20.20.2
Stock of domestic debt, gross15.214.517.617.816.617.117.117.216.816.0
Stock of external debt, net10.216.316.519.918.719.721.021.822.322.0
Nominal GDP (millions of kwacha)93,344105,983120,952139,113139,113139,113158,275178,864202,101228,462
Sources: Zambian authorities; and IMF staff estimates and projections.

Includes royalties paid by mining companies.

Includes arrears payments for goods and services and other liability payments.

Includes financial restructuring.

The discrepancy largely reflects changes in the carryover of budgetary releases.

Includes eurobond proceeds collected in 2012 to be spent in 2013.

Sources: Zambian authorities; and IMF staff estimates and projections.

Includes royalties paid by mining companies.

Includes arrears payments for goods and services and other liability payments.

Includes financial restructuring.

The discrepancy largely reflects changes in the carryover of budgetary releases.

Includes eurobond proceeds collected in 2012 to be spent in 2013.

Table 4.Zambia: Monetary Account, 2011–181(Millions of kwacha, unless otherwise indicated)
20112012201320142015201620172018
ActualProj.
Baseline scenario
Monetary survey
Net foreign assets9,39312,01412,73815,07520,01524,81730,47137,642
Net domestic assets12,41213,68517,63221,23723,53727,38132,15037,702
Domestic claims16,85019,72726,52330,76535,78542,07649,07757,212
Net claims on central government5,2003,2429,06310,19511,50912,88213,90614,800
Claims on other sectors11,65016,48517,46020,56924,27629,19435,17042,412
Claims on other financial corporations8578666666666666
Claims on state and local government1219222222222222
Claims on public non-financial corporations99694102102102102102102
Claims on private sector11,45415,69517,26920,37924,08629,00434,98042,222
Other items net−4,438−6,041−8,891−9,528−12,248−14,695−16,927−19,510
Broad money (M3)21,80525,69930,37036,31143,55152,19862,62175,344
Quasi money (M2)14,29819,51422,83227,28132,70139,16946,96156,467
Foreign exchange deposits7,5076,1857,5399,03010,85113,02915,66018,877
Monetary authorities
Net foreign assets6,14010,7899,45511,48216,11420,60725,95332,815
Asset11,99116,62315,21117,05921,34525,44230,40736,919
Liabilities−5,851−5,834−5,757−5,576−5,232−4,835−4,454−4,105
Of which: IMF liabilities−2,131−2,085−2,008−1,827−1,483−1,086−705−356
Net domestic assets−609−2,415−1,886−2,548−5,575−8,166−11,339−15,609
Net domestic claims−149−2,097−923−1,585−4,612−7,203−10,376−14,646
Net claims on central government−218−2,1516317769691,1711,3471,501
Claims on other sectors3829969696969696
Other items (net)−460−317−963−963−963−963−963−963
Reserve money5,5318,3757,5698,93410,53912,44114,61317,205
Currency outside banks and cash in vaults3,4063,8404,3345,0605,9226,9218,0909,476
Other depository corporation reserves2,1064,5153,2073,8424,5785,4746,4677,661
Liabilities to other sectors1921273339475768
Memorandum items:
Reserve money (end-of-period, annual percent change6.851.4−9.618.018.018.117.517.7
Broad Money (M3) (annual percent change)21.717.918.219.619.919.920.020.3
Credit to the private sector (annual percent change)28.237.010.018.018.220.420.620.7
Velocity (nominal GDP/M3)4.34.14.03.83.63.43.23.0
Money multiplier (M3/reserve money)3.93.14.04.14.14.24.34.4
Credit to the private sector (percent of GDP)12.314.814.314.615.216.217.318.5
Gross foreign exchange reserves of the
Bank of Zambia (millions of U.S. dollars) 22,1672,4572,3682,8713,7044,5005,4656,730
Exchange rate (kwacha per U.S. dollar, end period)5.1175.147
Sources: Zambian authorities; and IMF staff estimates and projections.

End of period.

Unencumbered reserves only

Sources: Zambian authorities; and IMF staff estimates and projections.

End of period.

Unencumbered reserves only

Table 5.Zambia: Balance of Payments, 2011–181(Millions of U.S. dollars, unless otherwise indicated)
20112012201320142015201620172018
Baseline scenarioEst.Proj.
Current account70518−305−159−102−51−1553
Trade balance2,2061,4531,3621,7672,2122,6262,9983,339
Exports, f.o.b.8,6609,41310,84512,75214,55116,40218,31020,390
Of which: copper6,6606,2946,9067,9288,6409,34610,06310,861
Imports, f.o.b−6,454−7,961−9,484−10,985−12,339−13,776−15,313−17,051
Services (net)−724−770−835−964−1,061−1,162−1,266−1,382
Income (net)−1,155−1,119−1,302−1,550−1,807−2,078−2,305−2,461
Of which: interest on public debt−14−36.9−71−177−245−317−397−452
Current transfers (net)378454471589554562558557
Budget support grants1341241187688909089
Sector-wide approach grants122431185131130117109
Private transfers232307322327335342351359
Capital and financial account−4821,267465531,0019241,0541,281
Capital account15117969103151147129117
Project grants15117969103151147129117
External debt cancellation00000000
Financial account−6331,089−234508507779251,164
Foreign direct and portfolio investments1,1812,5461,9703,1313,1353,4093,6113,593
Other investments−1,814−1,457−1,993−2,680−2,285−2,633−2,687−2,430
Public sector (net)3125374275210187217307
Disbursements338241500320376383391400
Of which: budget support315223048464645
Amortization due−26−235−126−45−166−196−175−93
Monetary authority200000000
Commercial banks (net)−208398−60−60−60−60−60−60
Other sectors−1,917−1,860−2,307−2,896−2,436−2,759−2,844−2,677
Errors and omissions−21−558000000
Overall balance202727−2593949008731,0381,333
Financing
Central bank net reserves (- increase)−202−727259−394−900−873−1,038−1,333
Of which: Gross reserve change−228−722274−359−833−796−965−1,265
Of which: Use of Fund resources27−5−15−35−67−77−74−68
Exceptional financing00000000
Financing gap00000000
Memorandum items:
Current account (percent of GDP)3.70.1−1.3−0.6−0.4−0.20.00.1
Current account, excluding grants (percent of GDP)2.9−0.6−2.0−1.6−1.1−0.9−0.6−0.4
Change in copper export volume (percent)0.36.012.013.28.27.57.07.0
Copper export price (U.S. dollars per tonne)8,0037,1366,9907,0897,1407,1857,2307,292
Total official grants (percent of GDP)1.51.61.01.41.31.21.00.8
Gross international reserves32,1672,4572,3682,8713,7044,5005,4656,730
In months of prospective imports2.82.72.32.52.83.13.43.8
Excluding FDI-financed imports3.33.12.62.83.23.53.84.2
GDP (millions of U.S. dollars)19,20420,59022,58625,55328,34131,40734,88238,758
Sources: Zambian authorities; and IMF staff estimates and projections.

Based on a recent Bank of Zambia survey on foreign private investment, the authorities are in the process of revising data for 2012 and the first half of 2013 on FDI inflows and their financing composition (reinvested earnings, borrowing from investors, equity capital). As the authorities were still analyzing this new data at the time the staff report was completed, this data has not been reflected in the tables in this report.

SDR allocation, long-term liability.

Unencumbered reserves only.

Sources: Zambian authorities; and IMF staff estimates and projections.

Based on a recent Bank of Zambia survey on foreign private investment, the authorities are in the process of revising data for 2012 and the first half of 2013 on FDI inflows and their financing composition (reinvested earnings, borrowing from investors, equity capital). As the authorities were still analyzing this new data at the time the staff report was completed, this data has not been reflected in the tables in this report.

SDR allocation, long-term liability.

Unencumbered reserves only.

Table 6.Zambia: Financial Soundness Indicators, 2007–13(Percent, unless otherwise indicated)
2007200820092010201120122013

June
Capital adequacy
Regulatory capital to risk-weighted assets18.618.622.322.119.221.323.3
Tier 1 regulatory capital to risk-weighted assets15.915.718.919.116.819.421.7
Capital to total assets9.29.911.210.410.212.013.0
Asset quality
Past due advances (NPL) to total advances8.87.212.614.810.48.18.2
Loan loss provisions to nonperforming loans73.2104.686.680.376.773.573.2
Bad debt provisions to advances6.46.110.911.98.06.04.7
Loan concentration
Households15.530.130.932.230.834.332.9
Government and parastatals9.11.93.14.64.73.99.3
Agriculture18.416.019.017.617.722.621.1
Mining4.15.04.03.24.25.75.9
Manufacturing11.011.012.012.712.211.311.4
Construction3.74.03.05.84.23.73.6
Services13.39.08.07.07.13.94.3
Others25.023.020.016.919.114.611.5
Earnings and profitability
Return on average assets4.73.62.12.93.73.93.3
Return on equity35.120.89.412.125.520.818.1
Gross interest income to total gross income63.166.665.158.659.361.364.4
Gross noninterest income to total gross income36.933.434.941.440.738.735.6
Net interest margin11.510.410.79.08.18.48.5
Liquidity
Liquid assets to total assets37.635.538.043.840.336.034.9
Liquid assets to total deposits46.049.952.658.553.349.048.1
Advances to deposits ratio57.466.360.153.157.166.065.7
Exposure to foreign currency
Foreign currency loans to total gross loans 1/32.542.136.432.839.128.727.3
Foreign currency liabilities to total liabilities 1/27.135.838.039.639.022.924.7
Net open position in foreign exchange to capital7.16.92.54.15.52.82.2
Source: Bank of Zambia.

Data for 2013 are as of April.

Source: Bank of Zambia.

Data for 2013 are as of April.

Table 7.Zambia: Millennium Development Goals, 2002–10
2002200320042005200620072008 Target
Goal 1: Eradicate extreme poverty and hunger1
Proportion of population living in extreme poverty (%)46535142.329
Poverty gap ratio (incidence X depth of poverty) (%)53342831
Prevalence of underweight under 5 children (%)28.12014.613.311
Goal 2: Achieve universal primary education2
Primary net enrollment ratio (%)77.785.197.0102.093.7100
Pupils reaching grade 7 (%)828391.790.9
Literacy rate for 15–24 year olds (%)7088.7100
Goal 3: Promote gender equality3
Ratio of girls to boys in primary education (%)9597969699100
Ratio of girls to boys in secondary education (%)86898886100
Ratio of literate women to men (15–24 olds) (%)808080100
Share of women employed in the nonagricultural sector (%)
Proportion of seats held by women in national parliament (%)14141411.430
Goal 4: Reduce child mortality4
Under 5 mortality rate (per 1,000)168119.0137.663.6
Infant mortality rate (per 1,000 live births)9570.076.235.7
One - year - olds immunized against measles (%)8484.994100
Goal 5: Improve maternal health5
Maternal mortality ratio (deaths per 100,000 live births)729591.2483162.3
Births attended by skilled personel (%)43.446.544
Contraceptive Prevelance rate (%)18.624.6
Goal 6: Combat HIV/AIDS, malaria, and other diseases6
HIV prevalence rate (%)15.614.3… 16 or less
Proportion of 15 - 24 - year - olds with comprehensive, correct knowledge of HIV & AIDS (%)31.048.040.2
Ratio of school attendance of orphans to non-orphans (10–14 years, %)79.19392
Proportion of population with advanced HIV infection on ART (%)77.680
New malaria cases per 1,000 population388383412358246330255 or less
Malaria fatality rate per 1,000 population48334040293411
Proportion of households with ITNs (pre - or - post treated, %)13.637.853.364.3
Goal 7: Ensure environmental sustainability7
Land covered by forest (%)59.649.9
Land protected to maintain biological diversity (%)39.64141
CO2 emissions (metric tons per capita)0.20.20.217.4^
Consumption of ozone depleting CFCs (ODP MT)106.64.1
Propotion of population using solid fuels (%)83.883.782.9
Goal 8: Develop a Global Partnership for Development8
Official Development as a percentage of GDP4.64.75.93
Source: Millenium Development Goals Progress Report - Zambia - 2013, United Nations Development Programme.

Includes emissions from deforestation and land use change

Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger.

Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-5 mortality rate.

Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water.

Goal 8 targets: Develop further an open, rule-based, predictable, nondiscriminatory trading and financial system. Address the special seeds of the least developed countries. Address the special needs of landlocked countries and small island developing countries.

Source: Millenium Development Goals Progress Report - Zambia - 2013, United Nations Development Programme.

Includes emissions from deforestation and land use change

Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger.

Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-5 mortality rate.

Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water.

Goal 8 targets: Develop further an open, rule-based, predictable, nondiscriminatory trading and financial system. Address the special seeds of the least developed countries. Address the special needs of landlocked countries and small island developing countries.

Figure 1.Zambia: Real Sector Developments

Sources: Zambia, Central Statistics Office; IMF, World Economic Outlook database.

1 Median of Ghana, Kenya, Mauritius, Mozambique, Nigeria, Senegal, Tanzania, and Uganda.

Figure 2.Zambia: Fiscal Developments

(Percent of GDP)

Sources: Zambian authorities and IMF staff estimates.

Figure 3.Zambia: External Developments

Source: Bank of Zambia.

Figure 4.Zambia Banking Sector Developments

Source: Zambian authorities.

Appendix I. Competitiveness 1

Over the last decade, Zambia’s competitiveness has been boosted by strengthened macroeconomic fundamentals and a favorable business environment. However, exports remain dominated by copper, and weaknesses in infrastructure, scarcity of skilled labor and rising labor costs, and recent uncertainty about the policy direction pose challenges to sustaining rapid economic development. To secure continued growth and diversification, Zambia will need to boost investment in infrastructure and enhance provision of education, while maintaining a business friendly environment.

Background

Zambia’s economy has over the past decade expanded rapidly. Overall output growth has been strong at an average of 6.2 percent a year since 2003, about half a percentage point more than for Sub-Saharan Africa (SSA) as a whole. This positive outcome has been supported by prudent macroeconomic policies that kept fiscal balances and inflation in check as well as by rising copper prices that improved the country’s terms of trade.

While exports remain dominated by copper, non-copper exports are now growing rapidly. Increased copper production notwithstanding, the largest contributors to real GDP growth over the past decade have been construction and services. From 2002 and until 2008-10, non-copper exports were declining as a share of both GDP and of total exports. Since 2010, however, growth has started to diversify, with the mainly agricultural non-traditional exports growing in nominal US dollar terms by an average of about 45 percent a year.

Merchandise Exports

(in percent of GDP)

Source: Bank of Zambia.

Sustaining Zambia’s strong overall growth performance in the face of uncertain prospects for copper prices will require that the ongoing diversification of the economy is maintained. That, in turn, will require a supportive business environment and availability of credit and needed human and infrastructure resources. This appendix examines the progress and challenges towards improving the business environment, access to finance, and labor quality and cost. Additionally, the annex considers key issues relating to the agricultural sector, where the majority of the workforce remains employed.

The Business Environment

According to the World Bank’s Doing Business indicators, Zambia’s business environment—although middling from a global perspective—is among the best in Africa.2 At 83rd in the world, Zambia’s doing business ranking is the 7th highest in SSA and in Southern Africa is only surpassed by South Africa and Botswana.3 Moreover, Zambia is 47th worldwide in terms of overall progress since 2005. Zambia performs especially well in areas such as the ease of starting a business, getting credit, and dealing with construction permits. The country also benefits greatly from political stability and a conflict-free setting.

Ease of Doing Business

(distance to frontier, percentage points)

Source: World Bank, Doing Business 2014.

Note: Scores show how far Zambia is from the best performing economy on each indicator, with higher values indicating a smaller gap. Southern Africa is average of Botswana, Lesotho, Namibia, South Africa, Swaziland, Zambia, and Zimbabwe.

Constraints on competitiveness include lacking infrastructure and in some areas high costs of doing business. International trade is expensive (comparable to Rwanda and Uganda), a result of the country being landlocked with weak transport infrastructure. Moreover, a shortage of electricity despite sizable hydropower potential is a major impediment to growth. In addition, a series of recent regulatory changes, including bans on using foreign currency in domestic transactions and new requirements for making international transactions, have added to firms’ costs. Imposed with little prior consultation among stakeholders and in some cases revised multiple times, these new regulations have also raised uncertainty about the policy direction.

Costs of Trade

(US dollars per container)

Source: Doing Business Indicators, World Bank

Efforts towards modernizing transport and energy infrastructure would help ease the structural bottlenecks. Zambia has a fast-growing market for exports to neighboring countries, including for agricultural products, cement, and electricity. If well implemented, the country’s plans to upgrade road, rail, and power infrastructure could provide important support to continued economic development by facilitating trade internationally as well as within Zambia. Calderon (2009) measures the potential growth dividend from infrastructure improvement in Zambia and estimates that bringing the country’s infrastructure to a level comparable to the regional leader (Mauritius) would boost real GDP per capita growth by between 2 and 3½ percentage points.4

Access to Credit, 2012

(in percent)

Sources: National Authorities

Access to Finance

One of the main drivers of Zambia’s improved Doing Business score relates to access to credit. Indeed, according to the World Bank, Zambia is now among the best performing SSA countries in terms of institutions and regulations that facilitate access to credit, reflecting the depth of its credit information infrastructure and good enforcement of contracts. Progress in this area has helped boost overall credit growth to an average of over 30 percent during 2011-12. Notably, the share of credit to sectors such as agriculture and manufacturing—where access to finance is traditionally limited in SSA—is significantly higher than in peer countries. Overall, however, Zambia’s financial depth remains shallow compared to its peers, with credit to the private sector at 15 percent of GDP in 2012, well below the median for lower-middle income countries in the region of 28 percent of GDP.

Foreign financing is another important source of investment funding in Zambia, but inflows have largely been limited to the mining sector. As of 2011, almost 70 percent of Zambia’s $11 billion stock of inward foreign direct investment (FDI) was in the mining sector. These investments have enabled a surge in copper production from an estimated 260 thousand tons in 2000 to current levels of about 800 thousand tons a year. More FDI inflows into other sectors besides mining would support overall growth, as foreign investment not only boosts available resources but also tends to bring know-how and technological improvement.

Zambia: Foreign Direct Investment Stocks by Sector

(billions of US dollars)

Source: Bank of Zambia.

Human Capital and Cost of Labor

Aside from high transport costs and other infrastructure weaknesses, the availability and cost of human capital is an important constraint on Zambia’s competitiveness, even as health and education indictors show considerable progress in recent years. Life expectancy at birth has increased by over 15 percent since 2002; HIV prevalence among adults is on a declining trend; and school enrollment rates have increased markedly. At 6.7 years, average schooling compares favorably within the region: on par with Ghana and exceeding all low-income neighbors in the region and even Namibia, and slightly above the average for countries assessed to have medium human development by the UNDP.

Public Spending on Health

(percent of GDP)

Sources:World Bank and IMF staff estimates

Public Spending on Education

(percent of GDP)

Sources: UNDP, World Bank, and IMF staff estimates

However, there remains significant scope for improvement. Life expectancy is among the lowest in Sub-Saharan Africa, even when compared to lower-income Malawi where HIV prevalence is similar. Access to education and health services remains very limited in rural areas. Water and sanitation conditions remain poor, with only 50 percent of rural population having access to improved water sources. Moreover, even those with access to schooling often receive a substandard education, with Zambian students underperforming in both reading and mathematics compared with their peers in other countries (Hungi and others 2010). This is in part due to an elevated pupil-to-teacher ratio in primary education, which at 61 in 2011 was the highest in the region after the Central African Republic and Chad, as sampled by the World Bank. Teachers are especially scarce in rural areas due to the difficulty of attracting qualified candidates.

High labor costs are another challenge. Labor costs in Zambia have contributed to high levels of informality or self-employment, with wage employment estimated at only 16.8 percent of total employment in 2010 (World Bank, 2013). Based on firm-level data, labor costs in manufacturing at about $2,100 in 2007 were among the highest in SSA, although on par with other regions when viewed in relation to productivity. Since 2007, however, minimum wages in the private sector have increased by about 80 percent in real terms and currently stand at close to $2,600 a year (about 160 percent of GDP per capita) when allowances are included. Moreover, following the recent wage increase for civil servants, the lowest wage in the public sector is now about $6,500 a year—about 4½ times GDP per capita and 2½ times the minimum wage for the private sector—and is bound to put further upward pressure on wages in the private sector.

Labor Costs in Manufacturing

(survey medians, annual, per worker, in 2012 US dollars)

Source: Gelb and others (2013), based on World Bank Enterprise Surveys data.

Notes: Original data converted from 2005 to 2012 prices using US CPI. Unit labor cost is labor cost divided by value added per worker. Regional mean for Sub-Saharan Africa based on countries shown. East Asia and Pacific: Indonesia, Philippines, and Vietnam; Europe and Central Asia: Russia, Turkey, and Ukraine; Latin America: Argentina, Brazil, Chile, Columbia, Mexico, and Uruguay; and South Asia: Bangladesh and India.

Agriculture

A key sector for continued economic development in Zambia is agriculture. While agriculture accounts for 55 to 65 percent of total employment, the sector’s contribution to GDP stands at less than 10 percent. The country is very well endowed for farming, but less than 20 percent of arable land is cultivated and most farmers operate on a subsistence basis with low productivity. Average farm yields, although higher than in many other countries in the region, trail behind South Africa and agricultural exporters in Asia. Key obstacles to development include lack of transportation and market infrastructure, difficulties in obtaining land titles and finance, and policies that have been overly focused on maize to the detriment of crops with higher income potential. With effective efforts to address these constraints, the sector could be a significant source of export earnings and a major driver of poverty reduction.

Cereal Yields

(average 2009-11, kg/hectare)

Source: World Bank, World Development Indicators.

Conclusion

Zambia’s favorable business environment and strong macroeconomic fundamentals have supported high economic growth over the past decade. More recently, there has been rapid progress towards diversifying exports and lessening the country’s dependence on copper. This all speaks to the healthy competitiveness of the Zambian economy. Nevertheless, the country faces significant constraints that will hold back continued growth and diversification unless addressed. These include an inadequate infrastructure, especially in transportation and electricity; poor health and education standards; high labor costs in the formal sector; and low yields in agriculture. These are all areas that are being targeted in the National Development Plan. The challenge will be to ensure that fiscal space is made available for the resulting spending needs and also to ensure that what is spent is effectively used. Careful planning and prioritization is needed, supported by evaluation of implementation capacity, estimates of return on investment, and clear communication.

References

    Calderon, Cesar,2009. “Infrastructure and Growth in Africa.” World Bank, Policy Research Working Paper Series 4914.

    Gelb, Alan, ChristianMeyer, and VijayaRamachandran,2013. “Does Poor Mean Cheap? A Comparative Look at Africa’s Industrial Labor Costs.” Center for Global Development, Working Paper No. 325.

    • Search Google Scholar
    • Export Citation

    Hungi, Njora, DemusMakuwa, KennethRoss, MiokoSaito, StephanieDolata, Frankvan Cappelle, LauraPaviot, and JocelyneVellien,2010. “SACMEQ III Project Results: Pupil Achievement Levels in Reading and Mathematics.” Southern and Eastern Africa Consortium for Monitoring Educational Quality.

    • Search Google Scholar
    • Export Citation

    The World Bank, 2013. Doing Business 2013. World Bank.

    The World Bank, 2013. “Zambia’s Jobs Challenge: Realities on the Ground.” World Bank, Zambia Economic Brief.

Appendix II. Risk Assessment Matrix
Main Sources of RisksLikelihood

(high, medium or low)
Expected Impact on Economy

(high, medium or low)
Delayed fiscal adjustment in ZambiaMedium

The needed fiscal adjustment to address the emerging financing gaps would be delayed until after the next elections in 2016.
High

Given the government’s high funding needs, the failure to contain the wage bill and other recurrent expenditure could reduce needed capital and social spending (which will hurt growth potential and poverty reduction), or crowd out private sector credit, raise interest rates, and prompt currency depreciation (which will hurt growth and generate inflationary pressure).

Public debt would rise rapidly, reducing fiscal buffers.
Loss of investor confidence in the Zambian business environmentLow to Medium

The measures taken recently to tighten regulation of interest rates, together with the increases in minimum and government wages and concern about fiscal sustainability could undermine investor confidence.
Medium to High

Loss of investor confidence could result in a sharp drop in FDI, which will hurt exports, job creation, and growth potential.

Zambia’s funding costs in the global capital markets could rise substantially, resulting in additional debt service costs for the government given its need for substantial external financing.
Re-emergence of financial stress in the Euro areaMedium

Re-emergence of financial stress in the Euro area as a result of stalled or incomplete delivery of national or Euro area policy commitments could lead to strains in cost of market access for peripheral sovereigns.
Medium

Given the emerging fiscal financing gaps, Zambia needs a substantial amount of external financing. A sustained shutdown of global funding markets would put pressure on the domestic government securities market, leading to a rise in interest rates and crowding out private sector credit.
Lower than anticipated growth potential in emerging marketsMedium

Lower demand from emerging markets, especially China, could result in a substantial drop in commodity prices.
Medium

A substantial fall in commodity prices, particularly copper prices, could result in a sharp drop in exports and FDI in the mining sector. Part of the impact would be offset by lower profit and dividend payments to foreign owners.

A deterioration in the current account could weaken the currently low reserve buffer.
Appendix III. A Regional Comparison of Government Wage Spending 1,2

This appendix illustrates how Zambia compares to peer countries in the region on government wage spending.3 The rapid increase in average wages that took place in September 2013 is raising pressures on government finances, potentially crowding out public investment and priority spending in health and education. This appendix also illustrates a few recent examples from countries where public wage spending increased rapidly describing macroeconomic outcomes following such spending and policies that may have helped mitigate the impact of ratcheted wage increases. Finally, the appendix draws implications for Zambia.

Background. The government has increased wages of civil servants by an average of 45 percent following the annual wage negotiations round with the unions. The increase in wages targeted a tripling of the minimum salaries. Even though the wage increase did not take effect until September 2013, wage spending has gone over budget and is expected to reach almost 10 percent of GDP by end year. The result is that Zambia’s wage bill will close in on some of the highest in Sub-Saharan Africa, comparable to Mozambique, Angola, and Cape Verde and about 2.5 percent of GDP higher than the average in Sub-Saharan Africa (SSA). Despite a planned wage freeze in 2014 (both on salaries and net recruitment), the wage bill is expected to reach 11 percent of GDP, reflecting the full year impact of the 2013 wage increase.

Wages in percent of GDP

(2014)

Sources: WEO and IMF staff projections

Wages in percent of Revenues Excluding Grants

(2013 except where noted)

Sources: WEO and IMF staff projections

Fiscal risks and stress are even higher than ratios-to-GDP suggest due to the comparatively weak revenue mobilization in Zambia. The wage bill relative to revenues is expected at 49 percent in 2013 rising to 54 percent in 2014, among the highest in Sub-Saharan Africa and nearly 18 percent higher than the median. Moreover, Zambia’s wage bill will be among the largest in the comparator group relative to its current expenditure, which restricts the scope for financing the wage bill through cuts to other noninvestment expenditure.

Wages in percent of Government Current Expenditure

(2013 except where noted)

Sources: WEO and IMF staff projections

Government wage spending can be a significant contributor to fiscal, and in some cases external, imbalances due to the ratcheting impact of such spending on expenditure. Rising wage spending not only affects fiscal balances, but through rising demand for imports may have repercussion on the external position. Wage commitments are politically difficult to reverse through cutting wages or firing public workers. The following section examines cases from three countries in Sub-Saharan Africa: Angola, Botswana, and Ghana.

Experiences of Peers

The experience of countries in the region that have abruptly raised wage spending over the last five years shows how challenging it is to unwind the impact from such expenditure. This section covers experiences from Angola, Botswana, and Ghana where real wage spending increased significantly (37 percent in 2008 followed by 8 percent in 2009 in Angola; 22 percent in 2010 in Botswana; 45 percent in 2011 followed by 66 percent in 2012 in Ghana).4 These countries raised their wage bill in excess of 1.5 percent of GDP in one year through increased salaries in Botswana and Ghana, and increased recruitment in the case of Angola. Only Angola has managed to reduce the wage burden from peak through containing wages and adjusting the exchange rate, which was further helped by rising oil revenue. All three countries experienced rising fiscal deficits and loss in international reserve coverage following the wage increase with two of the countries, Angola and Ghana, experiencing significant exchange rate depreciation.5

In Angola and Ghana exchange rate depreciation helped to partially mitigate the wage spending increases. In the case of Angola the wage bill increased by 2.5 percent of GDP in 2008, while in Ghana the wage bill increased by 2.7 percent of GDP over 2011-12. The wage bill as a percent of revenue peaked at 32 percent in Angola in 2008 and 66 percent in Ghana in 2012. A ramp up in oil revenue in Angola together with a decline in real wage spending helped reduce this ratio to around 20 percent of revenues in 2010. The exchange rate depreciated in both countries significantly with devaluation in the case of Angola by 22 percent over 2008-10, and by 26 percent in Ghana over 2010-12. While exchange rate depreciation contributed to rising inflation in Angola, it had limited impact on inflation in Ghana where monetary policy tightened significantly. Tightened monetary policy in Ghana raised rates on government bonds, which attracted portfolio inflows and stemmed the decline in gross international reserve coverage from 3.2 to 2.8 months of imports over 2010-12. In Angola, recovering oil prices helped rebuild gross international reserves in 2010 following a sharp decline in 2009 that led to a Stand-By Arrangement with the Fund.

Angola

(percentage)

Source: IMF, World Economic Outlook.

Ghana

(percentage)

Source: IMF, World Economic Outlook.

A multi-year structural wage freeze in Botswana has helped contain the wage bill though its impact was limited by temporary increases in allowances. Botswana established a three-year structural wage freeze in 2009 following a 125 percent cumulative increase in public wages over 2001-09. In the third year, union strikes demanded that the government increase wages by 16 percent. The government settled worker demands by raising wages by 3 percent. However, wage spending as a share of GDP remained persistently high and increased by 2012 due to temporary allowances aimed at the lower end of the wage ladder. The wage bill as a share of revenue declined by a small margin from a peak of 39 percent in 2010 to 35 percent in 2012. Throughout the wage freeze period, international reserve coverage declined significantly from 16 months of imports in 2009 to 11 months of imports by 2012.

Botswana

(percentage)

Source: IMF, World Economic Outlook.

Lessons Learned

Zambia’s adjustment to the wage increase will require significant fiscal and monetary policy tightening. On the fiscal side, revenue mobilization is critical to help alleviate the risks from the elevated wage bill and a multi-year wage freeze is necessary to contain spending. On the monetary side, maintaining tight policies will be necessary to support low inflation and reduce pressures on the currency. Given the currently low international reserve coverage, the authorities would need to abstain from central bank intervention in the foreign exchange market, except to smooth volatility while gradually building up reserves.

A multi-year wage freeze will require clear communication and support from stakeholders and strengthened expenditure controls. Much of the public discontent surrounding the recently announced wage freeze policy is related to disparities in the salary structure and not to public salaries themselves, which are significantly higher than private sector wages. The government needs to highlight the risks stemming from the current wage levels and the need for a wage freeze while reaching an agreement with stakeholders on how to manage current disparities in the civil service salary structure. Following the currently planned wage freeze for 2014-15, multi-year wage negotiations, rather than agreements on a year-by-year basis, would facilitate the efforts at containing the wage bill and would help mitigate political pressures to raise wages in election years. Additionally, wage freeze decisions need to imply controlling not only of base structural salaries, but also of merit increases, allowances, and recruitment. In order to do so, strengthening expenditure controls on salaries and enhancing communication with government agencies on wage and staffing policies will be critical.

Appendix IV. External Stability Assessment 1

Zambia’s real effective exchange rate (REER) has appreciated since the early 2000s, mostly because of the improvement in terms of trade (Figure 1). High copper prices were a major driver of the terms of trade, and copper contributed about three-fourths of export earnings. The depreciation in 2008–09 was mainly driven by a plunge in copper prices associated with the global financial crisis. In 2012, the REER appreciated by 3 percent mainly due to the inflation differential.

Figure 1.Zambia: Real and Nominal Effective Exchange Rate

Sources: IMF Information Notice System and World Economic Outlook.

The standard tools developed by the IMF’s Consultative Group on Exchange Rate (CGER) have been used to assess the Zambian exchange rate. For that purpose, the current account balance presented in the Balance of Payments (Table 5) has been adjusted. The balance of payments for Zambia shows the (mostly foreign-owned) mining companies as keeping a large share of the mining export proceeds abroad. This large financial account outflow is simply the estimated difference between the declared mining related inflows and outflows, conventionally recorded in the financial account instead of in the current account. To better reflect the true impact of the mining related flows on the foreign currency market, and the exchange rate and international reserves, for the purpose of this exercise, these outflows have been reclassified to the current account as additional dividend outflows.2

Under current policies (without fiscal adjustment), there is conflicting evidence of whether the real effective exchange rate is over- or undervalued (Text Table 1). The estimates based on the external sustainability approach suggest an overvaluation of almost 6 percent, consistent with a medium-term projection of 75 percent in the net foreign liabilities ratio. In addition, the macroeconomic balance approach suggests an overvaluation of 8 percent. On the other hand, the real equilibrium exchange rate approach suggests an undervaluation, but that is not statistically significant because the actual REER is within the confidence intervals around the equilibrium real exchange rate (Figure 2). Under an alternative scenario (Text Table 2), where the baseline current account is adjusted with 60 percent of the financial outflows, both the external sustainability and macro-balance approach do not suggest a real exchange rate misalignment.

Text Table 1.Exchange rate assessment: baseline results 1/
ApproachCurrent account/GDPREER
NormUnderlying 2/GapOvervaluation
External sustainability 3/−8.3−10.1−1.85.7
Macroeconomic balance−7.5−10.1−2.68.4
Equilibirum real exchange rate−13.9

Based on IMF CGER methodology and extension by Francis Vitek (IMF 2009, unpublished).

Adjusted current account ratio to GDP (current account under the baseline plus 80% of financial outflows).

Current account norm consistent with a net foreign liability ratio (NFL) of 75 percent. Using a NFL ratio of 80 percent would imply an overvaluation of 3.9 percent.

Based on IMF CGER methodology and extension by Francis Vitek (IMF 2009, unpublished).

Adjusted current account ratio to GDP (current account under the baseline plus 80% of financial outflows).

Current account norm consistent with a net foreign liability ratio (NFL) of 75 percent. Using a NFL ratio of 80 percent would imply an overvaluation of 3.9 percent.

Text Table 2.Exchange rate assessment: alternative scenario results 1/
ApproachCurrent account/GDPREER
NormUnderlying 2/GapOvervaluation
External sustainability 3/−8.3−7.90.4−1.4
Macroeconomic balance−7.5−7.9−0.41.3
Equilibirum real exchange rate−13.9

Based on IMF CGER methodology and extension by Francis Vitek (IMF 2009, unpublished).

Adjusted current account ratio to GDP (current account under the baseline plus 60% of financial outflows).

Current account norm consistent with a net foreign liability ratio (NFL) of 75 percent. Using a NFL ratio of 80 percent would imply an undervaluation of 3.2 percent.

Based on IMF CGER methodology and extension by Francis Vitek (IMF 2009, unpublished).

Adjusted current account ratio to GDP (current account under the baseline plus 60% of financial outflows).

Current account norm consistent with a net foreign liability ratio (NFL) of 75 percent. Using a NFL ratio of 80 percent would imply an undervaluation of 3.2 percent.

Figure 2Equilibrium Real Effective Exchange Rate

Sources: IMF World Economic Outlook and staff estimates.

Appendix V. Lending Rate Ceilings and Their Impact on the Nonbanking Sector 1

1. The authorities are concerned about high lending rates and limited access to credit by SMEs. The financial sector, dominated by the banking sector, has grown steadily and remains profitable. However, despite various measures taken, the authorities believe that lending interest rates in Zambia remain very high, which has limited access to credit by SMEs in particular, given high borrowing costs.

Bank Lending Rate

(In percent)

Sources: Bank of Zambia and Central Statistics Office.

2. In early 2013 the BOZ introduced ceilings on effective annual interest rates for banks, nonbanks and microfinance institutions.2 The ceilings were initially set at 18.25 percent for banks, 30 percent for non-banks, and 42 percent for microfinance institutions, with the levels tied to the BOZ policy rate, which was 9.25 percent at that time.

3. Banks initially indicated that the ceilings were not binding for their customers, except for a few SMEs. However, indications are that the ceiling for micro-finance institutions (MFIs) is particularly binding, as shown by their very high lending rates amounting to over 90 to 120 percent. In addition, the ceiling for banks has likely become more binding, as the spread between Treasury bill rates and the ceiling has declined since the ceiling’s introduction.

Nonbanks’ Lending Rates and Interest Rate Caps(In percent)
NBFI SubsectorAverage

Interest Rates

in Q4 2012
Interest rate

caps
Enterprise-lending MFIs91.442
All other MFIs120.630
Leasing companies42.930
Building societies25.330
Development Bank of Zambia20.630
National Savings and Credit Bank27.030
Source: Bank of Zambia
Source: Bank of Zambia

4. Since the introduction of the lending rate caps, most nonbanks have continued to expand their loan portfolios. Total nonbank loans have thus risen, albeit from a small base, by almost 30 percent from December 2012 to August 2013. The nonbank sector, excluding enterpriselending MFIs, also continued to remain profitable.

5. Some restructuring of the nonbanking sector is underway since the introduction of the ceilings. In response to the declining interest margins, nonbanks, particularly the MFIs, have implemented cost reduction programs, including closing marginal branches, and adjusted their business models to remain viable. Four consumer-lending MFIs decided to exit the financial sector, which could indicate that some inefficient nonbanks are weeded out since the introduction of the lending rate caps. The BOZ, however, has continued to receive MFI license applications this year. The BOZ has asked a foreign NGO (Financial Sector Deepening Africa) to conduct an indepth study of the impact of the lending rate ceilings.

Nonbanks’ Profitability

(Thousands of Kwacha)

Source: Bank of Zambia

1

The wage increases took effect September 1, so the full year effect will only be felt in 2014.

2

In addition, staff strongly supports the proposal to move wage negotiations with civil servants to before, rather than after, budget approval.

3

Under the new PIT tax-free threshold, only about 33 percent of employees in the formal sector are expected to pay income taxes.

4

The deficit could be significantly higher if the increase in nontax revenue falls short of the authorities’ ambitious projections.

5

The baseline in Tables 2 and 3 assumes a fiscal outcome in 2014 based on the authorities’ planned financing. Over the medium term the baseline assumes that the authorities arrive at their medium-term target of raising tax revenue by around 3 percent of GDP over 2014-18 through the measures recommended by staff, and that recurrent expenditures are contained to levels agreed upon during discussions with a gradual increase in capital spending. For this baseline to hold, the authorities would need to identify additional measures to arrive at their targeted deficit.

6

The attached fiscal tables reflect these medium-term fiscal goals. As the authorities have not yet spelled out all policies required to meet these goals, the tables include a line for fiscal measures yet to be taken.

7

Zambia’s maiden sovereign bond issue in September 2012 was a 10-year dollar-denominated bond, in the amount of $750m (initially $500 million). Orders for the offer amounted to some $12 billion, allowing the country to price the bond at a yield of just 5.625 percent.

8

Food comprises 53 percent of Zambia’s consumer price index basket so the BOZ uses headline inflation as its inflation target while monitoring food and non-food inflation developments.

9

The policy rate was introduced in April 2012 to replace reserve money targeting as BOZ’s main monetary policy tool.

10

The interest rate caps were initially set at 18.25 percent for banks, 30 percent for non-banks, and 42 percent for microfinance institutions, with the levels tied to the BoZ policy rate.

11

The capital requirement was increased in 2012 from $2.4 million to $20 million for locally owned banks and to $100 million for foreign-owned banks, but banks have been given to end-2013 to meet the new requirement.

12

The minimum wage law applies to the formal private sector, and sets different minimums for different job categories, including domestics, shopkeepers, and general workers. In the public sector, the lowest wage paid is much higher than specified in the minimum wage law.

1

Prepared by Kareem Ismail and Tobias Rasmussen.

2

As pointed out in an independent evaluation of the Doing Business survey (see www.worldbank.org/ieg/doingbusiness), care should be exercised when interpreting these indicators given subjective interpretation, limited coverage of business constraints, and a small number of informants which tend to overstate the indicators’ coverage and explanatory power.

3

In Doing Business 2014, Zambia’s ranking of 83, compares to 41 for South Africa, 56 for Botswana, 98 for Namibia, 123 for Swaziland, 136 for Lesotho, 170 for Zimbabwe, and an average of 141 for SSA.

4

The study does not specify how long such a growth dividend would last, but by using a linear estimate based on data spanning 1960-2005, the methodology suggests that the effect would persist over possibly several decades.

1

Prepared by Kareem Ismail.

2

Projections and data in this note are IMF staff estimates based on the October 2013 WEO.

3

Comparator countries (see charts) include Angola, Cameron, Cape Verde, Ghana, Kenya, Mozambique, Nigeria, Rwanda, Uganda.

4

For Ghana, the wage bill includes deferred payments associated with transition to the single spine salary structure.

5

In the case of Angola, the decline in international reserves was due to a combination of oil revenue collapse and expansionary policies. Gross international reserves recovered in 2010, but even then net international reserves remained lower than they were in 2008.

1

Prepared by Marco Arena.

2

Based on discussions with the authorities, the estimation is done assuming that 80 percent of the financial outflows are reclassified to the current account. An additional scenario is presented with an adjustment of 60 percent. In this context, the underlying current account would be equal to the baseline current account plus 80 (60) percent of the financial outflows.

1

Prepared by Byung Kyoon Jang.

2

The effective annual interest rate is defined as the total costs of borrowing expressed as an annual percentage rate. The total costs of borrowing are all the costs known to the financial service provider, including interest, commissions and any other kind of fees which the borrower is required to pay in connection with a credit agreement, and any other costs in respect of ancillary services relating to the credit agreement, if the conclusion of a service contract is compulsory in order to obtain the credit or to obtain it on the terms and conditions marketed.

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