Zimbabwe: Selected Issues and Statistical Appendix

The public sector debt stock and interest outlays, particularly related to the domestic debt, rose rapidly in Zimbabwe during the 1990s, suggesting that fiscal policy became unsustainable. The government’s efforts in recent years have reduced fiscal deficits and lowered the level of public debt relative to GDP. The fiscal stance has benefited, however, from other economic policies that themselves are unsustainable. Major policy adjustments will be required in order to address the serious economic imbalances, including high inflation, negative real interest rates, a chronic shortage of foreign exchange in the official market, the absence of productive investments, and negative real growth. As these adjustments are made, the real cost of borrowing will rise, and a tightening of the fiscal stance will be needed to dampen the rising debt-service costs and facilitate the achievement of fiscal sustainability over the medium term.

Abstract

The public sector debt stock and interest outlays, particularly related to the domestic debt, rose rapidly in Zimbabwe during the 1990s, suggesting that fiscal policy became unsustainable. The government’s efforts in recent years have reduced fiscal deficits and lowered the level of public debt relative to GDP. The fiscal stance has benefited, however, from other economic policies that themselves are unsustainable. Major policy adjustments will be required in order to address the serious economic imbalances, including high inflation, negative real interest rates, a chronic shortage of foreign exchange in the official market, the absence of productive investments, and negative real growth. As these adjustments are made, the real cost of borrowing will rise, and a tightening of the fiscal stance will be needed to dampen the rising debt-service costs and facilitate the achievement of fiscal sustainability over the medium term.

IV. Domestic Debt Restructuring and Fiscal Sustainability in Zimbabwe36

A. Debt Sustainability Framework

73. The sustainability of fiscal policies should be considered in an intertemporal framework because current policies will have implications for the future. For example, expansionary fiscal policies of the past will increase the level of public debt and future debt-service obligations. If the real cost of servicing public debt grows faster than output, then the increase in public borrowing will eventually become unsustainable.

74. The concept of fiscal sustainability relates to public debt sustainability because fiscal deficits are financed through borrowing domestically or from abroad. The evaluation of fiscal sustainability requires projecting future tax receipts and expenditures, as well as specifying the environment facing the economy, including the growth rate of output, inflation, and domestic and foreign borrowing costs. A medium-term macroeconomic framework is thus necessary for an assessment of fiscal sustainability.

75. A considerable empirical literature analyzes fiscal sustainability, mainly focusing on domestic debt sustainability.37 The analysis of external debt sustainability has developed separately, especially in the context of the initiative to reduce the debt levels of heavily indebted poor countries (HIPC Initiative) to sustainable levels. While there is no universally agreed upon measure of the sustainability of fiscal policy, it is commonly accepted that fiscal policy becomes unsustainable if current and future fiscal policies result in a persistent and rapid increase in the public debt-to-GDP ratio; therefore, one indicator of sustainability is the debt-to-GDP ratio.38 Early policy adjustment is necessary to achieve debt sustainability because delays will compound the problems and require larger fiscal adjustments (expenditure cuts or tax/revenue increases) in the future. High debt levels also tend to put pressure on interest rates, as creditors demand larger premiums to compensate for higher credit risk; this situation, in turn, will raise the fiscal debt service and reduce the room for policy adjustments to strengthen the fiscal stance.39

76. Using an analytical framework, the government’s budget constraint for period t may be written as follows:

G(t)T(t)+iD(t)BD(t1)+FX(i)iF(t)BF(t1)=ΔBF(t)+FX(t)ΔBF(t)+ΔM(t),(1)

where G = government noninterest expenditure;

T= government (tax and nontax) revenue;

BD = government domestic debt stock;

BF=government foreign debt stock;

M= monetary base;

ΔX(t) = X(t) −X(t−1); and

iD and iF are domestic and foreign interest rates, and FX the exchange rate (local currency per one unit of foreign currency).

The left-hand side of equation (1) defines the overall deficit, which comprises the primary deficit and domestic and foreign interest outlays, and the right-hand side explains how it is financed, including domestic and foreign borrowing, and seigniorage income. Equation (1) holds ex post for any period t.

77. An analysis of public debt sustainability over a longer period of time requires the use of an intertemporal budget constraint, which can be derived by solving equation (1) forward. Period t total public debt, bT, which is the sum of domestic and foreign debt stocks, then becomes the following:40

bT(t)=E(t)δ(t,n)bT(t+n)+E(t)Σj=[0,n]δ(t,j)[z(t+j+1)-d(t+j+1)]+E(t)Σj=[0,n]δ(t,j)bF(t+j)[(1+rD(t+j))/(1+rF(t+j))],(2)

where bT(t) - total public debt as percent of GDP;

E(t) = an expectations operator conditional on information available at time t;

δ(t,n) = ∏i=[0,n]λ(t+i) is a time-varying discount factor n periods ahead adjusted for real GDP growth;

λ(t)=1/(1+rD(t));

rD(t)= domestic real interest rate adjusted for real GDP growth;

rF(t) = foreign real interest rate adjusted for real GDP growth;

z (t) = seigniorage income as a percent of GDP;41

d (t) = primary deficit as percent of GDP;

bF(t) = foreign debt stock as percent of GDP; and

e (t) = the rate of exchange rate depreciation.42

The first term on the right-hand side represents the expected present value of the total public debt at time t + n. As n approaches infinity, this term becomes zero. The second term specifies the sum of all future seigniorage income and primary balances discounted at a time-varying real interest rate, and the third term is the net present value of current and expected future foreign debt-service costs, which depends on domestic and foreign real interest rates.

78. Equation (2) implies that a country cannot borrow indefinitely because this behavior will lead to rising debt levels unless the real cost of borrowing is less than the growth rate of real output. If the latter holds, then there will be a finite debt-to-GDP ratio for any period t corresponding to a finite primary deficit. A country can thus “grow out of its public debt.” If the real cost of borrowing rises faster than output, the debt-to-GDP ratio will rise, and fiscal policies will need to be adjusted to achieve a sustainable fiscal position. The discount factor, 5, which depends on the domestic real interest rate, rD, plays an important role and influences the net present value of future public debt. For example, a small discount factor will reflect high future real interest rate or slow real growth, and reduce the net present value of future debt.

79. Foreign borrowing can play an important role in an intertemporal fiscal adjustment to achieve sustainability. As the third term of equation (2) suggests, foreign borrowing can be used to offset primary deficits if the real cost of foreign borrowing is lower than the real cost of domestic borrowing. That is, access to external resources could assist the government in maintaining a level of spending while improving fiscal sustainability. If debt ratios are very high, it might be difficult to achieve fiscal sustainability through fiscal adjustment alone. The HIPC Initiative recognizes this and is reducing the external debt of beneficiary countries to levels they can service without further recourse to debt relief.43

B. Sustainability of Fiscal Policies in Zimbabwe

Fiscal Policies and Debt Developments in the 1990s

80. The central government’s fiscal position in Zimbabwe was relatively stable throughout the 1990s, as the primary deficit averaged about 1 percent of GDP with relatively little variation in the yearly outcome (Table IV.1). Domestic real interest rates, after adjusting for real GDP growth, were close to zero and were not a significant source of risk to fiscal stability (Figure IV.l). Overall borrowing requirements ranged between 5 and 10 percent of GDP, and were met mostly by domestic bank and nonbank financing. Zimbabwe received significant foreign financing and grants, in particular in the early 1990s, related to the Fund-supported adjustment program of 1992; but foreign financing and grants became very small in the second half of the decade (Figure IV.2). Privatization from 1995/96 yielded less than 1 percent of GDP in most years. The ratio of total public debt to nominal GDP, comprising domestic and foreign debt, was in the 60–80 percent of GDP range until the end of the decade (Table IV.1).

Table IV. 1

Zimbabwe: Central Government Debt and Debt-Service Payments, 1990/91–2002 1/

article image
Source: Zimbabwean authorities and staff estimates.

Fiscal years July-June through 1996/97; 1997/98 covers the 18-month period July 1997-December 1998. Annual thereafter.

Outstanding debt at the end of the fiscal year.

Refers to debt at the end of the year. The initial amount of debt assumed as of January 1995 (Z$3974 million) Included banker acceptance comprising an element of Interest subsequently paid during January-June 1995.

External debt may differ according to treatment of certain publicly guaranteed debts. Discrepancies with Statistical Appendix Tables 15 and 17 relate to different data sources.

Medium- and long-term debt.

End-calendar year basis (including arrears). In millions of U.S. dollars.

Nominal U.S. dollar GDP adjusted for real growth and International Inflation (1996 base year).

Figure IV.1:
Figure IV.1:

Indicators of Fiscal Sustainability

(percent)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

81. In the late 1990s, public sector financing increasingly shifted toward domestic credits as access to foreign financing, official and private, was lost, reflecting faltering investor confidence in Zimbabwe’s economy and the deterioration in the government’s fiscal stance (Figure IV.2); the government also began to accumulate external payment arrears in 1999. The fiscal stance weakened considerably in 2000 when the primary deficit swelled to 5½ percent of GDP. The Reserve Bank of Zimbabwe (RBZ) attempted to contain the inflationary effects of the loose fiscal stance, and as a result domestic interest rates rose sharply.44 The government’s debt-service cost increased to 1/3 of total expenditure in 2000, compared with 14 percent at the beginning of the 1990s (or to 18 percent of GDP in 2000 from 5 percent in 1990/91). This pushed the government’s financing need up to 23 percent of GDP in 2000, and the debt stock to a high of 114 percent of GDP.

Figure IV.2:
Figure IV.2:

Foreign Debt Financing, Foreign Grants, and Privatization Proceeds

(percent of GDP)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

82. As a result, Zimbabwe’s domestic borrowing became increasingly short term: the share of three-month treasury bills in total domestic debt rose from 12 percent in 1991/92 to 95 percent in 2000 (Table IV.1 and Figure IV.3).45 These factors, combined with an absence of foreign financing of the budget deficit, resulted in a rapid increase in the domestic debt stock in 2000. Using equation (2), persistent large primary deficits, combined with high real interest rates, would have led to a situation where the fiscal policy would have become unsustainable. The risk of losing control over fiscal policy, together with the fall in real output, contributed to the end-2000 turnaround.

Figure IV.3:
Figure IV.3:

Composition of Domestic Debt

(In percent of total domestic debt)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

Restructuring of Government Domestic Debt in early 2001

83. In the November 2000 budget statement, the government announced the restructuring of its domestic debt (Figure IV.4) such that at least 30 percent of the domestic debt stock would be in medium- and long-term securities in 2001 (with maturities of longer than one year). In order to achieve this goal, it would begin enforcing the portfolio requirement, namely, that at least 45 percent of non-deposit-taking financial institutions’ assets be held in long-term paper. This requirement had not been enforced owing to the lack of long-term securities.

Figure IV.4:
Figure IV.4:

Government Debt

(In percent of GDP)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

84. In January 2001, the government did not roll over but instead paid out its maturing three-month treasury bills. To do this, it resorted to RBZ net credit, which rose from Z$4.6 billion at end-2000 to ZS15 billion in January 2001. This liquidity injection (equivalent to 50 percent of end-2000 reserve money) resulted in a collapse of nominal interest rates: the yield on the three-month treasury bills fell from 72 percent at end-2000 to 39 percent in January 2001. Interest rates became highly negative in real terms (Figure IV.5). The government restricted the issuance of three-month treasury bills in subsequent months and increased the use of RBZ overdrafts through September, when net credit from the RBZ reached Z$27 billion, or 135 percent of end-2000 reserve money. Contrary to earlier years, the rise in RBZ net credit to the government was the primary factor behind the growth of reserve money and the surge in inflation in 2001.

Figure IV.5:
Figure IV.5:

Real and Nominal Three-month Treasury Bill Interest Rate

(In annual percent)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

85. At the same time, the government lengthened the maturity of its debt. In 2001, it issued 27 percent of its treasury bills with maturities of one to two years. This ratio was increased to 85 percent in 2002, raising the share of longer-term debt in total domestic debt from 6 percent at end-2000 to 35 percent at end-2001 and to 86 percent at end-2002. The government indicated that it intended to maintain the share of long-term domestic debt at about that level.

86. The government’s debt restructuring and the subsequent implementation of loose monetary policies kept nominal interest rates low and reduced the domestic borrowing costs to the budget markedly. The share of domestic interest outlays in total expenditure fell from 1/3 in 2000 to 12 percent in 2002, while the ratio of domestic debt to GDP declined from 52 percent to 36 percent over the same period, reflecting the erosion of the real value of debt in an environment of negative real interest rates. The reduction in interest costs, together with the reduction in real government spending during 2001–02 (through the compression of real wages and other expenditure outlays), reduced the government’s domestic borrowing requirement from about 20 percent of GDP in 2000 to 4 percent in 2002.

Implications and Sustain ability Outlook

87. The debt restructuring led to a widening of imbalances in the economy. The RBZ’s accommodative stance in early 2001 and subsequent provision of liquidity to the economy through special facilities46 kept interest rates low in nominal terms, and they grew increasingly negative in real terms. This response increased the demand for goods, pushed up their prices, and put pressure on the parallel market exchange rate. In conjunction with a drought-related increase in food prices, this raised inflation from 55 percent at end-2000 to 228 percent in the year to March 2003. Increasingly negative real interest rates have fueled demand for credit, not to fund productive investments but to finance consumption and speculative investments.47

88. Negative real interest rates also have had a significant adverse impact on the level of household savings, as they have eroded deposits with the banking system (the deposit base declined by about 20 percent during 2001–02, when adjusted for inflation). They also damaged the financial viability of institutional investors: pension funds and life insurance companies, which are required to hold government securities, have witnessed the erosion of the real value of their financial assets by inflation, as the income earned from them has been reduced significantly, putting at risk the future solvency of these institutions. The low interest rates have resulted in a redistribution of wealth from net creditors to net debtors, which contributed to a significant decline in national savings, from 9 percent of GDP in 1999 to -4 and -2 percent in 2001 and 2002, respectively.

89. The government has significant contingent obligations. The debt stock of public enterprises is mostly guaranteed by the central government, and given the weak finances of most enterprises, the guarantees may well be called. Several public enterprises have sizable external debts. This will make the consolidation of the government’s position more difficult. The situation of domestic financial institutions is also precarious. Pension funds and life insurance companies, in particular, have been adversely affected by the low interest rate policy. This could give rise to potential future liabilities for the central government.

90. In order to address the serious imbalances in Zimbabwe’s economy and put it back on a sustainable path, a tightening of financial policies will be required. However, monetary tightening will raise real interest rates, which, in turn, will adversely affect the cost of domestic debt to the government. The effect of the rise in interest outlays will be cushioned by the large share of domestic debt at fixed interest rates and the sizable portion of treasury bill debt that has been issued at longer maturities. Fiscal policy will need to support economic stabilization and the government will not be able to finance its fiscal deficits through significant seigniorage income. At the same time, in light of the collapse of real activity in Zimbabwe and the extensive need to provide services in the key social areas, in particular health and education, together with the cost of land reform and the limits on the government’s ability to raise revenues, the budget will continue to be under pressure. The intertemporal budget constraint (equation 2) indicates that, in the absence of access to foreign financing, the domestic debt stock could rise again—albeit from a relatively low level—unless the fiscal deficit is contained. In order to offset the rising real cost of domestic borrowing, the government will need to run primary surpluses in the future to stabilize the domestic debt stock. A return to positive real growth in the economy will cushion the effect of the increase in the real cost of domestic borrowing.

91. Zimbabwe is facing a looming foreign debt problem. The overvalued official exchange rate is reflected in the decline in the external debt-to-GDP ratio from 62 percent in 2000 to 20 percent in 2002, notwithstanding the build-up of external payments arrears.48 When measured as a percent of GDP at world prices, the government’s external debt stock rose from 41 percent in 2000 to 53 percent in 2002 (Table IV.1) in part as a result of the continuing contraction of real GDP. The accumulation of external payment arrears became the main source of net foreign financing during 2000–2; grant financing to the budget, mainly for humanitarian causes, continued to decline. Reflecting the sharp decline in exports, the government’s external debt/export ratio reached a level of 230 percent by 2002 (Figure IV.6).49 This increase in the foreign debt level will need to be addressed. In equation (2), debt sustainability can be achieved through a reduction in the foreign debt-service costs or an improvement in the primary balance. The latter alone may not be sufficient as foreign debt service costs are likely to rise. For example, the clearance of Zimbabwe’s external payments arrears itself and the unavoidable subsequent increase in cash outlays for foreign debt service will put further pressure on the cash budget.50 A restructuring of Zimbabwe’s foreign debt, possibly including debt reduction, will eventually be needed in order to bring the country’s external debt to a manageable level.

Figure IV.6:
Figure IV.6:

Ratio of Public External Debt to Exports of Goods and Services

(In percent)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

Sensitivity tests

92. The sustainability of the fiscal stance is sensitive to the government’s ability to contain current non-interest expenditure and changes in the macroeconomic environment In order to gauge how these components would impact the level of public debt, we considered the main risks to stabilization, which relate to the authorities’ ability to bring real interest rates down, how quickly conditions for the return of positive real growth can be established, and what would be the consequences if the government cannot improve its primary balance sufficiently:51

  • i. Reflecting a lack of confidence in the authorities’ stabilization policies, we assume that real interest rates would be one standard deviation higher in each year during 2003–8 (i.e., 6 percentage points);

  • ii. An increase in the primary deficit by one standard deviation in each year during 2003–8 resulting from higher spending on goods and services (i.e., 1.9 percent of GDP); and

  • iii. Reflecting a delay in the return to positive real growth, we assume that real growth would be lower by one standard deviation in each year during 2003–4 (i.e., 5 percent lower than the baseline), and would return to the baseline in 2005.

93. While each of these shocks will increase domestic borrowing, their effects are not identical. The results further suggest that relatively limited shocks can have substantial impacts on the debt levels when they occur simultaneously (Figure IV.7). A shock to the real interest rate (i.e., an increase in real interest rates) has a relatively small impact on the debt levels as the projected rise in the domestic debt stock will be higher by about 9 percent of GDP in 2008 relative to the baseline. A decline in real growth in the early years of stabilization or a larger primary deficit throughout the medium-term has a much larger impact on the domestic debt stock, increasing it by about 17 percent of GDP respectively in 2008 relative to baseline. This points to the importance of implementing economic policies that would put the economy back on a sustainable path of positive real growth as soon as feasible, and also suggests that the cost of failing to curtail non-interest spending would lead to higher borrowing over the time. As noted earlier, foreign grant financing would help mitigate the impact of higher spending on the fiscal finances. Finally, a combination of these shocks would increase domestic debt by about 50 percent of GDP over the medium term relative to baseline, bringing the stock of domestic debt to 84 percent of GDP in 2008.

Figure IV.7:
Figure IV.7:

Impact of Shocks on Domestic Debt

(Deviation from baseline; percent of GDP)

Citation: IMF Staff Country Reports 2003, 225; 10.5089/9781451841480.002.A004

36

Prepared by Arto Kovanen and Louis Erasmus.

37

With efficient capital markets and capital mobility, the distinction between domestic and foreign debt will not matter for the analysis.

38

The Maastricht Treaty specifies that European Union countries wishing to participate in the European Monetary Union should not have public debt levels that exceed 60 percent of their national GDP. Another commonly used external debt indicator is the debt service-to-exports ratio.

39

An increase in the debt-to-GDP ratio will also affect real interest rates by crowding out private sector credits. See Paul Masson, “The Sustainability of Fiscal Deficits,” Staff Papers, International Monetary Fund, Vol. 32 (December 1985), pp. 577–605.

40

Studies often focus on either domestic debt sustainability or external debt sustainability. A study by Sebastian Edwards, entitled “Debt Relief and Fiscal Sustainability,” NBER Working Paper No. 8939 (Cambridge, Massachusetts: National Bureau of Economic Research, 2002), analyzes the aggregate debt of the public sector.

41

Seigniorage is defined as revenue raised by printing money and can be measured by the change in the real stock of money balances (see, for example, Abdessatar Ouanes and Subhash Thakur, Macroeconomic Accounting and Analysis in Transition Economies Washington: International Monetary Fund, 1977). This can be decomposed into pure seigniorage, which is the change in real cash balances, and inflation tax, which is seigniorage received by the government from the expansion of reserve money.

42

For additional information about the derivation of an intertemporal budget constraint, see Merih Uctum and Michael Wickens, “Debt and Deficit Ceilings, and Sustainability of Fiscal Policies: An Intertemporal Analysis,” Oxford Bulleting of Economics and Statistics, Vol. 62, (May 2000), pp. 197–222. Equation (2) is the so-called transversality condition.

43

For an analysis of external debt sustainability, see, for instance, Kausik Chaudhuri and Ning S. Zhu, “External Debt Sustainability: Theory and Application to Heavily Indebted Poor Countries,” Albany Discussion Papers, No. 98–01 (Albany, New York: State University of New York at Albany, 1998.

44

This led to a severe crowding out of the private sector—credit to the private sector in real terms declined in 1999 and 2000 by 30 percent and 10 percent, respectively.

45

All treasury bills at end-2000 had maturities of less than one year.

46

These comprise on-lending at highly subsidized interest rates to exporters and key domestic productive sectors, and special exchange rates for gold and tobacco exporters.

47

Gross fixed investment to GDP declined from 15 percent in 2000 to an estimated ½ of 1 percent in 2002.

48

Arrears on interest obligations reflect forced foreign financing, and have reduced the domestic financing needs of the government.

49

Under the HIPC Initiative, a beneficiary country obtains debt forgiveness to reduce its net present value of external debt to 150 percent of its exports (or, in some cases, 250 percent of government revenue).

50

At the same time, a renewed access to foreign financing, especially grants, would alleviate budget pressures.

51

Standard deviations are calculated for the pre-crisis period, that is 1990/91–1999. We only focus on domestic debt while holding foreign borrowing constant.

Zimbabwe: Selected Issues and Statistical Appendix
Author: International Monetary Fund
  • View in gallery

    Indicators of Fiscal Sustainability

    (percent)

  • View in gallery

    Foreign Debt Financing, Foreign Grants, and Privatization Proceeds

    (percent of GDP)

  • View in gallery

    Composition of Domestic Debt

    (In percent of total domestic debt)

  • View in gallery

    Government Debt

    (In percent of GDP)

  • View in gallery

    Real and Nominal Three-month Treasury Bill Interest Rate

    (In annual percent)

  • View in gallery

    Ratio of Public External Debt to Exports of Goods and Services

    (In percent)

  • View in gallery

    Impact of Shocks on Domestic Debt

    (Deviation from baseline; percent of GDP)