This paper examines Zambia’s 2003 Article IV Consultation and Ex Post Assessment of Performance Under IMF-Supported Programs. Zambia’s economic performance has improved significantly in the last four years. After more than two decades of economic decline and inflation averaging more than 50 percent, growth has averaged about 4 percent per year since 2000. The Ex Post Assessment of Performance under IMF-supported programs pointed out that implementation under the Enhanced Structural Adjustment Facility arrangement, approved in 1995, was poor, but generally improved under the Poverty Reduction and Growth Facility arrangement, approved in 1999.

Abstract

This paper examines Zambia’s 2003 Article IV Consultation and Ex Post Assessment of Performance Under IMF-Supported Programs. Zambia’s economic performance has improved significantly in the last four years. After more than two decades of economic decline and inflation averaging more than 50 percent, growth has averaged about 4 percent per year since 2000. The Ex Post Assessment of Performance under IMF-supported programs pointed out that implementation under the Enhanced Structural Adjustment Facility arrangement, approved in 1995, was poor, but generally improved under the Poverty Reduction and Growth Facility arrangement, approved in 1999.

I. Introduction

1. This paper seeks to assess Zambia’s progress in implementing economic reforms supported by Enhanced Structural Adjustment Facility (ESAF) and Poverty Reduction and Growth Facility (PRGF) arrangements since 1995 and draws lessons for a possible successor arrangement. Section II briefly presents economic developments prior to these arrangements, including economic deregulation and reform in the early 1990s. Section III reviews the performance and progress under the two arrangements in the period 1996 to 2002. Section IV draws some lessons from these program experiences and considers the main challenges facing Zambia. Section V discusses the role the Fund could play in helping the authorities to meet those challenges.

II. Background

2. From the mid-1970s onwards, Zambia’s formerly strong mining-based economy suffered more than two decades of decline. In the first decade following independence in 1964, a strategy of import-substituting industrialization and state ownership was initially supported by copper revenues, which provided almost all export earnings and about half of GDP. However, after the oil price shocks of the 1970s, which also marked the beginning of a long-term decline in real copper prices, Zambia took on large external debts and resorted to an array of exchange and trade controls rather than a restructuring of the economy. During the 1980s, attempts to reform the economy to support diversification away from the failed policy of state-led industrialization were subject to frequent reversals. Large-scale borrowing, including under Fund-supported programs, was not matched by sufficiently strong adjustment efforts and Zambia fell into arrears to the Fund in the mid-1980s. Mounting losses in the enterprise sector contributed to a sharp acceleration in inflation in the second half of the 1980s. By 1990, nominal per capita GDP had fallen to US$450, about half its level 20 years earlier.

3. The elections of 1991 and the return to a multiparty political system provided the opportunity for Zambia to embark on a more concerted reform effort. Under a rights accumulation program (RAP) covering the period 1992-95, the Zambian authorities implemented extensive market-oriented reforms. Prices were liberalized, interest rates were decontrolled, and the kwacha was allowed to float. By 1994, virtually all exchange controls on current and capital transactions had been removed. Quantitative controls on imports and exports were removed in 1992, and the levels and dispersion of customs duties were reduced. The privatization process also took on greater vigor following the passage of the Privatization Act in 1992 and the establishment of the Zambia Privatization Agency (ZPA). Starting from a highly adverse position—inflation reached 180 percent at the end of 1992—some progress was also made toward macroeconomic stabilization. However, in part reflecting the large continuing losses of Zambia Consolidated Copper Mines (ZCCM), the parastatal which dominated the mining sector, monetary expansion remained excessive, and inflation was above 40 percent in both 1994 and 1995. The ZCCM’s inefficient operations were also a severe drag on mining sector output, which declined by more than 10 percent per year in the four years to 1995. Real GDP contracted by an average of 2.3 percent per year over the same period.

III. Developments Under ESAF-and PRGF-Supported Programs, 1996-2002

A. Goals of the Programs

4. Since the conclusion of the RAP, Zambia has had two arrangements with the Fund. In December 1995, the Executive Board approved a three-year ESAF arrangement in the amount of SDR 701.7 million (193 percent of quota), of which SDR 661.7 was made available immediately after Zambia cleared its overdue obligations to the Fund (Figure 1). In March 1999, the Executive Board approved a three-year PRGF arrangement. Access under this arrangement was, at 52 percent of quota, lower than the norm for second-time users in recognition of Zambia’s high level of outstanding obligations to the Fund.

Figure 1.
Figure 1.

Zambia: Transactions with the Fund, 1970-2005 1/

(In millions of SDR)

Citation: IMF Staff Country Reports 2004, 214; 10.5089/9781451921601.002.A002

1/ Excludes bridge loan operation in 1995 -- purchase and repayment of SDR 652 million.

5. The program supported by a three-year ESAF arrangement approved in 1995, was designed to reverse the economic decline through the strengthening of market-oriented reforms, more efficient use of resources by the public sector, the cessation of inflationary financing, and restoration of normal relations with the international financial community. Structural reforms aimed to strengthen the banking system, continue the privatization program (particularly the ZCCM), reform the civil service, and complete the government’s withdrawal from agricultural finance and marketing.

6. The PRGF-supported program again sought to bolster economic growth and reduce inflation to single digits. Faster growth and improved provision of social services was intended to support progress towards the poverty reduction goals of the government’s interim-strategy paper endorsed by the Board in July 2000, and the PRSP, endorsed in May 2002. The effectiveness of monetary policy was to be supported by fiscal tightening, a broadening of the use of indirect monetary instruments, including open market operations, and strengthened liquidity management. The program aimed to strengthen the role of the private sector by privatizing the ZCCM (whose debt obligations had reached 16 percent of GDP), and by privatizing telecommunications and electricity utilities, financial institutions, and the petroleum sector. The program also sought to improve governance.

B. Compliance with Program Conditionality

7. Program implementation under the ESAF arrangement was poor, but generally improved under the PRGF arrangement. Shortly after Board approval, key performance criteria (PCs) for end-December 1995 were missed. Satisfactory performance under a staff-monitored program (SMP) allowed the delayed completion of a midyear review in March 1997, but no further reviews were completed and the ESAF arrangement expired in December 1998. Implementation under the subsequent PRGF arrangement initially faltered, and key performance criteria in 1999 were missed as a result of shortfalls in donor support, delays in the privatization of the ZCCM, and inadequate progress in civil service reform. However, performance improved markedly thereafter; the arrangement was extended by 12 months and expired in March 2003, with five of the six reviews completed. The sixth review was not completed because of delays in privatizing the Zambia National Commercial Bank (ZNCB).

8. The monitoring framework for programs supported by ESAF/PRGF arrangements included quarterly quantitative and structural PCs and benchmarks, with semiannual reviews. Under the ESAF arrangement, six out of ten PCs for end-December 1995 were not observed. In 1999, few quantitative PCs were met under the PRGF arrangement (two out of nine for March and June 1999 and only one in September and December 1999), and none of the structural PCs were observed. Performance improved substantially in 2000 (all quantitative and structural criteria for September 2000 were observed and seven out of the ten for December). Results were again mixed in 2001 when all structural PCs were observed, but only three of the seven quantitative PCs were met for March and September. In 2002, virtually all quantitative and structural performance criteria were observed for March, June, September, and December.

9. Conditions set under the two arrangements were broadly within the Fund’s core areas of responsibility. Under the ESAF arrangement, structural PCs and benchmarks were largely restricted to issues that have a direct bearing on macroeconomic stability. The large fiscal losses and large financial sector risks posed by the ZCCM and ZNCB justified increased monitoring. Under the ESAF arrangement, the average number of structural conditions per year was low (Table 1) because few were set while the program was off track. Under the PRGF arrangement, the number of structural conditions was in line with other PRGF arrangements, except for the lack of prior actions in the Zambian program. The distribution of conditions was also comparable to the average for all ESAF- and PRGF-programs, with heavy emphasis on conditions in the fiscal and financial areas (Table 2). The major difference between the profile for Zambia and for other countries was that measures associated with privatization and with governance were given greater weight in Zambia. This was appropriate given the importance of these issues for budgetary performance.

Table 1.

Zambia: Program Conditions Versus Other ESAF/PRGF Arrangements

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Source: Staff estimates.
Table 2.

Zambia: Percent Distribution of Conditions Across Standard Areas

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C. Attainment of Program Objectives

10. Economic performance improved under the two arrangements but fell short of program objectives (Table 3 and Figure 2). During the period 1996-98, growth averaged 2.7 percent, sharply above the average of -2.3 percent in 1992-95 but well below the original program target of 6 percent per year. Under the PRGF arrangement, and despite a severe drought in 2002, Zambia recorded its strongest period of sustained expansion in three decades, with growth averaging 3.5 percent in 1999-2002, compared with the targeted increase of 4-5 percent per annum. Similarly, inflation remained well above the original program targets—which called for a decline to 4 percent per annum over both three-year periods—but still slowed sharply from an average of almost 100 percent per year in the period 1992-95 to average 28 percent in 1995-98 and 24 percent in 1999-2002.

Figure 2.
Figure 2.

Zambia: Performance Under the ESAF/PRGF-Supported Programs, 1995-2002 1/

Citation: IMF Staff Country Reports 2004, 214; 10.5089/9781451921601.002.A002

Sources: IMF staff reports; and Zambian authorities.1/ Owing to delays in completing the first annual review, the Board approved an extension of the 1999 PRGF-supported program through March 28, 2003.2/ ESAF-supported program during 1995-98, PRGF-supported program during 1999-2002.3/ Based on last revised annual program targets and projections.

11. Progress toward macroeconomic stabilization was hampered by both exogenous shocks—including a persistent decline in copper prices and droughts—and slippages in implementation. Revenue performance remained relatively strong by regional standards and was generally in line with program expectations. However, continued delays in the privatization of the ZCCM adversely affected implementation, particularly when the fall in copper prices accentuated operating losses, and led a revision of subsequent annual program targets. Under the ESAF-supported program, central government’s fiscal deficit was broadly in line with the program until 1998. However, the financing of ZCCM’s losses through quasi-fiscal operations contributed to excessive monetary expansion in this period. The original fiscal targets of the PRGF-supported program were substantially relaxed, particularly in 2000, to take account of operating losses in ZCCM. The privatization of the ZCCM then paved the way for the pursuit of a more coherent macroeconomic framework. However, weaknesses in expenditure policy and management continued to hamper fiscal policy implementation. Thus, recourse to domestic financing typically exceeded program targets, complicating the implementation of monetary policy and contributing to a slower decline in inflation and to upward pressure on real interest rates.

12. The government wage bill has increasingly been a source of fiscal slippages. The public service reform program launched in 1998 included the separation of over 15,000 contractual workers and reduced the public service from 139,000 to 104,000. However, by 2002, the total had risen again to around 120,000.19 Pay reform initiatives launched with the support of the World Bank have, since 2001, focused on decompressing the wage structure and rationalizing cash and noncash allowances. Progress in these areas has been incomplete and fragmented; some decompression was implemented in 2003, but the government failed to reform the system of allowances and allowed total costs to substantially exceed the agreed resource envelope. As a result of the larger payroll and average wage increases, the wage bill rose sharply from 5.6 percent of GDP in 1996 to 8.5 percent of GDP in 2003. At this level, the wage bill now accounts for 47 percent of domestic revenues and is also high by regional standards. The expansion in the wage bill has, together with a rapidly increased burden of domestic interest payments, crowded out domestic capital expenditures, including poverty-reducing spending.

13. Despite some progress, the overall reform effort in public expenditure management under both programs was slow. 20 Procedures for budget preparation and expenditure control remain weak, despite sustained technical assistance efforts in this area. A strengthened commitment control system, which was not implemented until early 2003, has slowed the accumulation of arrears, but enforcement of sanctions against over commitment and the veering of funds between budget subheads remains inadequate. A comprehensive database of outstanding bills was completed only in June 2003, and the preparation of a plan for settling domestic arrears was delayed.

14. Despite the difficulties implied by fiscal slippages, progress was made in strengthening monetary policy implementation. The effectiveness of the Bank of Zambia’s (BoZ’s) monetary operations was improved by greater use of new indirect instruments, improvements in the treasury bill market, the introduction of repurchase agreements, and steps to improve liquidity management. Progress was also made in financial sector reforms including strengthening the regulatory framework. However, there were persistent delays in moving forward with privatization of the troubled ZNCB. The Financial System Assessment Program (FSAP) prepared jointly with the World Bank in 2002 identified several weaknesses, including a low level of financial intermediation, weaknesses in central bank independence, absence of small and medium-sized enterprise financing, immediate threats posed by insolvent public nonbank financial institutions, and the pressing problem of high interest rates fueled by domestic government borrowing.

15. Zambia’s open and liberal trade and exchange regime and a flexible exchange rate have supported economic diversification. Large tariff reductions reduced the simple average import duty from 27 percent in 1994 to 19 percent in 1996. The trade-weighted average tariff rate subsequently declined from 16 percent in 1996 to 11.5 percent in 2003 as a result of the removal of a 5 percent import declaration fee, a reduction in the maximum tariff to 20 percent, and reclassification of some goods into lower tariff brackets. Improvements in the exchange system included the successful introduction of an interbank foreign exchange market in July 2003 and the cessation of central bank foreign exchange auctions. In the 1990s and into the early part of this decade, the real effective exchange rate has fluctuated around a trend of moderate appreciation, despite the weakening of the terms of trade stemming from lower copper prices. This outcome in part reflects the impact of rising real interest rates. For example, a sharp upwards movement in the real effective rate in 2001 coincided with an increase in domestic interest rates, as well as the sharp depreciation of the South African rand. However, the real effective exchange rate has since moderated significantly and there is little indication that the trend of gradual appreciation has adversely affected competitiveness. Nonmining exports expanded under the PRGF arrangement and sustained growth in nonmining GDP, especially agriculture, contributed importantly to the overall gains in economic growth.

16. External viability has yet to be achieved. Satisfactory implementation of the PRGF-supported program allowed Zambia to reach the decision point under the enhanced Initiative for Heavily Indebted Poor Countries (HIPC Initiative) in December 2000. However, following the expiry of the PRGF arrangement in March 2003, Board consideration of a new PRGF arrangement was precluded by a large projected wage overrun, and a staff monitored program covering July-December 2003 also went off track, due mainly to large unbudgeted expenditures. These delays in moving to a new PRGF arrangement have also postponed attainment of the completion point under the HIPC Initiative, which will be key to restoring external sustainability. Exceptional front-loading of HIPC Initiative relief from the Fund was provided in the interim period to reduce cash debt service payments to the Fund. Zambia’s gross reserves recovered to more than two months of imports at the end of 2002, but declined to about half this level at the end of December 2003.

17. The privatization program accelerated between 1995-97 after the restructuring of the ZPA in 1995, but subsequently lost momentum. 21 By end-2002, 254 out of 280 parastatals under the ZPA were privatized through a relatively transparent and competitive tendering process. However, privatizations in the mining sector were handled largely outside of the ZPA and were subject to less transparent bidding and selection processes. Lack of transparency in the asset valuation and bidding stages contributed to very costly delays in the privatization of the ZCCM. Although the sale of ZCCM’s largest asset, the Konkola Copper Mines (KCM) to Anglo American (AA) in 2000 was followed shortly thereafter by AA’s decision to withdraw, the privatization did yield significant productivity gains and an end to the use of budgetary resources. 22 In contrast, the sale of the Roan Antelope Mining Company of Zambia (RAMCOZ) in 1997, which was also handled in a nontransparent manner, proved unsuccessful because the buyers had no experience in mining operations and quickly faced difficulties in meeting obligations to employees and suppliers, including the electricity parastatal, ZESCO. Despite additional loans extended from the ZNCB and guaranteed by the government, as well as tax deferrals, RAMCOZ was ultimately placed into receivership in 2000. Further costs to the budget arose when the resale of the RAMCOZ to private investors at the end of 2003 was facilitated by the government’s assuming responsibility for wage arrears and retrenchment costs totaling about 0.7 percent of GDP. In addition, the terms of privatizations in the mining sector included generous, ad hoc tax treatments. These have set a precedent for mining investors, and the sector now provides only very modest revenues to the budget.

18. Despite some setbacks in privatization, the programs did see an increase in the role of the private sector. The resumption in growth of mining and nonmining activity was driven by the private sector. Although caution is needed in interpreting national accounts data, a reported increase in private investment was also reflected in foreign direct investment, which was negative in the early 1990s, rose to an average of 5 percent of GDP under the ESAF-supported program, and reached an average of more than 6 percent of GDP per year under the PRGF arrangement.

19. In recent years, progress was made in addressing governance issues at the political level. Following elections in December 2001, the new government pronounced a zero-tolerance policy on corruption, and launched a national movement against corruption with broad-based representation from government, civil society, and the private sector. Parliament also enacted changes to promote participation in the debating of bills presented in parliament. Funding for the Anti-Corruption Commission (ACC) was increased to ensure that it was adequately staffed and independent. In 2002, the ACC received 836 complaints, compared with 315 in 2001; high-profile cases of alleged abuse of public resources were prosecuted and have reached trial stage. The Office of the Auditor General (OAG) was strengthened, and audited public accounts for 2001 were completed and submitted to parliament in 2002, as required by law. However, these efforts need to be seen against the background of continued fundamental weaknesses in budgetary processes, which are an obstacle to good governance.

D. Program Design and Implementation Lessons

20. The growth target of 6 percent in the ESAF-supported program may have been too optimistic. In 1996, the rebound in GDP from the drought of 1995 exceeded expectations. Thereafter, the delay in the sale ZCCM adversely affected copper production, which stagnated in 1997 and then fell by a fifth in 1998. The growth of manufacturing output was also constrained by the sector’s strong linkages to the mining sector, and private sector activity was hampered by limited progress towards macroeconomic stability. Nevertheless, the impact on growth of developments in the mining sector, which accounted for only 12 percent of GDP in the mid-1990s, should not be exaggerated. Even if copper production had developed as programmed, nonmining GDP would have had to grow by more than 5 percent per annum to meet the overall growth target—a sharp reversal of the decline in nonmining GDP in the previous three years. Under the PRGF-supported program, the growth in nonmining activity slightly exceeded the implied target of 4 percent per annum through 2001. However, growth fell short of the original targets as privatization of ZCCM was delayed and copper production again declined; following the privatization, copper production rose by an average of more than 20 percent in 2001 and 2002. However, in 2002 overall growth slowed to 3 percent as a result of a severe drought.

21. Fiscal outcomes were not strong enough to support programmed disinflation. As noted, delays in the privatization of ZCCM and shortcomings in budget policy and execution resulted in higher recourse to domestic financing. Persistent shortfalls in external budget support (see below) also contributed to higher domestic borrowing by the government. Broad money typically exceeded program targets and inflation objectives were revised upwards. Acute difficulties emerged in 2001 when the combination of fiscal slippage and a shortfall in donor assistance resulted in a sharp depreciation of the kwacha. Against this background of fiscal dominance, and in the light of the mixed record of implementation, original program targets, which aimed to reduce inflation to 4 percent over three years, appear over optimistic. However, inflation targets in annual programs were subsequently eased.

22. Recourse to domestic financing has introduced an additional risk. Although the stock of domestic debt appears low by international standards, at around 20 percent of GDP, the sharp increase in domestic debt in an environment of modest financial savings brought real interest rates to high levels. As a result, domestic interest payments now exceed external debt service. Moreover, decisive action is needed to break the cycle of rising domestic debt and interest payments, which poses a serious risk to macroeconomic stability.

23. Program assumptions for external assistance appear, with hindsight, to have been too optimistic. Shortfalls were typically due to failure to observe policy objectives set by bilateral and multilateral donors. In addition, bureaucratic delays on the part of donors and a lack of clarity on conditions for the release of funds have also played a role. At times, program monitoring also allowed too much recourse to domestic financing. The ESAF-supported programs included a ceiling on borrowing from the banking system rather than on total domestic financing. This was rectified under the PRGF, but the adjuster for shortfalls in external financing was initially capped at the relatively high level of US$45 million or more than one percent of GDP. As a result, monetary policy was again called upon to take the burden of adjustment.

24. The programs did not include ex ante contingencies to address exogenous shocks other than shortfalls in aid inflows. Program implementation was adversely affected by shortfalls in copper exports, which were in part attributed to the delay in the privatization of the ZCCM. These shortfalls also prompted some modifications to targets during program reviews. Growth objectives set in the poverty reduction strategy paper (PRSP) and, hence, in the PRGF arrangement took into account the possible adverse impact of the subsequent withdrawal of AA.

25. The programs were not successful in controlling the wage bill. Civil service reform was included in the conditionality of the ESAF-supported program but, with the exception of a hiring freeze, this area was not covered by structural conditionality under the PRGF arrangement. This move was consistent with the policy of streamlining conditionality, and the World Bank’s lead role in supporting and monitoring wage reform. However, given the crucial importance of the wage bill for macroeconomic stability—with adequate provisions for poverty-reducing expenditure—closer monitoring of the wage bill, possibly supported by conditionality covering related reforms, would be appropriate under a successor arrangement. The SMP is also seeking to strengthen the process of wage bargaining with government employees to ensure greater transparency and predictability, with all parties aware of, and constrained by, the budgeted wage bill. This process will also be helped by the government’s decision to bring forward wage negotiations to coincide with budget preparation.

26. The experience under the ESAF arrangement, in which the ZCCM’s losses were highly adverse to program outcomes, raises questions on the choice of program conditionality. In retrospect, it may have been preferable to insist on the privatization of the ZCCM before starting the ESAF arrangement, in which disbursements were heavily front-loaded. However, given the time needed to conclude the sale, and the need not to undermine the government’s bargaining position, this approach could have jeopardized Zambia’s progress in other areas, as well as delayed the clearance of arrears to the Fund. Alternatively, the program could have put greater emphasis on attempting to strengthen the ZCCM’s financial position in preparation for privatization. 23 More generally, Zambia’s experience of repeated early derailments after approval of the arrangement and subsequent delays in completing reviews suggests that, where possible, key reforms should be front-loaded and monitored as prior actions.

27. The difficulties that emerged in KCM and RAMCOZ following their privatizations contributed to increased public and political disquiet over the privatization program. This was an important factor that delayed steps toward the privatization of the ZNCB in late 2002 and may also have influenced the government’s decision to commercialize, rather than privatize, the Zambia Electricity Services Corporation (ZESCO). In both cases, long-standing policy commitments, which were included as triggers for reaching the HIPC Initiative completion point, were called into question. This experience, and the contrast with the more successful privatizations conducted by the ZPA, underlines the importance of the privatization process for the outcome of such privatizations. In retrospect, the results may have been better if the Fund and the World Bank had insisted that the ZPA be solely responsible for the privatization of mining as well as nonmining sector assets, in order to ensure the transparency of the privatization process.

28. Program implementation was hampered by limited institutional capacity and lapses in coordination within the economic team. These difficulties appear to have been exacerbated during the course of the PRGF arrangement by high staff turnover, particularly in the Ministry of Finance and National Planning (MoFNP), in part because of the impact of HIV/AIDS but also because many high officials were removed as a result of the new government’s efforts to tackle corruption. Monitoring of program implementation needs to be strengthened through improved coordination both within and among agencies; under the SMP, existing interministerial arrangements for program monitoring are to be reinvigorated with the President serving as chair. In addition, greater cohesion of the economic team is required to ensure that policymakers are fully apprised of the implications of spending and other decisions. In this vein, following the difficulties that emerged in 2003 as a result of decisions to grant wages and allowances well in excess of budgeted amounts, the SMP includes steps to ensure that such decisions are not taken without the agreement of the MoFNP and the cabinet.

29. Fund technical assistance was geared to improving public expenditure management (PEM), supporting tax policy and administration, and strengthening the capacity of the BoZ. Despite repeated mission recommendations and the assignment of resident advisors, implementation of PEM reforms has not had the desired results. Although there has been some progress—for example, improvements in the commitment control system, which helped to sharply reduce arrears accumulation in the first half of 2003—these gains have been undermined by extrabudgetary expenditures and the circumvention of budget procedures. FAD’s technical assistance (TA) recommendations on the revenue side, including reform of the Zambia Revenue Authority (ZRA), widening of the tax base, and introduction of the value-added tax (VAT) have mostly been implemented and have been influential in keeping the revenue-to-GDP ratio stable at 18-19 percent. MFD has provided extensive TA under both programs in the areas of bank supervision, monetary and exchange operations, payments systems, information technology, the resolution of insolvent nonbanks, and the preparation of a Financial Sector Development Plan. Improvements observed in meeting PCs in the financial sector, the relatively stable state of the banking system, the generally adequate supervisory and regulatory framework (based on the 2002 FSAP), and the introduction of the interbank foreign exchange market and indirect monetary policy instruments, suggest that the MFD’s TA had a positive impact.

30. The mixed record of policy implementation, including limited follow-up on TA recommendations, especially in the area of expenditure, also calls into question the extent of program ownership. In some key areas, ownership of policy reforms has been very strong. Thus, for example, in July 2003, after the expiration of the PRGF arrangement, the BoZ successfully introduced an interbank foreign exchange market, making good use of MFD’s technical support. However, repeated lapses in expenditure policy and the recent reconsideration of privatization policy point to incomplete ownership of the program. This may, despite the good participatory process used to develop Zambia’s PRSP, in part reflect popular misgivings over economic reforms and the role of the Fund. Although growth has resumed in Zambia, this has not been adequate to reverse public perceptions of poor economic performance that derive from more than two decades of economic decline. In addition, Zambia’s prolonged involvement with, and continued high indebtedness to, the Fund inevitably complicate relations and public perceptions of the process of policy formulation. In these circumstances, the authorities’ advocacy of the chosen policy path assumes a particular importance in demonstrating ownership at the highest levels of government and convincing a skeptical public and often hostile local press that policies are not “imposed” from outside.

31. The experience under Zambia’s two arrangements also suggests that a different modality for the repayment of arrears cleared in 1995 would have been desirable. The effective refinancing using ESAF and Structural Adjustment Facility (SAF) resources meant that Zambia remained heavily indebted to the Fund, with all of these obligations falling due in the period 2001-05. Clearance of some of the arrears with resources other than new disbursements from the Fund, may have been beneficial for the policy dialogue. Alternatively, requiring some earlier repayments (i.e., before the end of the 5½-year grace period for ESAF/PRGF loans) would have provided a stronger incentive for policy implementation under the ESAF, lowered Fund exposure to Zambia, and avoided the large “hump” in debt-service payments that both heightens the risk of Zambia’s falling back into arrears and complicates the policy discussions.

E. Collaboration with the World Bank

32. Collaboration with the World Bank has generally been close during the two arrangements. The World Bank took a lead role in supporting public enterprise reform and privatization, except for the privatization of the ZNCB, in which the Fund took the lead role. In the petroleum sector, this included price liberalization and liquidation of the Zambia National Oil Corporation. Support has also been given to the ZPA and for commercialization of ZESCO. In the mining sector, the World Bank has played a key role in assisting in efforts to bring a strategic investor into the KCM following the withdrawal of AA. The World Bank has also supported a strengthening in public sector management, including under a Public Service Capacity-Building Project. As noted earlier, the World Bank has also taken the lead in the civil service reforms, including recent attempts to reform the pay structure.

IV. Policy Challenges for the Medium Term

33. Notwithstanding recent gains in economic growth, the extent of Zambia’s poverty remains formidable. The PRSP set an initial growth target of 5 percent, recognizing the numerous obstacles to faster growth that remain. However, Zambia will need to grow by 6-8 percent per year to attain a reduction in poverty consistent with the corresponding MDG for 2015. The main sources of growth are expected to be agriculture, mining, manufacturing, and tourism, with policies to support a private sector- and export-led growth performance. Key elements of the strategy for more rapid growth and poverty reduction would include consolidation of macroeconomic stability, a strengthening of the budgetary processes to improve fiscal outcomes and governance and facilitate higher donor support of priority social spending; civil service reform to bring the wage bill to a more affordable level; completion of the privatization program and removal of obstacles to private sector growth in the areas business licensing and regulation, land tenure and labor legislation; and financial sector development to support improved financial intermediation including in rural areas. Progress in these and other areas is also needed to allow Zambia to attain the HIPC Initiative completion point, which will be a key step toward reducing the country’s debt to sustainable levels.

34. Prudent fiscal and monetary policies will remain crucial to achieving durable macroeconomic stability and faster growth. Recent program experiences point to the need to ensure that the burden of macroeconomic stability is borne mainly by tight fiscal policy, and that real interest rates are lowered to levels supportive of higher domestic private investments. Conversely, if the government were to continue borrowing in 2004 at the same pace as in 2003, Zambia would risk entering into a destabilizing and widening cycle of domestic higher debt and interest rates. Against this background, it is also essential that the authorities cease to regard domestic borrowing as a convenient means to facilitate unbudgeted expenditures. Monetary policy will need to be aimed at supporting lower inflation, while ensuring that the BoZ’s international reserve coverage remains adequate.

35. Controlling the wage bill will be crucial to fiscal consolidation. With the support of the World Bank and other donors, development and implementation of a public sector reform plan will, therefore, need to be a key component of a coherent program that takes into account the need to maintain tight fiscal policy. At the same time, wage increases will have to be tightly controlled.

36. Zambia’s PEM system still requires substantial upgrading in the areas of budget formulation and execution. The government has identified PEM reform and financial accountability as priorities in its PRSP. Major initiatives, which are being supported by the World Bank and other donors, include the introduction in the 2004 budget of an activity-based classification of operations, a medium-term expenditure framework (MTEF) and the development of an Integrated Financial Management System (IFMIS). Considerable efforts are also being made to improve existing reporting, accounting, cash management, and expenditure control systems. The government has recently established a joint donors’ group to oversee and monitor progress in public sector reforms, including progress in PEM reform. A technical team is developing a specific action plan, largely based on the World Bank’s Public Expenditure Management and Financial Accountability Review (PEMFAR). However, it will take time before these major initiatives can deliver their anticipated benefits. Progress is also needed in developing and implementing a strategy to clear the stock of domestic arrears.

37. Special attention will need to be focused on ensuring that the higher levels of support needed to facilitate progress toward the Millennium Development Goals (MDGs) are forthcoming. This will require continued close consultation with donors to clarify commitments and policy conditions. A substantially improved record of program implementation will also be crucial to gaining higher levels of donor support.

38. Strengthening budget processes will also be crucial to improving governance. The government should enforce compliance with existing systems and regulations in a comprehensive and transparent manner to promote accountability. The independence and authority of the OAG needs to be enhanced to bolster public sector accountability. More generally, these steps need to be reinforced by the publicly articulated support of policymakers and political leaders for greater accountability.

39. The authorities need to ensure that the mechanisms for tracking poverty reduction and social spending are improved. In addition to a well-functioning, activity-based budgeting, the authorities will need to ensure that regular assessments of poverty programs are carried out with the participation of civil society, and that these assessments are fed into the budget.

40. While government revenues have remained relatively strong, risks remain. In particular, as the experience of the mining sector has demonstrated, there is a need to develop a consistent policy for granting exemptions, to avoid ad hoc exemptions and to preserve the revenue base. Similarly, there is a need to ensure that tax concessions in the Export Processing Zone Act do not undermine corporate tax collections.

41. Although the privatization program is nearing completion, it is essential to carry through with the remaining sales, to improve economic efficiency and protect the budget. In particular, in the mining sector, the sale of the KCM to a strategic investor is expected to be completed shortly. Similarly the sale of the ZNCB to a reputable private bank will help to improve financial intermediation, while safeguarding the budget from further losses in the bank. There is, however, no consensus within the government for the privatization of the telecommunications company.

42. Zambia’s FSAP report highlighted issues that the authorities now intend to address in their Financial Sector Development Plan. Key issues include strengthening the capacity and independence of the BoZ; improving financial sector supervision and regulation; resolving insolvent nonbank financial institutions; appropriately regulating and supervising the National Pension Scheme Authority (NAPSA) to address the problems of unfunded liabilities; developing mechanisms to improve the delivery of rural banking services; implementing strategies to channel finance for small and medium-sized enterprises; completing the sale of the ZNCB; improving liquidity forecasting through more effective coordination between the BoZ and the Ministry Finance and National Planning; establishing a comprehensive debt-management framework; and implementing the Prohibition and Prevention of Money Laundering Act of November 2001.

43. To mitigate the medium-term growth risks posed by dependence on copper, the authorities need to maintain the open trade and flexible exchange rate regimes that have supported the strong growth of nontraditional exports in the past ten years. The real effective exchange rate continues to show relative stability, and the introduction of an interbank market for foreign exchange should enhance the response of the exchange rate to short-term movements in the foreign exchange market.

V. Future Fund Relations with Zambia

A. Rationale for a Successor Arrangement

44. The Fund can play an important role in supporting Zambia’s progress toward macroeconomic stability, which is crucial for growth and poverty reduction. Key elements of the remaining reform agenda fall within the Fund’s core areas of expertise and responsibility. These include supporting fiscal consolidation, reducing vulnerabilities to external shocks, strengthening governance in areas of public expenditure policy and management, and supporting financial sector reforms.

45. A sound track record under a successor PRGF arrangement would facilitate Zambia’s attainment of the HIPC Initiative completion point and ease the burden of repayments facing Zambia. In addition, with a sustained track record of implementation, including progress in PEM, a successor arrangement could play an important role in helping to catalyze donor budget support for meeting the MDGs.

46. The Fund will need to continue providing adequate and timely TA to strengthen capacity in key areas, such as public expenditure management, expenditure controls, tracking of poverty reduction expenditures, tax and administration reforms, financial sector reforms, and capacity strengthening at the BoZ (as discussed above) and the Central Statistical Office. The mixed record of implementation underlies the importance of integrating TA recommendations into program monitoring.

B. Exit Strategy

47. Zambia faces large and immediate financing needs. Although Zambia’s external debt service will fall sharply in 2006 with the completion of repayments from the 1995 ESAF that cleared Zambia’s arrears, large payments are due in 2004 and 2005. Strong adjustment efforts, supported by a successor arrangement, will be needed to meet the larger financing needs resulting from the delay in reaching the HIPC completion point.

48. The Fund’s exposure to Zambia remains high. After falling back in 2006, debt service to the Fund will build up toward the end of the decade as repayments to the Fund on disbursements under the recent PRGF arrangement fall due. Since the Fund is expected to have provided all of its assistance under the HIPC Initiative by 2007, and because Fund disbursements have shorter maturities than other official lending, the Fund’s share of debt service could peak at over 60 percent of total debt service by the end of the decade (about 70 percent with a new PRGF arrangement). However, total external debt service is expected to average no more than 7 percent of exports. While Zambia should be able to stabilize the net present value (NPV) of debt in relation to GDP after reaching the HIPC Initiative completion point, this will require growth of about 4 percent per annum in real terms, a stable real exchange rate, and a current account deficit, after grants, of about 5 percent of GDP. Recent staff projections indicate that these requirements for the stabilization of Zambia’s debt are possible, assuming continued gains in the trade balance due to stronger copper prices. The outlook would also depend on the provision of additional external assistance to meet the MDG targets, largely in the form of grants.

49. Zambia’s limited progress toward macroeconomic stability and the scale and duration of the reforms to be addressed do not suggest that the country is a strong candidate for early graduation from the use of Fund resources. As noted above, the current large financing needs are expected to decline in 2006. However, debt service to the Fund is projected to increase thereafter, in an echo of the hump in debt service from the clearance of arrears in 1995. Further support under the PRGF may be required to help meet this balance of payments need directly and to provide strong monitoring framework as a catalyst for higher donor support.

VI. The Views of the Authorities

50. The authorities indicated that they agreed with many of the points made in the assessment. However they felt that greater emphasis needed to be placed on some factors which had contributed to Zambia’s poor growth performance and thereby prevented the delivery of adequate social services.

51. In particular, adjustment programs supported by both the Fund and World Bank did not provide, in their view, adequate support for economic growth. The thrust of this support was on policy and institutional reform, geared to encouraging investment and growth. Although such reforms were necessary, they needed to be backed by practical steps, including improvements in infrastructure, to encourage investment. For example, while functioning infrastructure is essential for sectors like tourism and mining, no major investment was made or supported in the areas with the highest potential, such as Livingstone for tourism and the “New Copperbelt” for mining. Furthermore, while it is widely recognized that Zambia’s agricultural potential can be exploited with the benefit of improved infrastructure (e.g., irrigation and power) very little investment was carried out in these areas. As it turned out, much of the financing received by Zambia was adjustment credit, which was mostly used for servicing the huge debt that Zambia faced. While useful in terms of avoiding a further contraction of the economy under the heavy debt burden, this did not contribute directly to growth. Adjustment money was largely used to deal with past problems (debt) rather than dealing with the future (growth).

52. In the past four years, the Zambian economy has shown consistent growth, although still at rather low levels compared to what is needed. The growth has come from mining, manufacturing, tourism and services. Agriculture has grown when the weather has permitted and with timely input support; within this, export-based agriculture has shown the strongest growth. Investments in these emerging growth areas have sometimes occurred with little or no public (government and donor) support. If public support had been directed to these areas, growth would be much faster. The authorities conclude therefore that this is one of the key challenges for the future.

1

The team comprised Mr. Andrews (head-AFR), Mr. Tharkur (AFR), Mr. Fassina (FAD), Mr. Giancarlo Gasha (MFD), and Mr. Thomas (PDR). The paper includes contributions from other members of the Zambia team and World Bank staff.

19

Including security forces, employees of grant-aided institutions, and other bodies, total government employment stands at about 160,000.

20

In 2001, Zambia met three out of sixteen benchmarks under the HIPC Initiative expendituretracking and action plan (AAP). By 2003, four of the benchmarks were met.

21

This discussion draws upon the conclusions of the (unpublished) report of December 2002, “Zambia: Privatization Review—Facts, Assessment and Lessons,” prepared by World Bank staff at the request of the Minister of Finance and National Planning.

22

The withdrawal of Anglo-America from KCM in 2002 did not lead to a renewed need for budget support. The exit package negotiated with AA made provisions for operating losses through to 2004 and copper prices have been sufficient to cover KCM’s operating costs.

23

In 1998, when the company was a severe drain on the government budget, measures taken to improve its financial position amounted to quasi-fiscal subsidies involving lower electricity tariffs, import duty concessions, and lower tax rates.

Zambia: 2003 Article IV Consultation and Ex Post Assessment of Performance Under Fund-Supported Programs—Staff Reports; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Zambia
Author: International Monetary Fund