Abstract
This paper examines Zambia’s Second Review Under the Three-Year Arrangement Under the Poverty Reduction and Growth Facility (PRGF) and a Request for Waiver and Modification of Performance Criteria (PC). Performance under the PRGF-supported program has been good, although there were delays in some structural measures. All but one of the PCs and all benchmarks under the quantitative program for December 2004 were observed. Two structural PCs were observed, and the third one, for end-February 2005, is now a prior action for the completion of the second review.
April 8, 2005
1. On behalf of the Zambian authorities, we thank staff and Fund management for the constructive engagement in Zambia and for the positive assessment that Zambia has satisfactorily met the requirements for reaching the completion point under the Enhanced Initiative for Heavily Indebted Poor Countries (HIPC). The successful implementation of the economic program supported by the PRFG arrangement, along with the implementation of the PRSP and the significant progress made in meeting the completion point triggers, have been the basis for Zambia’s attainment of these achievements. The authorities have implemented almost all the triggers, with only three out of fifteen which have not been fully implemented; however, substantial progress has been made towards reaching them. The authorities view the staff report as fair and balanced and would like to reiterate their commitment to the objectives of the economic program and the strategy for reaching them as outlined in the Memorandum of Economic and Financial Policies (MEFP) attached to their Letter of Intent.
Recent Economic Developments
2. Zambia’s economy continued to expand solidly for the fifth consecutive year, fueled by agriculture, mining and construction. Real GDP growth is estimated to have reached 5.0 percent in 2004, while inflation, despite a sharp increase in fuel oil prices during the year, was contained at 17.5 percent. Instrumental to this good performance were the structural reforms and improved macroeconomic management, particularly in the fiscal area implemented in previous years.
3. Fiscal discipline remains the cornerstone of Zambia’s macroeconomic stabilization effort. In this regard, fiscal policy implementation in 2004 was broadly in line with the program. Total spending was 1.0 percent of GDP less than programmed, while tax collection strengthened. Improved fiscal discipline, and the delivery of external budget support in line with program expectations, allowed for a sharp decline in government’s domestic borrowing from over 5.0 percent of GDP in 2003 to less than 1 percent of GDP in 2004. In addition, the authorities strengthened expenditure controls, including the wage bill, which was restrained at 7.8 percent of GDP as budgeted.
4. During 2004, despite efforts to tighten liquidity conditions, monetary growth surged at the end of the year mostly due to unanticipated large donor disbursements and increased foreign currency deposits by corporations. As a result, reserve money increased to 21 percent at end-year, while broad money reached 30 percent. Notwithstanding these developments, commercial banks’ lending rates, supported by fiscal discipline stabilized at around 37 percent in the second half of 2004, while interest rates on treasury bills rose in mid-year and stabilized in the final quarter at about 18 percent. Credit to the private sector increased strongly in 2004, driven by large demand for financing in agriculture and manufacturing sectors.
5. The external current account position improved in 2004, benefiting from increases in earnings from copper and other metal exports due to higher prices and increased production. Most notably, growth of non-traditional exports, including cotton, lint and tobacco, exceeded projections and contributed to strengthening Zambia’s external position. Gross international reserves exceeded program target by US$35 million, reaching US$222 million by year-end, an import coverage of 1.2 months of goods and services. The exchange rate has remained relatively stable in nominal terms, although for the whole year the kwacha has appreciated in real terms by about 8 percent.
6. The authorities have finalized their second PRSP Implementation Progress Report reviewing the period of July 2003 to June 2004 and policies for 2005. The authorities view the joint staff advisory note as a balanced assessment of the progress being made in the implementation of the PRSP and have reiterated their commitment to the policies and strategy in the PRSP.
7. Performance under the program continued to be strong, as most of the performance criteria and policy benchmarks set under the program for the period up to end-December 2004 were observed, several of them with large margins. The authorities are, nevertheless, requesting the Board to grant waivers for the nonobservance of two performance criteria. However, the two criteria on external arrears payments and strengthening of the Bank of Zambia’s supervision capacity have in the mean time been met.
Medium-Term Strategy and Program for 2005
8. Notwithstanding the encouraging economic results, the Zambian authorities are fully committed to the reform agenda. The medium-term strategy, embedded in the government’s PRSP, aims at bolstering the conditions for sustained high levels of private sector led economic growth needed to reduce poverty and achieve the MDGs. Key macroeconomic objectives include real GDP growth of at least five percent a year over the medium term, with annual inflation falling to single digits by 2007. The authorities remain committed to increasing poverty-reducing spending by at least 1.6 percent of GDP between 2004 and 2007, while gradually reducing government domestic borrowing over the medium term.
9. The economic policy agenda for 2005 remains essentially unchanged from that presented in the MEFP during the First Review under the PRGF arrangement. The policies set forth in the current MEFP continue to be adequate to achieve the objectives of the program, which envisage a real GDP growth of 5.0 percent and a further deceleration of inflation to 15 percent, with a target of reaching single digits by 2007. However, due to the sharp increase in monetary aggregates in late 2004, some adjustments to the monetary program were necessary to achieve the objective of lowering inflation by end-2005. In addition, new structural measures have been introduced in the areas of public expenditure management and financial sector development.
10. The authorities are determined to enhance the fiscal consolidation process, while ensuring increased effectiveness of public spending, promoting strong economic growth and meeting poverty reduction goals. The budget for 2005, which was approved by parliament on March 30, this year is consistent with the framework of the first review and limits government’s domestic borrowing to 1.6 percent of GDP. It also includes measures to ease the burden of direct taxation, while broadening the tax base to raise revenues. Overall, the tax policy measures are expected to raise revenues by 0.1 percent of GDP. On the expenditure side, the authorities recognize that containing the wage bill is critical for maintaining macroeconomic stability and fiscal targets. The budget limits the wage bill to 8.1 percent of GDP, a slight augmentation as compared to 7.8 percent of GDP achieved in 2004. This increase will mostly accommodate the hiring of additional teachers and health workers. The overall deficit, including grants, is projected at 2.5 percent of GDP.
11. Monetary policy is geared towards reducing inflation and strengthening international reserves. In addition, the monetary program for 2005 was tightened to reverse the unanticipated increase of monetary aggregates at end of 2004. Growth in reserve money will be limited to 10.5 percent, while growth of broad money will be contained at 14.8 percent. However, the program will continue to accommodate an expansion of credit to the private sector in real terms as commercial banks are expected to make good use of the extraordinary buildup of foreign assets at the end of last year.
12. The external outlook for 2005 is expected to be favorable, despite the oil import bill which is likely to remain high. In this connection, with the continued recovery in export earnings, the external current account deficit, including grants, is expected to narrow further to 3.1 percent of GDP in 2005.
13. The authorities are committed to stepping up the structural reform agenda during 2005, which they see as providing critical support to macroeconomic stability and growth. The reforms will continue to focus on public expenditure management and financial accountability (PEMFA), including implementation of the integrated financial management information system (IFMIS) and on financial sector development, and improvement of the operations of Non-Bank Financial Intermediaries (NBFIs). The authorities are also committed to strengthening their capacity for debt management capacity and preparation of a public debt management reform plan. With regard to private sector development, they intend to actively collaborate with the World Bank in designing a work program that will address existing deficiencies in this area. Special attention will also continue to be devoted to creating an enabling environment for private sector development, including supporting the implementation of the private sector development initiative (PSDI) and advancing further the commercialization strategy. In this regard, the authorities intend to conclude the sale of 49 percent of the equity in the Zambia National Commercial Bank to a strategic investor. On March 31, 2005, the Zambia Privatization Agency issued a new invitation for bids for the purchase of 49 percent equity with management control. The authorities are also proceeding with the implementation of a comprehensive commercialization strategy for ZESCO.
Conclusion
14. The Zambian authorities are grateful to the Fund and the international community for their financial and technical assistance support, which has been instrumental in enabling them meet the existing social and economic challenges in the reform agenda. The authorities are looking forward to the completion of this review under the PRGF arrangement and to achieving the completion point under the Enhanced HIPC Initiative. The authorities have consented to the publication of the staff papers and the Memorandum of Economic and Financial Policies (MEFP).