Zimbabwe
2005 Article IV Consultation: Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Authorities of Zimbabwe

This 2005 Article IV Consultation highlights that Zimbabwe’s pace of economic deterioration slowed somewhat in 2004, but appears to have picked up again in the first half of 2005. IMF staff estimates that real GDP fell by about 4 percent in 2004, compared with a contraction of 10½ percent the preceding year. Monetary policy has been tightened, but not consistently. Overnight interest rates were raised sharply in early 2004 and lowered subsequently as inflation declined, with real interest rates maintained at high levels for most of the year.

Abstract

This 2005 Article IV Consultation highlights that Zimbabwe’s pace of economic deterioration slowed somewhat in 2004, but appears to have picked up again in the first half of 2005. IMF staff estimates that real GDP fell by about 4 percent in 2004, compared with a contraction of 10½ percent the preceding year. Monetary policy has been tightened, but not consistently. Overnight interest rates were raised sharply in early 2004 and lowered subsequently as inflation declined, with real interest rates maintained at high levels for most of the year.

Executive Summary

After some improvement in 2004, Zimbabwe’s economic and social conditions have deteriorated sharply this year. Staff estimates a further contraction in real GDP of 4 percent in 2004. While inflation slowed from a peak of 623 percent in early 2004 to around 130 percent in early 2005, it has picked up again to 164 percent in June. With the official exchange rate overvalued and imports restricted, shortages of basic goods have become pervasive. The parallel market premium widened sharply to 100 percent by early July 2005. Social indicators have worsened and Zimbabwe is off-track in meeting all but two MDGs.

The authorities have not met the policy commitments made last December and, absent decisive policy action, the outlook appears bleak. Staff projects a further decline in real GDP of 7 percent in 2005, mainly due to difficulties in agriculture. The fiscal deficit would widen to 14 percent of GDP (from 4¾ percent of GDP in 2004) and contribute—together with the RBZ’s expanding quasi-fiscal activity—to a pick up in inflation to 320 percent by end-2005. Food security is an urgent concern. Non-food imports will be squeezed further, increasing vulnerability to a rise in world oil prices. “Operation Restore Order” could add to fiscal pressures and—by curtailing informal markets—could lower GDP and raise price pressure. Over the medium term, GDP would continue to contract given difficulties in agriculture and foreign exchange shortages. Inflation would remain in the 200-300 percent range reflecting substantial fiscal deficits and quasi-fiscal activities. Given limited external financing, the current account would be broadly stable and arrears would accumulate.

Staff pressed for a comprehensive policy package to achieve sustained growth, external viability, and low inflation. Macrostabilization, the immediate priority, could be achieved by: (i) strong fiscal adjustment to limit this year’s deficit to 5 percent of GDP to ensure a broadly neutral fiscal stance; (ii) liberalizing the exchange regime and unifying the exchange rate, with immediate substantial depreciation; (iii) tightening monetary policy to achieve the authorities’ end-year inflation target of 80 percent; and (iv) curtailing the RBZ’s quasi-fiscal activity. Staff noted that the financial system appeared to be adequately supervised and resilient to significant shocks. It would be critical to ensure that supervisors remain empowered to take timely action to address identified weak institutions.

Fundamental structural reform is essential over the medium term to ensure a stable and efficient financial system; increase the role of markets; place the fiscal accounts on a strong medium-term footing and reform public enterprises; improve agricultural productivity including through further land reform; and strengthen governance. Relations with the international community would need to be rebuilt and a strategy formulated to reduce arrears.

The authorities had a different view of prospects and policies. In their estimate, output would grow by 2 percent this year due to strong performance in tobacco, wheat and mining. Moreover, inflation was still much lower than early last year. They would attempt to stay within the budget deficit limit by taking offsetting measures for appropriated (discretionary) spending. Their room for maneuver on the exchange rate was limited, but sufficient flexibility would be maintained to ensure export viability. Broad money growth would be lowered to 80 percent by end-2005, in line with their inflation target. Producer and credit subsidies were needed, given the lack of foreign financing, and would be effective in lowering inflation through increases in productivity and output growth. Credit subsidies would be eliminated by end-2006.

I. Background and Key Issues

1. Zimbabwe’s economy has deteriorated sharply since 1997. Real GDP declined by almost 30 percent from 1997 to 2003, while inflation soared from about 20 percent in December 1997 to a peak of 623 percent in January 2004 (Table 1 and Figure 1). Agricultural production—the mainstay of the economy—collapsed with the disruption caused by the violent implementation of fast-track land reform. With the official exchange held constant at Z$55 per U.S. dollar—and later at Z$824 per U.S. dollar—(Figure 2), and declining exports and foreign financing, the supply of foreign exchange to the official market shrank, leading to sharp restrictions on imports and accumulation of external arrears (Figure 3). Investment fell sharply and shortages of food, fuel, electricity and other basics became pervasive. The performance of the economy lagged markedly behind those of other countries in the region.

Table 1.

Zimbabwe: Selected Economic Indicators, Baseline Scenario, 2001-2006

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Sources: Zimbabwean authorities; World Bank, World Development Indicators 2004, UNAIDS and CDC (2003) ; and IMF staff estimates and projections.

Foreign currency units are converted into Zimbabwe dollars at the official exchange rate.

GDP at world prices using real GDP growth and trading partner countries’ inflation (base year is 1996).

Figure 1.
Figure 1.

Zimbabwe: Prices and Money

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

Sources: Zimbabwean authorities; Zimbabwe market sources; and staff estimates for 2004.1/ Percentage change in consumer prices (year-on-year).2/ In percent.3/ Percentage change in consumer prices (yearly average).4/ Index 2000=100.
Figure 2.
Figure 2.

Zimbabwe: Exchange Rates

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

Sources: Zimbabwean authorities; Zimbabwe market sources; and staff estimates for 2004.1/ In Zimbabwe dollars per US$. From January 2004 onwards, the official rate reflects a blend between the surrender rate of Z$824 per US$ and the average tender rate.2/ Index 1990=100. Based on the offical exchange rate.
Figure 3.
Figure 3.

Zimbabwe: Saving/Investment and External Balances

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

Sources: Zimbabwean authorities; and staff estimates for 2004.1/ In percent of GDP.2/ Excludes grants.3/ Includes IMF.
A01ufig02

Real GDP Growth

(In percent)

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

A01ufig03

Real GDP growth and inflation

(Annual average, 1998-2004)

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

2. The human cost of these policies has been high. Zimbabwe’s human development indicators—once among the best in sub-Saharan Africa—have deteriorated sharply to a rank of 147th out of 177 countries in the world. More than two out of three Zimbabweans are unemployed while poverty and emigration have risen sharply. The HIV/AIDS pandemic has been left largely unchecked, with the infection rate estimated at about 25 percent of the adult population. Life expectancy has declined to below 40 years from around 60 years fifteen years ago, while child mortality has risen sharply to 126 (per 1,000 live births) from 90 in 1995, partly reflecting declining immunizations and the AIDS pandemic.

A01ufig04

Percentage of population living in poverty

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

Selected Social Indicators

(latest data available)

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Source: United Nations, Human Development Report 2004; World Bank, WDI 2005; and IMF staff estimates.

3. Zimbabwe’s political situation mains difficult. Relations with the international community have become increasingly strained—the United States and European Union imposed targeted sanctions on top officials in 2002, and external financial support is confined to humanitarian assistance. The ruling ZANU-PF party won a two-thirds majority in the parliamentary elections held on March 31, 2005. Although less violence was reported than in the past, the opposition party and Western governments have criticized the elections as being neither free nor fair, but governments in the region, as well as the Southern African Development Community (SADC) and the African Union have accepted the results.

4. As of June 30, 2005, Zimbabwe’s arrears to the Fund totaled SDR 199.6 million (US$ 290.7 million).1 The authorities have followed through on their pledge to increase payments to US$9 million per quarter beginning in April 2005, which has begun to reduce arrears. The Executive Board at its February 16 meeting deferred for another six months taking action on the Managing Director’s complaint regarding Zimbabwe’s compulsory withdrawal in order to provide the country a further opportunity to significantly strengthen cooperation with the Fund. The next review of Zimbabwe’s overdue financial obligations will take place at the time of the Board’s discussion of the 2005 Article IV consultation.2

5. Against this background, the discussions focused on the following key issues:

  • What are the prospects and risks for Zimbabwe’s economy?

  • Are the authorities’ macroeconomic and structural policies adequate for addressing Zimbabwe’s pressing economic problems? How sound is the banking system, financial supervision, and the authorities’ framework for resolving problem banks?

  • What macroeconomic and structural policies are needed for Zimbabwe, both in the short and medium term, to achieve sustained growth with low inflation as well as improved cooperation with the Fund?

II. Report on the Discussions

A. overview

6. The discussions took place against the backdrop of a deteriorating economic and social situation. In view of economic prospects and risks, staff pressed for a comprehensive package of measures to stabilize the economy and create the conditions for sustained growth, external viability, and low inflation.

  • Macro stabilization is the immediate priority and could be achieved with a package comprising: (i) strong fiscal adjustment; (ii) liberalizing the exchange rate regime and unifying the exchange rate; (iii) tightening monetary policy; and (iv) curtailing the quasi-fiscal activities of the Reserve Bank of Zimbabwe (RBZ).

  • Fundamental structural reforms initiated in 2005-06 and followed through by a comprehensive medium-term program will be essential, particularly to: ensure a stable and efficient financial system; increase the role of markets; strengthen the fiscal position and public enterprises; improve the conditions in agriculture, including through land reform; and strengthen governance.

  • Relations with the international community will need to be rebuilt to obtain external support for domestic policy reforms.

B. Economic Prospects

7. The pace of economic deterioration slowed somewhat in 2004, but showed signs of picking up again in the first five months of 2005. Staff estimates that real GDP fell by about 4 percent in 2004, compared with a contraction of 10½ percent the preceding year, reflecting a marked recovery in mining and a slower decline in services that partly offset the continued contraction in agriculture. Year-on-year inflation decelerated sharply from a peak of 623 percent in January 2004 to stabilize around 130 percent in early 2005, before picking up again to 164 percent in June.3 (Seasonally-adjusted 3-month data indicate rising price pressure since November 2004). Price controls were reinstated and an Income and Price Commission was established to review public and private sector prices. With the Reserve Bank able to meet only 4-8 percent of bids in its foreign exchange tender, shortages of basic necessities, especially fuel, have become more acute, particularly since end-March. The parallel market premium which had narrowed markedly in the first quarter of 2004, widened sharply from 45 percent in January 2005 to about 100 percent by early July.

A01ufig06

Contribution to GDP growth

(Annual growth rates in percent)

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

A01ufig07

Zimbabwe: CPI Inflation

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

8. Without decisive policy action, the outlook for 2005 and beyond is bleak. Staff projects that continued difficulties agriculture (the maize crop was well below expectations partly due to low rainfall), rising inflation, and foreign exchange shortages, particularly for fuel imports, would cause real GDP to contract by some 7 percent this year (Table 1). The widening fiscal deficit and quasi-fiscal activities would contribute to money growth, pushing inflation to about 320 percent by end-2005. The current account deficit would widen temporarily to 7½ percent of GDP due to higher food imports. Output is projected to contract again in 2006, with a less severe decline in agriculture assuming normal levels of rainfall. Inflation would decelerate to 200 percent by end-year as the fiscal deficit is held back by the erosion of government expenditure in real terms.

9. Over the medium term, output would decline further in the absence of significant structural reform (Table 2). Following past patterns, the fiscal deficit is projected to narrow and then widen again, with inflation fluctuating in the 200-300 percent range. 4 With no appreciable change in external assistance, the current account would remain broadly stable in U.S. dollar terms and arrears would accumulate.

Table 2.

Medium Term Outlook, 2003-2010

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Sources: Zimbabwean authorities; and staff estimates and projections.

Foreign currency units are converted into Zimbabwean dollars at the official exchange rate.

GDP at world prices using real GDP growth and trading partner countries’ inflation (base year is 1996).

10. Zimbabwe is off-track in achieving most Millennium Development Goals (MDGs). A recent assessment indicated that under current policies only two targets are achievable: immunization of one-year olds against measles and access to safe drinking water (Table 3).5 The HIV/AIDS pandemic, falling incomes, and the rapidly deteriorating health and education services affects most of the other MDGs. Progress will depend on achieving sustainable growth, controlling the HIV/AIDS pandemic, and improving food security.

Table 3.

Zimbabwe: Millennium Development Goals

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Source: World Development Indicators 2005, Zimbabwe Human Development Report 2004, UN Statistics Division, UNAIDS and IMF estimates.

The poverty headcount ratio is the proportion of population below the poverty line.

Preferably by 2005.

A value of the GINI index of 1 denotes perfect distribution or equality, while a value smaller than 1 denotes degree of inequality.

11. The authorities took a different view of recent developments and the economic outlook. In their estimate, output declined by only 2½ percent in 2004 and will grow by 2 percent this year. Although drought had severely affected the 2004-05 maize crop,6 tobacco and wheat (which were less affected) as well as mining would perform well this year while manufacturing would bottom out. The support prices and subsidized credit facilities for agriculture and manufacturing were evoking a supply response and would increase flows into the official market. Moreover, they stressed that in comparison to the peak in early 2004, inflation had declined considerably by mid-2005 on account of their policies to turn around the economy.

12. Staff noted several risks and vulnerabilities to the outlook. In particular,

  • Food security. Food imports will need to rise sharply this year, with the World Food Programme aiming to raise 300,000 tons of maize out of an import requirement of 1.2 million tons during April 2005-March 2006. Moreover, capacity constraints at ports and railways could hamper rapid delivery of large quantities of maize. The authorities indicated that they had obtained private external financing to meet grain import needs this year.

  • The squeeze on non-food imports. Staffs balance of payments projection indicates that even with food imports financed externally, non-food imports would decline by some 15 percent in real terms—a sharp compression from already low levels (Table 4). Zimbabwe would thus be highly vulnerable to any deterioration in the terms of trade, particularly a further rise in world oil prices.

  • The economic consequences of “Operation Restore Order,” the government’s recent effort to remove unauthorized dwellings and structures. Given uncertainty over the magnitudes, the projections do not fully incorporate these consequences. Pressures for additional fiscal spending may result (see paragraph 14). Also, by reducing informal market activity and real incomes, the operation could contribute to lower GDP and upward price pressures.

Table 4.

Zimbabwe: Balance of Payments, 2001-2005

(In millions of U.S. dollars, unless otherwise indicated)

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Sources: Zimbabwean authorities; and staff estimates and projections.

Include flows associated with underinvoicing of exports and arrears on short-term private debt.

End of period.

Gold valued at market prices. Usable gross reserves.

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

C. Fiscal Policy

13. The fiscal deficit for 2004 is estimated at 4.7 percent of GDP, compared with a projected deficit in the budget of 7½ percent of GDP and an estimated deficit of 3 percent of GDP reported at the February Board meeting. Revenue performance was broadly in line with expectations in February, but final data indicate that statutory spending on pensions and interest payments picked up sharply late in the year (Table 5).7

Table 5.

Zimbabwe: Central Government Operations, 2001-05

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

Commitments with respect to foreign interest payments.

14. Staff projects the fiscal deficit to increase substantially in 2005 to 14.3 percent of GDP due to higher spending. This estimate well exceeds the projected deficit of 7½ percent in the budget and the authorities’ commitment communicated to the Board in February to keep the fiscal deficit unchanged from the previous year. Revenue is expected to perform as budgeted despite lower-than-expected customs duties (due to lower non-food imports), given efforts to improve collections by bringing new tax payers into the tax net and the strong performance of corporate taxes, partly reflecting the shift to taxation of contemporaneous income. Expenditure would rise due to higher-than-budgeted spending on elections; drought-related welfare programs; larger pension payments from unexpectedly large retirements (particularly from the military); higher interest costs from the doubling of treasury bill issues in the first quarter; as well as Z$1 trillion (1½ percent of GDP) in unbudgeted spending to address the consequences of “Operation Restore Order”.8

15. Staff urged the authorities to submit a mid-year supplementary budget to lower the deficit to 5 percent of GDP as part of a comprehensive stabilization package and in line with previous commitments. Such a level of the deficit—unchanged from the previous year—would provide a broadly neutral fiscal stance to support the stabilization.9 With the expenditure ratio now close to 50 percent of GDP, the bulk of the adjustment would need to come from spending restraint, particularly on the wage bill. Staff noted that Zimbabwe’s government wage bill was high by regional standards—even before the 270 percent wage increase at the beginning of 2005. Although expenditure was concentrated on education and health, there was a sizeable deficit of workers in these areas (due to emigration and AIDS) and government wages were considered low.10 Staff urged an overall hiring freeze as well as a payroll audit to eliminate possible ghost workers and improve spending efficiency—without compromising the already deteriorating quality of services. Civil service reform would be needed over the medium term to obtain a sustained reduction in the wage bill. Capital outlays and transfer payments, which have risen sharply, could also be curtailed while cash management practices could be improved. Given the size of the adjustment, some revenue measures would also be needed, such as a significant narrowing of exemptions and zero rating in the VAT and an increase in income tax and VAT rates.

Fiscal indicators, 2004

(In percent of GDP)

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16. The authorities indicated their intention to stay within the budget’s deficit limit, while emphasizing the difficulties given the lack of external support. They acknowledged that the front-loading of expenditure in the first quarter would make it more difficult to find cuts later in the year, but underscored their track record of over-performing on budget targets in recent years. They were already implementing a hiring freeze (excluding limited additional posts created after the elections for a Senate and an expanded Cabinet) and were limiting capital spending to completing existing projects. A supplementary budget would likely be submitted to Parliament in July to accommodate the additional spending pressures (noted above), which would be offset by cutbacks in other spending and revenue measures, such as a drought levy that could augment selected taxes by some 5 percent. The authorities acknowledged, however, that even if they stayed within the budget limit for appropriated expenditure, the increase in statutory spending on pensions and interest would increase the fiscal deficit to about 10 percent of GDP.

D. Monetary Policy

17. Monetary policy was tightened in 2004, but the stance was relaxed prematurely. Overnight interest rates were raised sharply in early 2004 and lowered subsequently as inflation declined, with real interest rates maintained at high levels for most of the year (albeit with credit subsidies for selected borrowers). Interest rates were lowered sharply around the end-2004 and reduced further in early 2005, despite evidence from monthly data of rising price pressures. The January Monetary Policy Statement preannounced a path of further rate cuts if inflation continued to decline, although this was reversed in May by an increase in the RBZ’s overnight rate to 390 percent (annualized).

A01ufig09

Inflation and Money Growth

(annual percent change)

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

A01ufig10

Short-term annualized nominal and real interest rates

(percent change)

Citation: IMF Staff Country Reports 2005, 360; 10.5089/9781451841510.A001

18. The high rates of money growth that have fuelled the triple-digit inflation are mainly due to the RBZ’s quasi-fiscal activities, reflected in mounting losses on its balance sheet (Table 6). Although fiscal deficits eventually lead to high inflation, the link is indirect in Zimbabwe given the scope for non-RBZ financing through treasury bills. Much of the reserve money growth in 2004 can be attributed to: (i) exchange losses from foreign exchange purchases from exporters at a higher exchange rate than sales to importers (see text table below);11 and (ii) the RBZ’s initial provision of prolonged liquidity support to troubled banks. Following the resolution of troubled banks (see paragraph 28), credit to banks declined and reserve money growth in early 2005 stemmed mainly from substantial losses due to interest payments on RBZ bills issued to mop up liquidity, as well as to continued exchange losses. Subsidies paid to gold and tobacco producers also contributed. With the higher fiscal deficit, continued interest payments on outstanding RBZ bills, as well as the enlargement and proliferation of producer and credit subsidies in the May 2005 Monetary Policy Statement, staff projects broad money growth to pick up to almost 250 percent by end-2005 from over 200 percent at end-April (Table 6).

Table 6.

Zimbabwe: Monetary Survey, 2001-2005

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

Reserve money growth slows more sharply than broad money growth from April 2005 to end-2005 due to the netting out from banks’ statutory reserves of loans under the new credit facilities (especially PSF). This reduction would be more than offset by an increase in the money multiplier due to the effective reduction in the required reserve ratio. (A reversal of this process, as the PSF was wound down, partly explains the increase in reserve money and the fall in the multiplier from December 2004 to April 2005).

Reserve Bank of Zimbabwe’s net foreign assets and net domestic assets have been adjusted for memorandum of deposits. Includes valuation effects.

Subsidies and exchange rate losses amounted to Z$ 3,688 billions in 2004.

Reservey money also includes liquidity support provided by RBZ to trouble banks.

Credit to the government differs from the fiscal table as it includes accrued interest on domestic government debt, while domestic interest in the fiscal table is recorded as it falls due.

Table 6a.

Zimbabwe: Monetary Survey, 2001-2005 (concluded)

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

Reserve money growth slows more sharply than broad money growth from April 2005 to end-2005 due to the netting out from banks’ statutory reserves of loans under the new credit facilities (especially PSF). This reduction would be more than offset by an increase in the money multiplier due to the effective reduction in the required reserve ratio. (A reversal of this process, as the PSF was wound down, partly explains the increase in reserve money and the fall in the multiplier from December 2004 to April 2005).

Reserve Bank of Zimbabwe’s net foreign assets and net domestic assets have been adjusted for memorandum of deposits. Includes valuation effects.

Subsidies and exchange rate losses amounted to Z$ 3,688 billions in 2004.

Reservey money also includes liquidity support provided by RBZ to trouble banks.

Credit to the government differs from the fiscal table as it includes accrued interest on domestic government debt, while domestic interest in the fiscal table is recorded as it falls due.