Zambia: Selected Issues and Statistical Appendix
Author: International Monetary Fund
Publication Date:
21 Mar 2006
eISBN:
9781451841282
Language:
English
Keywords:
ISCR; CR; government; monetary policy; real GDP; bank deposit; nontraditional export; composite index; investment promotion; export promotion function; B. export performance; Exports; Real effective exchange rates; Export competitiveness; Real exchange rates
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This Selected Issues paper on Zambia reports that the authorities have outlined a range of alternative policy scenarios to achieve greater pro-poor growth. The thrust of these policies is to support higher growth in rural areas, where the incidence of poverty is particularly high, by investing more in infrastructure development, while also stepping up delivery of public services, notably in health and education. Implementing these alternative policies would require significantly more financial assistance from the donor community.

Abstract

This Selected Issues paper on Zambia reports that the authorities have outlined a range of alternative policy scenarios to achieve greater pro-poor growth. The thrust of these policies is to support higher growth in rural areas, where the incidence of poverty is particularly high, by investing more in infrastructure development, while also stepping up delivery of public services, notably in health and education. Implementing these alternative policies would require significantly more financial assistance from the donor community.

IV. Export Performance and Competitiveness1

A. Introduction

1. Prospects for sustained growth of the Zambian economy over the long run are closely tied to the diversification of exports. The favorable performance of the Zambian economy in recent years has largely been driven by a rebound in copper sector output following the privatization of the main mining company in 2000, as well as the recent rise in world market prices for copper to historic highs. Nontraditional exports2 have also grown strongly but their contribution to export earnings is dwarfed by that of metals. With mining output likely to slow over the next few years, following a period of rapid growth associated with the refurbishment of old mines and sustained investment in new ones, and the possibility that copper prices will retreat from current levels, Zambia’s growth over the long run will need to be supported by the strengthening and diversification of nontraditional exports. Among the nontraditional export sectors that have been identified as ripe for expansion are floriculture, horticulture, agro-processing, textiles and garments, gemstones, and tourism.

2. The expansion of nontraditional exports will hinge on productivity improvements and lower costs of doing business in Zambia. Zambia cannot rely on a depreciating real exchange rate to strengthen the international competitiveness of nontraditional export sectors. As a result of improvements in the terms of trade and renewed confidence in the economy, arising from the marked improvement in fiscal performance and the commitment of extensive external debt relief, the real effective exchange rate of the kwacha has appreciated considerably over the last two years. While a weakening of the real exchange rate cannot be precluded if and when copper prices ease from their current highs, greater productivity and a lower cost of doing business are essential for securing the international competitiveness of the Zambian economy.

3. This paper reviews some of the issues that impinge on the competitiveness of nontraditional export sectors in the Zambian economy. The first section below reviews Zambia’s export performance over the last decade, and highlights that nontraditional export sectors have done reasonably well in recent years, although less spectacularly than the copper sector. The next section considers movements in the real effective exchange rate of the Kwacha, both from a longer term perspective and in recent years. This also discusses the recent sharp appreciation of the Kwacha and its potential implications, if sustained, for competitiveness. The paper then reviews factors that have been identified as obstacles to private sector investment in the Zambian economy. The penultimate section touches on trade policy measures that could support export diversification. A short section concludes.

B. Export Performance

4. Zambia’s exports, led by copper, have grown sharply in recent years. Between 2001 and 2004, total goods exports more than doubled, from US$880 million to US$1,780 million (Figure IV.1); a further increase to US$2,090 million is projected for 2005. Metals exports, owing to a recovery in mining output and a sharp rise in copper prices on world markets, account for most of this increase; between 2001 and 2005, the volume of copper exports is estimated to have grown by 40 percent while copper prices have doubled. Nontraditional exports have also recorded healthy growth, rising from US$295 million in 2001 to US$457 million in 2004, an average annual increase of 16 percent; a further increase of 18 percent is projected for 2005. However, after rising during the late 1990s, the share of non-traditional goods exports in total goods exports has declined in recent years, from a peak of 38 percent in 1999 to 26 percent in 2004 (Figure IV.2). As a share of world exports, total exports have risen in recent years, following a long-standing downward trend (Figure IV.3); however, the share of non-traditional exports in world exports has been relatively flat.

Figure IV.1.
Figure IV.1.

Zambia. Goods Exports, 1995–2004

(In millions of US dollars)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

Figure IV.2.
Figure IV.2.

Zambia. Goods Exports, 1995–2004

(Percentage shares)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

Figure IV.3.
Figure IV.3.

Zambia. Exports relative to World Exports, 1995–2004

(In percent)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

5. The improved export performance of recent years has led to a sharp strengthening of Zambia’s external balances. Thus, notwithstanding rising imports associated with the pick up in economic activity and renewed investment in the copper sector, the merchandise trade balance went from a deficit of 9½ percent of GDP in 2001 to a surplus of 1½ percent in 2004 (Figure IV.4). Over the same period, the current account deficit narrowed from 21 percent of GDP to 11 percent.

Figure IV.4.
Figure IV.4.

Zambia. Trade and Current Account Balances, 1995–2004

(percent of GDP)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

6. Zambia’s nontraditional exports consist of a variety of products and are destined for widely spread markets. In 2004, primary agricultural products accounted for more than a third of nontraditional exports, while engineering products (mainly copper wire) and floricultural and horticultural products (for example, cut flowers) each accounted for between 13–14 percent (Table IV.1). In 2004, about 43 percent of Zambia’s total exports were absorbed by industrial countries, of which European Union countries accounted for 25 percent but the United States only 1 percent (Table IV.2).3 South Africa received more than a quarter of exports in 2004, and was the origin of almost one half of imports.

Table IV.1.

Zambia: Structure of NonTraditional Exports, 2004

(in percent of total)

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Source: Export Board of Zambia.
Table IV.2.

Zambia. Direction of Trade, 2004 (percent of total)

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Source: IMF, Direction of Trade Statistics.

7. Recent export performance contrasts sharply with that of the 1980s and 1990s, when export earnings steadily eroded, as mining output contracted and copper prices were subdued, and export diversification failed to take off, despite extensive liberalization of the economy during the first half of the 1990s.1 On the mining side, the privatization of the Konkola Copper Mines was instrumental in reversing the trend of declining output. The favorable performance of nontraditional exports can, at least in part, be seen a delayed response to the liberalization of the 1990s, although a more favorable macroeconomic environment, including stable nominal and real exchange rates, have also been at work.2

C. Exchange Rate Developments

8. Movements in the real exchange rate of a currency are a gauge of changes in the international competitiveness of an economy. In principle, the real effective exchange rate can me measured in a variety of ways, using different price and cost indices. For Zambia, the only available measure of the real effective exchange rate is based on relative consumer price developments in Zambia and in trading partners. While this measure is inferior to cost-based measures of the real effective exchange rate, not least because the CPI includes imported goods, the price of which is a function of the exchange rate, it nevertheless provides an indication of trends in international competitiveness.

Long-Term Perspective on the Real Effective Exchange Rate

9. Long-term movements in the kwacha’s real effective exchange rate reflect the vagaries of the Zambian economy, especially the swings in world prices of copper and the terms of trade more broadly (Figure IV.5). During the first decade of independence, in 1964, Zambia enjoyed robust export earnings from copper. When copper prices collapsed in the mid-1970s, Zambia resorted to large scale foreign borrowing to finance its import needs and avoid an adjustment to the real exchange rate.3 However, when access to foreign loans was cut off in the 1980s, a sharp depreciation of the real exchange rate was inevitable.

Figure IV.5.
Figure IV.5.

Zambia. Real Effective Exchange Rate and the Terms of Trade, 1980–2004

(1990=100)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

Recent Developments

10. Over the past several years, the real effective exchange rate has been fairly stable, apart from the very recent period.4 During 2000–04, the gradual depreciation of the nominal effective exchange rate largely offset the higher inflation in Zambia than in trading partners (Figure IV.6). Developments in the kwacha’s bilateral real exchange rates have been somewhat different (Figure IV.7). Thus, the kwacha appreciated sharply against the South African rand in real terms in 2001 before quickly depreciating again, reflecting movements in the rand. Against the U.S. dollar, the kwacha has appreciated steadily in real terms since early 2003.

Figure IV.6.
Figure IV.6.

Zambia. Nominal and Real Effective Exchange Rates, January 2000–September 2005

(2000=100)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

Figure IV.7.
Figure IV.7.

Zambia. Real Effective Exchange Rate and Bilateral Real Exchange Rates vs. the U.S. dollar and Rand, 2000–05

(2000=100)

Citation: IMF Staff Country Reports 2006, 118; 10.5089/9781451841282.002.A004

11. Over the last year, the real effective exchange rate of the kwacha has appreciated sharply. From December 2004 to September 2005, the real effective exchange rate appreciated by 26 percent. Moreover, the real appreciation continued in October and November, as the kwacha strengthened sharply in nominal terms. The appreciation stems from an improvement in the terms of trade and renewed confidence in the economy, resulting from the marked improvement in fiscal performance and the international commitment of extensive debt relief, both under the HIPC Initiative but even more so under the Multilateral Debt Relief Initiative (MDRI).5 Interest in government securities, both domestically and abroad, has also been strong owing to their high nominal yields.

12. From a long-term perspective, the appreciation of the kwacha during the past year may be seen as an adjustment to the upward shift in the equilibrium real value of the exchange rate, as a result of the greatly improved prospects of the copper sector and cancellation of the bulk of Zambia’s external debt. This suggests that the kwacha may not be overvalued currently. Nevertheless, the higher external value of the currency may pose a challenge for non-traditional exports, which will have to rely on improvements in productivity to enhance international competitiveness.

D. Business and Investment Climate6

13. An environment conducive to private sector investment and growth is crucial for greater productivity and strengthened competitiveness of nontraditional exports. With the authorities exercising limited control over the exchange rate, real depreciation cannot be relied on to strengthen competitiveness. Instead, extensive structural reforms, coupled with macroeconomic stability, are required to create an environment conducive to private sector development. Surveys of Zambian firms, conducted by the World Bank in 2003, have highlighted a host of structural constraints to private sector investment: Chief among these are: (i) the limited access to and high cost of financing; (ii) high tax rates and poor tax administration, including of customs; (iii) bureaucratic barriers to business establishment and regulatory uncertainty; (iv) poor physical infrastructure and high cost of utilities; and (v) corruption.7

Access to and Cost of Financing

14. Bank lending to the private sector is low and real lending rates are high. Four-fifths of Zambian companies cited the high cost of financing as a major or severe constraint on their activities. The main reason for the limited access to and high cost of capital has been crowding out by government borrowing, not only trough the exhaustion of available credit but also by providing financial institutions a low-risk alternative to investing in private businesses.

Taxes and Tax Administration

15. High marginal tax rates and arbitrary tax administration are a major source of complaint. The World Bank found some justification for the complaint over high marginal tax rates when comparing Zambian rates to those of some neighboring countries, although this does not apply to the mining sector, which enjoys tax concessions.8 Widespread dissatisfaction with tax administration was also reported, notwithstanding sustained donor-supported efforts to improve it. Complaints concern frequent and arbitrary changes in tax policy, unclear eligibility criteria and delays in VAT refunds, and the wide discretionary powers of the Zambian Revenue Authority.

Bureaucracy and Regulations

16. Regulatory uncertainty is a major concern of Zambian companies. While Zambia compares favorably with other Sub-Saharan African countries in terms of the cost of bureaucracy and regulations,9 regulatory uncertainty associated with shifts in policy is regarded as a significant risk in doing business in Zambia, one that the World Bank reports has been an obstacle to foreign direct investment in recent years. In addition to unforeseen policy changes, companies also complain about the inconsistent and unpredictable interpretation of regulations by government officials.

17. Labor market laws and regulations are for the most part not a hindrance to hiring, except for the requirements regarding terminal benefits. Zambian labor law calls for the payment of terminal benefits of 2–3 months basic salary for every year of service. These are far more generous terms than in some peer countries.10

Physical Infrastructure and Cost of Utilities

18. Zambian firms are concerned about the generally poor quality and limited availability of infrastructure services. The areas concerned are electricity, telecommunications, roads and water. Power outages are frequent, as are delays in getting access to electricity. There are also complaints about the poor quality of telephone services, not least about the provision of landlines and the capacity of the international gateway, controlled by ZAMTEL, the state-owned telephone company.11 While the road system in some parts of Lusaka has improved, the rest of the country has seen no improvements. In many areas, including the Copperbelt, the quality of roads is such that it significantly affects the efficiency of transportation of raw materials and finished goods. Water supply is also reported to be inadequate in many areas, forcing many companies to incur large expenditures to drill wells to ensure its steady availability.

Corruption

19. Corruption adds to the cost of doing business in Zambia, although perhaps not much more so than in other countries in the region. The companies surveyed indicated that they spent an average of 1.7 percent of revenue on bribes to get things done, an outcome that does not compare unfavorably with other East African countries. In 2005, Zambia received a score of 2.6 on Transparency International’s Perception of Corruption index and ranked 107th on a list of 155 countries.

20. The Zambian authorities have formulated policies aimed at improving the climate for investment and business activity. Wide-ranging policy measures have been laid out in the Financial Sector Development Plan (FSDP) and the Private Sector Development Initiative (PSDI). Many of these measures have also been prioritized in the Green Paper accompanying the Medium-Term Expenditure Framework (MTEF) for 2006–08 and the National Development Plan (NDP) for 2006–11. The question is whether these reforms will be pursued more vigorously than past reform efforts that floundered. Planned investments in electricity generation capacity should reduce the frequency and duration of power outages while the liberalization of the international gateway should improve telecommunications services. As a large, landlocked country, Zambia would also benefit from improvements in both the domestic and regional transportation infrastructure.

E. Trade Policy Issues12

21. Zambia’s trade regime is one of the most open in Africa. A recent Diagnostic Trade Integration Study (DTIS) for Zambia concluded that, to support export diversification, the key priority areas in trade policy were to: (i) make export incentives work for exporters; (ii) improve trade facilitation; and (iii) enhance the authorities’ capacity to formulate, coordinate, and implement trade policy, and negotiate trade agreements. It also concluded that further liberalization of imports was a lesser priority, 13 although duties on imported capital goods should be removed to stimulate private sector investment. Moreover, it found that market access was not a limiting constraint on export growth, as most of Zambia’s exports face zero or low tariffs and qualify for preferential access to the major developed country and regional markets.14

22. Drawing in part on the recent DTIS, the authorities have incorporated a number of export promoting trade policy measures into the MTEF and NDP. Key measures include: (i) streamlining of procedures for the duty drawback scheme and improved management of bonded warehouses and RIB (removal in bond), and the establishment of an accessible and affordable export financing facility; (ii) improving efficiency in customs administration; (iii) strengthening standards and certification services; (iv) enhancing export-oriented investment promotion and export promotion functions; and (iv) strengthening capacity to formulate and implement trade policy and negotiate trade agreements. As with the FSDB and the PSDI, the success of these measures will depend on the steadfastness of their implementation.

F. Conclusion

23. Zambia needs to vigorously pursue reforms aimed at creating an environment conducive to private sector investment and export diversification and growth. Such reforms are essential to allow productivity to improve and nontraditional exports to make a growing contribution to overall exports, as a depreciation of the real exchange rate cannot be relied on to ensure competitiveness. These reforms are made doubly important by the recent real effective appreciation of the kwacha, which, at least in part, reflects an adjustment to an upward shift in the long-run equilibrium exchange rate in response to a fundamental improvement in Zambia’s external prospects, owing to the recovery of the copper sector and the commitment of deep debt relief. The Zambian government has formulated an ambitious agenda of reforms and incorporated it in its FSDP, PSDI, MTEF, and NPD. The key to success, however, lies in the implementation.

Table 1.

Zambia: Gross Domestic Product by Sector of Origin at Constant Prices, 1998–2004

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Source: Central Statistical Office.

Includes public administration, defense, sanitary services, education, health, recreation, and personal services.

Table 2.

Zambia: Gross Domestic Product by Sector of Origin at Current Prices, 1998–2004

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Source: Central Statistical Office.

Includes public administration, defense, sanitary services, education, health, recreation, and personal services.

Table 3.

Zambia: Gross Domestic Product by Type of Expenditure, 1998–2004

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Source: Central Statistical Office; and Fund staff estimates.

Beginning in 2000, public investment is estimated to be equal to government capital expenditure.

Excludes net income and net transfers from the external current account and grants.

Total revenue (excluding grants) minus government consumption.

Gross domestic savings plus net factor income and net current transfers from abroad.

Table 4.

Zambia: Index of Industrial Production, 1998–2004

(2000 = 100)

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Source: Central Statistical Office.
Table 5.

Zambia: Volume of Mineral Production, 1998–2004

(In thousands of metric tons)

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Sources: Central Statistical Office; and Bank of Zambia.
Table 6.

Zambia: Marketed Production of Selected Agricultural Crops, 1998/99–2004/05 1/

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Source: Central Statistical Office.

Crop years run from May 1 to April 30.

Table 7.

Zambia: Area Under Cultivation for Selected Crops, 1998/99 2004/05 1/

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Sources: Ministry of Agriculture and Co-operatives; and Central Statistical Office.

Crop years run from May 1 to April 30. Data are based on Post Harvest Survey results.

2003 data based on the Final Crop Forecasting Survey for 2003.

Table 8.

Zambia: Paid Employment by Economic Sector, 1998–2004

(In number of employees)

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Source: Central Statistical Office.
Table 9.

Zambia: Annual Composite Index of Retail Prices, 1998–2004

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Source: Central Statistical Office.

Composite index consists of food and nonfood indices.

Table 10.

Zambia: Monthly Composite Index of Retail Prices, 2002–2004

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Source: Central Statistical Office.

Composite index consists of food and nonfood indices; alternatively, it consists of metropolitan high and low incomes, and nonmetropolitan indices.