Zambia
Fourth Review of the Three-Year Arrangement Under the Poverty Reduction and Growth Facility, Request for Modification of Performance Criteria, and Financing Assurances Review: Staff Report; and Press Release on the Executive Board Consideration
Author:
International Monetary Fund
Search for other papers by International Monetary Fund in
Current site
Google Scholar Close
Publication Date:
19 Jul 2006
eISBN:
9781451841299
Language:
English
Keywords:
ISCR; CR; PRGF arrangement; PRGF loan; PRGF-supported program; economic statistics; currency appreciation; fiscal policy; MDRI assistance; adjustment effort
Download PDF (1.4 MB)

Zambia has achieved robust economic growth over the years, and poverty has begun to trend downward under the Poverty Reduction and Growth Facility Arrangement. Prudent fiscal policy has reduced the domestic financing need and facilitated the implementation of a firmer monetary policy. Executive Directors agreed that the relief under the economic program and the Multilateral Debt Relief Initiative has reduced its external debt, and its economic fundamentals have helped in gaining market confidence. They advised the authorities to maintain macroeconomic stabilization and stressed the need to accelerate structural reform.

Abstract

Zambia has achieved robust economic growth over the years, and poverty has begun to trend downward under the Poverty Reduction and Growth Facility Arrangement. Prudent fiscal policy has reduced the domestic financing need and facilitated the implementation of a firmer monetary policy. Executive Directors agreed that the relief under the economic program and the Multilateral Debt Relief Initiative has reduced its external debt, and its economic fundamentals have helped in gaining market confidence. They advised the authorities to maintain macroeconomic stabilization and stressed the need to accelerate structural reform.

I. Background and the Issues

1. Economic growth in Zambia has been robust for several years and poverty, though still widespread, has begun to trend downward. Inflation, which was high for much of this period, has fallen markedly since last year, aided by a sharp appreciation of the currency and, more recently, lower food prices as agriculture recovers. Prudent fiscal policy has reduced the government’s domestic financing needs and facilitated implementation of a more restrained monetary policy. Government revenue has not kept pace with economic growth, however. The external position has strengthened, as record high copper prices significantly improved the terms of trade and nontraditional exports grew briskly. Relief under the enhanced HIPC Initiative greatly reduced Zambia’s external debt burden and the Multilateral Debt Relief Initiative (MDRI) cancelled the bulk of the remaining external debt. Zambia’s improved economic fundamentals have boosted market confidence in the economy, leading to substantial inflows of portfolio investment—a new phenomenon for Zambia—and contributing to a large real appreciation of the currency. International reserves, though, are low. The outlook is for continued robust economic growth, led by strong performance in mining and construction, although the currency appreciation could hamper export diversification. The policy challenge is to continue on the path of macroeconomic stabilization—anchored on lower domestic borrowing—while stepping up execution of the structural reform agenda.

2. Against this background, discussions with the authorities focused on

  • (i) the implications of recent developments for the macroeconomic framework for 2006, especially:

    • the adverse impact of the kwacha’s appreciation on the fiscal position and measures to close the projected fiscal gap;

    • the inflow of portfolio capital and its implications for monetary and exchange rate policy; and

    • the use of MDRI resources.

  • (ii) the importance of staying the course for greater macroeconomic stability over the medium term and executing the structural reform agenda to increase productivity and competitiveness.

II. Recent Developments and Program Performance

3. Performance under the PRGF-supported program has been satisfactory:

  • Real GDP grew in 2005 by an estimated 5.0 percent. Strong performances in construction and mining overcame negative supply shocks such as drought in some regions, high world oil prices, and fuel shortages arising from unplanned shutdowns of the country’s oil refinery. Economic activity in the first quarter and an anticipated good harvest point to real growth of about 6 percent in 2006 (Table 1).

    uA01fig01

    Real GDP Growth, 2000–06

    (Annual percent change)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • Inflation fell in 2005 to 15.9 percent, slightly above the program target (15 percent). It fell further in early 2006 to 8.6 percent in May, the lowest rate in about 30 years.

    uA01fig02

    Inflation, January 2000–May 2006

    (12-month percent change)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • Firm expenditure control kept the fiscal deficit, including grants, in line in 2005, notwithstanding a modest shortfall in government revenues (Table 2). Spending on poverty-reducing programs (PRPs) other than externally financed projects amounted to 6.1 percent of GDP in 2005, 1.1 percentage points more than programmed (Table 3).

    uA01fig03

    Overall Fiscal Balance and Financing, 2000–06

    (Percent of GDP, excluding MDRI assistance)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • Net domestic financing (NDF) was below the program ceiling in 2005, as not all of the K 120 billion released for payment of domestic arrears to road contractors, had cleared by the end of the year.1 Nonbank financing more than covered the government’s domestic borrowing needs in 2005, reflecting strong demand for government securities from pension funds and insurance companies, as well as by foreign investors. In 2006Q1, continued weakness in revenues, together with a sizable float effect from releases in late 2005, resulted in the benchmark ceiling for NDF being exceeded by about ¾ percent of GDP.

    uA01fig04

    Selected Current Expenditures, 2000–06

    (Percent of GDP)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

    uA01fig05

    Revenue and Grants, 2000–06

    (Percent of GDP, excluding MDRI assistance)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • Relative to GDP, tax revenues in 2005 slipped by half a percentage point to 17.0 percent. The slippage was particularly marked in income taxes, import VAT, and customs duties. In 2006Q1, tax revenues were weaker than expected, mainly due to (i) the impact the appreciated kwacha had on import taxes and on domestic taxes on goods and services priced in U.S. dollars (such as VAT on electricity sales to the copper mines), and (ii) the extension through June 2006 of reductions in import and excise duties on petroleum products, which were introduced in 2005Q4 in the wake of the fuel crisis brought about by the shutdown of the oil refinery, because the refinery continued to experience production difficulties.

    uA01fig06

    Reserve Money and Broad Money Excluding Foreign Currency Deposits, December 2000–March 2006

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • Monetary expansion was restrained in 2005. Reserve money grew by 8.4 percent and broad money by just 0.4 percent, as foreign currency deposits fell by nearly 20 percent in kwacha terms.2 Credit to the private sector expanded by 18.4 percent.3 The monetary aggregates continued to expand at a moderate pace in 2006 (Tables 4 and 5).

    uA01fig07

    Treasury Bill Yields and Average Weighted Lending Base Rates of Commercial Banks, January 2004–May 2006

    (Percent)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • The average nominal yield on t-bills, which was fairly steady over the second half of 2005, declined sharply in 2006, mainly in response to falling inflation and strong demand by investors. In May 2006, the average yield on t-bills and bonds was over 10 percentage points lower than in December 2005. In real terms, the yield on the 91-day t-bill rose sharply before falling to near zero in May 2006. Commercial bank lending rates have also fallen, though at a more moderate pace.

    uA01fig08

    Real and Nominal Yields on 91-Day T-Bill, January 2005–May 2006

    (Percent)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

  • The kwacha appreciated sharply in late 2005. Extensive debt relief, combined with record high world copper prices and growing confidence in macroeconomic management, resulted in a marked strengthening of market sentiment, which triggered significant inflows of portfolio investment (Box 1). At the same time, commercial banks reduced their foreign assets position in favor of higher-yielding kwacha assets, and donors increased their support for the budget and for projects with a substantial domestic component. The absence of the BoZ from the foreign exchange market in 2005Q4 also influenced perceptions of the course of the currency. The kwacha appreciated by 20 percent against the U.S. dollar in 2005 and by 24 percent in real effective terms on a period-average basis (Box 2). It strengthened further against the U.S. dollar, though at a more gradual pace, in early 2006 but gave up most of the gains in late May as copper prices softened.4

    uA01fig09

    Exchange Rates, January 2004–May 2006

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

    uA01fig10

    Copper Prices, January 2000–May 2006

    (US$/ton)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

    Source: London Metal Exchange.

  • Zambia’s external position improved markedly in 2005. Receipts from both copper and nontraditional exports grew strongly and the country benefited from extensive debt relief under the HIPC Initiative, debt cancellation by Paris Club creditors, and MDRI.

    uA01fig11

    Real Effective Exchange Rate and Terms of Trade, (1980–2005; 2000=100)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

    uA01fig12

    Current Account & Overall Balance, 2000–06

    (Percent of GDP)

    Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

    Despite the high price of imported petroleum products and a 40 percent decline in the price of cobalt—Zambia’s second major export—the terms of trade improved in 2005 as copper prices rose to record heights. Gross international reserves increased to US$357 million as of end-2005, well above the program floor, but import coverage was low at an estimated 1.6 months. These trends largely continued into 2006 (Table 6).

uA01fig13

Exports of Goods and Services, 2000–06

(In millions of US$)

Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

uA01fig14

Imports of Goods and Services, 2000–06

(In millions of US$)

Citation: IMF Staff Country Reports 2006, 263; 10.5089/9781451841299.002.A001

Table 1.

Zambia: Selected Economic and Financial Indicators, 2003–08

article image
Sources: Zambian authorities, and IMF staff estimates and projections.

Figures reflect cancellation of obligations to the Fund under the Multilateral Debt Relief Initiative (MDRI) and related capital transactions and financing amounting to SDR 402.59 million (5.1 percent of GDP) in 2006.

Excludes external interest payments and foreign-financed project expenditure.

After debt relief from the enhanced HIPC Initiative, Paris Club creditors, and MDRI.

Includes government arrears to the Public Sector Pension Fund and other domestic claimants.

Table 2.

Zambia: Central Government Overall Operations, 2003–08

(Billions of Kwacha)

article image
Sources: Zambian authorities, and Fund staff estimates and projections.

Statistical discrepancies for 2004 and 2005 mainly reflect end-year releases to line ministries that have not been fully executed and thus are not reflected in the domestic financing figures. For 2006, the statistical discrepancy of K 50 billion reflects releases to clear expenditure arrears to road contractors in 2005 but executed in 2006.

The overall deficit without the IMF MDRI assistance for 2006 relief is K 1,068 billion or 2.7 percent of GDP.

From 2005, fiscal accounts identify poverty-reducing spending according to a wider definition consistent with Zambia’s Poverty Reduction Strategy Paper.

Audited at June 30 for K 593.5 billion by the Zambian authorities, excluding statutory pension arrears, which were K 414 billion for 2005.

From 2004, at cost value. Includes bonds issued in 2001 in favor of BoZ (K 1,646 billion) and in 2002 in favor of the Zambia National Commercial Bank (K 248 billion).

Table 3.

Zambia: Central Government Overall Operations, 2003-08

(Percent of GDP)

article image
Sources: Zambian authorities, and Fund staff estimates and projections.

Statistical discrepancies for 2004 and 2005 mainly reflect end-year releases to line ministries that have not been fully executed and thus are not reflected in the domestic financing figures. For 2006, the statistical discrepancy of K 50 billion reflects releases to clear expenditure arrears to road contractors in 2005 but executed in 2006.

The overall deficit without the IMF MDRI assistance for 2006 relief is K 1,068 billion or 2.7 percent of GDP.

From 2005, fiscal accounts identify poverty-reducing spending according to a wider definition consistent with Zambia’s Poverty Reduction Strategy Paper.

Audited at June 30 for K 593.5 billion by the Zambian authorities, excluding statutory pension arrears, which were K 414 billion for 2005.

From 2004, at cost value. Includes bonds issued in 2001 in favor of BoZ (K 1,646 billion) and in 2002 in favor of the Zambia National Commercial Bank (K 248 billion).

Table 4.

Zambia: Monetary Survey, 2003-08

(Billions of kwacha, unless otherwise indicated; end of period)

article image
Sources: Zambian authorities, and IMF staff estimates and projections.

The base for the year t is obtained by recalculating the figures for end-year t - 1 on the basis of the program exchange rates assumed for the year t.

The proposed revised program is based on an exchange rate of K3509/US$ (as against K4550/US$ for the original program).

Beginning in 2004, government securities are recorded at cost rather than face value.

Resources available from a deposit account previously maintained for making debt service payments to the IMF.

The 2005 program figure is based on the year end stock of broad money. All other figures are based on the average stock during the year.

Table 5.

Zambia: Assets and Liabilities of the Bank of Zambia, 2003-06

(Billions of kwacha, unless otherwise indicated; end of period)

article image
Sources: Zambian authorities, and IMF staff estimates and projections.

The base for the year t is obtained by recalculating the figures for end year t - 1 on the basis of the program exchange rates assumed for the year t.

The proposed revised program is based on an exchange rate of K3509/US$ (as against K4550/US$ for the original program).

Beginning in 2004, government securities are recorded at cost rather than face value.

Resources available from a deposit account previously maintained for making debt service payments to the IMF.