Zambia
2007 Article IV Consultation: Staff Report; Staff Statement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Zambia
Author: International Monetary Fund
Publication Date:
30 Jan 2008
eISBN:
9781451841343
Language:
English
Keywords:
ISCR; CR; Reserve money growth; poverty headcount; staff appraisal; government; revenue performance; firm monetary policy; further exchange rate appreciation; last quarter; equilibrium exchange rate; forward market
Download PDF (1 MB)

The Zambian economy has performed well owing to its strong macroeconomic policies, high copper export prices, and extensive debt relief. Executive Directors encouraged the authorities to reduce poverty and attain the Millennium Development Goals (MDGs) under the Fifth National Development Plan (FNDP), and emphasized to authorities to improve budget execution and create fiscal space for increased spending on infrastructure and social sectors. They commended the tight monetary policy and fiscal stances, revenue reforms, and efforts to strengthen debt management. They welcomed financial sector reforms and also the trade regime to accelerate export development.

Abstract

The Zambian economy has performed well owing to its strong macroeconomic policies, high copper export prices, and extensive debt relief. Executive Directors encouraged the authorities to reduce poverty and attain the Millennium Development Goals (MDGs) under the Fifth National Development Plan (FNDP), and emphasized to authorities to improve budget execution and create fiscal space for increased spending on infrastructure and social sectors. They commended the tight monetary policy and fiscal stances, revenue reforms, and efforts to strengthen debt management. They welcomed financial sector reforms and also the trade regime to accelerate export development.

I. Background

1. The Zambian economy has performed well in recent years because of stronger macroeconomic policies, a favorable external environment, and extensive debt relief. The broad-based economic expansion has benefited greatly from the revival of the mining sector and high copper prices. Public finances have improved markedly and inflation has been brought under control. The external position has strengthened significantly, mainly due to booming copper export receipts and debt relief through the HIPC Initiative and MDRI, which have contributed to a substantial real appreciation of the exchange rate and a buildup in international reserves.

2. The improved economic position presents a historic opportunity for Zambia to accelerate growth and reduce poverty. By maintaining macroeconomic stability and implementing the economic reforms in the Fifth National Development Plan (FNDP)-Zambia's Poverty Reduction Strategy—economic growth could be sustained at a higher rate that would benefit the poor.1

II. Recent Developments

3. The positive economic performance of recent years continued in 2006 and the first half of 2007. Poor execution of the 2007 budget, however, has created considerable uncertainty about the end-year fiscal and monetary outcome.

  • The economy continued to grow at a robust pace with inflation held in check (Table 1 and Figure 1). Real GDP accelerated to 6.2 percent in 2006, driven by a vigorous expansion in mining, construction and telecommunications. Favorable terms of trade boosted real gross domestic income well above real GDP. Inflation, after falling to single digits in 2006, picked up in early 2007, but tighter monetary conditions and a turnaround in the kwacha brought it back to single digits (9 percent) in October.

  • Fiscal consolidation continued in 2007, but budget execution has been problematic (Table 2 and 3). Revenue rebounded to outperform projections through September 2007, reflecting higher income tax payments from mining companies. Expenditures were below projections owing to a large shortfall in releases for capital projects and because the released funds were not fully spent due to delays in tender procedures. This underspending resulted in a significant increase in government deposits at the Bank of Zambia (BoZ) and a large discrepancy in the fiscal accounts. The overall balance (including grants) was 0.8 percent of GDP through September—about 2½ percentage points of GDP higher than projected.

  • The rate of monetary expansion has fluctuated widely (Table 4 and Figure 2). Reserve money grew by about 30 percent in 2006 because the BoZ was unable to sterilize fully the sizable foreign exchange purchases. Money growth slowed to 20 percent in June 2007, reflecting intensified open market operations and a tight fiscal position. Reserve money growth again picked up in the third quarter and additional liquidity was injected into the banking system through a reduction in the cash reserve requirement from 14 percent to 8 percent on October 1. Nominal interest rates on government securities have trended upward since late 2006, while real rates have risen moderately since inflation peaked earlier in the year.

  • The exchange rate has been highly volatile in response to variations in the price of copper and shifts in market sentiment toward emerging markets (Figure 2). In late summer 2007, Zambia felt the effects of the increased risk aversion and flight to liquidity that affected global financial markets. The currency came briefly under strong downward pressure as copper prices fell sharply, prompting the BoZ to intervene to maintain orderly market conditions. The kwacha subsequently strengthened as markets settled and copper prices rebounded.

  • The banking sector remains sound. It is generally well capitalized, profitable and liquid (Table 6).

  • The external position has strengthened considerably (Table 5). The current account deficit (excluding grants) declined markedly to 1.3 percent of GDP in 2006, as copper export receipts doubled and nontraditional exports increased by 30 percent. Copper export receipts remained strong in the first half of 2007. The strong external position and the tight fiscal conditions contributed to a build up of international reserves to about 2.4 months of imports at end-June 2007.

  • Notwithstanding progress in some areas, the achievement of the MDGs remains a challenge (Table 7).

A01ufig01

Real GDP and Gross Domestic Income1

(In billions of kw acha, constant 1994 prices)

Citation: IMF Staff Country Reports 2008, 041; 10.5089/9781451841343.002.A001

1/ Real GDI equals real GDP plus net gains from term of trade changes.
A01ufig02

Contribution to GDP Growth in Zambia,

(Percentage points)

Citation: IMF Staff Country Reports 2008, 041; 10.5089/9781451841343.002.A001

Table 1.

Zambia: Selected Economic Indicators

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

Excludes Zimbabwe.

The projected reduction in reserve money for December 2007 reflects the lowering of statutory reserve requirements from 14 to 8 percent on October 1, 2007.

Grants in 2006 include MDRI debt cancellation amounting to 21.4 percent of GDP.

Including discrepancy between the above-the-line balance and below-the-line financing.

Figure 1.
Figure 1.

Zambia: Selected Macroeconomic Indicators

Citation: IMF Staff Country Reports 2008, 041; 10.5089/9781451841343.002.A001

Table 2.

Zambia: Fiscal Operations of the Central Government

(In billions of kwacha)

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

Discrepancy largely reflects the net change in releases to line ministries that are not fully executed by the end of the year and thus are not reflected in the domestic financing figures until the following year.

Excluding donor financed projects.

Table 3.

Zambia: Fiscal Operations of the Central Government

(In percent of GDP)

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

Discrepancy largely reflects the net change in releases to line ministries that are not fully executed by the end of the year and thus are not reflected in the domestic financing figures until the following year.

Excluding donor financed projects.

Figure 2.
Figure 2.

Zambia: Selected Financial Market Indicators

Citation: IMF Staff Country Reports 2008, 041; 10.5089/9781451841343.002.A001

1 Excludes Zimbabwe.
Table 4.

Zambia: Monetary Accounts 1

(In billions of kwacha, unless otherwise indicated)

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

End of period.

Include valuation and HIPC Initiative Account (balances were K3,253 billion and K2,209 billion at end-2005 and end-2006, respectively).

The projected reduction in reserve money for December 2007 reflects the lowering of statutory reserve requirements

Table 5.

Zambia: Balance of Payments

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

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

Defined as disbursements, plus grants, less debt service.

Table 6.

Zambia: Financial Soundness Indicators, 2002-07

(In percent, unless otherwise indicated)

article image
Source: Bank of Zambia

Components do not add up to 100 because loans to households, government, and parastatals are included in loans classified by economic sectors.

Liquid assets were redefined to exclude one-year Treasury bills beginning in 2005.

Table 7.

Zambia: Millennium Development Goals

article image
Source: World Development Indicators database, August 2007.Note: In some cases the data are for earlier or later years than those stated.

Goal 1 targets: Halve, between 1990 and 2015, the proportion of people whose income is less than one dollar a day. Halve, between 1990 and 2015, the proportion of people who suffer from hunger.

Goal 2 target: Ensure that, by 2015, children everywhere, boys and girls alike, will be able to complete a full course of primary schooling.

Goal 3 target: Eliminate gender disparity in primary and secondary education preferably by 2005 and to all levels of education no later than 2015.

Goal 4 target: Reduce by two-thirds, between 1990 and 2015, the under-5 mortality rate.

Goal 5 target: Reduce by three-quarters, between 1990 and 2015, the maternal mortality ratio.

Goal 6 targets: Have halted by 2015, and begun to reverse, the spread of HIV/AIDS. Have halted by 2015, and begun to reverse, the incidence of malaria and other major diseases.

Goal 7 targets: Integrate the principles of sustainable development into country policies and programs and reverse the loss of environmental resources. Halve, by 2015, the proportion of people without sustainable access to safe drinking water.

Goal 8 targets: Develop further an open, rule-based, predictable, nondiscriminatory trading and financial system. Address the special seeds of the least developed countries. Address the special needs of landlocked countries and small island developing states.

III. Policy Discussions

4. Zambia's key medium-term objectives are to further raise growth and enhance income opportunities for the poor while maintaining domestic and external stability. The discussions with the authorities focused on the challenges they face in reconciling the following objectives with domestic and external stability:

  • creating fiscal space for increased spending on infrastructure and the social sectors;

  • implementing the public expenditure and financial management reforms necessary to strengthen the capacity to undertake the expansion in public investments and to increase overall efficiency;

  • managing the macroeconomic effects of foreign exchange inflows from donors and the mining sector; and

  • improving conditions for private sector growth.

5. The authorities remain committed to a flexible exchange rate regime, which is characterized as a managed float. Staff analysis indicates that the exchange rate is broadly aligned with macroeconomic fundamentals, including the large improvement in the terms of trade in recent years (Box 1). Despite a large real exchange rate appreciation in recent years, nontraditional export receipts expanded by 30 percent in 2006 and remained strong in the first-half of 2007.

A. Near-Term Policy Challenges and Medium-Term Outlook

Policies for the rest of 2007

6. Incomplete execution of the 2007 budget through September will challenge fiscal and monetary policy for the rest of the year. With about 1½ percent of GDP of budgetary releases still unspent by mid-September, full implementation of the budget would result in a large injection of liquidity in the last quarter of the year. The authorities argued that a large proportion of these releases are likely to remain unspent because it will not be possible to carry out all of the planned projects. To ease the burden on monetary policy, however, the authorities will keep releases for the rest of the year below budgeted levels in nonpriority areas. Lower expenditure, together with the overperformance on revenue, is expected to result in net domestic financing for the year as a whole about 2 percentage points of GDP below that budgeted. There is considerable uncertainty about the outcome, however, since ministries may try to spend as much as they can before year end because under newly implemented procedures to reduce the budget carryover from one fiscal year to the next, any unspent funds at year-end must be transferred back to the treasury and new budget authorization sought for the spending.

Zambia: Assessment of External Stability

A balance of payments position consistent with external stability is one in which (i) the underlying current account is broadly in line with its equilibrium, i.e., there is no fundamental exchange rate misalignment, and (ii) the capital and financial account does not create risks of abrupt shifts in the capital flows.

Current account and fundamental misalignment. Directly estimating Zambia's equilibrium and underlying current account is complicated by data limitations, including the absence of international investment position data, and structural breaks. Moreover, the long-run current account equilibrium (or norm) is difficult to determine in a commodity-dependent economy, particularly one that is undergoing major structural changes, including in its major export base. The exchange rate therefore is assessed by (i) analyzing the relationship between the real effective exchange rate (REER) and a set of fundamental macroeconomic variables; (ii) assessing the exchange rate policy framework; and (iii) assessing the sustainability of domestic financial policies.

  • Equilibrium REER. Estimation of the equilibrium REER for the period 1986-2006 found that the long-run behavior of the REER is explained by the terms of trade and openness to trade. The estimates indicate that the REER appreciation in recent years is consistent with an appreciation of the equilibrium exchange rate, driven mainly by the large increase in copper prices. In the first half of 2007, the REER was 3 percent above the estimated equilibrium REER. Assessment: the current exchange rate does not appear fundamentally misaligned.

  • Exchange rate policy. The exchange rate is determined in the interbank foreign exchange market, with intervention by the BoZ confined to keeping market conditions orderly and meeting its international reserves target. Since Zambia is a recipient of sizeable aid inflows, the BoZ can accumulate international reserves without intervening directly in the foreign exchange market if it does not sell all of the aid inflows. Assessment: the exchange rate broadly reflects market conditions and no important market restrictions can be identified.

  • Domestic policies. The fiscal position is sustainable and is supported by a projected primary deficit of 1.1 percent of GDP in 2007 and expected medium-term real GDP growth of 6 percent. A firm monetary policy has supported a declining trend in inflation. While keeping macroeconomic stability and continuing with structural reforms are expected to generate productivity gains and REER appreciation, all else being equal, the exchange rate adjustment is expected to be very gradual. Assessment: fiscal and monetary policies are consistent with domestic stability and internal balance.

Capital and financial accounts and external stability. Private capital inflows are related primarily to foreign direct investment in mining. Since 2005, some portfolio inflows into public securities have also taken place. However, only about 15 percent of government securities (corresponding to about one-fourth of international reserves) are foreign held and largely in securities with maturities of more than one year. There is no significant secondary market for government securities. Assessment: the current structure of Zambia's capital and financial account suggests a relatively low risk of external instability.