Introduction and Context

Our Zimbabwean authorities appreciate the continued engagement with the Fund and thank staff for the constructive discussions during the recent Article IV mission in Harare, and the reviews of the Staff Monitored Program (SMP). The authorities agree with the assessment of the staff report and also broadly concur with the analysis of the challenges facing the Zimbabwean economy, especially on the need to continue with the transformation agenda and on the importance of external financing.

Fund support has played a critical role in efforts to transform the economy and normalize relations with the international community. Against this background, Zimbabwe has made considerable progress through a strong performance under the SMP, formulated a reengagement strategy which has received broad support from creditors and development partners. In addition, the authorities are pursuing key policies and structural reforms to stabilize the macroeconomic environment and spur sustainable and inclusive growth.

The country’s output is increasingly constrained by infrastructure bottlenecks in electricity, water, transport and the high cost of capital. This situation has been further exacerbated by the impact of the El-Niño-induced drought. Nevertheless, our authorities remain committed to their medium-term economic transformation agenda which, among others, addresses these bottlenecks. However, the success of the economic transformation program remains at risk if access to external financing continues to be limited. In this context, our authorities’ top priority is to achieve full re-engagement with the international community as soon as practical and unlock external financial flows.

Recent Economic Developments and Outlook

In light of inadequate external inflows, lower commodity prices, the dollar appreciation, and the El-Niño-induced drought, the economic situation has continued to be challenging. The drought could worsen the poverty levels which were at 72 percent in 2012. Overall, economic growth for 2015 has been revised significantly from an earlier projection of 3.2 percent down to 1.5 percent in September 2015 and most recently to 1.1 percent following further declines in agricultural production, mining and manufacturing sectors. The decline in water levels has adversely affected hydropower generation and crop production, and resulted in a decimation of livestock herds. In some parts of the country, higher rainfall totals were registered so the loss of cattle was limited. In the Southern parts of the country, however, the impact of the drought was more severe and cattle farmers incurred devastating losses. In 2016, growth is estimated at 1.4 percent, while inflation is projected to remain in negative territory, only picking up over the medium term.

While this projected growth is still too low to ensure sustainable development and poverty reduction, the authorities are taking bold policy reforms to bring growth to a higher trajectory. For instance, recognizing that the contribution of the mining sector is crucial to Zimbabwe’s long term growth prospects, the authorities have taken steps to increase transparency and accountability in the diamond sector. In this respect, they have established Zimbabwe Consolidated Diamond Corporation (ZCDC) to, among other functions, trace diamond mining from extraction to sales and to transfer of proceeds.

In spite of growing spending pressures, the authorities remain committed to fiscal discipline. The primary fiscal deficit (on a cash basis) at end December 2015 was lower than programmed despite the high employment costs for the public sector. Employment costs continue to be the main source of fiscal pressure consuming about 82 percent of all revenues. In 2016, this will be compounded by the need to import maize to meet food security for 3 million vulnerable people following the El-Niño-induced drought. It is expected that the pressure from employment costs will dissipate with the continued implementation of public service reforms in the broader context of public expenditure rationalization.

The current account balance improved in 2015 on account of lower oil prices, weak economic activity and fiscal consolidation efforts. It is expected to narrow in 2016, but remain high over the medium term.

The Zimbabwean authorities have also made remarkable progress in strengthening the financial sector and restoring confidence following the various measures taken by the Reserve Bank of Zimbabwe (RBZ). Banking sector conditions have improved and all banks now maintain capital buffers above the minimum requirements. NPLs have declined to 10 percent at end December 2015 from 21 percent at end September 2014. The authorities remain committed to the multi-currency regime in the short-to-medium term.

Performance under the SMP

With support from the private sector, civil society and the general public, the authorities’ commitment has been instrumental in ensuring that the SMP remained on track despite the substantial economic and financial challenges. Amid rising challenges, the Zimbabwean authorities have continued to meet all their commitments under the Staff-Monitored Program (SMP), through each successive review.

This third and last review is no exception. All the quantitative targets for end-December 2015 regarding the floor on the primary cash balance and the net international reserves target were met with comfortable margins. The floor on protected social spending, the target for Poverty Reduction and Growth Trust (PRGT) payments, and the ceiling on non-concessional debt were also met. All three structural benchmarks for the third review relating to the financial sector; amendments to the Public Financial Management (PFM) and Procurement Acts; and the investment climate were also met. The benchmark on investment climate entailed publication of guidelines on implementation of the indigenization policy.

During the 15 months SMP period, the authorities have also made remarkable progress in a number of other areas including:

• Recapitalization of the Reserve Bank of Zimbabwe (RBZ) through the debt assumption bill;

• Amendment of the Reserve Bank and Banking Acts;

• Establishment of the Zimbabwe Asset Management Corporation (Private) Limited (ZAMCO) to tackle the high level of nonperforming loans (NPLs);

• Amendment of the Labor Act;

• Development of a strategy for reducing the public service wage bill; and

• Instituted reforms to the fiscal regime for the mining sector.

Current and Medium Term Reforms and Policies

As the staff report notes, Zimbabwe’s deteriorating economic conditions reinforce the urgency to move forward and implement comprehensive ambitious reforms to transform the economy, and to advance the re-engagement process. Clearly, without external financial support, the reform efforts cannot be sustained. Instead, they might impose an unbearable burden on a population that is already facing increasingly severe economic and social challenges. Against this background, the authorities have pro-actively designed policies geared at transforming the economy whose key priorities include:

(i) Fiscal discipline and expenditure rationalization away from employment costs toward development and social spending to restore fiscal sustainability supported by strengthened public financial management (PFM), enhanced revenue administration, and acceleration of SOE reforms. In this area, the Public Service Commission already finalized audits covering about 50 percent of public service employees and authorities have started to implement measures to, among others, eliminate duplications and redundancies, rationalize posts, revise leave policy and reduce employment costs which would result in a lower wage bill for 2016. In the period ahead, the authorities aim to maintain total wage costs unchanged in nominal terms until 2019. Other commissions will also perform audits and propose recommendations to rationalize employment. Forensic and performance audits are being conducted on most of the ten largest SOEs targeted for priority action and employments costs have already been reduced in a number of them.

(ii) Further enhancing financial stability and depth to ensure that the financial sector plays its role in savings mobilization and investment and contribute to economic development. The levels of financial inclusion in Zimbabwe improved markedly from 60 percent in 2011 to 77 percent in 2014 placing Zimbabwe among the highest levels of financial inclusion in SSA. Thus to further facilitate inclusive growth, the authorities launched the national financial inclusion strategy in early March 2016;

(iii) Tackling the external arrears and advancing the re-engagement process to allow the country to eventually access external financing. Accordingly, to clear the external arrears to the IFIs, the authorities’ strategy presented in Lima seeks to: a) obtain bridge financing from Afriexim bank to repay arrears to the AfDB, the African Development Fund, and IDA; b) get a long-term loan from a bilateral creditor to repay the IBRD; and c) use of SDR holdings to clear the arrears to the Fund; d) request debt treatment from the Paris Club; d) request a Fund Financial supported program;

(iv) Enhancing agricultural productivity. In this area policy measures are focusing on land reforms and addressing bottlenecks in the agricultural sector particularly on security of tenure, compensation of former famers, irrigation and infrastructure rehabilitation and development. Presently, the authorities are working on measures to improve the security of tenure for resettled farmers which will lead to issuance of permits and tradable lease agreements. In addition, they are working on a program to compensate former farmers and will spearhead a comprehensive irrigation program aimed at supporting national food self-sufficiency.

(v) Addressing structural weaknesses to boost Zimbabwe’s growth potential. Given that the Zimbabwe economy is operating below capacity, the authorities are taking steps to address constraints to growth especially in infrastructure—electricity, water, transport; unavailability and high cost of long-term capital; and high cost of doing business. On doing business, the reported recent political situation has reasonably stabilized and the authorities plan to, among other measures, establish a one-stop investment centre. They already published the new framework, procedures and guidelines for implementing the indigenization policy on the Zimbabwe Investment Authority (ZIA) in January 2016, as part of the structural benchmarks under the SMP.

Update on the Indigenization and Economic Empowerment

In addition, in order to address conflicting positions in interpretation, President Mugabe, in a recent gazetted statement further clarified that the Indigenization and Economic Empowerment Policy is sector specific and will, thus be implemented differently across four economic sectors namely: Natural Resources Sector; Non-Resources Sector; Financial Sector; and Reserved Sector.

In order to ensure that the Natural Resources are exploited in a manner that safeguards the best interest of the country’s current and future generations, in terms of the Policy, Government and/or its designated entities will hold a 51% stake in businesses in the Natural Resources Sector, with the remaining 49%, belonging to the partnering foreign investor(s). The policy also provides for exceptions in compliance where government does not have 51% ownership.

On Non-Resource Sectors, it is expected that businesses in this sector should exhibit socially and economically desirable strategic objectives that contribute towards the turnaround and sustainable socio-economic transformation of the economy of Zimbabwe. Thus the businesses should, among other things, aim to ensure beneficiation of raw materials for the purposes of value addition and exporting; and transfer of appropriate technology to Zimbabwe for the purpose of enhancing productivity; and creation of employment.

With regard to the Financial Services Sector, the banking sector shall continue to fall under the ambit of the Banking Act, which is regulated by the Reserve Bank of Zimbabwe, and the insurance sector under the auspices of the Provident and Insurance Act. This policy position is essential for the promotion of financial sector stability, confidence and financial inclusion. These institutions will, nonetheless, be expected to make their contributions by way of financing facilities for key economic sectors and projects, employee share ownership schemes, linkage programs and such other financial empowerment facilities as may be introduced by the Reserve Bank of Zimbabwe, from time to time.

Businesses under the Reserved Sector category are reserved for Zimbabwean entrepreneurs with the exception of existing businesses. The Reserved Sector category includes businesses such as specific categories in Transportation; Retail and Wholesale Trade; Grain Milling; and Tobacco Processing.

Cooperation and Financial Obligations to IFIs

To date, Zimbabwe continues to make efforts to cooperate with the Fund on policies and payments, and to make good use of technical assistance (TA). The authorities continue to make the agreed $150,000 monthly payment to the PRGT, the increased pari passu payments to the World Bank and AfDB, and token payments to the European Investment Bank. The authorities have committed to increase payments to the IFIs as their payment capacity increases. In addition, Zimbabwe continues to benefit from targeted Fund TA to address policy challenges, strengthen institutional capacity, and support its ongoing reform efforts.

Thus, the authorities’ intend to proceed with the re-engagement process based on the strategy that was presented in Lima and received support from creditors and development partners. Currently, the International Finance Corporation (IFC) in the World Bank is preparing proposals for possible investments in Zimbabwe that could be reviewed by its management over the coming months.

In addition, on April 20, 2016, the Board of Directors of the African Development Bank (AfDB) approved a US $25-million Trade Finance Line of Credit facility to Central Africa Building Society (CABS) of Zimbabwe. This medium-term facility will help to support the expansion of CABS’ operations as a provider of trade finance to local firms as well as Small and Medium-sized enterprises within Zimbabwe’s tradable sector.

Conclusion and Next Steps

On the basis of the strong performance under the SMP, the authorities’ demonstrated commitment to sound macroeconomic policy management, the policy intentions described in the Letter of Intent, and the far-reaching economic transformation agenda, we believe that our authorities’ have built a solid foundation for a path to full re- engagement, including clearance of arrears to the IFIs, a Fund-financial arrangement, and debt treatment under the Paris Club.

Our authorities are committed to repay the arrears to the IFIs as they take steps to normalize relations with all creditors and anticipate that this will eventually culminate into a financial arrangement with the Fund. They further expect that as soon as the arrears are settled, the process to consider removal of the remaining remedial measures which would include restoration of Zimbabwe’s eligibility to the PRGT will be effected.

Our authorities count on the Executive Board’s support in this process. The support of this institution, and its ability to catalyze other creditors, will be even more crucial in the period ahead as the country consolidates the commendable progress made this far in pursuance of its objectives to achieve sustained economic development, reduce poverty, and improve living conditions for the people of Zimbabwe.