Introduction

1. Our authorities appreciate the candid and constructive policy dialogue during the recent Article IV consultation. They broadly concur with the staff assessment and key policy recommendations.

2. The Zambian authorities have continued to pursue their long-term development aspirations through the implementation of the Seventh National Development Plan (7NDP) and Economic Stabilization and Growth Programme. The 7NDP seeks to create a diversified and resilient economy for sustained growth and socioeconomic transformation driven by agriculture, tourism, manufacturing and mining, among others. Consistent with this objective, the authorities have prioritized public infrastructure investment financed largely by foreign borrowing.

3. In the course of implementing the 7NDP, significant fiscal pressures have arisen leading to large fiscal deficits, the accumulation of domestic arrears and a growing debt service obligation. Recognizing these challenges, in May 2019, the authorities announced a series of measures to contain spending including, the indefinite postponement of the contraction of new non-concessional loans; cancellation of some committed but undisbursed loans; and increased control and management of disbursements on foreign-financed loans. In this context, our authorities recognize the need for an urgent policy adjustment to entrench macroeconomic stability and bring debt to sustainable levels.

Recent Economic Developments and Outlook

4. Real GDP grew marginally by 3.7 percent in 2018 from 3.5 percent in 2017, reflecting modest expansion in telecommunications, financial and insurance activities, wholesale and retail trade, and mining. However, in 2019 growth is expected to be weighed down by the drought in the southern and western parts of the country, which has affected agricultural output and electricity production as well as weak domestic demand. Over the medium term, growth is expected to recover following the completion of large public infrastructure projects.

5. Inflation has remained within the Bank of Zambia’s (BOZ) target band (6–8 percent), rising from 6.6 percent in 2017 to 7.0 percent in 2018. Going forward, inflation is expected to trend upwards due to an increase in food and fuel prices as well as exchange rate depreciation.

6. The current account deficit declined to 1.3 percent of GDP in 2018 from 1.7 percent of GDP in 2017, reflecting a recovery in copper exports at higher prices. At the same time, foreign reserves declined from 2.4 months of import cover in 2017 to 1.9 months in 2018.

Fiscal Policy and Debt Sustainability

7. The authorities are committed to pursue a front-loaded fiscal adjustment with a view to reduce the budget deficit to 6.5 percent of GDP in 2019 and reaching 3 to 4 percent of GDP in the medium term. In this regard, they are taking measures to enhance domestic revenue mobilization by broadening the tax base, reducing tax expenditures and exemptions, simplifying the tax system, strengthening compliance, and enhancing tax audit capacity. The auditing of large tax payers, particularly in the mining sector, is presently being carried out. The switch from VAT to Sales Tax, announced as part of the 2019 budget, is expected to result in large windfall gains. To ensure smooth transition, the authorities are addressing some implementation issues that were identified during the recently concluded country-wide consultation.

8. On the expenditure side, efforts to contain spending include aligning cash spending with available financing. Specific measures currently being undertaken include: prioritizing the funding of projects that are at least 80 percent complete; delaying the implementation of non-growth supportive projects; controlling foreign financed disbursements; curtailing personal emoluments (PEs) related expenditures, including the restriction of leave commutation while obliging all Government officials to take leave; and suspending both foreign and domestic travel for top Government officials. At the same time, strict adherence to the provisions of the Public Finance Management Act (PFMA) will be enforced. The authorities are also taking steps to tighten the commitment control system with a view to curb accumulation of domestic arrears. They plan to steadily clear the existing stock of arrears to ease liquidity in the market and improve financial sector performance.

9. The authorities recognize that strengthening public finance management will anchor fiscal sustainability and ensure efficient utilization of public resources. In this context, they are taking steps to improve the efficiency of public investments, including procurement, selection and implementation of projects. Accordingly, the authorities are working to review the Zambia Public Procurement Act (ZPPA) to ensure value for money. They have also established a Public Investment Board (PIB) to review and take decisions relating to public investment management for new capital projects. In parallel, the authorities are working on the Planning and Budgeting Bill and revising the Loans and Guarantees Act, which will provide the necessary framework for medium-term debt management.

10. Our authorities note the outcome of the debt sustainability analysis (DSA) and reiterate their commitment to bring debt onto a sustainable path. In this regard, they have taken a decision to indefinitely postpone contraction of all new non-concessional debt. They plan to re-scope, cancel or postpone some projects with a view to free up $500 million annually over the medium term. In addition, they are discussing some debt reprofiling. On debt obligations, they are determined to remain current on debt service, with no default or arrears on either external or domestic debt. Further, measures are being taken to enhance debt management capacity and contain debt vulnerabilities. These include improving monthly cash flow forecasts to facilitate more flexibility in domestic debt auctions and enhancing oversight of state-owned enterprise (SOE) debt to allow timely monitoring of fiscal risks. In this context, the authorities look forward to the debt management TA to be jointly delivered by IMF, World Bank, and the Macroeconomic and Financial Management Institute of Eastern and Southern Africa (MEFMI).

Monetary and Exchange Rate Policies

11. In response to rising inflationary pressures, the Monetary Policy Committee (MPC) increased the policy rate by 50 basis points to 10.25 percent in May 2019, further demonstrating the authorities’ resolve to stabilize monetary conditions. Going forward, the BoZ will continue to use monetary policy instruments at its disposal to keep inflation within the target band. Supported by the fiscal reorientation, the authorities believe that the current policy framework is adequate to anchor inflation expectations. They look forward to the completion of the forecasting and policy analysis system (FPAS) being developed with Fund TA, which will be useful in monetary policy decision making. The authorities reiterate their commitment to a flexible exchange rate. In this context, interventions in the foreign exchange market will be limited to smoothing excessive volatility as well as opportunistically building reserves, consistent with staff’s recommendation.

Financial Sector

12. Safeguarding financial sector stability and resilience remains a key priority for the authorities. To this end, they have made good progress in upgrading the institutional, regulatory, supervision and crisis management frameworks in line with the 2017 FSAP recommendations. The amended BoZ Act is expected to enhance the bank’s operational independence complemented by the new Banking and Financial Services Act (BFSA), whose implementing regulations are being finalized. While the banking system is well capitalized, the authorities are aware that deepening macro financial linkages could contribute to keeping non-performing loans (NPLs) above prudential norms. In this regard, they will continue to enhance supervision to mitigate risks. The legal framework for Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT) which was revised and strengthened in 2017, in line with FATF, is also useful in supporting the authorities’ anti-corruption efforts. Zambia recently underwent an evaluation which was largely positive, and recommendations thereof are being undertaken.

Structural Reforms

13. The authorities realize that far reaching structural reforms will be necessary to complement macroeconomic policies, promote inclusive growth and reduce poverty in the context of the 7NDP which emphasizes agriculture, tourism, energy, and mining as the drivers of diversification. In agriculture, one of the labor-intensive sectors, the authorities developed the Zambia Integrated Agriculture Management Information System (ZIAMIS) to support agri-businesses, farmer expansion and extension services for agriculture-related public programs. In addition, they are implementing measures aimed at raising productivity and building resilience as well as improving the delivery of the Farmer Input Support Programme (FISP).

14. The 7NDP highlights access to markets, ICT, and infrastructure development as key growth enablers. In this respect, energy supply and transportation infrastructure are identified as development priorities to address infrastructure bottlenecks. To boost the energy generation capacity, a few projects are under construction while others are in the pipeline including solar energy projects that would reduce heavy reliance on hydroelectric power. On pricing, the ongoing cost of service study would inform electricity tariffs adjustments based on utilization with appropriate protection for the vulnerable groups. The authorities are also addressing human capital development through investments in quality education and healthcare systems given their significance in promoting inclusive growth. Notwithstanding the fact that Zambia compares favorably with the SSA average on several dimensions of the 2019 Doing Business Indicators, our authorities continue to take measures to further improve the business environment.

Conclusion

15. The authorities reiterate their commitment to preserving macroeconomic stability including bringing public debt on a sustainable path. They will continue with efforts to create a diversified and resilient economy for sustained growth and socioeconomic transformation. To this end, they look forward to continued collaboration with the Fund, requisite advice and technical assistance.