The tenth Zambia Economic Brief has been published by the World Bank Group with a focus section on sustainable borrowing and improved debt management.

Regional economic developments

Economic recovery continued in Sub-Saharan Africa (SSA) in the second half of 2017 following a slump in 2015 and 2016. Growth is forecast to increase to 2.4% in 2017 from 1.3% in 2016, but will remain below population growth (2.7%). Recovery is underpinned by improved global conditions for growth and easing domestic constraints. In most metal-exporting countries, growth remains below the longterm trend, but economic activity has improved driven by higher metal prices and the recovery of the agriculture sector.

SSA GDP growth is expected to reach 3.2% in 2018 and 3.5% in 2019, but remains insufficient to make a sizeable reduction in poverty. The medium-term outlook assumes a moderate increase in commodity prices and the implementation of reforms to address macroeconomic imbalances. There is a potential upside to the region’s outlook, but the risks are tilted downwards. They include lower than expected commodity prices, faster than expected normalization of monetary policy in the United States, and a slower pace of economic reforms.

The state of the Zambian economy

Despite a bumper harvest, improved electricity generation, and an easing of monetary policy, economic recovery in Zambia has remained subdued in 2017. This follows weak performances of the services, mining and construction sectors, and lower levels of public investment (than in 2013-15). Growth is forecast to improve only modestly to 3.8% in 2017, up from 3.6% the previous year.

Following two El-Niño influenced agricultural seasons; a heavier and longer 2016-17 rainy season stimulated the agriculture, forestry and livestock sectors. All major crops recorded a bumper harvest, resulting in a 19% increase in overall crop production. However, the major drags on growth in H1 2017 were wholesale and retail, and financial services. These two sectors account for over a quarter of Zambia’s total GDP, and 40% of the output of the services sector. The wholesale and retail sector grew by 1.9% in Q1 2017, before contracting by 1.2% in Q2 following low consumer demand and expensive lending rates. The financial sector contracted by 3.0% in Q1 and a further 2.5% in Q2 as pressures from the slowdown and tight liquidity of 2016 spilled-over into 2017. The pressure on the financial sector is clearly illustrated in the build-up of non-performing loans, reaching 12.2% of outstanding loans in November 2016.

Over the first quarter of 2017, and helped by higher copper prices, exports increased at a faster pace than imports. This led to a merchandise trade surplus in Q1 2017 and narrow trade deficits in Q2 2017. However, temporary copper production disruptions in August and September 2017 led to a fall in exports of 18% in September 2017.

The kwacha has been more stable in 2017, and it strengthened by 10.3% between January 2017 and end-July 2017. However, between August 2017 and November 2017, the kwacha came under renewed pressure and depreciated by 11.9% to ZMW 10.1 per US$. As inflation has been within the Bank of Zambia’s (BoZ) medium-term target range of 6-8% since December 2016, the gradual easing of monetary policy (started in November 2016) continued. At its Monetary Policy Committee (MPC) meeting in November 2017, the BoZ reduced the policy rate by 75 basis points to 10.25% and the reserve ratio by 150 basis points to 8.0%. These measures have been aimed at improving liquidity and reducing the cost of BoZ lending to commercial banks. However, lending rates have remained high and constrain private sector credit growth.

To clean up after fiscal slippages and the build-up of payment arrears in 2016, the government targeted a fiscal deficit of 7% (cash basis) in 2017 and issued an economic recovery plan (called Zambia Plus). The intention was to achieve ‘fiscal fitness’ via a well-planned fiscal consolidation alongside structural reforms to boost inclusive growth. Progress in achieving fiscal fitness has been made in some areas in 2017, but in other areas it lags. The expectation is that the actual deficit will be slightly above the target at 7.6% (cash basis). The expectation is also that 2.7% of GDP’s worth of arrears will be cleared by the end of 2017, resulting in the fiscal deficit on a commitment basis reaching 4.9% of GDP.

Medium-term outlook

We forecast GDP growth for 2017 at 3.8%. This is down from our March 2017 forecast (of 4.1%) as the services sector’s recovery has been slower than expected in H1 2017. Reflecting on expectations for improved global conditions and eased domestic constraints, we maintain our forecast of 4.3% growth in 2018, and 4.7% in 2019. The outlook is subject to downside risks and the possibility of positive developments. The main external risks are that recent copper price gains reverse and quicker than expected normalization of interest rates in the United States would tighten global financing conditions and increase the cost of raising external financing over the medium term. The main domestic downside risk would relate to delayed fiscal adjustment, which would further weaken the fiscal position, increase debt, and further subdue market sentiment.

Zambia can consolidate the gains from improved global and domestic conditions for economic recovery and build a more inclusive economy. However, to harness these gains, the government needs to take actions to address fiscal-debt issues and to expedite progress with structural reform. Key areas in which to focus efforts are: (i) continue the path of restoring fiscal fitness; (ii) restore investor confidence and rebuild reserves; (iii) Improve revenue collection; and (iv) calm down the rate of borrowing and improve debt management.

How Zambia can borrow without sorrow

Debt is an important source of development finance, and a key tool for eradicating poverty. Countries all over the world borrow to finance their investment and development. Zambia is no different. There are huge and immediate needs, including that infrastructure must be improved and expanded. However, the debt needs to be managed carefully and the proceeds of borrowing shrewdly invested. There has recently been an increasing amount of discussion about Zambia’s debt levels. A little over 10 years after a huge debt relief effort, the rapid accumulation of debt has once again put Zambia in the spotlight. Total public sector and publicly guaranteed debt was recorded at 60.5% of GDP (US$13.3 billion) at the end of 2016, up from 35.6% in 2014.

A recent World Bank and IMF debt sustainability analysis puts Zambia at high risk of debt distress, indicating that there are heightened vulnerabilities associated with public debt. This indicates that Zambia is accumulating too much debt too quickly and a calmer and more sustainable pace is now required. Zambia had limited borrowing options in the 1990s and early 2000s, and these were linked to cooperating partners like the World Bank or African Development Bank. Zambia would know the terms; the loans would be concessional; and support would be given to help design, appraise, and implement the projects. However, now that Zambia is tapping debt capital markets and has many sources of borrowing, a new ‘active’ approach to debt management is needed that contrasts with the ‘passive’ approach to debt management since debt relief.

The fact that investors will buy a country’s bonds should not be taken as a signal that an economy is doing well. It could mean that the risks are worth facing for the investor, if the returns are high enough, or that the investor might not know exactly what they are buying if they are investing in indexes. This suggests that opportunities for finance should not be an automatic cause for celebration and signatures. Instead, a careful strategy and a more active approach to debt management is required.

The environment for public debt management in Zambia has been changing, and will continue to change in the coming years. Access to grants and to funding on concessional terms will reduce, and debt issued on market terms will increase. The bad news is that costs will increase further. The good news is that market borrowing comes with financial choices, i.e. the government can better achieve its preferred debt composition and risk exposure.

The tragedy is not the recent rapid build-up of debt, but the lack of productive assets Zambia can show from the borrowing. The first two Eurobonds were accompanied by a detailed plan on how they would be spent. The third Eurobond had no such plan. Where resources have not been linked to specified investment, it is most likely that they have been used to finance government’s consumption. Most of the resources were earmarked for the transport sector and mainly the road sector. Roads therefore are a good lens through which to assess how well borrowed resources have been invested. Unfortunately, when compared to the median cost of paving roads in the region, Zambia’s roads stand out as being very expensive

A new approach, that closely links managing investment and responsible borrowing, is required going forward. The following ideas are provided to support government in meeting these challenges:

Halt the pace at which debt is accumulating

The World Bank and IMF debt sustainability analysis has shifted Zambia to a high risk of debt distress. This assumes that current policies continue and new loans totalling US$3.5 billion are added to the US$4 billion of already contracted debt over the next five years. However, there is another path (the adjustment scenario) in which the government halts the signing of any new non-concessional borrowing, except for a US$282 million government communications project and any issuance with the purpose of reducing the repayment risks or rolling-over the existing Eurobonds.

To take an alternative route, where Zambia shifts back to ‘moderate risk’ of debt distress, the government could: (i) carry out a full review of the non-concessional loan pipeline; and (ii) reduce refinancing risks of the portfolio by dropping the idea of a sinking fund and instead plan to reduce the cost of borrowing, and extend maturities, by buying back some of the outstanding Eurobond debt in the years prior to their maturity.

Switch from passive to active debt management

Being ‘active’ means implementing a well-crafted strategy to reduce the cost of borrowing, extend the terms, and diversify the sources of debt funding. The following steps will help achieve this: (i) improve and annually update the debt strategy; (ii) complete the reorganization of the debt office; (iii) formulate a debt management reform plan; and (iv) strengthen public investment management.