Zambia can beat the economic slowdown by making every kwacha count
Zambia is facing tough conditions for growth. Despite the current slowdown, investment in mineral and non-mineral sectors in the country remains attractive. This is according to the seventh World Bank Zambia Economic Brief, titled Beating the slowdown: Making every kwacha count, released on 21 June 2016.
Zambia, like many other African countries, is facing external headwinds while domestic pressures have intensified. The external headwinds include slower regional and global growth and lower copper prices. Domestic pressures include a power crisis impacting on all sectors of the economy and repeat fiscal deficits that have made achieving macroeconomic stability harder. The report observes that GDP growth is forecast to remain close to 3.0 percent in 2016, assuming new power generation capacity comes on line and a better harvest is achieved.
The report states that making every kwacha count should include the removal of fuel subsidies and moves to improve the financial sustainability of the power sector. According to Country Manager for Zambia, Ina-Marlene Ruthenberg, “international experience demonstrates that such measures are best complemented by scaling-up cash transfer programs, both in terms of the amount household’s receive and the number of vulnerable households benefiting to protect the vulnerable during any transition.”
The medium-term horizon for the economy looks brighter and growth of the economy is forecast to improve in 2017 (to 4.2 percent) and again in 2018 (to 5.0 percent). The outlook for the Zambian economy is underpinned by an assumption that copper prices remain soft throughout 2016 and 2017. However, if global copper supply better matches demand, and prices recover once again, improved growth could be achieved. The return to faster growth requires that uncertainty about whether persistent and growing fiscal deficits can be reined in is met with clear and credible budget policies toward a more sustainable fiscal stance.
“The changes in the global conditions for growth require that countries in the region ensure any under-utilized resources are re-allocated to where they can have greater impact,” said Gregory Smith, Senior Economist. “There is a need to carefully look at the efficiency and effectiveness of public expenditure, and ensure that every kwacha counts,” he added.
The report observes that commodity price shock highlights the need for Zambia to reduce its dependence on copper. The Seventh National Development Plan provides a good opportunity to set this agenda and set a path to clear impediments to private sector activity and improving the business environment.
Regional economic developments
The external environment confronting Sub-Saharan Africa (SSA) is expected to remain difficult in the near term. Commodity prices are expected to remain low, and in 2016, growth in the region is forecast to drop to 2.5% from 3.0% in 2015 (World Bank forecast). There is considerable variation in economic performance across countries, with the slowdown concentrated among the region’s largest commodity exporters. Growing economic vulnerabilities, amid weakened policy buffers, continue to pose challenges for policy makers.
The balance of risks to the outlook remains tilted to the downside. The global risks include: (i) a sharper than expected slowdown in China (as the country rebalances growth toward consumption and services), (ii) a further decline in commodity prices, and (iii) tighter global financing conditions that would result in higher borrowing costs and reduced sovereign bond access for emerging and frontier countries. On the domestic front, delays in adjustment to external shocks in affected countries would create policy uncertainties that could weigh on investor sentiment and weaken the recovery.
The state of the Zambian economy
Since mid-2015, the Zambian economy has come under strain as external headwinds and domestic pressures have intensified. Zambia is facing tough conditions for growth, which is estimated to have slowed to 3.2% in 2015. The external headwinds include slower regional and global growth (crucially in China) and lower copper prices. Domestic pressures include a power crisis impacting on all sectors of the economy and repeat fiscal deficits that have increased the cost of maintaining macroeconomic stability and reduced investor confidence.
The fall in copper prices and the slower growth were met in 2015 with large shifts in the exchange rate and inflation above 20%. Since fiscal policy has been expansionary, monetary policy has shouldered the burden of moderating inflation. Though costly, monetary policy actions have proved effective, as the extreme exchange rate shifts of 2015 have so far been avoided in 2016 and inflation has started to decelerate.
The Living Conditions Monitoring Survey (LCMS) finds that despite a GDP growth averaging 7.4% between 2004 and 2014, there has only been a marginal reduction in poverty. The Central Statistical Office (CSO) reports that in 2015, 54.4% of the population were defined as poor and 40.8% of the population were experiencing extreme poverty as per the government’s poverty line. Using the US$ 1.9 per day (2011 PPP terms) measure for international comparison, poverty is estimated at 61.3% in 2015. The poverty measured is largely a rural phenomenon with 77% of the poorest households located in rural areas.
Zambia’s economic outlook
GDP growth is forecast to remain close to 3.0% in 2016, before improving in 2017 (4.2%) and again in 2018 (5.0%). For 2016, this assumes new power generation capacity comes on line and a better harvest is achieved. Despite the current slowdown, long-term investment in mineral and non-mineral sectors in Zambia remains attractive.
The outlook for the Zambian economy is underpinned by four main assumptions. First, copper prices remain low, based on World Bank forecasts that suggest commodity prices are likely to remain soft throughout 2016 and 2017. However, if global copper supply better matches demand, and prices recover once again, improved growth could be achieved. Second, uncertainty about whether persistent and growing fiscal deficits can be reined in is met with clear and credible budget policies toward a more sustainable fiscal stance supporting mediumterm growth. Third, confidence in the economy is improved via an agreement with the International Monetary Fund (IMF) on a program of support. An IMF program would help in restoring investor confidence and give other cooperating partners greater confidence to provide budget support. Fourth, the impact of the power crisis is less severe than in 2015 as new generation capacity comes on stream.
The outlook is subject to both domestic and external downside risks. Externally, output growth in China that is lower than predicted would weigh on the demand for Zambia’s exports, further reducing copper prices, and would severely affect Zambia’s prospects.
The main domestic risks are fourfold: (i) that the power crisis does not abate and continues into 2017; (ii) that a lack of fiscal adjustment takes place, so that the cost of macroeconomic stabilization remains high in terms of expensive and limited availability of credit to the private sector; (iii) that an excessively abrupt or disorderly fiscal adjustment takes place, eliminating any improvement of confidence in the economy that a well-planned shift to fiscal sustainability might bring; and (iv) that if fiscal deficits persist and exchange rate uncertainty continues to be a threat to inflation, tight monetary policy will continue to dampen credit growth and reduce economic growth in 2016 and 2017.
Economic policy challenges
Commodity-exporting countries’ policy makers face increasing challenges across the globe. Zambia is no exception and must grapple with multiple challenges. Falling copper prices and a power crisis could be met with fiscal buffers, but in Zambia, such buffers were insufficiently built up when the economy was prospering. Furthermore, the debt burden has increased following repeat non-concessional borrowing and the depreciation of the kwacha.
This leaves the government with little room for maneuver, and large fiscal deficits and inefficiencies in government spending persist as sources of vulnerability for the country. Fiscal adjustment would put less pressure on monetary policy and eventually make space for interest rates to be reduced, easing the pressure on individuals and firms. It would also increase the confidence of domestic and international investors.
With market access comes greater scrutiny, and the credibility or otherwise of policy responses to shocks affects interest costs of new borrowing. The Eurobond issuance has also increased international observance of the Zambian economy and events are being watched much more closely than prior to 2012. To help maintain confidence in the economy, and Zambia as an investment destination, better dialogue on the economy should be targeted. A key step includes the timely publication of a debt strategy and the provision of quarterly debt and fiscal numbers on the Ministry of Finance website.
The commodity price shock highlights the need for Zambia to reduce its dependency on copper, a challenge it has been grappling with for over 50 years. Statements about diversification and growing manufacturing need to be met by a clear and realistic strategy, and by structural reforms aimed at removing impediments to private sector activity and improving the business environment. The Seventh National Development Plan provides a good opportunity to set this agenda.
Making every kwacha count
Fiscal adjustment should be accompanied by a shift in spending priorities that support both the efficiency of public expenditures and long-term inclusive growth. While in many areas this is difficult to achieve, there are obvious areas for attention, including the growing cost of fuel subsides.
Over the past five years, public expenditure has increased at an annual average of 13.8% (in real terms) and a thorough review of the quality of this expenditure is required. There is need to identify and reallocate under-utilized resources to ensure that every kwacha spent is contributing towards each sector’s objectives. Furthermore, the preliminary results from the LCMS 2015 suggest that economic expansion since the early 2000s has not sufficiently benefited the poor. The growth has been exclusive rather than inclusive.
A key area of under-utilized expenditure is the government subsidy of fuel and electricity. It is estimated that fuel subsidies have averaged close to US$36 million per month between September 2015 and May 2016 and electricity subsidies around US$26 million per month, a combined total of US$576 million, putting huge pressure on the budget.
To beat the slowdown, there is a need to make every kwacha of government expenditure count. Ideas aimed to ensure the quality of expenditure improves include: (i) eliminating fuel subsidies; (ii) improving the financial sustainability of the power sector; (iii) protecting the poor during the transition by scaling up the Social Cash Transfer system; and (iv) carrying out a review of public expenditure in key sectors so that the allocation of expenditure can be improved and lessons to boost the efficiency of spending can be found.
This Brief is part of a series of short economic updates produced twice a year by the World Bank. Each Brief includes two sections: the World Bank’s assessment of recent economic developments and the outlook in the short to medium term, and its analysis of a specific development topic or theme. Previous Briefs covered opportunities for the power sector, mining, jobs, trade, and financial inclusion.