Country Report Zambia
Lower copper prices, excessive public spending and the death of President Stata have turned 2014 into a challenging year for Zambia, but small improvements bode well for the future.
Strengths (+) and weaknesses (-)
(+) Generous natural resource endowment
Ample mineral resources, a vast amount of arable land and high potential in tourism and hydropower make Zambia a resource rich country, providing a strong economic base.
(-) Narrow export base
Metals account for 80% of Zambia’s exports, which makes the current account very vulnerable to volatile commodity prices.
(-) Low level of development
Zambia has a huge infrastructural deficit, especially in transportation and energy, which constrains economic growth below potential.
(-) Extreme poverty and inequality
An extremely high level of poverty and income inequality in Zambia, which have worsened in recent years, youth predominance (66% of the population is under 24) and elevated unemployment (13% in 2010) make up for an environment that is prone to social unrest.
1. Economic policy likely to improve after coming presidential by-elections
President Sata passed away on 28 October and presidential by-elections needs to be held within 90 days of his death. We expect the process will not affect domestic political stability and might even lead to a quicker shift towards more business- friendly policies, since a more moderate candidate is expected to win. Under former president Sata, policies had become increasingly interventionist and erratic, which unnerved investors. The mining sector has been a common target of such idiosyncratic policy as the government has been trying to strengthen tax revenues from the sector. While there is a case for such an increase, as also advised by the IMF, that does not justify the government’s aggressive stance in the past year, including intimidation tactics. For example, in response to allegations that mining companies might be underreporting copper export revenues, the government decided to withhold around USD 600mln in VAT refunds until the companies provide proof of the final destination of sold copper. In August 2014, the leftist oriented Wynter Kabimba was replaced by the moderate Edgar Lungu as Minister of Justice and secretary-general of the ruling Patriotic Front (PF), which marked a first step towards more business-friendly policies. It also strengthened the position of the moderate camp of Mr Lungu and Minister of Finance Chikwanda within the PF and reduced the risk of infighting related to the succession of president Sata. As a result, the unexpected death of President Sata is not expected to threaten domestic stability, though it might lead to policy paralysis ahead of the presidential by-elections. Given the PF’s loss of popularity, the polls are poised to be a tight race, though divisions within the opposition mean a PF victory is likely. Either way, with the hardliners wihtin the PF side-lined, economic policy is expected to become more sound and business-friendly.
2. Fiscal position deteriorates further
High budget deficits, driven by recurrent spending and increasingly financed on non-concessional terms, have placed Zambia on a fiscal path that is unsustainable in the long term. Recent data revision and a GDP rebasing exercise have increased the size of the Zambian economy by 25% and improved fiscal indicators in recent years. However, they also revealed a sharper than previously estimated deterioration of public finances in 2013. Indeed, the budget deficit soared from 2.3 % of GDP in 2012 to 5.7% of GDP in 2013. While subsidies were cut significantly in 2013, salaries were raised by 50% and accounted for roughly one-third of total expenditures that year. The problem with the higher public deficits is threefold. First, being driven by recurrent spending, it forces the government to cut on much needed public investment, which hurts future growth potential. Second, being increasingly financed from commercial sources, it leads to higher debt service costs in the future. Third, as accountability is poor, it is doubtful whether debt proceeds are used in a way that will lead to a sufficient return on investment. For example, the government is said to have used some proceeds from the 2012 Eurobond to pay for public wages. Moving forward, the government has committed to a prudent fiscal stance in 2014 and 2015. Planned tax increases and wage and hiring freezes, amongst others, should lead to estimated budget deficits of 5.6% of GDP in 2014 and 4.9% of GDP in 2015, while public debt should stabilize at 37% of GDP in both years. However, risks to this scenario are tilted to the downside, as coming elections could hurt fiscal consolidation plans. On the other hand, we find comfort in the fact that there is large demand for Zambian debt and that the level of debt remains low, although the current pace of deterioration risks altering these positives in the longer term.
3. Prompt government action contains economic woes for now
Falling copper prices and imprudent fiscal policy pushed Zambia on the verge of an economic crisis in the beginning of 2014, but firm action has helped contain the problems for now. Pressures on the kwacha began with a 13% fall in copper prices by the end of March. These pressures were exacerbated by an expansionary fiscal policy, as well as the detrimental impact this had on investor confidence. As a result, the kwacha had lost 15% of its value and the yields on the 10 year Eurobond were up by 11% by the end of March. Combined with a low level of FX reserves, reported to have fallen to close to 2 months of import cover at the time, it raised fears of a balance of payments crisis. The Bank of Zambia (BOZ) took firm action: it abolished FX restrictions that had been imposed in 2013, it increased the reserve requirement ratio for commercial banks from 8% to 14% and raised the policy rate twice by 225bps to 12%. Nevertheless, the kwacha continued its slide, losing 25% of its value by the end of May, even though copper prices had stabilized. Meanwhile, the fears about Zambia’s low level of FX reserves were reduced by a successful USD 1bn, 10 year Eurobond issued in April, though the country had to pay a 8.625% coupon, much higher than the 5.375% it paid in 2012. The tide changed in June, when the BOZ further tightened monetary policy and the government reached out to the IMF for help, reassuring the markets of fiscal consolidation moving forward. However, as the agreement with the IMF has not been signed yet and election related spending could endanger such a deal, Zambia is not out of the woods yet. Besides, a further slowdown in China could once again increase downward pressure on copper prices.
Zambia is a landlocked country in the south of Africa. Industry, particularly mining, is the country’s main foreign exchange earner. Zambia is the world’s third-largest emeralds producer and seventh-largest copper producer (and the largest in Africa). The agricultural sector accounts for more than 70% of total employment, however. Agricultural output is susceptible to weather conditions, as it is dominated by subsistence farming. China, the largest consumer of copper worldwide, is Zambia’s main export market and an important source of FDI and funding for infrastructure investment. The presence of a high number of Chinese immigrants that do business in Zambia has led to tensions with the local population. Based on GDP per capita, Zambia has been classified as a low middle-income country since 2011. However, the share of population living in poverty being one of the highest in the world and inequality is high and worsening (the Gini Index worsened from 42.1 in 2003 to 57.5 in 2010). Zambia gained independence in 1964 and has managed to avoid widespread violent conflict so far, which is remarkable for a country in Sub-Sahara Africa. The country became a multiparty democracy in 1990. The 2011 elections led to a peaceful change of power to the Patriotic Front, ending 20 years of dominance by the Movement for Multiparty Democracy. The Zambian system concentrates power in the function of the president. Elections are held every 5 years and the next ones are scheduled in 2016. The constitution has been under revision since 2003 and recent drafts indicate the revision will strengthen institutions. Despite the large number of neighbouring countries (8), Zambia maintains amiable relationships with all of them. However, the country is vulnerable to unrest in neighbouring DR Congo, which has led to a large inflow of refugees.