Zambia and the IMF
Country's Policy Intentions Documents
Free Email Notification
Zambia—Letter of Intent, Technical Memorandum of Understanding
Mr. Horst Köhler
Dear Mr. Köhler,
1. In this letter, we review progress in implementing the 2001 program, and the key economic and financial policies for 2002 including the government's response to a sharp deterioration in prospects for the mining sector. The letter requests completion of the fourth review under the PRGF arrangement and the disbursements related to the end-September and end-December 2001 performance criteria. As some performance criteria for end-September and end-December 2001 were not observed, the government is requesting waivers for their nonobservance. In the light of the agreement reached with Russia on amounts owed to them (see paragraph 8 below), the Zambian government is also requesting a waiver of nonobservance of the continuous performance criterion on the nonaccumulation of external payments arrears for the above-mentioned disbursements. The government is also requesting the next tranche of SDR 117.2 million of interim HIPC debt relief from the Fund for 2002, which would cover 69.8 percent of principal obligations falling due during 2002. In addition, we are also requesting that Zambia's access under PRGF-supported program be augmented by 5 percent of quota (SDR 25 million) in view of the balance of payments pressure.
2. All the program's structural performance criteria and benchmarks for end-September and end-December 2001 were met, although some quantitative performance criteria were missed (Tables 1 and 2). For end-September 2001 the performance criteria on domestic arrears was missed, although since the target was breached by a wide margin at end-March and end-June, it was not expected that the end-September target would be met. Mainly because of a delay in disbursement of US$50 million from the World Bank, the performance criteria for end-December 2001 were not met for net domestic assets (NDA) of the Bank of Zambia (BoZ),1 net claims on government (NCG), and gross international reserves. The reforms linked to this disbursement were delayed by the elections and will be implemented shortly.
3. Despite weak agricultural production, Zambia's economic performance during 2001 continued to improve, with real GDP growth provisionally estimated at 5.2 percent, led by the mining, construction, wholesale and retail trade, and manufacturing sectors. In addition, notwithstanding a sharp rise in maize prices in December, the end-year inflation rate declined from 30.1 percent to 18.7 percent, broadly in line with the program target of 17.5 percent, reflecting tight financial policies.2
4. Fiscal performance during 2001 was mixed. Revenue collections exceeded the program target, and cash releases to the social sectors were nearly 20 percent higher than budgeted. At the same time, however, the wage bill rose to 6.8 percent of GDP, and there were significant overruns in capital and other expenditures in the last quarter of the year, as a result of election-related pressures. There was also a shortfall in expenditure related to the HIPC Initiative, caused initially by a delay in establishing an appropriate accounting framework for HIPC resources, and subsequently by a lack of implementation capacity at the line ministries. Reports on HIPC expenditures were published in the press for the first three quarters of 2001 and the report for the last quarter is about to be finalized. In sum, the overall fiscal deficit was 8.1 percent of GDP compared with the program target of 7.4 percent. This, together with the delay in the World Bank oil-related program loan disbursement (amounting to 1.4 percent of GDP), resulted in net borrowing from the banking system exceeding the program target by about 1.8 percent of GDP, and nonbank borrowing was also higher than programmed.
5. During 2001, broad money rose by 10.7 percent (compared with 12.8 percent in the program) as monetary conditions were tightened mainly through increases in the cash reserve ratio. Also, the core liquid asset ratio of banks was raised from 25 percent to 35 percent. In line with developments in monetary policy, the interest rate on 91-day treasury bills rose from 34 percent at end-2000 to about 45-50 percent during the latter part of 2001. Thus, real interest rates rose significantly.
6. Reflecting tight financial policies, the kwacha appreciated against the U.S. dollar by about 8 percent in local currency terms in 2001, or about 23 percent in real terms, thereby reversing most of the real depreciation that took place in the fourth quarter of 2000. In November 2001, the kwacha came under pressure from uncertainties in the lead-up to the national elections and seasonal factors. In response, the BoZ tightened monetary policy and the kwacha remained broadly stable for the rest of the year.
7. During the year, balance of payments developments were less favorable than expected, largely on account of the delay in disbursement of external assistance, particularly the substantial shortfall in EU assistance. However, export performance was strong, reflecting a 27 percent increase in copper export volumes. Nontraditional exports, rose by 13 percent as a result of strong performance by horticulture and floriculture. Tourism earnings also rose sharply, partly on account of the solar eclipse. This strong export performance was more than offset by the increase in imports, particularly for the metal sector, leading to a current account deficit of about 1.9 percentage points of GDP more than anticipated. The higher metal imports were financed by private sector capital inflows. Although the overall balance of payments deficit was broadly in line with the program target, the targeted reserve build up was not met because of the substantial shortfall in external assistance.
8. Due to the delay in agreeing on a Paris Club rescheduling on Cologne terms, total interim HIPC relief of US$278 million in 2001 fell short of the program target of US$292 million. Payments made to some multilateral creditors during early 2001 were later refunded, but overpayments to Paris Club creditors totaling US$12 million have not yet been refunded, delaying this HIPC relief. Following the agreement with Russia noted above, the Paris Club agreed in early April 2002 to extend the consolidation period to end-March 2003 and to top-up the April 1999 rescheduling agreement on Naples terms to Cologne terms. The agreement with Russia includes a moratorium interest rate of 9 percent and an additional one percent penalty rate for late payments. The arrears of US$31 million that were disputed, including a penalty of US$1.6 million, will be paid over a period of three years starting immediately. As a result, Zambia's payments to Russia will amount to US$20 million in 2002, US$26 million in 2003 and about US$40 million in 2004.
9. Regarding structural reforms, in December 2001 the Zambia Privatization Agency (ZPA) advertised the sale of 35 percent of the Zambia National Commercial Bank (ZNCB) with management control to the buyer. More broadly, the BoZ strengthened the overall banking system by issuing instructions for injection of new capital in one bank, liquidating two others, and continued close supervision of the ZNCB's financial position. Progress was also made in the petroleum sector reform program supported by the World Bank. In particular, the state-owned Zambia National Oil Company (ZNOC) was put under receivership, and the authorities appointed international consultants to conduct due diligence and prepare a valuation of the Indeni refinery, the Tazama pipeline, and the Ndola storage facilities. In addition, the Cabinet approved the privatization option for the electricity company, ZESCO.
10. Regarding structural reforms in public expenditure management, education and housing allowances for foreign diplomats have been reduced, thus freeing resources for more pressing areas where arrears have often accumulated in the past. The 2002 budget also includes no line items with token one kwacha provisions, reducing the danger that spending will take place without cash backing. Planned improvements in the monthly reporting system between the line ministries and the Ministry of Finance and National Planning (MoFNP) have proceeded, and in particular a pilot version of the computerized system now includes commitments and arrears information. MoFNP has commenced a series of workshops for all government accountants on the importance of maintaining reliable commitment ledgers. The audited stock of arrears declined from K 375 billion in June to K 345 billion in September and all Controlling Officers have signed "certificates of acceptance," attesting that they agree with the audited figures prepared by the Controller, Internal Audit. The Auditor General completed the audit of arrears of the Ministry of Works and Supply and the results were consistent with those of the Controller, Internal Audit.
11. The government made progress in developing an Integrated Financial Management Information System (IFMIS), and the user requirements and a timetable for its implementation were approved by the Steering Committee in October 2001. A participatory Public Expenditure Review (PER) was completed, and the government is proceeding with plans to develop a Medium-Term Expenditure Framework, based on priorities outlined in the Poverty Reduction Strategy Paper (PRSP). Four ministries piloted an activity-based budgeting system, and work to merge the payroll and establishment register is continuing.
12. Regarding governance, to improve the transparency of public finances, the Accountant General submitted the final government accounts for 2000 to the Auditor General by end-September 2001 as required by Zambian law. Submission to Parliament was delayed by the elections until March 2002. The government has taken all steps to ensure that the report on ZCCM cobalt sales is finalized, although issuance of the report was not possible owing to threat of legal action against the auditors by the Metal Resource Group (MRG), to whom the cobalt was sold.
13. During 2001, the government worked intensely on the preparation of the full PRSP. A broad range of stakeholders participating in the working groups developed the sectoral strategies, which were discussed in provincial consultations and in a National PRSP Summit in October 2001. The final version was completed after the elections and was recently approved by the Cabinet.
II. The Medium-Term Strategy
14. The government's medium-term strategy for growth and poverty reduction, which is outlined in the full PRSP, will hinge critically on developments in the copper sector, which have become subject to considerable uncertainty. In late January 2002, Anglo American Plc, the major shareholder in Konkola Copper Mines (KCM), informed government that it would not proceed with further investments in KCM, citing financial losses linked to declining world copper prices and failure to secure funding for the Konkola Deep Mining Project (KDMP) which was the main basis for its investment in Zambia in March 2000. Other mining companies have also informed the government that the viability of their investment plans is threatened by low copper prices. Anglo American (AA) informed government that the remainder of committed shareholder funding would cover KCM operations for only 2-3 months, and that this period would be used to explore with government the following four options: (i) sell KCM to a third party; (ii) transfer KCM to government as a going concern; (iii) obtain concessional financing for KDMP; and (iv) initiate orderly closure of KCM operations. In response, government constituted a Task Force, which includes the private sector and mining, financial, and legal experts to look at these options and advise government on a course of action. At the same time, the government, in consultation with the private minority stakeholders3, is conducting negotiations with AA with a view to pursuing options including attracting a new strategic investor to ensure that KCM remains open and also in the hands of the private sector.
15. The key policy challenge facing Zambia is to sustain the gains made in the past two years in raising the rate of economic growth, in the face of these considerable uncertainties in the mining sector, and to ensure that the benefits of that growth reach all sections of the public in order to reduce poverty. Accordingly, government intends to maintain macroeconomic stability, strengthen and accelerate structural reforms, improve governance, and invest in productive infrastructure and human capital. Given the difficulties in the copper sector, the government is keenly aware of the urgent need to diversify the Zambian economy. Private sector investment will continue to be encouraged, particularly into export-oriented agriculture, light manufacturing, small-scale mining and tourism. However, even with rapid implementation of reforms, it is unlikely that growth in the non-mining sectors will offset the expected lower performance of the copper sector and, therefore, the medium-term growth prospects now appear less favorable. In light of these developments, the main macroeconomic targets for the period 2002-4 are to achieve: (i) real GDP growth of at least 4 percent a year; (ii) a substantial deceleration of inflation to single digits by 2003; and (iii) a build-up of gross international reserves.
16. Given these macroeconomic objectives, the medium-term fiscal strategy aims to maintain Zambia's relatively strong revenue effort and to restrain overall expenditures, while reorienting spending towards infrastructure, social services and poverty reducing programs. The overall deficit is projected to narrow from 8.1 percent of GDP in 2001 to 5.9 percent in 2004 while the domestic deficit (cash basis) is expected to decline from 4.7 percent of GDP in 2001 to 2.9 percent in 2003.4 However, despite the narrowing deficit, fiscal gaps averaging around 3 percent of GDP in 2003-04 are projected to emerge, partly reflecting the additional debt-service payments to Russia, and a projected further decline in donor budgetary support. Government hopes that these gaps could be covered by a recovery of such donor support and by debt relief beyond the enhanced HIPC initiative. In this context, the government will intensify efforts to enhance relations with donors. The government is also committed to taking such additional fiscal measures as needed to ensure that the remaining gaps are covered.
17. With the difficulties in the mining sector, Zambia's medium-term balance of payments outlook has worsened substantially. Under the revised baseline scenario,5 export receipts are projected to grow by 5 percent annually during 2002-4 compared with 13 percent previously. However, as a result of lower imports on account of reduced borrowing by the copper mines, the current account deficit is projected to narrow from 20.4 percent of GDP in 2001 to 16.2 percent in 2004, and financing gaps are projected to average about US$246 million during 2003-4. These gaps would need to be financed by external grants, highly concessional loans, and external debt relief going beyond the enhanced HIPC initiative.
III. The Program for 2002
18. While the situation remains highly uncertain, we believe that a solution can be found to the immediate financial difficulties of the mining sector and all parties are working toward that objective. Therefore, the key underlying assumption for the 2002 program is that KCM will not be closed, and that its production will be at the same level as in 2001. Output of the other mines is expected to increase modestly. The government is committed not to assume ownership of the mines, as this would entail potentially unlimited financial obligations. Moreover, we anticipate that the financial problems of the sector can be resolved without direct financial support from the government. Therefore, the fiscal program for 2002 does not include any expenditure explicitly related to the mining sector. Should such expenditures become unavoidable, the government will consult with the Fund staff before undertaking any new commitments. It will also seek external concessional financing for any such outlays. If such financing is not available, the government is committed to implement new fiscal measures including introducing broad-based tax measures to ensure that such expenditures would be fully financed. The 2002 program will be reviewed in mid-2002 in order to take into account any new developments related to the copper sector, including any changes to the base line scenario, as well as the overall outlook for external budgetary support.
A. Macroeconomic Objectives
19. The key macroeconomic objectives for 2002 are to achieve real GDP growth of about 4 percent; to limit the 12-month rate of inflation to 13 percent; and to build up gross international reserves by US$116 million. In addition, to address poverty reduction, budgetary allocations to social and poverty reducing programs are being increased. Achieving these objectives will require: (i) appropriate fiscal and monetary policies; (ii) a deepening and acceleration of structural reforms; (iii) improved public expenditure management and control; and (iv) increasing transparency and accountability in government.
B. Fiscal Policies, HIPC Initiative Resources and Expenditures
20. The fiscal program for 2002 targets revenues of 18.1 percent of GDP, slightly below the outturn for 2001,6 because of the introduction of the following pro-growth or pro-poor tax incentives: lowering the excise on diesel from 60 percent to 30 percent, and on electricity from 7 percent to 5 percent; restructuring PAYE in favor of the lower paid by increasing the basic tax allowance while removing the 10 percent and 20 percent bands in such a way as to reduce the tax liability for all taxpayers; making anti-malaria supplies tax exempt; and streamlining the VAT by increasing the registration threshold to K100 million and restricting voluntary registrations. Moreover, once the Indeni refinery becomes fully operational, the import duty on refined petroleum products will be reduced to 5 percent in order to limit monopoly pricing. The program also includes some revenue enhancing measures, such as making income from GRZ bonds taxable, and introducing a 5 percent excise on cars and a 10 percent excise on cosmetics and perfumes.
21. Program assistance from cooperating partners has been projected at 4.2 percent of GDP in 2002, representing a substantial decline in the past two years on budgeted amounts. External budgetary debt service is expected to rise slightly to 2.3 percent of GDP, after interim debt relief under the Enhanced HIPC Initiative of about US$114 million (excluding the IMF), which will support the government's plans to orient the budget increasingly toward poverty reduction.
22. Expenditures in 2002 will be restricted to 31.0 percent of GDP. Thus, the overall fiscal deficit is projected to narrow from 8.1 percent to 7.3 percent of GDP, while the domestic deficit will fall from 4.7 percent to 3.1 percent. The existing wage agreements with most public sector unions extend through end-December 2002, and the government wage bill for 2002 is estimated at 7.1 percent of GDP. This significant increase from last year's programmed level mainly reflects a large wage increase granted to other public workers in November 2001. The domestic interest bill has increased dramatically from last year, along with the sharp rise in interest rates and the stock of government paper outstanding. Government recognizes the critical importance of reducing deficits so as to preserve fiscal sustainability in the medium term. Spending on recurrent departmental charges will be significantly lower than in 2001, reflecting the completion of elections and the OAU summit. Cash costs related to the privatization of ZNCB will be minimized by selling a majority share to offset the one-off costs of cleaning up the balance sheet. The budget includes provision for recapitalization of the BoZ, but this will not be implemented until after the mid-term review of the program, taking account of the report of the Task Force on Government Accounts (see paragraph 27). Although the targeted overall deficit will largely be covered by external resources, there will be a need for domestic financing equivalent to about 1.2 percent of GDP.
23. As noted earlier, resources will increasingly be directed toward poverty-reducing activities. The government is in the process of identifying line items in the budget, which are poverty-related based on the PRSP. Appropriations for the key social and economic functions have increased from 56.4 percent of the total budget in 2001 to 61.5 percent in 2002. Moreover, government intends to continue adhering to the operational rules to ensure that cash releases are consistent with budget allocations in priority areas.
24. Part of the PRSP priority expenditures have been designated "poverty reduction programs" in the budget, and funded by HIPC resources. The MoFNP has developed a list of projects amounting to K 350 billion (2.2 percent of GDP or 7.1 percent of total spending). The government will continue to improve its monitoring and tracking of HIPC resources, and intends for these procedures to serve as a model for improved management and control of all PRSP expenditures in the future. Resources corresponding to debt relief are deposited monthly into a special account ("account 49"). These funds will be disbursed to the pre-identified HIPC activities which have a separate budget code. Line ministries are required to report each month on cash released, commitments incurred, and actual expenditures on HIPC activities, and the Accountant General will continue to make a quarterly summary of this information available to the public. An annual report on the use of HIPC resources will also be prepared for public discussion, starting with the report for 2001. A HIPC monitoring committee has been set up with representatives of nongovernmental groups and professional bodies to monitor the use of HIPC resources.
C. Monetary and Financial Policies
25. Monetary policy will be geared primarily toward achieving the program's inflation and international reserves targets. Consistent with an inflation target of 13 percent, broad money is expected to increase by about 15 percent in 2002. Achieving the monetary target will be facilitated by continued use of open market operations. The BoZ will continue to adhere to the revised Treasury bill auction guidelines in order to ensure a more efficient functioning of the market. Credit to public enterprises is expected to increase only slightly, which should enable banks to increase credit to the private sector in support of productive activities by about 17 percent.
26. The government is concerned about the very high level of interest rates prevailing in Zambia, which adversely affect private sector economic activity, particularly in agriculture. We recognize that these rates result mainly from continued high government borrowing together with persistent inflationary expectations and inefficiencies in the banking system. To facilitate a reduction in interest rates and bank spreads, the BoZ will: (i) evaluate and systematically allow banks to hold their cash reserve requirement for foreign currency deposits in foreign currency while sterilizing the liquidity impact in the transition through regular BoZ open market operation; (ii) review the current volume and price penalties put in place on rediscounting of treasury bills with a view to providing banks with greater flexibility in their cash management; (iii) introduce a pilot scheme to exempt the amount lent to agriculture by commercial banks in the calculation of their statutory reserve requirement; and (iv) continue to improve the effectiveness of tender and off-tender sales of government securities. In addition, to strengthen monetary management and financial operations, and thereby improve government's cash flow, the MoFNP in collaboration with the BoZ will develop a domestic debt management strategy.
27. The diverse range of instruments that government uses to borrow from the BoZ needs to be streamlined in order to simplify management of government finances and to better monitor overall net credit to government. Accordingly, the government and the BoZ will streamline and consolidate the BoZ's existing mechanisms for financing government operations to consist of three elements: an overdraft account at the BoZ, treasury bills (with maturity of less than one year), and treasury bonds (with maturity of more than one year). To facilitate implementation of the new system, the government, has appointed a task force which will report by July 2002 on possible modalities and timetable for consolidating the existing foreign exchange and kwacha bridging loan facilities; putting in place a new overdraft facility; and closing dormant government accounts. A critical element will be proposing terms and interest rates on the overdraft facility and on bonds. The task force's proposals will be geared toward containing the government's domestic interest costs while ensuring that the BoZ receives an appropriate income stream. The government will decide on the recommendations by September 2002 for implementation by end-December.
D. Exchange Rate and External Sector Policies
28. The exchange rate will continue to be market determined, with foreign exchange intervention limited to meeting the program's international reserves target and to smoothing short-term fluctuations. The external current account deficit is expected to narrow to 17.2 percent of GDP in 2002, mainly because of a compression of imports as private sector financing for the metal sector falls sharply. Despite growth in metal export volumes of 2 percent, export receipts are expected to decline slightly in 2002 as a result of lower copper prices. Foreign direct investment, largely outside the copper sector, is envisaged to grow by 14 percent. Notwithstanding the large overall balance of payments deficit, external assistance including interim HIPC debt relief should permit gross reserves to build-up to US$229 million, equivalent to 1.7 months of imports. The government intends to maintain the current liberal trade and exchange system. In order to further strengthen Zambia's stance as an open economy, we have written to the Fund accepting the obligations under Article VIII, Sections 2, 3, and 4.
29. Government recognizes the critical importance of improving the quality of external debt management to contain the obligations to the extent feasible by prudent negotiations, consistent with our legal liabilities, and to better forecast debt-service obligations. To this end, we intend to ask for assistance from cooperating partners. Finally, the government will consolidate refunds of debt service related to HIPC within the budget.
E. Structural Reforms, Public Expenditure Management, and Governance
30. Selling the government's majority interest in ZNCB will be critical to improving the investment climate and management of public finances, while also improving public finances. While ZNCB had been offered for sale, the response was limited by the lack of majority control for the buyer and uncertainty about the status of the balance sheet. Therefore, to complete the process as rapidly as possible and to avoid further losses, the Cabinet has approved the sale of at least 51 percent of government's share in ZNCB; that government will take over the liabilities to ZNCB of ZNOC and Roan Antelope Mining Company of Zambia (RAMCOZ) and the contingent liabilities of a legal action by some ex-employees of ZNCB that is in process; and that the buyer of ZNCB will not be required to maintain any non-viable rural branch for more than two years. On this basis, the sale has been readvertised. We anticipate that by end-July the ZPA Board will appoint a negotiating team with approval to finalize terms with the buyer and that the sale of ZNCB will be concluded thereafter. In the meantime, the government will commission a study to identify options for dealing with rural branches and creating a new rural financial institution with the objective of integrating the rural population into the economy. Technical and financial assistance from donors, including the World Bank, will be sought for the creation and operation of the new rural financial institution.
31. The BoZ will continue to monitor the financial situation of ZNCB. Based on the findings of the recently completed targeted inspection, ZNCB has implemented a number of recommended actions to ensure compliance with BoZ directives, including: stopping interest accrual; making additional loan loss provision in December 2001; and completing reconciliation of interbranch accounts. In addition, the BoZ will take steps to ensure compliance with remaining directives, including: stopping the recognition of unrealized exchange gains, and continuing to limit strictly ZNCB's new loans. Moreover, the government will act to expedite the sale of RAMCOZ, which is under receivership.
32. Regarding the oil sector, consistent with earlier commitments to the World Bank, we will expeditiously complete the actions necessary to facilitate disbursement of the remaining US$50 million tranche. To that end, Cabinet has approved the ZPA proposal on the concessioning of Tazama and Ndola storage facilities and for government to reduce its shareholding in the Indeni refinery to below 50 percent. The government put ZNOC under liquidation in April 2002, thereby eliminating its role as an importer and distributor of petroleum products. The financial liabilities of ZNOC and ZNCB will be treated separately from implementation of the reform program, and we will not meet any of ZNOC's liabilities for which government is not legally liable. Once Indeni becomes operational, government has agreed that the import tariff on petroleum products will be lowered from 25 percent to 5 percent. With regard to the electricity company, ZESCO, the ZPA has advertised for international consultants to be appointed to assist in preparing the company for concessioning and will soon invite international bids for concessioning.
Public Expenditure Management
33. Strengthened public expenditure management is critical to enhance efficiency and to deal with the accumulation of domestic payments arrears, which undermines economic management. The Controller, Internal Audit will be supplied with equipment in order to compile a database of individual bills by end-December 2002, and a plan will be drawn up for clearing these old arrears as soon as feasible. Line ministries will be required to document which particular bills in the database were paid with any funds released by MoFNP for arrears clearance. At the same time, government will endeavor to prevent the accumulation of new arrears by clarifying the financial regulations, adopting a Commitment Control System in line ministries, establishing an Expenditure Monitoring Unit in MoFNP, and introducing quarterly expenditure ceilings, as described in Annex II. Government is continuing its efforts to improve monthly reporting,7 which will be used as the basis for arrears monitoring, and regular quarterly audits by the Controller, Internal Audit will also continue. In addition, the government will be piloting the new computerized reporting system. Any cases of overcommitment or unauthorized virement (transfer) will be investigated thoroughly by MoFNP. The personal responsibility and accountability of permanent secretaries, chief accountants, and internal auditors in the line ministries will be further enhanced.
34. Government will also take steps to improve the cash release process. Any requests for virement between subheads will need to be submitted to the Secretary to the Treasury (ST) in writing before commitments are incurred, and requests for special funding above budget appropriations will no longer be permitted (except in cases of national emergencies, consistent with financial regulations). In the event that ex-ante Treasury authority is not sought, expenditures will be regarded as unauthorized and will be dealt with accordingly. Cash releases will be published in the newspapers and in Macroeconomic Indicators. A mid-term budget review will also be performed by July 2002. Government will also seek to improve cash management. Line ministries will be required to submit cashflow projections to MoFNP, which will use these to rephase expenditures in light of revenue forecasts so as to minimize costly borrowing. With these reforms, and tightened approval procedures at the Zambia National Tender Board (whose tender committee will now be chaired by the ST), we believe that public expenditure management will improve substantially.
35. In the longer term, introduction of an IFMIS will be key to improving government financial control. A three-member project management team was constituted in March 2002 to work full time on the IFMIS, and a short-term consultant was engaged to help with the functional design. Government intends to hire the main consulting firm by September 2002 to help design and pilot the IFMIS project, including hardware and software requirements, which should be initiated by December 2002. It is expected that procurement will take place soon thereafter, thus enabling a pilot program to be launched in at least three ministries during the 2003 budget year.
36. Government intends to develop a Medium-Term Expenditure Framework (MTEF) that will guide annual budgets from 2003 onward. Such a document will be of critical importance, serving as a bridge between the broad policy priorities outlined in the PRSP and the annual detailed budgeting exercise. The government has taken steps to improve its capacity to plan, coordinate and monitor its programs through the newly established Planning and Economic Management Department. This Department will be responsible for macro-economic planning, the development of the MTEF, monitoring the PRSP and use of HIPC resources, and donor coordination.
37. The PRSP articulates a broad agenda to improve governance. In order to fight corruption, the government is strengthening the Anti-Corruption Commission, the Office of the Auditor General (OAG), and other relevant government institutions. Furthermore, government has enacted a law against money laundering and related vices. Steps are also being taken to enhance transparency and accountability in the management of public resources. First, the government intends to sustain efforts to comply strictly with Zambian law that the Accountant General (AG) submit government accounts of the preceding year to the OAG by end-September and that the annual audited government accounts be submitted to Parliament by end-year. Second, government intends to publish mid-year budget reports in the mid-year economic review. As already indicated, once the legal liability issues are resolved and the consultants provide the final report on ZCCM cobalt sales, the government will publish the report and refer it to the appropriate authorities for possible further action.
IV. Technical Assistance and Data Issues
38. In recent years, Zambia has received substantial technical assistance (TA) in public expenditure management, tax policy, bank supervision, monetary policy and operations, financial sector issues, payment system and balance of payments statistics. A resident advisor in budget management was in place until December 2001 and we have requested that he be replaced as rapidly as possible. The government welcomes TA in the area of public expenditure management, as well as statistical and accounting issues. We recognize that delays in compiling and reporting macroeconomic data in recent times has somewhat undermined our ability to formulate and implement policies. While efforts are being made to improve the timeliness of monetary data, there are still long delays in compiling survey data for the national accounts, and there are methodological weaknesses relating to the use of outdated weights and estimation methods. These and other areas will require substantial efforts and government expects to address these weaknesses, with assistance from the Fund and other donors for capacity building.
V. Program Monitoring
39. The 2002 program will be monitored on the basis of the quantitative and structural performance criteria and benchmarks shown in Tables 3 and 4. These are defined in the attached Technical Memorandum of Understanding. Quantitative performance criteria will be monitored on a quarterly basis with associated disbursements taking place quarterly. Program reviews will be semi-annual. The fifth review of the PRGF-supported program to be completed no later than end-October 2002, will be conducted based on performance through end-June 2002, and will include an assessment of developments in the copper industry, progress in implementing the agreed budget and the projects specified in the PRSP and included in the budget, the monetary framework, progress in privatizing ZNCB, and progress in streamlining government accounts in the BoZ, public expenditure management and governance issues.
Controlling New Arrears
1. Clarifying the Financial Regulations
We intend to issue, by end-May 2002, a Treasury circular emphasizing that: (1) commitments are to be kept within the quarterly ceiling allocated for each budget line, even if this is smaller than the pro rata budget appropriation; (2) virement between subheads requires ex ante, written approval from the ST; (3) requests for "special funding" above appropriations will not be entertained; and (4) strict sanctions, including refusal to disburse future cash, will be imposed on controlling officers (COs) who fail to comply with the monthly reporting requirements, or with their financial responsibilities.
2. Introducing a Commitment Control System (CCS) at the Line Ministries
Even with an entirely clear legal framework, controlling officers will still benefit from a set of operational procedures to help them in their daily efforts to avoid overcommitments. As such, the government intends to establish a Commitment Control System for the line ministries by end-June 2002 . First, each ministry will have a Commitment Control Officer (CCO), who will usually be the controlling officer or a designated senior official. A commitment requisition will be prepared before a commitment is incurred in any form, and the Chief Accountant must ensure that the amount of the requisition is within the uncommitted balance under the relevant budget line in the expenditure ledger. Only then will the requisition be approved by the CCO, the commitment be recorded in the ledger (with the uncommitted balance reduced correspondingly), and an LPO be issued. The payment voucher will not be prepared unless the commitment has been approved and recorded in the ledger, and a copy of the approved requisition should be attached to the voucher. After a check is issued for the voucher, payment details are recorded in the ledger, and the commitment gets discharged.
3. Establishing an Expenditure Monitoring Unit (EMU) at MoFNP
The government also plans to reestablish an Expenditure Monitoring Unit at MoFNP, responsible for monitoring the receipt and the quality of the monthly expenditure returns. By the third week of each month, the EMU should present the ST with a report, summarizing information on government appropriations, cash releases, commitments, expenditures, and arrears, and also indicating those ministries which have incurred overcommitments, submitted reports of poor quality, or failed to report at all. The EMU should also prepare letters, for the ST's signature, seeking explanations from the concerned ministries. In the case of repeated noncompliance with the financial regulations, including in submission of expenditure returns, MoFNP will impose sanctions, including refusal to release cash, and disciplinary measures against the responsible controlling officers (COs).
4. Introducing Quarterly Expenditure Ceilings
To support line ministries' efforts to comply with the CCS, MoFNP will issue expenditure ceilings, guided by projected resource inflows and the Yellow Book, at the beginning of each quarter, and these will be fully backed by cash releases, which may continue on a monthly basis.1 COs are thus given firm funding assurances, three months in advance. This enhanced predictability and flexibility should facilitate better planning at the line ministries.
1MoFNP will do its best to ensure that ministries' quarterly ceilings are at least 80 percent of their pro rata Yellow Book appropriations. Even if this is not possible in every quarter, the 80 percent rule will still be observed for the year as a whole, for every ministry's RDCs, grants, and capital expenditure.
1After adjusting for the increase in the cash reserve ratio effective December 3, 2001.
2The 12-month growth rate in the nonfood component of the CPI, a measure of the underlying inflation, was 16.7 percent.
3The International Finance Corporation (IFC) and the Commonwealth Development Corporation (CDC).
4The domestic primary deficit is projected to narrow from 3.1 percent of GDP in 2001 to approximate balance during 2002-04.
5The revised baseline scenario assumes constant output from KCM and slight growth by other copper mines.
6The 2001 outturn included various one-off revenues totaling 0.5 percent of GDP.
7Government plans to use the improved data in the monthly reports from the line ministries to construct a consolidated expenditure report for government each month, so as to facilitate better monitoring and analysis.
1. This memorandum sets out the understandings between the Zambian authorities and the International Monetary Fund regarding the definitions of the quantitative and structural performance criteria and benchmarks for the program supported by the PRGF arrangement, as well as the related reporting requirements. The definitions are valid at the start of the program, but may need to be revisited during the program reviews to ensure that the memorandum continues to reflect best understanding of the Zambian and Fund staff to monitor the program.
II. Quantitative Performance Criteria: Definitions and Data Sources
A. Net Domestic Assets of the Bank of Zambia (BoZ)
2. NDA of BoZ is defined as the monthly-average (based on daily data), during the month of the test dates, of the reserve money less net foreign assets calculated at end-December, 2001 BoZ mid-exchange rates (program exchange rates).1 Reserve money includes currency in circulation, required reserves on kwacha deposits, required reserves on foreign currency deposits, positive current account balances of banks with the BoZ and deposits of non-central government institutions. Net foreign assets of the BoZ are defined as gross international reserves (defined below) plus any other foreign asset, including the IMF interim assistance and the US$25 million blocked reserves at the former Meridien Bank, minus foreign liabilities (defined below). The kwacha figures are derived from the U.S. dollar values using the program exchange rate of K 3,830 per U.S. dollar.
3. Foreign liabilities are defined as short-term (one year or less in original maturity) foreign currency-denominated liabilities of the BoZ to nonresidents and outstanding use of Fund credit.2
4. The ceilings on NDA will be adjusted upward by the amount of the shortfall of balance of payments support net of debt service as indicated in Table 3 of the letter of intent, up to a maximum of US$45 million for the program year. In the event of excess balance of payments support net of debt service, the ceiling on NDA will be adjusted downward by 100 percent of the additional excess support. The kwacha value of the cumulative shortfall/excess will be calculated at the program exchange rate.
5. The ceiling on NDA will be adjusted downward/upward to reflect decreases/increases in the legal reserve requirements. The adjustor will be calculated as the percent change in the reserve requirement multiplied by the actual amount of reserves (kwacha and foreign currency denominated) at the end of the previous calendar month.
6. The ceiling on NDA will also be adjusted upward by a maximum of K 80 billion to reflect the government's cash cost arising from the privatization of ZNCB.
B. Net Bank Claims on Government (NCG)
7. NCG refers to the net banking system's claims on Central government and is defined as:
(i) the net position of the government with commercial banks, including: (i) treasury bills; (ii) bonds issued by the Government of the Republic of Zambia (GRZ); (iii) loans and advances; less (iv) support to Meridien Bank (MBZ); and less (v) Central government deposits (defined to include account balances under the authority of controlling officers); plus
(ii) BoZ holdings of: GRZ statutory bonds; ordinary GRZ bonds; bonds in respect of loans to former parastatals; treasury bills on the trading portfolio of BoZ; treasury bills issued for interest on the BoZ foreign exchange bridging loan to GRZ; other government stock; and the BoZ Kwacha bridging loan to GRZ (including the GRZ's revolving fund under the Fiscal Sustainability Credit), less government deposits at the BoZ; plus
(iii) The BoZ foreign exchange bridging (forex) loan to the GRZ less donor suspense account balances. This will be calculated by taking the beginning period stock of the forex loan expressed in kwacha and then adding net external balance of payments support valued at current exchange rates.
8. The ceiling on the increase in NCG will be adjusted upward by the amount of the shortfall in balance of payments support net of debt service as indicated in Table 3 of the letter of intent, up to a maximum of US$45 million for the program year. In the event of excess balance of payments support net of debt service, the ceiling on NCG will be adjusted downward by 100 percent of the additional excess support. The kwacha value of the cumulative shortfall/excess will be converted at the program exchange rate.
9. The ceiling on NCG will also be adjusted upward by a maximum of K 80 billion to reflect the government's cash cost arising from the privatization of ZNCB.
10. The data source for the above will be the "Net Claims on Government Table" produced by BoZ Economics Department, submitted on a weekly basis, and reconciled with the monetary survey.
C. Domestic Arrears of Government
11. Domestic arrears are defined as: (i) any bill that has been received by a spending Ministry from a supplier for goods and services delivered (and verified) and for which payment has not been made within 30 days; (ii) wage and salary arrears that were due to be paid in a given month but remained unpaid on the 15th of the following month; and (iii) interest or principal obligations which remain unpaid 30 days after the due date of payment.
12. The information is to be compiled through audits of the accounts of spending Ministries and agencies, conducted by the Internal Audit division of MoFNP. The audits will be completed and data submitted to Fund staff by the Commitments Monitoring Unit within 6 weeks of the end of each quarter.
D. Gross International Reserves of the BOZ
13. Unless otherwise noted here, gross international reserves of the BoZ will be defined as reserve assets of the Bank of Zambia (Appendix II, Table 2). Reserve assets are defined in the IMF BOP manual (5th edition) and elaborated in the reserve template of the Fund's special data dissemination standards (SDDS). They exclude, for example, foreign assets not readily available to or controlled by the monetary authorities, and foreign currency claims on Zambia residents.
14. Gross international reserves consist of (i) monetary gold; (ii) foreign currency in cash; (iii) Unencumbered foreign currency deposits at non-resident banks; (iv) foreign securities and deposits; (v) SDR holdings and Zambia's reserve position with the Fund; and (vi) balances in the BIS account related to debt service to Paris Club creditors. Gross reserves will exclude non-convertible currencies, pledged, swapped, or any encumbered reserves assets including but not limited to reserve assets used as collateral or guarantees for third party external liabilities, and will exclude the US$25 million deposit in Meridien Bank which is under liquidation, and the IMF's interim assistance.
15. The floor on gross international reserves will be adjusted: (i) downward by the amount in U.S. dollars of the shortfall in balance of payments support net of debt service as indicated in Table 3 of the letter of intent, up to a maximum of US$45 million for the program year; (ii) upward by 100 percent of the cumulative excess balance of payments support net of debt service (iii) downward/upward for any shortfall/excess in the U.S. dollar value of disbursements from the IMF under the PRGF arrangement; and (iv) downward for any increase in BoZ short-term foreign currency denominated debt (to resident and nonresidents), using the definition of short-term debt below.
16. The floor on reserves will be adjusted downward by a maximum of US$21 million to reflect the government's cash cost arising from the privatization of ZNCB.
17. For the purpose of this performance criterion, as well as those for external debt and arrears, valuation will be in U.S. dollars using the program exchange rates.
18. Data on gross international reserves including its components will be reported by the BoZ on a weekly and end-month basis.
E. External Payment Arrears
19. Official external payment arrears are defined as the stock of external arrears on debt repayments by the central government and BoZ, except on debts subject to rescheduling.
20. Data on arrears are compiled jointly by the MoFNP and BoZ and will be reported by MoFNP on a quarterly basis.
F. Official Medium- and Long-Term Concessional Loans
21. This is defined as all forms of official debt contracted or guaranteed by the central government and BoZ having a grant element of more than 40 percent, but excludes debts subject to rescheduling. This includes loans, supplier's credits and leases, that constitute current, i.e. not contingent liabilities, which are created under a contractual arrangement or guarantee through the provision of value in the form of assets (including currency) or services, and which require the government or BoZ to make one or more payment in the form of assets (including currency) or services, at some future point(s) in time; these payments discharge the principal and/or interest liabilities incurred under the contract. Under this definition, such debt includes arrears, penalties, and judiciary awarded damages arising from the failure to make payments under a contractual obligation that constitutes debt as specified above. The grant element is to be calculated by using currency-specific commercial interest reference rates (CIRRs) reported by the OECD); for maturities of less than 15 years, the grant element will be calculated based on six-month averages of CIRRs, and for maturities longer than 15 years, the grant element will be calculated based on 10-year averages. Adjustment lending from the World Bank and IMF will be excluded.
22. The definition of debt, for the purposes of the limit, is set out in Executive Board Decision No. 6230-(79/140), Point 9, as revised on August 24, 2000 (see Annex below). This performance criterion applies not only to debt as defined in Point 9 of the Executive Board decision, but also to commitments contracted or guaranteed for which value has not been received.
23. Detailed data on all new concessional and non-concessional debt contracted or guaranteed will be provided by MoFNP on a quarterly basis.
G. Official External Short-Term Debt
24. This is defined as the outstanding stock of external debt (as defined above) with a maturity of less than one year contracted or guaranteed by the central government, and BoZ. For this purpose short term debt will include forward commodity sales but will exclude normal trade credit for imports. There will be no new official external short-term debt during the program period.
25. The data will be reported by the MoFNP and BoZ on a quarterly basis.
III. Structural Performance Criteria and Benchmarks
A. Monthly Revenue and Expenditure Reports
26. The Central Computer Services Department (CCSD) shall process monthly FMS reports from the line ministries, so as to enable the Accountant General to submit a consolidated summary of monthly government expenditure, along with revenue collections, to the Secretary to the Treasury (ST) as a management tool. This report should show expenditure by subhead for each spending agency, and should also include a summary for government as a whole. The report should be published, along with data on cash releases, with a lag of less than two months, either on the government's website or in Macroeconomic Indicators. As the quality of the Monthly Expenditure Returns improve—or, alternatively, as the FMS reports are modified to include more information—additional data on commitments and arrears shall be included in the report.
B. Database on Domestic Arrears
27. The Controller, Internal Audit shall, using the results of quarterly audits of arrears at spending agencies, construct a database containing records for each individual unpaid bill owed by government. Once constructed, this database will allow the Ministry of Finance to hold line ministries accountable for their requests for funds for arrears clearance. Such requests must identify the particular arrears to be cleared, and the corresponding records in the database will be deleted upon verification from the line ministry.
C. Submission of Audited Government Accounts
28. "Accounts for 2001" are defined as the 2001 annual financial statements, as prescribed in the Finance Act and Regulations thereunder. "Timely preparation of final audited accounts as required by law" is taken to mean that the Auditor General will audit the accounts for 2001 in sufficient time to allow the Minister of Finance to present the Financial Report to Parliament within twelve months of the end of the year, i.e., by December 2002.
D. Procurement of Hardware and Software for IFMIS
29. Once the long-term IFMIS consulting firm is in place, it will help design the hardware and software requirements for the process. Procurement of hardware and software should commence—i.e., tender documents should be issued—by December 2002.
E. HIPC Reporting
30. The benchmark on publishing an annual report on the use of HIPC debt savings during 2001 and allocations for 2002, will be met following the publication of a report detailing: (i) debt relief received during 2001 and the amounts credited to the MoFNP account 49 at the BoZ; (ii) programs to which HIPC resources were allocated in the budget during 2001, together with the amounts allocated from the non-HIPC budget to these programs; (iii) cash releases to line ministries and expenditures for these programs; (iv) progress with public monitoring of HIPC resources, and any other related activities (e.g. training workshops, dissemination); and (v) the list of programs to receive HIPC resources for 2002.
F. Privatization of Zambia National Commercial Bank (ZNCB)
31. The performance criteria on the privatization of the ZNCB will be met on the day the Zambia Privatization Agency (or other designated agency): advertises the sale of at least 51 percent of ZNCB along with the relevant terms and conditions in national and international newspapers/newsweeklies.
32. The benchmark on the appointment of the negotiating team will be met on the day the ZPA Board appoints a negotiating team with full authority to negotiate a contract for sale and related matters consistent with existing rules and practices.
G. Consolidation of BoZ's Existing Mechanisms for Financing Government
33. The benchmark and performance criteria on streamlining and consolidating the BoZ's existing mechanisms for financing government operations to comprise three elements: an overdraft facility with the BoZ; treasury bills and treasury bonds, will be met once the following three steps are completed:
(i) The joint task force comprising MoFNP and BoZ staff submits its proposals on the modalities and timetable for streamlining and consolidating government accounts (along the lines indicated above) to the authorities in MoFNP and the BoZ.
(ii) The MoFNP and the BoZ authorities formally decide on a strategy (mode and timing of streamlining and consolidating the accounts) and a decision is communicated in writing to all concerned officials.
(iii) The revised system becomes operational and the BoZ issues the first weekly/monthly report indicating the position of all government accounts in the BoZ under the new system.
H. Abstention from Tax Reductions and Other Measures
34. The government shall refrain from introducing any additional tax exemptions beyond those already included in the 2002 budget and all expiring tax exemptions will be allowed to lapse. The zero-rating for VAT for hotel accommodation in the Livingstone area is carried over until end-2002.
Guidelines on Performance Criteria with Respect to Foreign Debt
Excerpt from Executive Board Decision No. 6230-(79/140), as revised on August 24, 2000
9. (a) For the purpose of this guideline, the term "debt" will be understood to mean a current, i.e., not contingent, liability, created under a contractual arrangement through the provision of value in the form of assets (including currency) or services, and which requires the obligor to make one or more payments in the form of assets (including currency) or services, at some future point(s) in time; these payments will discharge the principal and/or interest liabilities incurred under the contract. Debts can take a number of forms, the primary ones being as follows:
(b) Under the definition of debt set out in point 9 (a) above, arrears, penalties, and judicially awarded damages arising from the failure to make payment under a contractual obligation that constitutes debt are debt. Failure to make payment on an obligation that is not considered debt under this definition (e.g., payment on delivery) will not give rise to debt.
1Unless otherwise defined, program exchange rates for 2002 between the U.S. and other (non-kwacha) currencies, including the SDR, will be equal to the end-2001 rates. Any other assets (e.g. gold) would be revalued at end-2001 market price.
2The liability to Camdex will continue to be treated as a short-term foreign liability of the BoZ.