## cr17327 ## Source details **Canonical URL:** [cr17327](https://www.imf.org/-/media/files/publications/cr/2017/cr17327.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2017/cr17327.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2017/cr17327.pdf.json) --- ### Recent developments: shocks, policy response, and macro outcomes - Near-crisis in 2015Q4 and most of 2016 driven by: low copper prices, poor rainfall, contraction in agriculture output in 2015, sharp drop in hydropower generation, severe power rationing, and government spending significantly above budget with underperforming revenues. - Monetary policy: - Tightened in 2015Q4 to stabilize the exchange rate and lower inflation; liquidity crunch, government arrears, and subdued activity led to financial stress. - BoZ policy rate: 2014: 9.75% → 12.5%; 2015: 12.5% → 15.5%; 2016: No Change; Jan-Aug. 2017: 15.5% → 11.0%. - Reserve requirements: 2014: 8.0% → 14.0%; 2015: 14.0% → 18.0%; 2016: No Change; Jan-Aug. 2017: 18.0% → 9.5%. - Overnight Lending Facility premium: 2014: 250bps → 1000bps; Jan-Aug. 2017: 1000bps → 600bps. - BoZ forced FX sales in 2015; since 2016 BoZ has made net purchases to rebuild reserves. - Growth and inflation: - Real GDP growth: 2005–2014 average 7 percent; 2015: 2.9; 2016: 3.4; 2017 (expected): 4.0. - Inflation: 7 percent mid-2015; 22.9 percent in February 2016; 18.9 percent in September 2016; 6.3 percent in August 2017; authorities’ target range: 6–8 percent. - Fiscal balances and public debt: - Cash-basis fiscal deficit: 2015: 9.3 percent of GDP (budgeted 4.6 percent); 2016: 5.8 percent of GDP (budgeted 3.3 percent). - Commitment-basis deficit: 2015: 12.1 percent of GDP; 2016: 8.6 percent of GDP. - 2017 budget targeted cash deficit: 7 percent of GDP (5.5 percent on commitment basis); staff projects cash deficit ~8.0 percent of GDP in 2017. - Public debt: increased from 36 percent of GDP at end-2014 to 61 percent at end-2016; public debt tripled from 21 percent of GDP at end-2011 to 60.5 percent at end-2016. - External debt: accounts for 60 percent of public debt; outstanding PPG external debt nearly US$8 billion (36.5 percent of GDP) at end-2016, including US$3 billion in Eurobonds. - Financial sector stress: - NPLs rose from 6 percent of outstanding loans at end-2014 to 12 percent in July 2017. - Funding costs and lending rates rose above 40 percent in 2016 in a very tight liquidity environment; average annual real lending rate ~20 percent. - BoZ takeover of a small bank and interventions in three nonbanks in late 2016. - External sector and reserves: - Current account: surplus 2014: 2.1 percent of GDP → deficits 2015: -3.9 percent; 2016: -4.4 percent. - Gross international reserves: end-2014: US$3.1 billion (4.2 months import cover); end-2015: US$3.0 billion (4.5 months); end-2016: US$2.4 billion (3.1 months). - Copper accounts for about 70 percent of Zambia’s export earnings; copper price: ~US$5,700/tonne in December 2016 → nearly US$6,500 in August 2017. ### Near-term outlook, drivers, and political risks - Near-term drivers: - Good rains and rising copper price expected to boost real GDP growth to 4 percent in 2017 from 3.4 percent in 2016. - Inflation projected to remain within authorities’ target range of 6-8 percent. - Political risks: - Heightened tensions following August 2016 elections; treason charge and jailing (April 2017) and release (August 2017) of UPND leader; arson attacks and a declared situation on July 5, 2017 that could degenerate into a state of emergency. - IMF engagement: - Discussions on a possible Fund-supported program; further progress contingent on greater clarity on fiscal policy commitments and aligning government borrowing plans with public debt sustainability. ### Medium-term scenarios and macro projections - Two scenarios: Baseline / current policies and Adjustment policies. - Baseline / current policies scenario: - Assumes more gradual fiscal consolidation and larger public investment plan funded by external loans; additional domestic borrowing needs possible. - Projected lower growth than adjustment scenario; slower arrears clearance and higher medium-term inflation. - Adjustment policies scenario: - Assumes prioritization of infrastructure in line with absorptive capacity and stronger fiscal consolidation; better debt trajectory. - Select projections (as in Text Tables 3 and 4; figures reported exactly): - Real GDP growth (%): 2014: 4.7; 2015: 2.9; 2016: 3.4; 2017: 4.0. - Inflation (y-o-y, %, end-period): 2014: 7.9; 2015: 21.1; 2016: 7.5; 2017: 5.8. - Overall balance (cash basis, % of GDP): 2014: -5.7; 2015: -9.3; 2016: -5.8; 2017 (budget): -7.0; staff projects around -8.0. - Public debt (% of GDP): 2014: 35.6; 2015: 61.4; 2016: 60.5. - Copper price (US$/tonne) examples: 2014: 6,863; 2015: 5,510; 2016: 4,868. - Key risks to outlook: - Continued fiscal slippage and accumulation of arrears. - Exchange rate and rollover risks due to high external debt share and foreign investor participation. - Political tensions and domestic security incidents. - Financial sector vulnerability from high NPLs and high lending rates. ### Debt dynamics, LIC-DSA findings, and public debt vulnerabilities - LIC-DSA assessment: - Zambia assessed at high risk of debt distress. - Under current policies: - PV of external debt-to-GDP breaches 40 percent threshold during 2019–23. - PV of debt service-to-revenue breaches 20 percent threshold in 2022 and 2024 when Eurobonds mature. - Sensitivity analyses: indicators breach thresholds under shocks to export earnings, growth, and the exchange rate. - Under adjustment scenario: - PV of external debt-to-GDP remains below 40 percent throughout projection horizon; debt-service-to-revenue still temporarily breaches threshold when Eurobonds mature. - DSA suggests Zambia would return to a moderate risk rating if authorities: - Restrain non-concessional borrowing. - Implement measures to achieve fiscal consolidation path consistent with adjustment scenario. - Total public debt: - Projected to exceed benchmark level (56 percent of GDP) associated with heightened vulnerabilities for medium performers under current policies over an extended period. - Under adjustment scenario, public debt declines steadily after 2018, falling below benchmark from 2019. - DSA numeric highlights (selected exact series reproduced in source tables): - PV of public and publicly guaranteed external debt: rises from 37 percent in 2016 to 42.6 percent by 2019 and peaks at 44.3 percent in 2022 (DSA tables). - Under current policies DSA (selected series): - Real Growth (2016–2021): 3.4 4.0 4.5 4.5 4.5 4.5. - Adjustments Policies DSA Real Growth (2016–2021): 3.4 4.0 4.5 5.0 5.5 5.5. - Inflation (deflator, av.) Current Policies: 14.3 7.9 8.1 8.1 7.8 8.0. - Budget Deficit (Percent of GDP) Current Policies: 5.7 8.0 7.8 7.2 6.5 5.3; Adjustments Policies: 5.7 7.3 5.9 4.0 3.2 2.4. - Current Account Balance (Percent of GDP) Current Policies: -4.4 -3.6 -2.8 -1.5 0.0 -0.2; Adjustments Policies: -4.4 -3.0 -1.5 0.1 1.2 1.4. ### Fiscal consolidation: recommendations and specific policy measures - Overarching guidance: "We cannot spend what we do not have. We cannot borrow beyond our ability to repay." (2017 Budget Speech) - Staff anchor: primary balance on a commitment basis. - Recommended path: target a 4 percent of GDP adjustment in 2017 followed by a 1 percent of GDP improvement over the next two years. - Outcome under recommended path: primary surplus of about 0.7 percent of GDP by 2019 versus a 2.5 percent primary deficit projected under current policies. - Revenue mobilization priorities: - Improve VAT efficiency and CIT productivity; address widespread tax incentives, multitude of income tax rates, zero-rating of non-exportable goods, and broad exemptions. - Actions urged: implement measures approved by parliament (including on land titling); speed up fiscal devices for tax compliance monitoring; clean taxpayer database; strengthen tax-auditing capacity; enhance monitoring of high income taxpayers. - Authorities’ actions: appointed VAT withholding agents in mining and construction; launched tax amnesty (April 20–September 15) expected to yield 1.2 percent of GDP (half collected in 2017, half in 2018). - Expenditure measures: - Fuel: October 2016 adjustment to full-cost recovery; ERB lowered pump prices January and August 2017 as oil prices and kwacha moved; staff urged continued adherence to cost-recovery. - Electricity: cost of service study commissioned (expected completion early-2018); tariff changes to non-mining consumers: 50 percent increase on May 15 and 16 percent increase on September 1 (two steps); effective average tariff increase ~48 percent due to lifeline threshold increase from 100 kwh to 200 kwh; mining average tariff increased from 50 percent of national income; bottom 50 percent accounted for <10 percent. - Gini coefficient: 2010: 0.65; 2015: 0.69. - Poverty rate: 2015 overall 54 percent; rural 76 percent; urban 24 percent. - Authorities’ medium-term development strategy: 7NDP (2017–2022) prioritizes agriculture and mining value addition, tourism, livestock and fisheries, energy and transport infrastructure, and human capital (healthcare and education). ### Capacity development, data, and Fund engagement - Fund capacity development priorities (FY2018): - Revenue and customs administration, PFM, financial supervision and regulation, monetary policy and operations, compilation and dissemination of statistics. - Planned TA and lending: DPOs (2 operations of $100 million); TA on PFM reform, e-procurement, financial inclusion, foreign operations, and statistics. - Data and statistics: - Data provision broadly adequate for surveillance but with shortcomings, especially fiscal reporting. - CSO now publishes quarterly GDP using VAT and business tax data; need for MoU between CSO and ZRA and new GDP benchmark within five years. - CPI weights based on 2002 household expenditure data; urgent household expenditure survey needed. - GFS coverage limited to budgetary central government; last GFSM 2001 submission fiscal year 2011; GFS TA mission planned after October 2017. - DSA and debt-related analytics: - DSA principal finding: Zambia at high risk of debt distress (downgraded from moderate in 2015); PV of PPG external debt breaches 40 percent threshold; debt-service-to-revenue temporarily breaches 20 percent in 2022 and 2024. - Recommended focus: strong fiscal consolidation, increase domestic revenue, strengthen public investment management, contain contingent liabilities, adopt appropriate debt management strategy. ### Staff appraisal and consolidated policy recommendations - Staff assessment: - Unbalanced response to 2015–16 shocks exacerbated impacts: tight monetary policy stabilized exchange rate and slowed inflation but contributed to financial system stress. - Recent easing of monetary policy appropriate but unsustainable if fiscal policy remains lax. - Economy recovering due to good rains and rising copper prices; authorities should use favorable environment to reduce fiscal deficit and build reserves. - Core policy recommendations (preserve wording and numeric targets where provided): - Achieve fiscal consolidation consistent with moving risk of debt distress from high to moderate: restrain non-concessional borrowing and implement measures to achieve the recommended primary balance path (4 percent of GDP adjustment in 2017; +1 percent over next two years). - Boost domestic revenue mobilization (VAT and CIT reforms, clean taxpayer database, strengthen audits). - Reign in recurrent spending and prioritize public investment considering absorptive capacity. - Strengthen commitment control and PFM (roll out IFMIS; Treasury Single Account). - Strengthen BoZ operational framework: formalize policy rate corridor, reinforce OMOs, seek formal operational independence, continue SRR reduction. - Limit FX intervention to smoothing volatility and opportunistic reserve rebuilding; reform IFEM to allow spreads to widen when liquidity is low. - Strengthen financial supervision, resolution regime, and implement FSAP recommendations before introducing deposit insurance; improve ELA safeguards. - Improve business climate and policy consistency, particularly in energy and agriculture; "speak with one voice" on key objectives and policies. *Source: IMF staff report — “1. Recent Developments” and associated annexes (cr17327).* ### 1. Recent Developments _________________________________________________________________________ 25 ### 1. Recent Developments ### Context: shocks, policies, and vulnerabilities - Near-crisis in 2015Q4 and most of 2016 driven by exogenous shocks and lax fiscal policy: low copper prices, poor rainfall, contraction in agriculture output in 2015, sharp drop in hydropower generation, severe power rationing, and government spending significantly above budget with underperforming revenues. - Monetary policy tightened in 2015Q4 to stabilize the exchange rate and lower inflation; liquidity crunch, government arrears, and subdued activity led to financial stress: NPLs rose sharply, credit growth plunged, BoZ took over a small bank and intervened in three nonbanks in late 2016. - Public debt trajectory: - Increased from 36 percent of GDP at end-2014 to 61 percent at end-2016. - External debt accounts for 60 percent of public debt. - Government securities account for about half of domestic debt; commercial banks and foreign investors hold about 40 percent and 17 percent of the total, respectively. - Government fiscal reform actions: - Reduced regressive subsidies in the energy sector. - Implementing reforms to enhance efficiency and focus of subsidies in the agriculture sector. - But pace and scale of contracting new loans for capital projects—sometimes before appraisals are ready—are inconsistent with stated debt sustainability objectives. - Near-term outlook drivers: - Good rains and rising copper price expected to boost real GDP growth to 4 percent in 2017 from 3.4 percent in 2016. - Inflation projected to remain within authorities’ target range of 6-8 percent. - Copper price increase cited: from about US$5,700 per metric ton in December 2016 to nearly US$6,500 in August 2017. - Copper accounts for about 70 percent of Zambia’s export earnings. - Political risks: - Heightened tensions following August 2016 elections; treason charge and jailing of UPND leader in April 2017, released in August 2017; series of arson attacks led President Lungu to declare a situation on July 5, 2017 that could degenerate into a state of emergency. - IMF engagement: - Discussions on a possible Fund-supported program; further progress contingent on greater clarity on fiscal policy commitments and aligning government borrowing plans with public debt sustainability. - Implementation of past IMF advice mixed: fiscal advice not followed; some structural fiscal reforms made; weaknesses in commitment control persist; BoZ maintained tight monetary policy in 2015 and most of 2016; BoZ has been opportunistically purchasing foreign exchange from the market. ### Recent economic developments and near-term outlook - Growth: - Real GDP growth averaged 7 percent during 2005-2014, dipped to 2.9 percent in 2015, picked up to 3.4 percent in 2016 (driven mainly by mining activities and private construction), and expected to reach 4 percent in 2017 due to a bumper harvest and increased hydropower generation. - Inflation: - 7 percent in mid-2015; rose to 22.9 percent in February 2016 after kwacha depreciation from K6.34/US$ (Dec 2014 monthly average) to K12.18/US$ (Nov 2015). - Declined to 18.9 percent in September 2016, then to 6.3 percent in August 2017; projected to remain within target 6-8 percent. - Monetary policy responses (Text Table 1 highlights): - Exchange rate movements (+ depreciation): 2014: 15.8%; 2015: 69.1%; 2016: -9.9%; Jan-Aug. 2017: -7.6%. - FOREX interventions (+ sales, million US$): 2014: 698.5; 2015: 759.5; 2016: -340.2; Jan-Aug. 2017: -347.9. - BoZ policy rate: 2014: 9.75% → 12.5%; 2015: 12.5% → 15.5%; 2016: No Change; Jan-Aug. 2017: 15.5% → 11.0%. - Reserve requirements: 2014: 8.0% → 14.0%; 2015: 14.0% → 18.0%; 2016: No Change; Jan-Aug. 2017: 18.0% → 9.5%. - Overnight Lending Facility (premium over the policy rate): 2014: 250bps → 1000bps; 2015: No Change; 2016: No Change; Jan-Aug. 2017: 1000bps → 600bps. - BoZ mopped up liquidity in 2015 by forced sales of foreign exchange; since 2016 BoZ has made net purchases to rebuild reserves. - Fiscal developments: - Fiscal imbalances very high: - 2015 cash-basis fiscal deficit reached 9.3 percent of GDP vs budgeted 4.6 percent; commitment basis deficit 12.1 percent of GDP (due to net accumulation of arrears and VAT refund claim clearances totaling 2.8 percent of GDP). - 2016 cash-basis fiscal deficit 5.8 percent of GDP (budgeted 3.3 percent); commitment basis deficit reached 8.6 percent of GDP. - Financing constraints in 2016 led government to turn to BoZ, which provided financing beyond the legal limit. - 2017 budget targeted a cash deficit of 7 percent of GDP (5.5 percent of GDP on a commitment basis); authorities introduced a tax amnesty in April expected to yield 1.2 percent of GDP (half collected in 2017, half in 2018). - Staff projects a cash deficit around 8 percent of GDP in 2017 due to unbudgeted and under-budgeted lines. - Public debt and borrowing: - Public debt tripled from 21 percent of GDP at end-2011 to 60.5 percent of GDP at end-2016. - External debt quadrupled to US$8 billion (36.5 percent of GDP) at end-2016, including US$3 billion in Eurobonds (compared to US$1.9 billion, 8 percent of GDP, at end-2011). - Fast pace of new debt contracted; Text Table 2 reports value of new loans contracted (US$ millions) by year and cumulative values (preserve table existence and figures in source). - BoZ Act limits direct lending to government to equivalent of 15 percent of previous year’s domestic revenue. - Financial sector stress: - Very tight liquidity in 2016 drove funding costs and lending rates above 40 percent; NPLs rose from 6 percent of outstanding loans at end-2014 to 12 percent in July 2017 (Table 7). - Heterogeneous NPL increases across banks; a handful of banks account for most of system increase. - Sharp reduction in credit growth; average annual real lending rate ~20 percent for banking system. - BoZ interventions in 2016: takeover of a small bank and intervention in three nonbanks; other small banks and several non-bank financial institutions face challenging conditions. - External sector: - Current account balance switched from a 2.1 percent of GDP surplus in 2014 to deficits of 3.9 percent of GDP in 2015 and 4.4 percent of GDP in 2016 due to lower copper export earnings and higher interest payments. - Despite large currency depreciation in late-2015, imports fell by only 12 percent in 2016 due to higher imports of fuel and electricity. - Gross international reserves: US$3.1 billion (end-2014), US$3.0 billion (end-2015), US$2.4 billion (end-2016) — equating to 4.2, 4.5, and 3.1 months of import cover respectively (Text Table 3 projections also present reserve levels and months of prospective imports). - Spreads on Zambia’s Eurobonds narrowed significantly in 2016Q4 and early 2017; movement also observed in other sovereigns indicating common market factors. ### Medium-term outlook and risks - Outlook contingent on policy actions to restore stability, increase productivity, and enhance competitiveness. - Two macroeconomic scenarios presented (Text Tables 3 and 4): - Baseline / current policies scenario: - Assumes more gradual fiscal consolidation than in 2017 budget and larger public investment plan funded by external loans. - Additional domestic borrowing needs may arise to cover government contributions to externally funded projects. - Projected outcomes: lower growth than adjustment scenario due to crowding out, slower clearance of arrears, and lower non-mining private investment; somewhat higher medium-term inflation due to delayed fiscal consolidation and larger depreciation pressures. - Adjustment policies scenario: - Assumes authorities prioritize infrastructure projects in line with absorptive capacity and the need to put public debt indicators on a downward path. - Implies stronger fiscal consolidation and better debt trajectory relative to baseline. - Select macro projections and indicators (as presented in Text Table 3 and Text Table 4; numeric values preserved exactly): - Real GDP growth (%): 2014: 4.7; 2015: 2.9; 2016: 3.4; 2017: 4.0; subsequent annual projections reported in tables. - Inflation (y-o-y, %, end-period): 2014: 7.9; 2015: 21.1; 2016: 7.5; 2017: 5.8; authorities’ target range: 6-8 percent. - Overall balance (cash basis, % of GDP): 2014: -5.7; 2015: -9.3; 2016: -5.8; 2017 (budget): -7.0; staff projects around -8.0. - Overall balance (commitment basis, % of GDP): 2014: -9.8; 2015: -12.1; 2016: -8.6; projections provided for 2017–2022 under baseline and adjustment scenarios. - External current account balance (% of GDP): 2014: 2.1; 2015: -3.9; 2016: -4.4; projected path varies by scenario. - Gross international reserves (US$ billions): 2014: 3.1; 2015: 3.0; 2016: 2.4; projected through 2022 in Text Table 3. - Public debt (% of GDP): 2014: 35.6; 2015: 61.4; 2016: 60.5; projected trajectories differ by scenario. - Copper price (US$/tonne) values included in Text Table 3 (examples: 2014: 6,863; 2015: 5,510; 2016: 4,868; projections for subsequent years provided). - Oil price (US$/barrel) entries provided in Text Table 3 (examples: 2014: 96; 2015: 51; 2016: 43; projections provided). - Key risks: - Continued fiscal slippage and accumulation of arrears. - Exchange rate and rollover risks given high external debt share and foreign investor participation. - Political tensions and domestic security incidents. - Financial sector vulnerability from high NPLs, high lending rates, and stressed small banks and nonbanks. *Source: IMF staff report — “1. Recent Developments” (cr17327).* ### 22. The external position improves at a more gradual pace under the current policies ### 22. The external position improves at a more gradual pace under the current policies ### External position and reserves - Exports earnings are projected to recover driven by the pick-up in copper prices. - Lower electricity imports partially offset higher imports associated with public sector capital projects. - Foreign exchange reserves are projected to increase gradually to 3-3½ months of import cover under both scenarios. - The gradual reserve rebuilding "underscores the need for structural reforms to support export growth and diversification." ### Debt dynamics and LIC-DSA assessment - Zambia is assessed to be at high risk of debt distress based on a full LIC-DSA prepared by Fund and World Bank staff. - Under the “current policies” scenario: - The present value (PV) of external debt-to-GDP ratio breaches its threshold (40 percent) during 2019-23. - The PV of debt service to revenue ratio breaches its threshold (20 percent) in 2022 and 2024 when Eurobonds mature. - Sensitivity analyses indicate that all indicators breach relevant thresholds under shocks to export earnings, growth, and the exchange rate. - Under the “adjustment” scenario: - Debt dynamics improve substantially. - The PV of external debt-to-GDP remains below the 40 percent threshold throughout the projection horizon. - The debt-service-to-revenue ratio temporarily breaches the threshold in years when Eurobonds mature. - The DSA suggests Zambia would return to a moderate risk rating if authorities: - Restrain non-concessional borrowing. - Implement measures to achieve the fiscal consolidation path consistent with the adjustment policies scenario. ### Total public debt and vulnerabilities - Analysis of total public debt indicates heightened vulnerabilities under current policies. - Total public debt is projected to exceed the benchmark level (56 percent of GDP) associated with heightened vulnerabilities for medium performers (the relevant group for Zambia) over an extended period. - Under the adjustment scenario (characterized by improving primary balances), public debt declines steadily after 2018, falling below the benchmark level from 2019. ### Risks to the medium-term outlook - Domestic risks: - Delayed fiscal adjustment, policy inconsistencies, and rising political tensions. - Delayed fiscal adjustment increases the risks of an unsustainable debt path and capital flow reversal. - Sharply rising domestic debt would crowd out credit to the private sector, harming growth. - Policy inconsistencies and rising political tension deter investment and growth. - External and exogenous risks: - Volatile global financial conditions. - Fluctuations in the world copper price. - Droughts. - Given current large fiscal deficits and modest international reserves, materialization of these risks could trigger capital outflows and result in much slower growth and higher inflation than under the current policies scenario. ### A. Achieving Fiscal Fitness — overarching guidance - "We cannot spend what we do not have. We cannot borrow beyond our ability to repay." (2017 Budget Speech) - Improved fiscal performance is needed to put public finances and debt on a sustainable path. - Achieving “fiscal fitness” requires: - Boosting domestic revenue mobilization. - Reining in recurrent spending. - Effective prioritization of public investment considering absorptive capacity and the objective of lowering the risk of debt distress from high to moderate. ### A. Fiscal stance and primary balance targets - Staff advised anchoring fiscal policies on the primary balance on a commitment basis. - Staff recommendation consistent with authorities’ objective of reducing Zambia’s risk of debt distress from high to moderate: - Target a 4 percent of GDP adjustment in 2017. - Followed by a 1 percent of GDP improvement over the next two years. - Resulting outcome: - A primary surplus of about 0.7 percent of GDP by 2019 under the recommended path. - Contrast: a 2.5 percent primary deficit projected under the current policies scenario. ### A. Revenue mobilization — issues and priorities - Zambia’s VAT efficiency and corporate income tax (CIT) productivity are "well below SADC comparators" due to: - Widespread tax incentives. - A multitude of income tax rates. - Extension of zero-rating to non-exportable goods and broad exemptions. - Staff urged authorities to: - Fully implement measures already approved by parliament (including on land titling). - Speed up introduction of fiscal devices to improve monitoring of tax compliance. - Prioritize cleaning the taxpayer database, strengthening tax-auditing capacity, and enhancing monitoring of high income taxpayers. - Authorities’ actions and views: - Appointed VAT withholding agents in mining and construction sectors. - Noted substantive progress on measures that would start yielding results in the second half of 2017. - Launched a tax amnesty (April 20-September 15) to partially offset revenue shortfall and reported it is yielding good results. ### A. Expenditure measures — fuel, electricity, agriculture - Fuel: - In October 2016, fuel prices were adjusted to full-cost recovery levels. - ERB lowered pump prices in January and August 2017 in line with declining world oil prices and kwacha appreciation. - Staff urged continued adherence to cost-recovery to avoid reemergence of fuel subsidies. - Electricity: - A cost of service study commissioned; expected completion in early-2018 to guide cost-reflective tariffs. - Tariff changes to non-mining consumers: a 50 percent increase on May 15, and a 16 percent increase on September 1 (two steps). - Staff estimates effective average tariff increase at about 48 percent, reflecting the increase in the lifeline threshold from 100 kwh to 200 kwh. - For mining companies, average tariff increased from less than US$0.06/kwh to US$0.093/kwh, effective (retroactively) from January 2017. - Staff estimates suggest with current adjustments there should no longer be a need for the government budget to subsidize electricity tariffs. - Staff concern: doubling the lifeline threshold may be poorly targeted; most poor are not connected to the grid. - Incidence analysis indicates that 84 percent of electricity subsidies accrue to the richest 20 percent households. - Agriculture: - Farmer Input Support Program (FISP) migrating fully to an E-voucher system to reduce operational costs, broaden inputs, and rationalize beneficiaries. - Food Reserve Agency (FRA) maize purchases limited to 500,000 metric tons from the 2017 marketing season, aligning with strategic food reserves and encouraging private sector participation. - Authorities’ views: - Committed to cost-plus model for fuel prices. - Expect cost-of-service study to guide electricity tariffs. - Preparations on track for full migration to e-voucher system in the 2017/18 season. ### A. Arrears clearance and PFM improvements - Arrears: - Staff highlighted negative economic impacts of government arrears (slower economic activity, rise in banking NPLs, taxpayers running arrears). - Government plan to reduce the stock of arrears by 2 percent of GDP in 2017. - Preliminary information: as of end-June 2017, arrears totaling 1.1 percent of GDP had been cleared. - VAT refund backlog: K2.9 billion as of end-April 2017 compared to K6.3 billion as of end-February 2015. - Authorities plan to clear the stock of arrears over the next three years. - Public Financial Management: - Steps to strengthen commitment control and legal framework: Planning and Budgeting Bill, amendments to Public Finance and Public Procurement Acts. - Staff urged strengthening public debt management capacity and improving the public investment cycle: - Prioritize projects in line with developmental needs and debt sustainability. - Require feasibility studies before including public projects in the budget. - Authorities’ plans: - Roll out IFMIS to all central government institutions in 2017. - Fully roll out the Treasury Single Account to improve liquidity management. - Draw on Public Investment Management Assessment (PIMA) findings to strengthen planning and execution of public infrastructure projects, align projects with the 7NDP and the ESGP, and enhance procurement and execution processes. ### B. Enhancing the Effectiveness of Monetary Policy - Background: - BoZ introduced a new Monetary Policy Framework (MPF) in April 2012 with the Policy Rate (PR) as the principal instrument. - During extended periods in 2014-16, the interbank overnight rate (IOR) deviated substantially from the PR; BoZ relied on quantitative and administrative measures rather than PR hikes. - The move away from using the PR blurred monetary policy signals and undercut credibility. - Recent measures (lifting lending rate caps, improved liquidity management within a narrow PR corridor) have strengthened the MPF. - Staff advice to strengthen the MPF: - Grant BoZ formal operational independence to pursue price stability as its primary mandate. - Strengthen open market operations as the main instrument of monetary policy. - Formalize the policy rate corridor by introducing deposit and lending standing facilities to keep the IOR inside the policy corridor. - Separate liquidity management from access to standing liquidity facilities to banks. - Continue reducing SRRs as part of move to market- and price-based instruments; unremunerated SRR are an implicit tax increasing cost of credit and hindering financial development. - Authorities’ views and actions: - BoZ acknowledged need to strengthen MPF, reduced the width of the PR corridor, increased use of OMOs, and will seek technical assistance to review formalizing the policy corridor. ### C. Exchange rate policy and foreign exchange market - IFEM functioning and pressures: - IFEM came under enormous pressure in 2015 due to significantly reduced FX inflows. - BoZ’s strong reaction to 2015 kwacha depreciation included forcing banks to buy large amounts of FX and close monitoring of transactions, producing lasting effects on IFEM functioning. - Since 2016, the average volume of transactions in IFEM plunged to 15 percent of the volume observed in 2014 and 2015. - The FX retail market appears to function normally; no evidence of FX shortages, long waiting times for current international transactions, or emergence of a parallel market. - Staff advice: - Limit intervention in FX market to smoothing excessive volatility and opportunistically rebuilding reserves. - Let market forces determine the bid-offer spread in IFEM so spreads and volumes can adapt flexibly when needed. - Authorities’ views and actions: - BoZ committed to a flexible exchange rate policy, with interventions aimed at smoothing volatility and building reserves opportunistically. - BoZ has used recent kwacha appreciation to rebuild reserves. - BoZ and the Bankers Association of Zambia are collaborating to review the IFEM framework to make it more resilient to liquidity shocks. ### D. Safeguarding financial stability - Financial soundness: - Despite deterioration in asset quality and declining profitability, reported indicators suggest banks remain well capitalized overall; several small banks are under pressure. - FSAP stress tests: system resilient to credit stress but vulnerable to moderate liquidity stress. - Supervision and crisis management weaknesses: - Supervision not fully effective; weak crisis management framework and lack of resolution funding mechanisms led to overuse of forbearance. - Out-of-date legal and regulatory framework, data limitations, and under-resourced supervisor undermined effectiveness. - Inadequate supervisory resources led to gaps in onsite inspections and insufficient analytical content in offsite reports. - Troubled banks accessed emergency liquidity assistance (ELA), reflecting weak limitations and safeguards on its use. - Main FSAP recommendations (Annex III): - Upgrade banking, BoZ and other financial sector laws to improve licensing; risk-based consolidated supervision; intervention; crisis management and resolution powers across the financial sector. - Hire more supervisors and complete onsite inspections of all banks over the next 12–18 months. - Strengthen ELA regulations to establish adequate statutory safeguards to prevent BoZ from providing solvency support. - Start work on a deposit protection scheme that meets international norms; to be introduced when necessary preconditions (including an effective resolution regime) are in place. - Authorities’ responses: - BFSA has been signed by the President; BoZ is drafting regulations to operationalize it. - BoZ Act is being revised; BoZ will seek Fund staff comments before sending to Parliament. - BoZ is hiring and training new supervisors and has a schedule for full onsite examination of all banks by end-2018. - BoZ plans to implement a deposit insurance scheme with Fund technical assistance. ### E. External sector assessment - The Fund’s EBA-lite methodologies suggest Zambia’s external position is broadly consistent with fundamentals. - Exchange rate and REER developments: - The kwacha lost half of its value against the U.S. dollar in 2015. - Due to a large inflation differential with trade partners, the depreciation in the real effective exchange rate (REER) has been considerably less than in the nominal effective exchange rate. - The REER has appreciated thus far in 2017 but does not seem out of line with the recent increase in the copper price. *Source: IMF staff report (Zambia) as provided in the supplied content.* ### 51. According to the Fund’s cost-benefit approach, Zambia’s international reserves are ### cr17327 - 51. According to the Fund’s cost-benefit approach, Zambia’s international reserves are ### External position and international reserves - International reserves are assessed to be below adequate levels under the Fund’s cost-benefit approach. - International reserves took a hit following the issuance of a US$1.25 billion Eurobond in 2015, the third issuance in a 4-year period, and are assessed as below an adequate level as at end-2016. - Staff advice: build reserves to a level of at least 4-4½ months of imports over the medium-term. ### Economic diversification and competitiveness - The need for diversification of the economy and export base remains a serious challenge. - Non-price indicators show significant competitiveness weakness. - Diversification requires improvement in the business climate to boost competitiveness and attract investment beyond copper mining. - World Bank Doing Business ranking deteriorated from 83 (out of 189) in 2014 to 98 (out of 190) in 2017. - Areas needing improvement: electricity supply, trading across borders, registering property, and policy consistency. - Government needs to enhance budget spending efficiency to support investment in human capital and physical infrastructure. ### Measures to improve business climate and sectoral policy - Authorities have initiated measures including passage of a law on the use of moveable collateral to improve access to finance. - Policy consistency in agriculture (e.g., avoiding export bans of maize and allowing prices to reflect market conditions) could attract private investments to serve surrounding countries with maize deficits. - Move toward cost-reflective electricity tariffs intended to attract private investment and boost domestic power supply. - Enhancing transparency in petroleum product procurement and pricing, and improving efficiency to cut the underlying cost of supplying fuels would enhance competitiveness of the Zambia’s economy. - Increased consultation with stakeholders on a stable mining tax regime is expected to boost investment in the sector and promote value addition. ### Authorities’ views on external balance and infrastructure - Authorities broadly agreed with staff’s assessment of the external balance and the exchange rate. - Government priority: improving physical infrastructure such as in electricity, a noted bottleneck to growth. - Recent move toward cost-reflective electricity tariffs aimed at attracting private investment. - Government plans to withdraw from procurement of refined petroleum products to reduce fiscal risks and improve efficiency and reliability of supply. ### Growth performance and sectoral patterns - Zambia recorded strong average annual growth at an annual average of 6.7 percent during 2001-15, higher than the Sub-Saharan Africa average (5.5 percent). - The mining sector grew faster than other major sectors. - Agriculture, which employs the most people, contracted by an annual average of about 1 percent. ### Income distribution and poverty - Income distribution is highly skewed: - The 2015 Living Conditions Monitoring Survey (LCMS) showed the top 10 percent of households accounted for more than half of total national income. - The bottom 50 percent of households accounted for less than 10 percent of national income. - Gini coefficient estimated to have worsened from 0.65 in 2010 to 0.69 in 2015. - LCMS reported an overall poverty rate of 54 percent in 2015, with rural poverty at 76 percent and urban poverty at 24 percent. ### Policies to achieve more inclusive growth - Authorities should focus on: stable policies, improving the investment climate, promoting productivity growth, increasing financial inclusion, and strengthening human capital. - Periodic trade bans (e.g., on maize exports) and market distortions caused by FRA pricing and procurement policies have discouraged private investment in commercial maize production. - Government preparing a National Financial Inclusion Strategy to address obstacles to accessing finance, especially for small and medium-size enterprises. - World Bank providing training to financial institutions on the use of movable collateral for credit decision making. - Investments in education and health are key for preparing the labor force for productive employment. - Given limited resources, increasing the efficiency of public spending would help create space for human capital development. ### Authorities’ medium-term development strategy (7NDP, 2017–2022) - 7NDP strategy for promoting inclusive growth over the medium-term (2017–2022). - Identifies agriculture and mining as having high potential for value addition to boost industrialization and job creation. - Views tourism as having high potential to generate jobs and boost incomes. - Measures to promote livestock and fisheries to diversify agriculture; full migration of FISP to the e-voucher system to diversify agriculture beyond maize. - Aim to diversify mining beyond copper by promoting gemstones and industrial minerals. - To address infrastructure bottlenecks, 7NDP prioritizes improvements in energy supply and transportation infrastructure. - Human capital measures include strengthening the healthcare system through capacity development of the health workforce, and increasing access to quality education through required infrastructure and teacher training. ### Relations with the Fund and capacity development - Data provision has some shortcomings but is broadly adequate for surveillance purposes; staff encourages further progress in dissemination under the e-GDDS. - Fund provides capacity development through targeted technical assistance and training (Annex V). - Current assistance priorities: enhance domestic revenue mobilization (revenue and customs administration); strengthen public financial management (budget controls and execution); strengthen financial supervision; enhance effectiveness of monetary policy and operations; improve compilation and dissemination of statistics. ### Staff appraisal and policy recommendations - An unbalanced response to the 2015-16 shocks exacerbated adverse impacts: tight monetary policy stabilized exchange rate and slowed inflation but contributed to elevated stress in the financial system. - Recent easing of monetary policy appropriate but cannot be sustained if fiscal policy remains lax. - Economy beginning to recover due to good rains and rising copper prices; authorities should use favorable environment to reduce the fiscal deficit and build international reserves. - Government has initiated bold fiscal measures (phasing out energy subsidies; implementing a more cost-effective agriculture subsidy); full implementation would address key budget pressures. However, rapid contracting of new loans for infrastructure undermines fiscal and debt sustainability objectives. - Public debt increasing at an unsustainable pace, crowding out credit to the private sector and increasing vulnerability to capital outflows; staff recommends restraining spending commitments and redoubling efforts to mobilize domestic revenues. - BoZ’s unwinding of quantitative and administrative measures and re-commitment to interest rates and market-based mechanisms is welcome; staff encourages steadfast implementation of the new MPF when faced with challenging macroeconomic situations to improve policy response and dampen volatility. - Staff urges BoZ to reform the IFEM during the period of relative calm; at minimum, adjust regulations to allow widening spreads when liquidity is low and volatility is unusually high. - Staff welcomes BoZ’s response to FSAP recommendations (strengthening supervision capacity and crisis preparedness); encourages strengthening licensing, supervision and resolution regime and ensuring prior conditions are met before introducing a deposit insurance scheme. - Important pending issue: revamping the BoZ Act to give it more operational autonomy, improve governance practices, and enhance transparency and accountability. - Staff urges authorities to address policy uncertainties clouding the investment climate, including mixed signals on the role of the private sector in the energy and agriculture sectors, and to "speak with one voice" on key objectives and policies. *Source: IMF staff report (cr17327).* ### 69. Staff recommends that the next Article IV consultation be held on the standard ### cr17327 - 69. Staff recommends that the next Article IV consultation be held on the standard ### Recommendation - Staff recommends that the next Article IV consultation be held on the standard 12-month cycle. ### Recent economic developments - "Growth has slowed down sharply in recent years..." - "...driven b y agriculture and wholesale and retail." - "The kwacha depreciated sharply in late 2015, which drove up inflation." - "The appreciation of the kwacha in the recent months has helped bring inflation down." - Consumer price index (2009=100) and Dollar Exchange Rate (ZMW/USD) shown for January 2011–July 2017 (Figure 1). ### Fiscal developments and public finances - "Fiscal imbalances driven by static revenues and spending overruns." (Figure 2) - "The wage bill and public investment dominate government spending." - "The 2016-17 budgets mainly financed with domestic resources." - "Public debt has risen rapidly pushed by external debt and the accumulation of domestic arrears." - "In 2016, tax revenue affected by a slower economy while non-tax revenue was boosted by a one-off receipt from BoZ." - "Accumulation of domestic arrears and backlog of VAT refunds are significant." - Table highlights (selected indicators as presented): - Revenue (percent of GDP, baseline): 18.9; 18.8; 20.7; 18.2; 19.4; 17.3; 18.4; 18.4; 18.9; 19.4; 19.6; 17.3; 18.3; 18.4; 19.0; 19.5; 19.5. - Expenditure (percent of GDP, baseline): 24.3; 27.6; 24.0; 23.8; 26.3; 25.6; 25.5; 24.7; 23.9; 24.6; 24.2; 22.2; 22.2; 21.8; 21.5. - Net lending/borrowing (cash basis, percent of GDP): -5.7; -9.3; -5.8; -8.0; -7.8; -7.2; -6.5; -5.3; -4.3; -7.3; -5.9; -3.9; -3.1; -2.3; -2.0. - Stock of domestic arrears (memorandum): values in Table 2 show substantial arrears levels (e.g., "Stock of domestic arrears 5,042; 10,148; ... 17,317; ..."). ### External sector and external balances - "Exports fallen due to lower copper prices." (Figure 3) - "Non-oil imports declined partly reflecting the kwacha depreciation and reduced economic activities." - "The current account has been in deficit since 2015 largely reflecting reduced exports." - "FDI inflows are lower..." - "Other outflows remain sizeable." - "Official reserves import coverage has declined." - Balance of payments highlights (selected figures as presented): - Current account (millions of U.S. dollars, baseline series): 571; -831; -934; -918; -776; -416; -6; -4; -8; -137; -761; -470; -562; 333; 374; 34. - Gross international reserves (total, millions of U.S. dollars): 3,078; 2,978; 2,366; 2,180; 2,629; 2,992; 3,232; 3,705; 4,295; 2,365; 2,773; 2,930; 3,187; 3,747; 4,447. ### Monetary and financial developments - Policy rate and interbank rates, average lending and deposit rates, government T-bill and bond yields, exchange rate (ZMW/USD), NEER and REER indices, and international reserves series are presented in Figure 4. - "Spot Purchases (Interbank) and Spot Purchases (Others) — Forex Purchase (14-day average, millions of US$)" series shown for January 2011–July 2017 (Figure 4). - Monetary survey highlights (selected indicators as presented in Table 4): - Broad money (M3) (annual percent change): 12.6; 35.2; -5.7; 14.0; 27.0; 20.6; 15.4; 15.6; 15.1; 14.1; 23.1; 12.9; 13.5; 14.0; 12.6. - Reserve money (end-of-period, annual percent change): 31.1; 22.2; 12.8; 5.9; 23.4; 21.3; 16.1; 15.1; 15.5; 6.0; 19.6; 13.6; 14.2; 13.6; 13.1. - Credit to the private sector (annual percent change): 26.4; 29.3; -9.4; 13.0; 12.9; 14.4; 14.7; 14.2; 14.8; 12.2; 14.7; 14.4; 14.0; 13.7; 13.5. - Gross foreign exchange reserves of the Bank of Zambia (millions of U.S. dollars): 3,078; 2,978; 2,366; 2,180; 2,629; 2,992; 3,232; 3,705; 4,295; 2,365; 2,773; 2,930; 3,187; 3,747; 4,447. ### Sovereign yields and risk spreads - Yields to maturity for Zambia Eurobonds (2012, 2014, 2015 Eurobonds) presented in Figure 5. - Spreads over U.S. Treasury for selected countries (including Zambia, Ghana, Senegal, South Africa, Nigeria, Cote d'Ivoire, Mongolia) shown (basis points) for January 2011–July 2017. ### Key macroeconomic indicators and projections (Table 1 highlights) - GDP growth at constant prices (selected series as presented): 4.7; 2.9; 3.4; 4.0; 4.5; 4.5; 4.5; 4.5; 4.5; 4.0; 4.5; 5.0; 5.0; 5.5; 5.5. - Mining and Non-mining growth series shown separately in Table 1. - Consumer prices (average and end of period) series provided (see Table 1 for full series). - Total central government debt, gross (end-period, percent of GDP): 35.6; 61.4; 60.5; 55.6; 60.0; 62.4; 63.3; 64.0; 63.1; 54.9; 56.1; 54.7; 53.1; 51.4; 49.1 (Table 1). ### Fiscal operations (central government) — summary points (Tables 2 and 3) - 2017 preliminary (millions of Kwacha): Revenue 31,564; Revenue excluding grants 30,297; Tax 25,837; Other revenue including mineral royalties 4,460; Grants 1,267. - 2017 preliminary expenditure (millions of Kwacha): Expenditure 40,640; Expense 31,770; Compensation of employees 15,750; Interest 3,711; Subsidies 3,308; Net acquisition of nonfinancial assets 8,870. - Net lending/borrowing (overall balance, cash basis, 2017 prelim.): -9,530 (millions of Kwacha). - Net domestic financing (memorandum): 1,911 (millions of Kwacha) in 2017 preliminary. - Backlog of VAT refunds (stock, memorandum): 4,706.0 (millions of Kwacha) in 2014; 4,310.0 in 2015; 3,224 in 2016; 3,224 in 2017 prelim.; 2,096 projected. ### Balance of payments and external financing (Tables 5 and 6) - Exports, f.o.b. (millions of U.S. dollars): 10,220 (2014); 7,362 (2015); 6,505 (2016); 7,659 (2017 prelim.); projections provided for 2018–22. - Of which: copper exports series shown (e.g., 7,619; 5,234; 4,399; 5,422; ...). - Imports, f.o.b. and oil import series are presented (see Tables 5 and 6). - Current account (percent of GDP) series: 2.1; -3.9; -4.4; -3.6; -2.8; -1.5; 0.0; -0.2; -0.4; -3.0; -1.7; -0.2; 0.8; 1.0; 1.2 (Table 6). ### Financial soundness indicators (Table 7, selected) - Regulatory capital to risk-weighted assets (percent): 18.6 (2008); 22.3 (2009); 22.1 (2010); 19.2 (2011); 21.3 (2012); 26.8 (2013); 27.0 (2014); 21.2 (2015); 26.2 (2016); 27.8 (2017 July). - Past due advances (NPL) to total advances (percent): 7.2; 12.6; 14.8; 10.4; 8.1; 7.0; 6.1; 7.3; 9.7; 12.1 (2008–2017 series). - Return on average assets and return on equity series provided (see Table 7). *International Monetary Fund — Zambia country chapter as presented in the supplied content.* ### Annex I. Main Recommendations of the 2015 Article IV ### Annex I. Main Recommendations of the 2015 Article IV Consultation ### Fiscal policy and public financial management - Recommendation: Reduce the fiscal deficit on a commitment basis to less than 6 percent of GDP in 2015 and to 3 percent over the medium term. - Recommendation: Fully roll out IFMIS, enhance commitment controls, and implement the Treasury Single Account (TSA), to strengthen transparency and accountability and reduce the risk of accumulating arrears. - Finding: Fuel and electricity subsidies and huge spending overruns on programs to support maize production compounded by revenue underperformance widened the deficit in 2015, on a commitment basis, to 12.1 percent of GDP and remained elevated at 8.6 percent of GDP in 2016. - Finding: Some progress has been made in implementing the TSA and rolling out the IFMIS. Weak expenditure controls led to significant accumulation of expenditure arrears. ### Monetary policy - Recommendation: Maintain the tight monetary policy stance and rebuild reserves buffers. - Finding: BoZ maintained a tight monetary policy during most of 2015-16. Reserves declined, largely reflecting BoZ’s intervention in the market in 2015. - Finding: Since mid-2016, BoZ has opportunistically purchased foreign exchange in the market to build reserves. ### Financial sector policy - Recommendation: Remove lending rate ceilings as part of the effort to improve access to financial services. Strengthen banking supervision. - Finding: BoZ removed the interest rate caps in November 2015. - Finding: Individual financial inclusion has increased but SMEs’ access to finance remains low. - Finding: The passage of a law on the use of moveable collateral in 2016 is expected to support access to finance. - Finding: The 2016 FSAP mission found that financial supervision was not fully effective. ### Inclusive growth and competitiveness - Recommendation: Reduce policy uncertainty to promote inclusive job-creating growth. - Finding: Frequent changes in regulations, periodic bans on maize exports, and payment arrears to suppliers and contractors are clouding the business climate. ### Key statistics (selected) - Fiscal deficit on a commitment basis: 12.1 percent of GDP in 2015; 8.6 percent of GDP in 2016. - Removal of interest rate caps: November 2015. --- ### Annex II. Risk Assessment Matrix (selected risks, likelihood, expected impact, recommendations) - Delayed fiscal adjustment/sharply rising public debt - Likelihood: High - Expected Impact: High. Increased domestic borrowing will crowd out credit to the private sector. Continued accumulation of domestic arrears will increase stress in the financial sector and slowdown growth. Increased non-concessional external borrowing will worsen debt dynamics. Delayed fiscal adjustment increases risk of sudden stop/reversal of portfolio inflows to domestic government securities market. - Recommendations: Implement fiscal consolidation measures, including: increase domestic revenues; strengthen prioritization of capital spending; rationalize subsidies by full application of cost-reflective pricing in the energy sector and improved efficiency in the Farmer Input Support Program. - Policy inconsistency - Likelihood: Medium - Expected Impact: Medium to High. Ambivalent policies (e.g., on fiscal consolidation, maize exports, and private sector role in procurement of refined petroleum products) are clouding the investment climate. - Recommendation: The government should speak with one voice on key objectives and policies. Provide space for private sector to take the lead in maize marketing and procurement of refined petroleum products. - Rising political tensions - Likelihood: Medium - Expected Impact: Medium. Rising tensions sour investor sentiments, with negative impact on investment and capital inflows. - Recommendation: Maintain the relative political stability enjoyed by Zambia over the years to sustain investor confidence in the economy. - Tighter and more volatile global financial conditions (external) - Likelihood: High - Expected Impact: Medium. Increased external commercial borrowing costs will squeeze fiscal space for priority spending. - Recommendation: Rely more on concessional external borrowing for public investment projects. Greater scrutiny of financial and economic viability of projects financed by non-concessional loans. - Volatility in global copper prices (external) - Likelihood: Medium - Expected Impact: High. Rising global copper prices is positive in the near term; but volatility in the copper prices remain a risk to export earnings and the exchange rate. - Recommendation: Maintain exchange rate flexibility and build resilience against external shocks by strengthening the efforts to diversify the economy. --- ### Annex III. FSAP Key Recommendations (selected, with timing) - Bank Supervision and Regulation - Recommendation: Upgrade the BoZ and banking Acts to grant BoZ operational independence, provide for Basel II-III standards, sole BoZ licensing powers, setting down broad supervisory principles and leaving the details for regulations. (I) - Recommendation: Complete onsite inspections of all banks and nonbanks, and conduct an asset quality review that focuses on the loan classification process. (I) - Recommendation: Introduce a regular cycle of on-site inspections on a risk basis, informed by offsite analysis. (I) - Recommendation: Implement a centralized, structured, relational database for banking supervision and stress testing. (I) - Recommendation: Urgently increase staff resources in number and expertise, in an orderly and manageable fashion. (I) - Recommendation: Introduce a consolidated supervision regime and BoZ implement the new risk-based approach to onsite supervision. (NT) - Recommendation: Introduce proactive information sharing by BoZ with home supervisors of Zambian Banks and ensure that BoZ is involved in resolution plans of parents of Zambian banks. (NT) - Recommendation: Issue risk management directives incorporating concentration and cross-border exposure limits. (NT) - Recommendation: Strengthen the AML/CFT legal framework and terrorist financing offense, in line with the FATF standards. (NT) - Crisis Preparedness and Management - Recommendation: Stipulate exceptional nature of ELA in regulatory texts and establish adequate statutory safeguards to prevent the BoZ from providing solvency support. (I) - Recommendation: Include purchase and assumption, bridge bank, and bail-in resolution provisions in new BFSA. (I) - Recommendation: Refine draft deposit protection scheme (DIS) bill in line with IADI norms. (I) - Recommendation: Introduce DIS law only once the preconditions for deposit protection are fully in place, as per IADI norms. (NT) - Capital Markets, Pensions, and Insurance - Recommendation: Review Insurance Bill to allow enforcement of risk-based solvency criteria and market conduct supervision before submission to Parliament. (I) - Recommendation: Pass Securities Bill to allow SEC to conduct effective supervision and enforcement. (I) - Recommendation: Rollout uniform compliance-based supervision by SEC, ahead of implementing risk-based supervision. (I) - Recommendation: Upgrade SEC systems and staff resources. (I) - Insolvency and Creditor/Debtor Rights - Recommendation: Reform insolvency legislation (Companies Act and Insolvency Bill) to incorporate best practices such as modern corporate restructuring and robust regulation of insolvency practitioners. (I) - Payment System, Credit Information, and Consumer Protection - Recommendation: Finalize Credit Reporting Bill and ensure compliance with BoZ directive to report to credit bureau. (I) - Recommendation: Assign adequate resources to payment systems oversight function and ensure its independence from other BoZ functions. (NT) - Timing key: I (immediate) is within one year; NT (near-term) is one–three years; MT (medium-term) is three–five years. --- ### Annex IV. External Sector Assessment ### A. Developments in the external sector - Finding: A number of factors have adversely impacted Zambia’s external sector since end-2014, including the fall in commodity prices, which eventually contributed to a sharp depreciation of the Zambian Kwacha. - Finding: The exchange rate is assessed to have realigned from an overvalued positioned, as assessed in the 2015 Article IV staff report, to broadly in line with equilibrium at end-2016, but has since appreciated. - Finding: Reserves have taken a hit and are assessed to have been below an adequate level at end-2016. - Finding: An analysis of broader non-price indicators underscores significant competitiveness weakness, highlighting the need for structural reforms to broaden the economic base and strengthen resilience. - Finding: The decline in copper prices by almost 30 percent during 2012–16 adversely affected Zambia’s external position. Copper accounts for about 70 percent of export earnings. - Finding: The terms of trade deteriorated every year during 2012–16. - Finding: By end 2016, the Zambian Kwacha lost more than half its value against the dollar compared to mid-2014. - Finding: With the inflation differential vis-à-vis Zambia’s trade partners widening, the REER depreciation was considerably less than the nominal depreciation. The REER has appreciated by 5.3 percent for the first half of 2017, with the nominal depreciation around 6.4 percent. - Finding: Zambia’s external current account shifted from surpluses (averaging 2.2 percent of GDP between 2005 and 2014) to deficits of 3.5 percent of GDP in 2015 and 5.5 percent of GDP in 2016. - Drivers of the current account deterioration: surge in oil and electricity imports to cover domestic power shortages; rising interest payments on public debt; elevated non-oil imports; heavy export concentration in copper. ### Outlook and projections - Finding: The current account deficit is projected to remain substantial in 2017 and gradually improve over the medium term. Exports are expected to pick up gradually, supported by a recovery in copper prices and improving export volumes. Over the medium-term imports are projected to grow in line with aggregate demand, as the economy recovers. ### B. Real exchange rate assessment - Methodology: External Balance Assessment (EBA-lite) using three approaches: current account model (CA), real exchange rate model (REER), and external sustainability (ES) approach. - CA approach: - Result: The current account approach suggests that the real effective exchange rate is about 5½ percent overvalued. - Assumption: Desirable fiscal policy stance assumed to be a 3½ percent deficit over the medium term. - Estimate: CA norm of -4.3 percent of GDP and a CA gap of -1.3 percent of GDP in 2016. - Adjustment: The real effective exchange rate adjustment that would eliminate this difference over the medium term is calculated to be about 5.6 percent, based on an estimated elasticity of -0.23. - REER approach: - Result: The REER approach suggests that the real effective exchange rate is in line with fundamentals. - Assumption: Actual interest rate will converge to 6 percent for Zambia. - Estimate: The REER is estimated to be roughly 1 percent lower than its equilibrium value at end-2016. - External sustainability (ES) approach: - Result: Indicates an overvaluation of about 10 percent under some scenarios. - Details: Under the assumption of a benchmark equal to the projected external position for 2016 of 2.2 percent of GDP, the required adjustment implies an overvaluation of 4.2 percent. Under an external position target equal to the 5-year average position up to 2014 (−15 percent of GDP) to be achieved by 2021, implied REER overvaluation would be about 10.5 percent. ### C. Reserves adequacy assessment - Finding: Zambia’s international reserves buffer has fallen in recent years, mainly reflecting the challenging external environment and BoZ interventions in 2015. - End-2015: Gross international reserves stood at US$2.98 billion (4 months of future imports), which includes proceeds from the Eurobond issuance during the year of US$1.25 billion. - End-2016: Reserves fell by a further $612 million during 2016 to $2.4 billion or (3.3 months of future imports). - Assessment: The end-2016 reserves level is below what can be considered adequate. - Cost-benefit approach finding: At end-2016, the reserves level of 3.5 months of current imports was at the lower end of the optimal level range of 4–5 months of current year’s imports. The baseline scenario projection of 2.2 months of imports for 2017 would be an inadequate level. - Alternative indicators: - End-2016 reserves were equivalent to about 80 percent of broad money liabilities (less than full cover). - End-2016 reserve coverage was about 6-fold the expected debt repayments due within the next 12-months. - Risks and implications: - Zambia’s heavy reliance on copper exports suggests a higher reserves buffer than the three-month rule to protect against current account shocks. - Non-resident holdings of domestic currency debt have increased since late 2016 and are susceptible to sudden stops or reversal, implying the necessity for returning to a path of reserve buildup to sustain investors’ confidence. - Peer comparison (2016): Zambia reserve buffers are significantly lower than in several peers (e.g., Kenya, Uganda, Tanzania). ### D. Assessment of structural competitiveness - Finding: Broader non-price indicators underscore significant competitiveness weakness and point to the need for structural reforms to broaden the economic base and strengthen resilience. *Source: Annex I. Main Recommendations of the 2015 Article IV Consultation (cr17327).* ### 12. Exports remain heavily concentrated in ### 12. Exports remain heavily concentrated in one product, copper ### Export concentration and trends - Zambia’s export market shares in the global exports increased between 2008 and 2013. - The increase between 2008 and 2013 largely reflected increased copper exports due to: - improved domestic production as new mines came on stream, and - increased copper concentrates imported from the Democratic Republic of Congo for processing. - Since 2013 there was a notable decline in the global export market shares, largely reflected in reduced copper concentrates from Congo DR, which more than offset the increase in domestic production of copper. - The country remains vulnerable to reliance on one dominant export product: copper. ### Key statistics and time references - Increase in Zambia’s export market shares: between 2008 and 2013. - Notable decline in global export market shares: since 2013. *Source: Staff Report for the 2017 Article IV Consultation (Informational Annex), IMF.* --- ### 13. Business environment has deteriorated (World Bank Doing Business indicators) ### Overall ranking and change - 2017 Doing Business rank: position 98 out of 190 economies. - 2014 Doing Business rank: position 83 out of 189 economies. - Although Zambia’s ranking is higher than the SSA regional average, there is room for improvement towards peers such as Rwanda and South Africa, and other commodity exporters such as Chile and Botswana. ### Weak areas identified (Doing Business) - Getting electricity - Starting a business - Trading across borders - Registering property - Enforcing contracts ### Investor perceptions (World Economic Forum Global Competitiveness report for 2016–17) - Main constraints to doing business as perceived by investors were: - access to financing, - tax rates, - corruption, and - inflation. - The 2014 version of the report also listed inadequate supply of infrastructure as a major constraint. - WEF competitiveness rankings cited: - 2016–17 ranking: 118th (out of 138 countries). - 2015–16 ranking: 96 (out of 140 countries). *Source: Staff Report for the 2017 Article IV Consultation (Informational Annex), IMF.* --- ### 14. Policy measures underway to improve the business climate and diversify exports ### Government measures and reforms noted - Passage of law on the use of moveable collateral to access finance. - Focus on economy diversification, including facilitating diversification of agricultural output to cash crops such as: - cotton, - cashew nuts, - soya beans, - cassava, and - rice, to broaden the export base and improve resilience to external shocks. - Establishing policy consistency in the agriculture sector, including: - abolishing maize export ban, - limiting the role of the Food Reserve Agency in the marketing of maize, to attract private sector investments to serve surrounding countries with maize deficits. - Move towards cost reflective tariffs on electricity to attract private investments in the sector, boosting domestic supply of electricity. - Enhanced transparency in petroleum product procurement and pricing, and improving efficiency to cut the underlying cost of supplying fuels. - Increased consultation with stakeholders in the mining sector towards establishing a stable mining tax regime, expected to: - boost investment in the sector, and - promote value addition. ### Intended outcomes - Improved competitiveness. - Attraction of investment and promotion of growth. - Broadened export base and improved resilience to external shocks. *Source: Staff Report for the 2017 Article IV Consultation (Informational Annex), IMF.* --- ### 15. Structural reforms to promote higher value-added and diversified exports ### Strategic priorities and rationale - Step up reforms to improve investment prospects and attract FDI to diversify into higher value-added products and other sectors. - Improve agricultural productivity to enhance exports, particularly maize given potential market from surrounding countries with maize deficits. - Note on cereal yields: Zambia’s average cereal yields per hectare is higher than SSA regional average and most neighboring countries, but remains quite low compared to South Africa. ### Policy consistency and incentives - Establishing policy consistency in agriculture (abolishing maize export ban and setting of prices) to create certainty and attract private sector investments. - Rationalizing farm subsidies and reallocating savings to measures that enhance crop yields and long-term competitiveness. *Source: Staff Report for the 2017 Article IV Consultation (Informational Annex), IMF.* --- ### Annex V. Capacity Development Strategy for FY 2018 — summary ### Overall assessment - Fund capacity development (CD) supports implementation of authorities’ economic and financial policies. - Zambia has benefited from many TA missions from the Fund focusing on key priorities. - Broad priority areas: - revenue and customs administration to enhance domestic revenue mobilization, - public finance management (PFM) to improve budget controls and execution, - financial supervision and regulations to strengthen financial stability, - monetary policy and operations, and - compilation and dissemination of statistics to inform policy analysis and implementation. ### Implementation progress and constraints - Good progress: compilation of national accounts statistics, including quarterly GDP, and external sector statistics. - More progress required: strengthen domestic revenue mobilization and public financial management to put public debt on a downward path. - 2016 FSAP highlighted risks to financial stability from inadequate capacity for bank supervision, systemic risk analysis, and financial crisis management. - Limitations slowing TA implementation include: - lack of buy-in from key national stakeholders (line ministries on PFM), - lack of financial resources to conduct surveys to improve statistics, - inadequate staffing and complementary trainings, - lack of coordination between various government agencies. ### Forward-looking priorities for FY 2018 (key themes) - Fiscal consolidation, debt management and financial stability. ### Key priorities and objectives for FY 2018 (as listed) - Public Financial Management: - Comprehensive, credible, and policy based budget preparation - Budget execution and control, including measures to avoid the accumulation of new arrears as well as accounting and fiscal reporting reforms - Management of fiscal risks - Debt management - Public investment - Tax policy: - Revenue quantity particularly by broadening the income tax and value added tax bases and enhancing tax compliance - Financial supervision and regulation: - Risk-based supervision and other supervisory processes - Systemic risk analysis - Systemic risk monitoring - Financial crisis management - Contingency planning for crisis, and deposit insurance - National accounts statistics: - High frequency output indicators and improvement in estimates of informal activity - Tax and customs administration: - Administration organizational structure and core functions - Central bank operations: - Foreign exchange market and operations, monetary policy implementation and operations - Prices: - Producer price index, import price index - External sector statistics: - Compilation of quarterly international investment position statistics and timelier quarterly balance of payments statistics ### Main risk to capacity development and mitigation - Main risk: slow implementation of TA recommendations and weak absorptive capacity. - Mitigating measures: - proper sequencing of TA and complementary trainings, - adequate engagement of implementing agencies and stakeholders, - communications strategy on consequences of inaction. ### Authorities’ view - The authorities are broadly in agreement with the overall assessment and priorities of the capacity development strategy. *Source: Staff Report for the 2017 Article IV Consultation (Informational Annex), IMF.* ### 1. Analytical work – biannual Economic Briefs focused on debt ### 1. Analytical work – biannual Economic Briefs focused on debt ### IMF work program and planned products (next 12 months) - Analytical work: biannual Economic Briefs focused on debt (December 2017) and the tourism sector (June 2018). - Other analytical work and TA with timing: - Inflation and Exchange Rate Dynamics Working Paper (July 2017). - Debt Management Reform Plan (June 2018). - Health Public Expenditure Review (Start June 2015; Analytical work noted). - Zambia Fiscal Charter (January 2018). - Structural Transformation in Zambia (December 2017). - Lending and TA: - DPO focused on Fiscal/debt, agriculture and social protection reforms (2 operations of $100 million). - TA – PFM reform program and dialogue (Continuous). - TA – E-procurement support (Continuous). - TA – Financial Inclusion Support Framework (2-3 year program). - IMF technical assistance (2017/18) planned areas: - Foreign operations and foreign exchange policy implementation (August–September 2017). - Public financial management 2017/18. - Revenue administration 2017/18. - Contingency planning for crisis preparedness and management 2017/18. - Financial supervision and regulation 2017/18. - Monetary policy implementation and operations 2017/18. - National accounts statistics 2017/18. - External sector statistics 2017/18. - Producer price index 2017/18. - Government finance statistics 2017/18. - Joint products in next 12 months: - DSA for Article IV and for WB DPO (August 2017). - FSAP Financial System Stability Assessment (August 2017). - Regular meetings with the Bank of Zambia (Continuous). ### Statistical issues and data adequacy (as of September 11, 2017) - General assessment: - Data provision has some shortcomings, but is broadly adequate for surveillance. - Issues with source data and compilation affect most datasets, particularly fiscal reporting. - National accounts: - CSO estimates GDP for the current year from benchmark year 2010 using survey and administrative data. - CSO now compiles GDP estimates using value added (VAT) and business income tax data from the Zambian Revenue Authority (ZRA). - In October 2016, CSO started publishing quarterly GDP estimates using quarterly source data, including VAT records from the ZRA. - Three priority areas: (a) develop an MoU between CSO and ZRA; (b) obtain additional resources to sustain quarterly GDP quality; (c) develop a new GDP benchmark within the next five years. - Price statistics: - CPI classification follows Classification of Individual Consumption by Purpose; current weights based on 2002 household expenditure data. - Urgent need for a household expenditure survey to update CPI weights. - AFRITAC South project on PPI expected to enhance measurement of volume changes of GDP and components. - Government finance statistics (GFS): - Coverage limited to budgetary central government; intergovernmental transfers about 2 percent of GDP to extra-budgetary, social security, and local government units. - Monthly budget releases reported to IMF African Department timely but often subject to substantial revisions. - Reconciliation between fiscal outturns and government accounts in monetary statistics requires significant improvement. - Zambia last reported data to STA in GFSM 2001 format for fiscal year 2011. A GFS TA mission planned after October 2017. - Monetary statistics: - Bank of Zambia reports monetary data to STA for central bank, other depository corporations, and other financial corporations on a timely basis, based on standardized report forms and IMF MFSM concepts. - Financial sector surveillance: - BOZ resumed reporting FSIs to STA following recent e-GDDS mission; data under review for posting on IMF FSI website. - Balance of payments statistics: - BoZ compiles BOP and IIP according to BPM6. BOP quarterly, IIP annually with publication lag higher than 120 days. - Plans to compile quarterly IIP. - New services surveys under BPM6 contributed to significant revision in services series and fob valuation of exports and imports of goods. - Coverage of quarterly investment survey (financial account and primary income) should be improved and incorporated into BOP statistics. - External and domestic debt statistics: - Data provision broadly adequate for surveillance. Recent TA-led efforts improved consolidation of external and domestic debt databases; further work underway. ### Data dissemination and quality frameworks - Zambia participated in GDDS since November 2002 and implemented e-GDDS recommendations in June 2016, publishing 14 of 15 e-GDDS data categories and remaining in Baseline 2 of the e-GDDS. - Since June 2016, updating of the NSDP has not been consistent. - A Data ROSC Assessment was published in February 2005. ### Debt Sustainability Analysis (DSA) – key findings (Staff Report on the 2017 Article IV Consultation) - Risk assessment: - Risk of external debt distress (current policies): High. - Augmented by significant risks stemming from domestic public and/or private external debt? Yes. - DSA principal findings: - The DSA indicates Zambia is at high risk of debt distress, downgraded from a moderate rating in the 2015 Article IV consultation. - The present value (PV) of public and publicly guaranteed external debt breaches the 40 percent of GDP threshold; it rises from 37 percent in 2016 to 42.6 percent by 2019 and to a peak of 44.3 percent in 2022. - The debt-service-to-revenue ratio temporarily breaches its 20 percent threshold in 2022 and 2024 when Eurobond payments fall due. - All indicators breach their respective thresholds in the case of extreme shocks. - Overall public sector debt vulnerabilities are elevated; fixed primary balance scenario (primary deficit-to-GDP unchanged from 2016 at 2.2 percent) shows the debt ratio rising throughout the forecast period. - Recommended focus to reduce risk of debt distress: - Strong and sustained fiscal consolidation. - Measures to increase domestic revenue. - Strengthen public investment management. - Contain fiscal risks, especially contingent liabilities of state-owned enterprises. - Adoption and implementation of an appropriate debt management strategy. ### Background and recent debt developments (selected statistics and trends) - Total external debt (public and private) rose sharply since 2011, mainly reflecting Eurobond issuance and rapid private sector debt rise. - At end-2016: - Outstanding public and publicly guaranteed (PPG) external debt: nearly US$8 billion (36.5 percent of GDP). - Compared to end-2011: US$1.9 billion (8.4 percent of GDP). - Publicly guaranteed debt (ZESCO and ZAMTEL) stood at US$771 million (3.5 percent of GDP), almost six times the amount at end-2012. - Composition shifts: - Share of central government debt from multilaterals fell from about 60 percent in 2011 to 20.5 percent. - Share of private banks/investors rose to almost 50 percent. - Private sector debt: - Rose from 6 percent at end-2014 to 40 percent at end-2016, reflecting increased survey coverage (firms surveyed increased from 30 in 2014 to about 350 in 2015). - Pace of contracting debt: - Number and value of loans increased from 5 loans totaling US$0.5 billion in 2011 to 30 loans totaling US$3.4 billion in 2016. - Public investment cycle (selection, procurement, monitoring) needs substantial strengthening to ensure value for money. - Domestic public debt: - Increased from 12.4 percent of GDP in 2011 to 24 percent of GDP in 2016. - In 2011, T-bills and T-bonds ~93 percent of total domestic debt. - In 2016: government securities (T-bills and T-bonds) dropped to 49.8 percent of total domestic debt; arrears increased to about 33 percent; remainder debt to Bank of Zambia and domestic commercial banks. - Text Table 1 (selected figures, percent of GDP): - Total External debt: 2011: 15.9; 2012: 17.3; 2013: 20.5; 2014: 28.5; 2015: 91.5; 2016: 78.5. (Table entries reproduced exactly as in source.) - Public and publicly guaranteed: 2011: 8.4; 2012: 13.7; 2013: 13.8; 2014: 20.1; 2015: 43.1; 2016: 36.5. - Central Government external debt: 2011: 6.5; 2012: 11.6; 2013: 11.3; 2014: 16.6; 2015: 37.6; 2016: 32.1. - Private and Parastatal external debt: 2011: 7.5; 2012: 3.6; 2013: 6.7; 2014: 8.4; 2015: 48.4; 2016: 42.0. - Total Public debt: 2011: 20.8; 2012: 25.4; 2013: 27.1; 2014: 35.6; 2015: 61.4; 2016: 60.5. - Domestic debt: 2011: 12.4; 2012: 11.7; 2013: 13.2; 2014: 15.5; 2015: 18.3; 2016: 24.0. - Composition of Central Government's External Debt (percent): Multilaterals: 2011: 59.7; 2016: 20.5. Private banks/investors: 2011: 0.0; 2016: 46.3. Suppliers' Credit: 2011: 31.0; 2016: 26.9. - Composition of Domestic Debt (percent): Securities: 2011: 92.6; 2016: 49.8. T-bills: 2011: 48.5; 2016: 25.1. T-bonds: 2011: 44.1; 2016: 24.7. Other (includes arrears and financing from BoZ and commercial banks): 2011: 7.5; 2016: 50.2. - Drivers of public debt dynamics: - Fiscal performance and exchange rate movements were main drivers; total public sector debt at end-2016 almost tripled relative to end-2011. - Fiscal deficits were significant contributors; in 2015 and 2016 exchange rate movements had the largest impact. ### DSA scenarios and underlying assumptions - Two scenarios presented: "current policies" and "adjustment policies". - Risk rating based on "current policies". - Current policies scenario assumptions: - Government ongoing efforts to increase tax compliance and address energy and agriculture subsidies. - Based on loans in pipeline, assumes disbursement of approximately US$3.5 billion in new non-concessional loans over next five years, on top of US$4 billion in already contracted loans, mainly to support capital projects (executed at a pace that raises quality-of-spending concerns). - Large domestic financing needs emerge, including government contributions to predominantly externally-financed projects. - Adjustment policies scenario: - Assumes capital spending will be more restrained, in line with 2017 Budget Speech policies and targets, including restrictions on new capital projects and major equipment purchases. - Additional key assumptions under current policies: - Economic growth will remain subdued over the medium-term, reflecting crowding out of private sector investment due to significant reliance on domestic debt financing. - External current account will remain in deficit up to 2022, reflecting higher imports related to government capital outlays; pickup in copper exports and less dependence on imported electricity expected to help narrow the deficit. - A total of US$7.5 billion in external debt will be disbursed over the next five years: assumes US$4.2 billion in non-concessional loans and US$3.3 billion concessional. - Assumes the three Eurobonds will be rolled over as they become due starting in 2022, and that there are no new Eurobond issuances prior to this. - Authorities implement fiscal consolidation measures in line with the 2017 Budget Speech, including: - Strengthen tax enforcement and compliance. - Remove obstacles to full implementation of measures approved by parliament (land titling, road-user charges, introduction of new technology to enhance monitoring of taxpayers’ activity reporting, including in the telecommunication sector). - Expenditure-side measures: (i) streamlining Farmer Input Support Program and full migration to e-voucher system; (ii) keeping Food Reserve Agency (FRA) operations in line with core mandate; (iii) cost-reflective pricing of petroleum products and electricity. - However, higher capital expenditure along with higher interest payments will limit consolidation efforts. *Source: cr17327 - 1. Analytical work – biannual Economic Briefs focused on debt* ### 9. Under the adjustment policies scenario, the authorities are assumed to implement ### cr17327 - 9. Under the adjustment policies scenario, the authorities are assumed to implement ### Scenarios and key assumptions - Adjustment policies scenario: - Authorities implement a more moderate public investment program aimed at restoring debt sustainability over the medium term. - Authorities halt the contracting of new non-concessional external loans except for a US$282 million communications project and debt to rollover the Eurobonds as they mature. - Comparison with 2015 DSA and Current Policies scenario: - Current policies scenario reflects a much lower growth path, largely reflecting lower copper prices and production than projected in the 2015 exercise. - Larger budget deficits projected over the medium term under current policies due to looser fiscal policy in 2015–16 and a larger investment program than assumed in 2015. - Current account balance revised down mainly because of lower exports (particularly of copper), higher energy imports (fuel and electricity), and larger imports of capital goods associated with the government public investment plan. - Adjustment scenario shows a steady pick-up in growth driven by increased confidence in government policies, lower inflation, and improvements in the external sector current account due to more coherent fiscal consolidation policies. ### Major projection tables (selected series preserved exactly as in source) - Real Growth (2016–2021) - 2015 DSA: 6.2 6.9 7.0 6.8 6.8 6.5 - Current Policies DSA: 3.4 4.0 4.5 4.5 4.5 4.5 - Adjustments Policies DSA: 3.4 4.0 4.5 5.0 5.5 5.5 - Inflation (deflator, av.) (2016–2021) - 2015 DSA: 7.3 6.3 5.2 4.8 4.8 5.0 - Current Policies DSA: 14.3 7.9 8.1 8.1 7.8 8.0 - Adjustments Policies DSA: 14.3 7.9 6.8 6.3 6.0 6.0 - Budget Deficit (Percent of GDP) (2016–2021) - 2015 DSA: 6.0 5.0 4.0 3.4 2.9 2.9 - Current Policies DSA: 5.7 8.0 7.8 7.2 6.5 5.3 - Adjustments Policies DSA: 5.7 7.3 5.9 4.0 3.2 2.4 - Net FDI (2016–2021) - 2015 DSA: 6.6 6.6 6.6 6.6 6.6 6.2 - Current Policies DSA: 7.3 6.3 6.1 6.0 5.8 5.8 - Adjustments Policies DSA: 7.3 6.3 6.1 6.0 5.8 5.8 - Current Account Balance (Percent of GDP) (2016–2021) - 2015 DSA: 1.4 2.5 3.0 3.3 3.4 3.2 - Current Policies DSA: -4.4 -3.6 -2.8 -1.5 0.0 -0.2 - Adjustments Policies DSA: -4.4 -3.0 -1.5 0.1 1.2 1.4 ### External DSA outcomes and risk assessments - Under current policies: - Zambia is assessed to be at high risk of debt distress. - PV of public and publicly guaranteed external debt as a share of GDP: rises from 34.5 percent in 2017 to 44.3 percent of GDP in 2020, sustained up to 2022, then gradually falling below the 40 percent threshold in 2024. - Debt-service-to-revenue ratio in the baseline temporarily breaches the 20 percent threshold in 2022 and 2024 when Eurobond payments become due. - Other debt burden indicators are below their respective thresholds in the baseline. - Under shocks (current policies): - All debt indicators breach relevant thresholds in the presence of shocks. - An exports shock would push the PV of debt-to-exports and the debt service-to-exports ratios well above their thresholds. - The largest impact on PV of debt-to-GDP and PV of debt-to-revenue ratios arises from a combination shock where both growth and the primary balance fall below their historical average by half a standard deviation; both indicators would rise sharply above their threshold, almost doubling by 2019, and remain elevated well into the medium-term. - These results highlight sensitivity of the debt trajectory to fiscal and growth assumptions and confirm the need for strong fiscal consolidation. ### Adjustment policies scenario impacts - Debt dynamics improvement: - PV of public external debt as a share of GDP remains below the 40 percent threshold, peaking at 37 percent of GDP in 2019 before tapering down on a sustainable trajectory. - Debt-service-to-revenue ratio still breaches the 20 percent threshold in 2022 and 2024 due to Eurobond bullet payments; authorities need to monitor and anticipate these temporary breaches. - Most extreme stress test: external debt burden indicators expressed as ratios to GDP would breach respective thresholds under a combined shock; indicators measured relative to exports are sensitive to an exports shock. - Under adjustment policies and halting new non-concessional external borrowing, Zambia quickly reverts to a moderate risk rating. ### Public DSA and total public debt - Vulnerabilities under current policies: - PV of total public debt to GDP reached 61 percent at end-2016, 5 percentage points above the benchmark level associated with heightened public debt vulnerabilities for medium performers. - After a projected temporary improvement in 2017 driven by a strengthening exchange rate relative to 2016, this indicator will continue to rise through 2022. - Under a fixed primary balance scenario, this indicator remains above the threshold and is projected to continue rising. - Improvement under adjustment scenario: - Additional consolidation measures and slowing down contracting of new non-concessional external loans would improve the fiscal position and public debt dynamics. ### Conclusions and policy recommendations - Current status: - Zambia faces a high risk of external debt distress and heightened vulnerabilities on total public debt. - Under current policies, PV of external debt-to-GDP breaches the 40 percent threshold during 2019-23. - Debt-service-to-revenue ratio temporarily breaches its threshold in 2022 and 2024 when Eurobonds mature. - All indicators breach thresholds for extensive periods under a variety of shocks, underscoring sensitivity of external debt burden to fiscal performance and developments in exports, growth, and the exchange rate. - Ratio of total public debt to GDP breaches the benchmark level associated with heightened vulnerabilities. - Policy recommendations: - Fiscal consolidation. - Restraint on non-concessional borrowing. - Strengthened debt and public investment management capacities to put debt on a sustainable path. *International Monetary Fund — Zambia: External and Public DSA findings and adjustment scenario analysis.* ### 17. The authorities broadly agreed with the DSA assessment. They indicated that they will ### 17. The authorities broadly agreed with the DSA assessment. They indicated that they will ### Authorities' response and policy intentions - The authorities broadly agreed with the DSA assessment. - Planned actions: - Soon publish the Medium-Term Debt Strategy to guide government borrowing, with a view to ensuring that public debt remains at sustainable levels. - Seek to maximize concessional loans. - Strengthen parliamentary over-sight of public borrowing through an amendment to the Loans and Guarantees Act. ### Analytical framework and scenarios used in the DSA - Analyses and projections draw on country authorities; and staff estimates and projections. - Scenario types and stress tests referenced: - Baseline, Historical scenario, and Most extreme shock (the most extreme stress test is the test that yields the highest ratio on or before 2026). - Specific stress tests referenced include: Combination shock; Exports shock; GDP deflator shock. - Sensitivity analysis covers alternative scenarios (e.g., key variables at historical averages, new public sector loans on less favorable terms) and bound tests (e.g., real GDP growth at historical average minus one standard deviation; one-time 30 percent nominal depreciation in 2017). - Revenues are defined inclusive of grants in several figures and tables. ### Key macroeconomic and fiscal assumptions used in projections - Real GDP growth (in percent): 5.1, 4.7, 2.9, 6.9, 2.3, 3.4, 4.0, 4.5, 4.5, 4.5, 4.5, 4.2, 5.0, 5.0, 5.0 (series reported across tables). - GDP deflator in US dollar terms (change in percent): 4.7, -7.5, -24.0, 4.4, 19.7, -4.4, 17.1, 2.3, -1.1, 0.1, 1.4, 2.6, 3.1, 3.1, 3.0 (series reported across tables). - Effective interest rate (percent) / Average nominal interest rate on forex debt: examples reported include 2.6, 3.2, 4.8, 2.9, 1.8, 2.7, 2.9, 2.7, 2.7, 2.5, 2.4, 2.7, 2.6, 2.8, 2.8 and 1.8, 3.5, 3.9, 1.7, 1.2, 4.8, 4.7, 4.5, 4.4, 3.8, 3.5, 4.3, 3.7, 3.8, 3.9 in different tables. - Growth of exports of G&S (US dollar terms, in percent): series reported includes 10.4, -4.6, -25.7, 14.3, 28.8, -10.1, 15.6, 14.9, 10.7, 7.5, 9.9, 8.1, 8.1, 5.0, 7.7 (across tables). - Growth of imports of G&S (US dollar terms, in percent): series reported includes 18.9, -7.0, -13.4, 15.4, 22.5, -10.6, 17.0, 12.2, 6.9, 4.4, 10.4, 6.7, 8.2, 5.0, 8.4 (across tables). ### Public and external debt indicators and fiscal pressures (high-level) - The DSA materials present a range of debt indicators and stress-test outcomes for public and publicly guaranteed external debt and public sector debt under multiple scenarios, including: - PV of external debt and PV of PPG external debt, expressed in percent of GDP and percent of exports, with stress-test trajectories shown through 2016–36. - Debt service-to-exports ratio and debt service-to-revenue ratio under baseline and stressed scenarios. - PV of debt-to-GDP, PV of debt-to-exports, PV of debt-to-revenue, and debt service ratios reported across baseline, alternative scenarios, and bound tests for 2016–36. - Sensitivity analyses and bound tests explore impacts on key ratios of shocks including lower export values, lower real GDP growth, lower US dollar GDP deflator, declines in net non-debt creating flows, combinations of shocks, and a one-time 30 percent nominal depreciation in 2017. - Grant element and grant-equivalent financing are explicitly tracked in the projections (grant element of new public sector borrowing and grant-equivalent financing in percent of GDP and percent of external financing). ### Projection and sustainability-related metrics highlighted - Gross financing need and debt-stabilizing metrics are presented: - Gross financing need (Billions of U.S. dollars) reported across years (negative and positive values reported in the tables). - Non-interest current account deficit that stabilizes debt ratio is reported in percent terms in the DSA tables. - Primary deficit that stabilizes the debt-to-GDP ratio is provided in the public sector debt framework tables. - Public sector debt dynamics components are decomposed: - Identified debt-creating flows, primary deficit, automatic debt dynamics (contributions from interest rate/growth differential, contribution from real GDP growth, contribution from real exchange rate depreciation), other identified debt-creating flows, and residual including asset changes are reported in detail in the public sector debt tables. ### Policy implications reflected in the DSA context - The authorities’ intention to publish a Medium-Term Debt Strategy and to maximize concessional borrowing is aligned with the DSA’s focus on: - Managing debt accumulation and the grant element of new borrowing. - Monitoring debt service-to-exports and debt service-to-revenue ratios under baseline and stress scenarios. - The planned amendment to the Loans and Guarantees Act to strengthen parliamentary oversight of public borrowing is a governance measure that complements debt strategy and concessional borrowing priorities. *Statement by Mr. Maxwell M. Mkwezalamba, Executive Director for Zambia; and Mr. Tanka Tlelima, Senior Advisor to Executive Director — October 6, 2017* ### 1. On behalf of our Zambian authorities, we thank staff for the constructive and wide-ranging ### On behalf of our Zambian authorities, we thank staff for the constructive and wide-ranging dialogue with the authorities on issues related to the 2017 Article IV Consultation ### Recent Economic Developments - Following weak performance in 2015 and 2016, on the back of a series of exogenous shocks, economic activity is beginning to recover. - In 2017, GDP growth is expected to increase to over 4.0 percent, from the 3.6 per cent estimated by staff for 2016. - Main growth drivers: mining, agriculture, and manufacturing sectors, supported by improved electricity generation. - Agricultural output expected to benefit from a bumper harvest from the 2016/17 farming season. - Hydro-power generation increased during the first eight months of 2017, boosting activity in other sectors, especially mining. - Copper production in 2017 is set to exceed the 2016 levels. - Authorities’ initiatives to modernize airport infrastructure have spurred growth in tourism. - External sector improved significantly during the first half of 2017, on account of higher exports of copper. ### Recent fiscal and monetary challenges - A sharp slowdown in the pace of economic activity, combined with low copper prices that reduced fiscal revenues, complicated fiscal policy management in 2015 and 2016. - Given limited fiscal maneuverability, authorities depended mostly on monetary policy tightening to combat inflationary pressure and stabilize the exchange rate. - Budget execution in 2017 remained challenging despite relatively benign prospects. - Revenue and grants are projected to be below target by 7.0 percent by the close of 2017, reflecting, among others, low tax compliance and non-disbursement of grants by cooperating partners. - Authorities aim to reduce expenditures to offset the impact of the revenue shortfall on the overall fiscal position. ### Macroeconomic Objectives, Policies, and Strategies - Authorities will pursue policies consistent with the Economic Stabilization and Growth Programme 2017-2019 (ESGP) and the Seventh National Development Plan 2017–2021 (7NDP). - ESGP objectives: - Restore credibility of the budget by minimizing unbudgeted expenditures and halting the accumulation of arrears. - Enhance domestic resource mobilization and rebalancing public spending towards core public sector mandates. - Improve economic and fiscal governance by raising levels of accountability and transparency in allocation and use of public finances. - Promote macroeconomic stability, growth and job creation through policy consistency to raise confidence for sustained private sector investment. - Scale-up social protection programs in favor of the most vulnerable. ### Fiscal Policy and Public Debt Management - Authorities agree with staff that improved fiscal performance is needed to place public finances and debt on a sustainable trajectory. - 2018 fiscal objective (as outlined in the 2018 Budget Speech presented to Parliament on September 29, 2017): lower the fiscal deficit on a cash basis to 6.1 percent of GDP. - This target is much closer to the 5.9 percent recommended in the staff’s adjustment scenario and lower than staff’s baseline projection of 8 percent in 2017. - Measures to achieve improved fiscal performance: - Enhanced domestic resource mobilization and expenditure control measures. - Modernizing and automating revenue collection processes; intensifying tax-payer education and services. - Rationalizing tax incentives and strengthening audit functions to address base erosion and profit shifting. - Implementing strong measures to contain expenditure overruns; in October 2016, fuel prices were adjusted to full-cost recovery to eliminate regressive fuel subsidies. - Commissioned a cost of service study to inform adoption of cost-reflective electricity tariffs. - Electricity tariffs to non-mining consumers increased substantially, starting with a 50 percent increase in May 2017. - Reforms to enhance efficiency and focus of subsidies in the agriculture sector. - Efforts to control the wage bill by limiting recruitment to critical areas. - Arrears management: - Authorities have started to reduce the stock of arrears. - Weaknesses in commitment controls and expenditure management contributed to accrual of arrears. - Expected full rollout of the Integrated Financial Management Information System (IFMIS) by end 2017; thereafter no government ministry, province or spending agency shall be allowed to spend outside the system. - Debt strategy: - Authorities share staff’s concern about rapid accumulation of public debt. - Ambitious infrastructure development program to ease growth constraints and lay foundation for long-term growth. - Government has published its Medium-Term Debt Management Strategy to return public debt to a sustainable level. - Strategy actions: maximize concessional financing before resorting to commercial borrowing; contraction of new debt over the medium-term will be scaled down, in line with reduced fiscal deficit targets. - Intend to strengthen legal framework for public debt management by enacting a new law to enhance oversight of government borrowing activities and require parliamentary approval of loans before they are contracted. ### Monetary, Exchange Rate, and Financial Sector Policies - Zambia maintains a flexible exchange rate regime. - Any intervention in the foreign exchange market will be aimed at smoothing excessive volatility and opportunistically building reserves, consistent with staff’s recommendation. - Financial sector status and reforms: - Despite vulnerabilities and weaknesses identified by the Financial Sector Assessment Program (FSAP), Zambian banks remain, overall, sound and well-capitalized. - Authorities agree with FSAP findings and have started implementing measures to address identified weaknesses to support financial stability, development, and inclusion. - Banking and Financial Services Act (BFSA) has been signed by the President; Bank of Zambia (BoZ) is drafting regulations to operationalize the new law. - BFSA addresses operational independence of the BoZ, Basel II/III standards, and licensing. - Authorities are reviewing the BoZ Act and the National Payments System Act. - BoZ is strengthening supervisory capacity and enhancing collaboration with other financial services regulators. - Since the FSAP mission in August 2016, staffing levels within the Financial Stability Unit of BoZ have been increased. - A prototype Financial Stability report has been produced and is undergoing internal review. - Government is finalizing the financial sector development policy aimed at promoting a well-developed, competitive, and inclusive financial system. - Authorities received Fund technical assistance that reviewed the draft Deposit Insurance Bill and informed proposed amendments in line with international principles before finalization of the Bill. - Anti-Money Laundering/Combating the Financing of Terrorism (AML/CFT): - In June 2017, BoZ undertook to revise and strengthen the AML/CFT legal framework, in line with the FAFT. - Development of the Bank of Zambia Anti-Money Laundering and Combating the Financing of Terrorism or Proliferation Directives, 2017. - Directives currently under review and shall apply to all reporting entities licensed or designated by the BoZ. - BoZ Anti-Money Laundering Directives of 2004 will be repealed once the new Directives take effect. ### Promoting Inclusive Growth - Strategies articulated in the 7NDP emphasize agriculture, tourism, energy, and mining as the basis for diversification. - Agriculture actions: - Implement measures aimed at raising farmer productivity and diversification within the sector. - Access to markets, ICT, and infrastructure development emphasized as key growth enablers. - Infrastructure and human development priorities: - Energy supply and transportation infrastructure identified as development priorities to address infrastructure bottlenecks. - Human development measures such as access to quality education and healthcare systems identified as essential in promoting inclusive growth. ### Conclusion and Engagement with Fund - Authorities remain committed to sound macroeconomic management. - Authorities will continue to engage staff towards a Fund-supported program. - Spending plans and fiscal target contained in the 2018-2020 Medium-Term Expenditure Framework and the 2018 Budget reflect determination to a growth-friendly fiscal consolidation, intended to form a foundation to conclude program discussions. *IMF staff report excerpt: Zambian authorities’ comments on the 2017 Article IV Consultation* --- _Source: https://www.imf.org/-/media/files/publications/cr/2017/cr17327.pdf_