## 1zmbea2019002 — 1. Impact of Drought and Other Climate-Related Shocks ## Source details **Canonical URL:** [1zmbea2019002 — 1. Impact of Drought and Other Climate-Related Shocks](https://www.imf.org/-/media/files/publications/cr/2019/1zmbea2019002.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2019/1zmbea2019002.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2019/1zmbea2019002.pdf.json) --- ### Context and recent economic developments - Macroeconomic and political context - Growth drivers and constraints: Growth rose to 3.7 percent in 2018 from 3.5 percent in 2017; agriculture’s contribution was negative. Presidential elections due in 2021; Vision 2030 and the Seventh National Development Plan (7NDP) emphasize ramping up infrastructure spending. - Vulnerabilities: Unemployment 12.5 percent at end-2018; Zambia hosts over 70,000 refugees; implementation of past IMF advice limited; Public Finance Management Act approved in 2018 but Planning & Budgeting Act and Loans and Guarantees Act pending. - Fiscal stance and debt financing: Expansionary fiscal stance financed by nonconcessional borrowing and domestic expenditure arrears; Eurobond spreads rose to 1,575 in early June. - Monetary and regulatory context: Bank of Zambia (BoZ) strengthened monetary policy framework and reformed supervision and crisis frameworks, though enforcement lagged. - Growth and activity - 2018 growth: 3.7 percent (2017: 3.5 percent), driven by telecommunications, financial and insurance activities, wholesale and retail trade, and mining; agriculture contracted. - Public investment: Ramp-up with low efficiency, high import content and buildup of expenditure arrears muting growth effects. - Inflation, exchange rate and monetary policy - Kwacha: Depreciated by 20 percent in 2018 (mostly in September). - Inflation: Year-on-year inflation hovered around BoZ target band (6–8 percent) in late 2018, rising to 8.1 percent in May 2019. - Policy rate: Monetary Policy Committee increased policy rate by 50 basis points to 10.25 percent at its May meeting. - Fiscal developments and domestic financing - 2018 fiscal outcome: Revenues performed strongly, but deficit rose to above 10½ percent of GDP due to increased public investment and rising interest bill. - Foreign-financed capital expenditure exceeded budget targets by 3½ percentage points of GDP in 2018. - Interest payments reached almost 20 percent of total spending. - Arrears and refunds: Accumulation of about 1½ percent of GDP in domestic arrears and almost 1 percent of GDP in audited but unpaid VAT refund claims; cash deficit widened to 8.3 percent of GDP from 7.7 percent in 2017. - Domestic debt market stress: Treasury auctions regularly undersubscribed from mid-2018; yields around 20 percent on T-bills and government bonds in September 2018. - Domestic arrears stock: K15.6 billion (5½ percent of GDP) at end-2018. - Private placements: Raised around 4.2 billion Kwacha in 2018 (about 2 billion Kwacha from NAPSA and remaining from commercial banks). ### Impact of drought and climate-related shocks - Agricultural production and food security - 2018 agricultural contraction: Agricultural activity contracted by 21 percent in 2018. - Crop Forecast Survey: Projects a 16 percent drop in agricultural production for the October 2018–April 2019 growing season. - Maize production: With drought affecting Lusaka and Central provinces (about one-third of national maize output), 2019 principal food staple production is estimated to be roughly 55 percent of 2017 levels. - Estimated Maize Production (million MT): 2017: 3.61; 2018: 2.39; 2019: 2.00. - Hydroelectricity and load-shedding - Power deficit: Projected to average roughly 13 percent of Q2–Q4 average load. - Load-shedding: ZESCO began implementing four hours of daily load-shedding in early June. - Constraints: Limited regional supply for electricity import and ZESCO’s financial weakness may complicate response. - Vulnerable populations and humanitarian needs - Employment and poverty: Vast majority of rural population depends on agriculture (directly or indirectly more than 50 percent of total employment) while agriculture contributes under 10 percent of GDP; rural poverty 77 percent. - Humanitarian need: World Food Program estimates as many as 1.3 million people may require humanitarian assistance between July 2019 and February 2020. - Government response and resilience-building - Short-term: Food Reserve Agency (FRA) centered response; maize exports banned; authorities expect current maize stocks adequate for 2019 despite past FRA inefficiencies and distributional biases. - Long-term resilience: Increased investment in irrigation systems (World Bank support), adoption of new technologies, enhanced farmer education and market information, AfDB climate-resilient livestock management project launched in 2017. ### Public debt, external sector and reserves - PPG debt stock and composition - PPG debt stock: Reached 78 percent of GDP at end-2018, up from 65.5 percent in 2017; two-thirds held by foreign creditors. - External debt: Increased from $9.5 billion (38 percent of GDP) in 2017 to $11.3 billion (48 percent of GDP) in 2018. - External PPG debt service: Increased from $0.5 billion in 2017 to $0.9 billion in 2018 (21¾ percent of government revenues). - Text Table (selected rows, billions of U.S. dollars): Total public debt: 2013: 7.4; 2014: 9.4; 2015: 10.4; 2016: 13.2; 2017: 16.3; 2018: 18.3. - Memo: total public debt to GDP (%): 2013: 27.1; 2014: 36.1; 2015: 62.3; 2016: 60.7; 2017: 65.5; 2018: 78.1. - Note: Accompanying DSA uses broader coverage and totaled 80¾ percent of GDP at end-2018. - External position and reserves - Current account: Deficit widened modestly to 2.6 percent of GDP in 2018. - FDI: Contracted as foreign firms repatriated earnings; new investment subdued. - FX reserves: Declined from 2.4 months of import cover in 2017 to 1.9 months in 2018; staff note reserves at 1.7 months of imports (modest compared to public debt needs). - Foreign holdings of LC debt: About $0.7 billion (memo), or half of FX reserves. ### Outlook and risks - Growth projections - 2019 growth: Expected to slow to 2.0 percent as agriculture and electricity production suffer weather-related shocks, domestic demand weak, and mining declines due to lower copper prices and policy changes. - 2020: Rebound in agriculture and moderate mining recovery projected. - Medium term: Financing constraints expected to force disorderly cuts in public expenditures, pushing growth down to 1.5 percent by 2023. - Inflation and reserves under baseline - Inflation: Absent effective policy adjustment, inflation would remain above BoZ’s upper band in 2019 and 2020 due to exchange rate pass-through and drought impacts. - Reserves projections: International reserves projected to decline to 1.6 months of imports by end-2019 and to around 1 month of imports by 2021. - Debt outlook and vulnerabilities - Under current policies, public debt projected to increase from 78 percent of GDP in 2018 to 91½ percent of GDP in 2019 as contracted but undisbursed project loans (roughly 40 percent of GDP) continue to disburse. - Debt service burden expected to rise above 30 percent of government revenues in 2019. - Staff assessment: Risk of debt distress increased substantially and is currently at a very high level. ### Key risks (selected) - Domestic risks - Continued drought: Relative Likelihood: M; Impact if realized: H — adverse impact on agriculture, food price inflation, hydropower generation and growth; policy response: support vulnerable populations, diversify crops, consider reservoir dam, tighten monetary policy if second-round effects significant. - Delayed/insufficient fiscal adjustment ahead of elections: Relative Likelihood: H; Impact if realized: H — accumulation of arrears, financial sector stress, capital outflows, exchange rate depreciation, higher debt service burden; policy response: credible fiscal adjustment, tax base widening, prioritize capital expenditures. - External risks - Sharp tightening of global financial conditions: Relative Likelihood: H; Impact if realized: H — higher external debt service and refinancing costs, reserve loss, kwacha pressure. - Weaker global growth and protectionism: Relative Likelihood: M/H or H; Impact if realized: H — lower copper demand/prices, reserve loss, wider current account deficit. ### Authorities’ views (summary) - Broad agreement with near-term staff growth and inflation outlook and recognition of drought impact on 2019 outcomes. - Authorities expect larger long-term payoff from recent public investments and emphasize large investment needs to close infrastructure gaps. - Government measures cited to offset drought: tapping strategic maize reserve stocks, support to farmers; load-shedding decision described as proactive. ### Policy discussions — objectives and core priorities - Objectives: - Reduce debt-related vulnerabilities. - Preserve macroeconomic stability. - Implement structural reforms for higher and more inclusive growth. - Staff key policy priorities (verbatim emphases) - Urgent fiscal consolidation with revenue mobilization and expenditure prioritization. - Strengthen PFM, public investment efficiency, and debt management. - Monetary tightening to keep real rates positive and support reserve accumulation, accompanied by fiscal reorientation. - Strengthen banking supervision and crisis preparedness; contain arrears to prevent financial sector stress. - Promote inclusive growth via agricultural resilience, electricity sector reforms, and improved governance. ### Recommended fiscal adjustment and PFM measures - Fiscal adjustment (alternate scenario features) - Key elements: Frontloaded revenue mobilization; moratorium on new external nonconcessional borrowing and guarantees; scaled-back capital spending. - Projected outcome: Debt on downward trajectory to about 60 percent of GDP by end-2029; government able to meet obligations while allowing resources for priority social spending and arrears repayment. - Trade-offs: Near-term drag on growth but low fiscal multipliers given limited growth impact from recent government spending; halting arrears accumulation should improve domestic liquidity. - Fiscal targets and staff recommended path - 2019 staff recommended fiscal deficit (commitment basis) about 6.3 percent of GDP in 2019 (from 10.7 percent of GDP in 2018). - Further consolidation in 2020 to bring deficit to 3.4 percent of GDP. - 2019 budget aimed to reduce deficit to 6½ percent of GDP (commitment basis) but binding financing constraints forcing sharper disorderly adjustment; financing constraints expected to hold cash deficit to 4¾ percent of GDP while deficit on commitment basis could reach close to 9 percent of GDP with weak controls. - Composition of recommended adjustment (percent of GDP, Text Table 5) - Contribution of revenue: Total domestic revenue increase 0.6 percent of GDP (from 18.9 in 2018 to 19.5 in 2019). - Contribution of expenditures: Capital spending reduction 3.5 percent of GDP (from 8.6 in 2018 to 5.1 in 2019). - Clearance of arrears: VAT refunds backlog contribution 0.5 percent of GDP. - Tax policy and revenue measures - 2019 budget proposal: Replace VAT with a dual-rate sales tax (9 percent on domestic goods; 16 percent on imports); hybrid levied at every stage, exemptions for production inputs, no refunds; authorities estimate windfalls up to 2 percent of GDP. - Staff advice: Carefully consider pros and cons of moving away from VAT; if transition proceeds, contain exemptions and estimate fiscal impact; raise tax revenues to 16 percent of GDP in 2020 through base broadening, reducing tax expenditures, strengthening compliance, simplifying system and enhancing audit capacity. - PFM strengthening and execution - Recent steps: Public Finance Management Act enacted April 2018; Development of Public Investment Management System expected to begin operating in 2020; establishment of Public Investment Board (PIB). - Staff recommendations: Early quarterly budget releases; IFMIS functionality to restrict line ministries’ monthly payments to a cash limit; reconcile payroll and HR data; pre-paid meters/vouchers for utilities and rent; vetting and ex ante appraisal of domestically-financed projects; establish small unit in Ministry of Finance to monitor 5–10 largest capital projects. - Authorities’ actions: Cabinet measures to contain/control spending: indefinitely postponing contraction of new non-concessional loans; cancelling some committed but undisbursed loans; increasing control and management of disbursements on foreign-financed loans. ### Debt management, market development and external financing - Debt management priorities - Strengthen management of large stock of contracted but undisbursed debt to prioritize projects and pace execution. - Close monitoring of portfolio risks with rapidly rising external debt payments and approaching Eurobond maturities. - Improve monthly cash flow forecasts to increase flexibility in domestic debt auctions. - Manage SOE debt systematically to monitor fiscal risks. - Domestic market development - BoZ planned launch of a Primary Dealership System (PDS) later in the year to ensure demand and liquidity for benchmark bonds. - Handling fee on government securities lowered to 1 percent from 2 percent to encourage market transactions. - BoZ buying government bonds in the secondary market to provide a backstop facility. - Authorities engaged with a bilateral creditor on voluntary debt reprofiling and possibility of servicing debt in lenders’ national currency. - Contracted but undisbursed external debt - Total contracted but undisbursed debt: Around US$9.7 billion (including guarantees) or 40 percent of 2018 GDP as of April 2019; projected to be fully disbursed within next 5 years (6.7 percent of GDP anticipated in 2019) under baseline. - Roughly 45 percent of contracted but undisbursed debt for projects that had not begun disbursing as of April 2019. ### Monetary policy, reserves and inflation guidance - BoZ framework and actions - Strengthened monetary framework; narrowed policy rate corridor; increased use of OMOs; developing FPAS with Fund TA. - Policy move: Policy rate raised by 50 bps to 10.25 percent in May; MPC emphasized countering inflationary pressures and supporting macro stability. - Staff view: Some further tightening warranted to keep forward-looking real rates positive and support reserve accumulation; monetary effectiveness higher if accompanied by large upfront fiscal consolidation. - Authorities: Committed to flexible exchange rate policy and bolstering reserves; believe reserves will be higher than staff projections. ### Financial stability and supervision - Progress and vulnerabilities - BoZ upgraded institutional, regulatory, supervision and crisis management frameworks consistent with 2017 FSAP recommendations. - Revised 2017 BFSA and amended draft BoZ Act address BoZ operational independence, Basel II/III standards and licensing; AML/CFT framework revised; deposit insurance scheme being considered with Fund TA. - Key risks: Strong sovereign–financial nexus could keep NPLs above Zambia’s 10 percent prudential benchmark; commercial banks’ foreign currency liabilities roughly 47 percent of total liabilities at end-2018 (dollarization risk). - Staff advice: Complete staffing/training of supervision department, enhance crisis preparedness and management, prioritize on-site inspections based on risk assessment. - Authorities agreed to improve supervisory capacity by filling vacancies and prioritizing capacity building. ### Growth, agriculture, electricity and inclusiveness (structural recommendations) - Structural and social indicators (verbatim figures) - Water resources: 6,000 cubic meters per inhabitant. - Share of arable land under cultivation: 14 percent. - Electricity access rate: 31 percent. - Rural poverty: 77 percent of the population live in poverty in rural areas. - Agriculture recommendations - Build resiliency to climate shocks; improve targeting of Farmer Input Support Programme (FISP) to poor and small-scale farms; establish more stable maize market regulation. - Electricity sector recommendations - Complete cost of service study and advance tariff reforms. - Protect vulnerable groups given subsidy distribution: richest decile receive 64 percent of electricity subsidies; poorest half receive 1.5 percent. - Expected increase in electricity generation capacity by end-2020: roughly 25 percent of current capacity from the Kafue Gorge Lower plant. - Business climate and governance - Need steady focus on business climate to revive private investment. - Governance indicators close to SSA average but deteriorated recently. - FIC reporting of suspicious activities related to tax evasion, corruption and procurement increased in 2017–2018. - Public Financial Management Act expected to improve procurement transparency and accountability. ### DSA, debt sustainability assessment and staff judgment - DSA findings and risk rating - DSA (LIC DSF) risk of external debt distress: High; overall risk of debt distress: High; staff assess current risk of external and overall public debt distress as very high. - Under baseline current policies: PV of public debt-to-GDP projected path increases (examples): PV of debt-to-GDP ratio projected to increase from 81 percent in 2018 to 95 percent by 2021 (Text). - Market indicators: EMBI spreads 1,575 basis points on June 11, 2019; gross financing needs (GFNs) peaking at 19 percent of GDP over next three years. - External debt service: External PPG debt service increased from $0.5 billion in 2017 to $0.9 billion in 2018; external debt service (public and publicly guaranteed debt plus foreign-held LC debt) projected to reach $1.6 billion in 2019 (increased from about $1 billion in 2018). - Near-term liquidity: FX reserves appear sufficient to cover the next 12 months’ external debt payments provided no sharp reversal in capital flows; reserves at end-June: $1.41 billion (staff/authorities reporting). - Staff-proposed adjustment scenario (quantitative features) - Envisages cumulative 8½ percent of GDP fiscal adjustment over next five years with 4½ percent of GDP front-loaded for 2019 centered on substantial scaling back of foreign-financed capital expenditure. - Projected outcomes: Regain investor confidence, improved growth prospects, rebuild FX reserves, strengthen debt-carrying capacity; debt downward trajectory to about 60 percent of GDP by end-2029 under alternate scenario. - Stress tests and vulnerabilities - Standardized exports shock most extreme shock for debt indicators. - Many external debt burden indicators breach indicative thresholds under baseline and several stress scenarios. ### Financial sector structure, soundness and sovereign–financial nexus - Financial sector composition and indicators (selected) - Commercial banks: 18 registered commercial banks account for about 70 percent of total financial sector assets; majority foreign-owned. - NBFIs: Dominated by NAPSA (~75 percent of NBFI assets); NAPSA assets around 30 billion Kwacha at end-2018. - Financial inclusion: 59 percent of adults use financial services; 38 percent have a formal transaction account. - Banks’ government securities holdings: Around 25 percent of assets in 2018 (declining more recently); most holdings are T-bills yielding annual real yield of around 10-15 percent. - Private sector credit: Declined from 15¾ percent of GDP in 2015 to around 11½ percent in 2018. - Financial soundness indicators (selected values as presented) - Regulatory capital to risk-weighted assets (selected): 18.6 22.3 22.1 19.2 21.3 26.8 27.0 21.2 26.2 26.5 22.1. - Past due advances (NPL) to total advances (selected): 7.2 12.6 14.8 10.4 8.1 7.0 6.1 7.3 9.7 11.5 11.0. - Foreign currency loans to total gross loans (selected): 42.1 36.4 32.8 39.1 28.7 25.6 29.0 36.9 35.7 41.6 44.5. - Sovereign–financial linkages and systemic risks - Sovereign exposure: Banks and NAPSA invest heavily in government securities to meet domestic financing needs; direct and indirect exposures increased in 2017–18. - Indirect pressures: Government domestic arrears to suppliers around 6 percent of GDP at end-2018; delays in remitting pension contributions and salary-backed loan repayments. - Impact: High government borrowing needs drive higher yields and hold back private sector credit; NPLs sticky around prudential benchmark increasing financial sector stress risk. ### Capacity development, data and IMF engagement - IMF CD priorities and activities - CD anchored on assisting authorities to achieve orderly fiscal adjustment: detailed technical advice and institutional capacity building. - CD focus areas: Tax policy and revenue administration; PFM; public investment management; debt management reform; BoZ capacity in bank supervision; systemic risk analysis and crisis management; national accounts and price statistics; GDP rebasing (work begun but likely delayed beyond end-2019). - Joint World Bank–Fund work program (2019/20) highlights IMF TA in: foreign operations and FX policy, PFM, revenue administration, contingency planning, financial supervision, monetary policy implementation, national accounts, external sector statistics, PPI and GFS. ### Staff appraisal — summary conclusions (verbatim emphasis) - Zambia faces a difficult macroeconomic environment driven by drought, growth slowdown, and large fiscal deficits financed through non-concessional borrowing. - On current policies, public debt is on an unsustainable path and financing constraints are forcing a disorderly fiscal adjustment; the risk of debt distress has increased substantially. - There is a narrow window for an orderly, large front-loaded and sustained fiscal adjustment to reduce debt vulnerabilities while protecting priority social spending. - Key policy priorities: - Urgent fiscal consolidation with revenue mobilization and expenditure prioritization. - Strengthen PFM, public investment efficiency, and debt management. - Monetary tightening to keep real rates positive and support reserve accumulation, accompanied by fiscal reorientation. - Strengthen banking supervision and crisis preparedness; contain arrears to prevent financial sector stress. - Promote inclusive growth via agricultural resilience, electricity sector reforms, and improved governance. *Source: 1zmbea2019002 - 1. Impact of Drought and Other Climate-Related Shocks (IMF).* ### 1. Impact of Drought and Other Climate-Related Shocks _________________________________________ 6 ### 1. Impact of Drought and Other Climate-Related Shocks ### Context - Zambia is facing slowing growth and acute vulnerabilities driven by a protracted fall in copper prices and severe droughts in 2015/2016 and 2018/2019 that constrained hydropower electricity generation and lowered agriculture output. - An expansionary fiscal stance financed by nonconcessional borrowing and domestic expenditure arrears has resulted in a rapid increase in debt and negative spillovers to the private sector; Eurobond spreads rose to 1,575 in early June. - Presidential elections are due in 2021; the Patriotic Front Party has pursued the development strategy in Vision 2030 and the Seventh National Development Plan (7NDP), emphasizing a significant ramping up of infrastructure spending. - Poverty and inequality are high: unemployment stood at 12.5 percent at the end of 2018; Zambia hosts over 70,000 refugees from neighboring countries. - Implementation of past IMF policy advice has been limited; approval of the Public Finance Management Act in 2018 is a step forward but accompanying legislation (e.g., the Planning & Budgeting Act and the Loans and Guarantees Act) remains pending. - The Bank of Zambia (BoZ) has strengthened the monetary policy framework and reformed regulatory, supervision, and crisis frameworks, though enforcement has lagged. ### Recent economic developments - Growth and activity - Growth rose to 3.7 percent in 2018 from 3.5 percent in 2017, driven by telecommunications, financial and insurance activities, wholesale and retail trade, and mining; agriculture’s contribution was negative. - Public investment ramped up, but low efficiency, high import content, and a build-up of public sector expenditure arrears muted growth effects. - Inflation and monetary policy - The kwacha depreciated by 20 percent in 2018, mostly in September. - Year-on-year inflation hovered around the upper end of the BoZ’s target band (6–8 percent) in late 2018, rising to 8.1 percent in May 2019. - The Monetary Policy Committee increased the policy rate by 50 basis points to 10.25 percent at its May meeting. - Fiscal developments - Revenues performed strongly in 2018, but the deficit rose to above 10½ percent of GDP due to further increases in public investment and a rising interest bill. - Foreign-financed capital expenditure exceeded budget targets by 3½ percentage points of GDP in 2018 despite a moratorium for projects less than 80 percent completed. - Interest payments reached almost 20 percent of total spending. - Accumulation of about 1½ percent of GDP in domestic arrears and almost 1 percent of GDP in audited but unpaid VAT refund claims occurred; the cash deficit widened to 8.3 percent of GDP from 7.7 percent in 2017. - Domestic debt market and financial conditions - Treasury securities auctions were regularly undersubscribed starting mid-2018; yields reached around 20 percent on T-bills and government bonds in September 2018. - The government repaid 1.9 billion Kwacha (0.6 percent of GDP) on a net basis by not rolling over the full amount of maturing treasury bills in 2018. - Private placements raised around 4.2 billion Kwacha, including about 2 billion Kwacha from NAPSA and the remaining amount from commercial banks. - Lending rates remained elevated; from early 2017 to March 2018 the monetary policy rate and the statutory reserve ratio (SRR) were progressively lowered by a cumulative 450 bps and 1000 bps respectively prior to the 2019 policy rate increase. - The stock of domestic expenditure arrears was K15.6 billion (5½ percent of GDP) at end-2018. - The September 2018 increase in credit to the private sector reflected exchange rate depreciation and the high share of foreign currency denominated loans in total loans (around 40 percent at end-2018); credit in domestic currency increased by 3 percent in real terms. - Sovereign–financial nexus - High levels of domestic arrears are exerting pressure on private sector creditworthiness, slowing the decline in NPLs and holding back credit growth and private sector activity. - Recent delays in remitting pension contributions and payroll-based deductions for civil servants’ loan repayments could increase liquidity pressures and boost NPLs at micro-financial institutions (MFIs). ### Impact of drought and other climate-related shocks (Box 1) - Agricultural production and food security - The drought hitting southern Africa impacted southern and western Zambia; flash floods occurred in the north. - Agricultural activity contracted by 21 percent in 2018. - The Crop Forecast Survey projects a 16 percent drop in agricultural production for the October 2018–April 2019 growing season. - With drought affecting Lusaka and Central provinces (about one-third of national maize output), production of the principal food staple in 2019 is estimated to be roughly 55 percent of 2017 levels. - Estimated Maize Production (million MT): 2017: 3.61; 2018: 2.39; 2019: 2.00. - Hydroelectricity and load-shedding - The power deficit is projected to average roughly 13 percent of Q2–Q4 average load. - ZESCO began implementing four hours of daily load-shedding in early June. - Limited regional supply for electricity import and ZESCO’s financial weakness may complicate the response. - Vulnerable populations and humanitarian needs - The vast majority of the rural population depends on agriculture (directly or indirectly more than 50 percent of total employment) while agriculture contributes under 10 percent of GDP. - Rural poverty is high at 77 percent. - The World Food Program estimates as many as 1.3 million people may require humanitarian assistance between July 2019 and February 2020 due to reduced incomes and higher food prices. - Government response and resilience-building - Short-term response centered on the Food Reserve Agency (FRA); maize exports have been banned. - Authorities expect current maize stocks to be adequate for food security in 2019, though past FRA interventions have shown inefficiencies and distributional biases. - Longer-term resilience measures include increased investment in irrigation systems (supported by the World Bank), adoption of new technologies, enhanced farmer education and market information, and projects such as the AfDB climate-resilient livestock management project launched in 2017. ### Public debt and external sector - Public and publicly guaranteed (PPG) debt - The stock of PPG debt reached 78 percent of GDP at end-2018, up from 65.5 percent in 2017; two-thirds is held by foreign creditors. - External debt increased from $9.5 billion (38 percent of GDP) in 2017 to $11.3 billion (48 percent of GDP) in 2018. - External PPG debt service increased from $0.5 billion in 2017 to $0.9 billion in 2018 (21¾ percent of government revenues). - Text Table: Stock of Public and Publicly Guaranteed Debt (2013–18) (billions of U.S. dollars) - Total public debt: 2013: 7.4; 2014: 9.4; 2015: 10.4; 2016: 13.2; 2017: 16.3; 2018: 18.3. - External public debt: 2013: 3.8; 2014: 5.4; 2015: 7.3; 2016: 8.0; 2017: 9.5; 2018: 11.3. - Multi/pluri-laterals: 2013: 1.5; 2014: 1.5; 2015: 1.5; 2016: 1.6; 2017: 1.7; 2018: 1.9. - o.w. IMF: 2013: 0.4; 2014: 0.3; 2015: 0.3; 2016: 0.2; 2017: 0.1; 2018: 0.1. - Bilaterals: 2013: 1.2; 2014: 1.5; 2015: 2.0; 2016: 2.4; 2017: 2.7; 2018: 3.0. - Commercial: 2013: 0.8; 2014: 1.8; 2015: 3.2; 2016: 3.2; 2017: 4.3; 2018: 5.1. - Guarantees: 2013: 0.3; 2014: 0.6; 2015: 0.7; 2016: 0.8; 2017: 0.7; 2018: 1.2. - Domestic public debt: 2013: 3.6; 2014: 4.0; 2015: 3.1; 2016: 5.3; 2017: 6.8; 2018: 7.0. - Treasury bills: 2013: 1.6; 2014: 1.5; 2015: 0.9; 2016: 1.0; 2017: 2.0; 2018: 1.5. - Treasury bonds: 2013: 1.6; 2014: 1.6; 2015: 0.9; 2016: 1.4; 2017: 2.8; 2018: 3.3. - Memo: foreign-held LC debt: 2013: 0.3; 2014: 0.4; 2015: 0.2; 2016: 0.6; 2017: 0.9; 2018: 0.7. - Memo: total public debt to GDP (%): 2013: 27.1; 2014: 36.1; 2015: 62.3; 2016: 60.7; 2017: 65.5; 2018: 78.1. - Note: The PPG debt stock includes outstanding central government direct and guaranteed debt (including budget expenditure arrears), consistent with the authorities’ official debt coverage. The accompanying DSA uses broader coverage and totaled 80¾ percent of GDP at end-2018. - External position and reserves - The current account deficit widened modestly to 2.6 percent of GDP in 2018 owing to higher imports and interest payments despite a recovery in copper exports. - FDI contracted as foreign firms repatriated earnings and new investment remained subdued. - FX reserves declined from 2.4 months of import cover in 2017 to 1.9 months in 2018. - Foreign holdings of local-currency debt are about $0.7 billion (memo figure), or half of FX reserves. ### Outlook and risks - Growth projections and fiscal constraints - Growth is expected to slow to 2.0 percent in 2019 as agriculture and electricity production suffer weather-related shocks, domestic demand remains weak, and mining activity declines somewhat due to lower international copper prices and policy changes in the mining tax regime. - A rebound in agriculture and a moderate recovery in mining activity is projected for 2020, but financing constraints are expected to force disorderly cuts in public expenditures, pushing growth down to 1.5 percent by 2023. - Absent an effective policy adjustment strategy, inflation would remain above the BoZ’s upper band in 2019 and 2020 due to exchange rate pass-through and drought impacts. - External sector risks - The current account deficit is expected to widen in 2019 on lower copper exports and higher imports and interest payments associated with public investment. - FDI and other financial account inflows are expected to remain subdued. - International reserves under the baseline are projected to decline to 1.6 months of imports by end-2019 and to around 1 month of imports by 2021, leaving little buffer for shocks or for redemption of the 2022 Eurobond. - Additional risks stem from foreign holdings of local-currency debt (currently about $0.7 billion). - Overall assessment - The medium-term outlook is clouded by substantial debt vulnerabilities, drought impacts, and subdued mining sector activity; a forced fiscal adjustment is underway given constrained financing and rising debt service. *Source: 1zmbea2019002 - 1. Impact of Drought and Other Climate-Related Shocks (IMF).* ### 15. Risks to the outlook are tilted to the downside (Annex 3). The impact on rural ### 15. Risks to the outlook are tilted to the downside (Annex 3) ### Risks to the outlook - Impact on rural households in regions affected by the drought could be more severe than anticipated, presenting challenges for an effective policy response. - Low water levels could further restrict electricity generation and negatively impact growth prospects. - Drought-related price shocks could further pressure inflation. - Delayed policy adjustment could: - Exacerbate the erosion of consumer and investor confidence. - Result in large capital outflows, exchange rate depreciation, and further tightening of domestic financial conditions. - Increase the debt service burden via a weaker kwacha, further crowding out priority social spending. - Tightened global financing conditions would further complicate rollover of the 2022 Eurobond. - Escalating trade tensions and a slowdown in growth in China could adversely impact copper prices. - The modest recovery anticipated in mining activity in 2020 after a decline in 2019 is subject to uncertainty. ### Authorities’ views - Authorities broadly agreed with staff’s near-term growth and inflation outlook, notably the impact of the drought on 2019 outcomes. - Over the longer term, authorities expected a larger growth pay-off from recent public investments that they consider have significantly increased the country’s growth potential. - Authorities emphasized large investment needs to close the infrastructure gap, especially in rural areas where fast population growth has led to increasing demand for social, health, education, and transportation infrastructure. - Government measures to offset the drought impact cited by authorities include tapping the strategic maize reserve stocks and providing support to farmers. - The decision to begin load shedding was described as a proactive response to the drought. ### Policy discussions — Objectives - Reduce debt-related vulnerabilities. - Preserve macroeconomic stability. - Implement structural reforms to achieve higher and more inclusive growth. ### A. Reducing debt-related vulnerabilities — Findings - Under current policies, public debt is on an unsustainable path (see accompanying DSA). - Total public debt is projected to increase from 78 percent of GDP in 2018 to 91½ percent of GDP in 2019 as the large stock of undisbursed project loans (roughly 40 percent of GDP) continues to disburse. - The debt service burden is expected to rise above 30 percent of government revenues in 2019. - The DSA baseline is characterized by large and protracted breaches of both solvency and liquidity indicators. - Authorities have committed to remain current on their debt obligations and there are no arrears on either external or domestic debt. - The risk of debt distress has increased substantially since the last DSA (October 2017) and is currently assessed to be at a very high level. ### Alternate scenario and policy recommendations - An alternate scenario entails a large upfront and sustained fiscal adjustment to reduce debt-related vulnerabilities and build credibility (Text Table 2). - Key elements of the orderly adjustment: - Frontloaded revenue mobilization. - A moratorium on new external nonconcessional borrowing and guarantees. - Scaled-back capital spending. - Projected outcomes under the alternate scenario: - Debt on a downward trajectory to about 60 percent of GDP by end-2029. - Government able to meet its obligations in a timely manner while allowing adequate resources for priority social spending and arrears repayment. - Near-term trade-offs and expected medium-term benefits: - The adjustment would have a drag on growth in the near-term, but fiscal multipliers are estimated to be low given the limited impact on growth of recent sharp increases in government spending. - Halting accumulation of expenditure arrears should improve domestic liquidity. - With a buildup of credibility, financing conditions should ease and growth would pick up starting in *Source: https://www.imf.org/-/media/files/publications/cr/2019/1zmbea2019002.pdf* ### 2020. Strong and ### 1zmbea2019002 - 2020. Strong and ### Fiscal outlook and required adjustment - Even with implementation of a credible consolidation, downside risks would remain very high and additional efforts could be needed. - 2019 budget aims and outcomes: - The 2019 budget aimed to reduce the deficit to 6½ percent of GDP (commitment basis) by increasing revenues and cutting current and capital expenditures. - Binding financing constraints are forcing a sharper disorderly adjustment. - Financing constraints are expected to hold the cash deficit to 4¾ percent of GDP, but the deficit on a commitment basis would reach close to 9 percent of GDP with weak expenditure controls and continued accumulation of arrears. - Staff recommended path: - Fiscal deficit on a commitment basis of about 6.3 percent of GDP in 2019 (from 10.7 percent of GDP in 2018). - Further consolidation in 2020 to bring the deficit to 3.4 percent of GDP. - Key quantitative fiscal risks and indicators: - Contracted but undisbursed debt equivalent to a further 40 percent of 2018 GDP. - VAT refunds backlog: 4 billion Kwachas (1½ percent of GDP) at end-2018. - NAPSA outstanding amount in April: 1.1 billion Kwacha (450 million in delayed contributions and 650 million in penalties). - Expected windfall from proposed sales tax: up to 2 percent of GDP annually. - Scenario objective: build reserves to about 2½ months of imports by 2023 (this assumes no additional IFI support). ### Budget composition, revenue and proposed tax changes - 2019 budget measures: - Proposed replacement of the VAT with a dual-rate sales tax (9 percent on domestic goods; 16 percent on imports). - Sales tax envisaged as hybrid levied at every stage of production, exemptions for production inputs, and no scope to claim refunds. - Authorities estimate windfalls up to 2 percent of GDP from the sales tax introduction. - Staff advice on tax policy: - Carefully consider pros and cons of moving away from VAT, including risks of cascading, complexity, and discretion through exemptions and preferences. - If transition to sales tax proceeds, contain exemptions and estimate their fiscal impact. - Raise tax revenues to 16 percent of GDP in 2020 through broadening the tax base, reducing tax expenditures and exemptions, strengthening compliance, simplifying the tax system, and enhancing tax audit capacity. ### Recommended fiscal adjustment measures (targeted elements) - Key elements to achieve consolidation and protect priority spending: - End uncertainty about the tax regime and raise revenues to 16 percent of GDP in 2020. - Introduce a moratorium on new non-concessional external borrowing and guarantees. - Significantly lower public investment spending; prioritize high-return projects. - Ensure adequate space for priority social spending, including on goods and services. - Halt accumulation of domestic arrears and gradually clear the existing stock. - Restrict new recruitments to essential personnel (health, education and police); continue efforts to identify ghost workers. - Update the Medium-Term Expenditure Framework (MTEF) to align with a strategy to reduce fiscal imbalances. - Composition of recommended adjustment (percent of GDP) from Text Table 5: - Contribution of revenue: Total domestic revenue increase 0.6 percent of GDP (from 18.9 in 2018 to 19.5 in 2019). - Contribution of expenditures: Capital spending reduction 3.5 percent of GDP (from 8.6 in 2018 to 5.1 in 2019). - Clearance of arrears: VAT refunds backlog contribution 0.5 percent of GDP. ### Public financial management (PFM) strengthening - Recent legal and institutional steps: - Public Finance Management Act enacted in April 2018. - Development of a Public Investment Management System expected to begin operating in 2020. - Establishment of a Public Investment Board (PIB) to review and decide on new capital projects. - Staff recommendations to improve PFM and budget execution: - Move to early quarterly budget releases to prevent purchase orders outside IFMIS and introduce IFMIS functionality to restrict line ministries’ monthly payments to a cash limit. - For expenses not covered by IFMIS commitment controls (wages, utilities), reconcile payroll and HR system data; introduce pre-paid meters and vouchers for utility and rent payments. - Improve public investment efficiency: vetting and ex ante appraisal of domestically-financed projects; strengthen procurement processes. - Establish a small unit in the Ministry of Finance to monitor and mitigate risks related to the 5–10 largest capital expenditure projects. - Authorities’ actions: - Cabinet measures announced to contain and better control spending: indefinitely postponing contraction of new non-concessional loans; cancelling some committed but undisbursed loans; increasing control and management of disbursements on foreign-financed loans. ### Debt management and market development - Key priorities and measures: - Strengthen management over the large stock of contracted but undisbursed debt to prioritize projects and pace execution. - Close monitoring of portfolio risks given rapidly rising external debt payments and approaching Eurobond maturities. - Improve monthly cash flow forecasts to increase flexibility in domestic debt auctions. - Manage SOE debt (guaranteed and nonguaranteed) more systematically to monitor fiscal risks. - Domestic market development: - BoZ planned launch of a Primary Dealership System (PDS) later in the year to ensure demand and liquidity for benchmark bonds. - Handling fee on government securities lowered to 1 percent from 2 percent to encourage market transactions. - BoZ has been buying government bonds in the secondary market to provide a backstop facility. - Authorities’ engagement on debt: - Engaged in discussions with a bilateral creditor on voluntary debt reprofiling and possibility of servicing debt in the lenders’ national currency. ### Monetary policy, reserves, and inflation - BoZ policy framework and actions: - Strengthened monetary policy framework; narrowed policy rate corridor; increased use of open market operations (OMOs); announced clear inflation targets largely observed. - BoZ developing a forecasting and policy analysis system (FPAS) with Fund TA. - Recent policy move: - Policy rate raised by 50 bps to 10.25 percent in May; MPC emphasized countering inflationary pressures and supporting macroeconomic stability. - Reserve and inflation context: - Reserves at 1.7 months of imports (noted as modest compared to public debt service needs). - Staff view: some further tightening warranted to keep forward-looking real rates positive and support reserve accumulation. - Staff advice: monetary policy effectiveness would be higher if accompanied by a large and upfront fiscal consolidation. - Authorities’ view: - Committed to flexible exchange rate policy and bolstering reserves; believe reserves will be higher than staff projections. ### Financial stability and supervision - Progress and vulnerabilities: - BoZ has upgraded institutional, regulatory, supervision and crisis management frameworks consistent with 2017 FSAP recommendations. - Revised 2017 Banking and Financial Service Act (BFSA) and amended draft BoZ Act address BoZ operational independence, Basel II/III standards and licensing. - Revised AML/CFT framework and consideration of a deposit insurance scheme (with Fund TA). - Key risks and supervision priorities: - Strong nexus between the financial sector and the sovereign could keep NPLs above Zambia’s 10 percent prudential benchmark. - Commercial banks’ foreign currency liabilities were roughly 47 percent of total liabilities at end-2018, raising dollarization risks. - Staff advised completing staffing and training of the supervision department, enhancing crisis preparedness and management, prioritizing on-site inspections based on risk assessment, and focusing on high-priority risks and functions. - Authorities’ view: - Agreed on improving supervisory capacity by filling vacancies and prioritizing capacity building. ### Growth, agriculture, electricity, and inclusiveness - Structural and social context: - Water resources: 6,000 cubic meters per inhabitant. - Only 14 percent of arable land is under cultivation. - Electricity access rate: 31 percent. - Rural poverty concentration: 77 percent of the population live in poverty in rural areas. - Agriculture sector recommendations: - Build resiliency to climate shocks; improve targeting of Farmer Input Support Programme (FISP) to poor and small-scale farms; establish more stable maize market regulation. - Electricity sector recommendations: - Complete cost of service study and advance tariff reforms. - Protect vulnerable groups given current subsidy distribution (richest decile receive 64 percent of electricity subsidies; poorest half receive 1.5 percent). - Expected increase in electricity generation capacity by end-2020: roughly 25 percent of current capacity from the Kafue Gorge Lower plant. - Business climate and governance: - Need steady focus on business climate to revive private investment. - Governance indicators close to SSA average but have deteriorated recently. - FIC reporting of suspicious activities related to tax evasion, corruption and procurement increased in 2017–2018. - Recent Public Financial Management Act expected to improve procurement transparency and accountability. ### Capacity development, statistics, and data - IMF CD priorities: - Support fiscal consolidation, budget preparation and execution, medium-term macro-fiscal framework, debt management reform, BoZ capacity in bank supervision, systemic risk analysis, and financial crisis management. - CD on national accounts and price statistics; GDP rebasing work begun but likely delayed beyond end-2019. - Data adequacy: - Data provision broadly adequate for surveillance but with shortcomings in national accounts and reconciliation of fiscal outturns between fiscal reports and government accounts in monetary statistics. ### Staff appraisal — summary conclusions - Zambia faces a difficult macroeconomic environment driven by drought, growth slowdown, and large fiscal deficits financed through non-concessional borrowing. - On current policies, public debt is on an unsustainable path and financing constraints are forcing a disorderly fiscal adjustment; the risk of debt distress has increased substantially. - There is a narrow window for an orderly, large front-loaded and sustained fiscal adjustment to reduce debt vulnerabilities while protecting priority social spending. - Key policy priorities: - Urgent fiscal consolidation with revenue mobilization and expenditure prioritization. - Strengthen PFM, public investment efficiency, and debt management. - Monetary tightening to keep real rates positive and support reserve accumulation, accompanied by fiscal reorientation. - Strengthen banking supervision and crisis preparedness; contain arrears to prevent financial sector stress. - Promote inclusive growth via agricultural resilience, electricity sector reforms, and improved governance. *Source: 1zmbea2019002 - 2020. Strong and* ### Section 2(a) (see Informational Annex). Staff does not recommend approval, as there is no ### 1zmbea2019002 - Section 2(a) (see Informational Annex). Staff does not recommend approval, as there is no ### Staff recommendation - Staff does not recommend approval, as there is no timetable for its removal. - Staff recommends that the next Article IV consultation be held on the standard 12-month cycle. ### Recent developments - Growth has slowed in recent years. Services and industry are the main sources of growth. - The 2015/2016 commodity price shock drove a spike in inflation and a sharp depreciation of the kwacha. - Inflation has crept up in recent months due to kwacha depreciation and increases in food and fuel prices. ### Fiscal developments (high‑level findings) - Fiscal imbalances have been driven by spending overruns. - The wage bill, rising interest payments (other) and public investment dominate government spending. - The 2018 deficit (cash basis) was mainly financed by external resources, unlike the 2016–2017 deficits. - Public debt has risen rapidly pushed by external debt and depreciation and the accumulation of domestic arrears. - Accumulation of domestic arrears and backlog of VAT refunds are significant. Key fiscal ratios and indicators (as presented) - Revenue18.217.519.119.419.719.819.819.719.719.720.020.220.620.720.7 - Expenditure23.925.027.424.224.823.322.922.622.424.124.023.623.623.523.3 - Net lending/borrowing (cash basis)-5.7-7.7-8.3-4.8-5.1-3.4-3.1-2.9-2.6-4.3-4.0-3.4-3.0-2.7-2.6 - Primary balance (cash basis)-2.7-3.7-3.60.20.11.92.42.93.20.00.71.21.41.61.4 - Stock of domestic debt, gross24.127.330.031.729.828.526.825.223.832.332.432.131.129.327.4 - Stock of external debt, gross36.638.248.159.965.669.570.871.571.352.252.752.350.549.147.4 - Total public debt60.765.578.191.695.598.097.696.795.184.685.084.481.678.474.8 Selected fiscal flows (millions of kwacha, as presented) - Revenue39,41043,03253,44960,80668,94976,28483,83691,616100,25960,45866,82373,75881,82290,28699,415 - Expenditure51,71361,50076,50575,76286,76389,56797,124104,907113,62373,72880,23686,15993,914102,243111,857 - Net acquisition of nonfinancial assets8,15713,65823,93623,00629,26126,39727,44728,48431,06315,51216,38817,49418,92820,43123,388 - Net lending/borrowing (overall balance, cash basis)-13,177-18,993-23,056-14,956-17,814-13,283-13,288-13,291-13,364-13,269-13,413-12,400-12,092-11,957-12,442 ### External sector (high‑level findings) - Exports will moderate with lower copper prices. - Non‑oil imports have picked up since 2017 with increasing public investment as a main driver. - Since 2015, the current account has moved into deficit on lower trade surpluses. - FDI inflows have declined. - Official reserves import coverage has declined; stock of reserves has fallen. Selected external sector indicators (as presented) - Current account (millions of U.S. dollars): -685-435-708-851-792-686-616-560-489-910-822-665-574-534-489 - Current account (percent of GDP): -3.3-1.7-2.6-3.6-3.4-2.9-2.6-2.3-2.0-3.7-3.2-2.4-2.0-1.8-1.5 - Trade balance (millions of U.S. dollars): 2389605144177158891,0251,1561,2304288111,0021,1401,2561,344 - Exports, f.o.b. (millions of U.S. dollars): 6,5358,2169,0298,5398,7039,0299,3699,71710,0678,5248,8249,1919,60310,11810,715 - Of which: copper (millions of U.S. dollars): 4,3996,1196,6586,0536,1076,2846,5216,7546,8816,0536,1076,3466,6497,0207,454 - Imports, f.o.b. (millions of U.S. dollars): -6,296-7,255-8,515-8,122-7,987-8,140-8,344-8,561-8,837-8,096-8,013-8,189-8,463-8,861-9,371 - Gross international reserves (millions of U.S. dollars): 2,3662,0811,5691,2851,0227665084904731,5871,7512,0202,1172,3282,475 - In months of prospective imports: 3.3 2.4 1.9 1.6 1.3 0.9 0.6 0.6 0.5 2.0 2.1 2.4 2.4 2.5 2.5 ### Monetary and financial developments (high‑level findings) - The policy rate, interbank rates, and money market rates fluctuated during 2015–19; data indicate use of a 2 percent corridor and an active interbank market. - Of ficial reserves import coverage has declined and reserve money and broad money trends show periods of contraction and expansion. - Bank credit growth (year‑on‑year percent change) shows a recovery in later projections. Selected monetary aggregates and indicators (as presented) - Broad money (M3)44,56754,08562,99770,52378,27886,16095,675105,926117,01270,34877,60185,54494,577104,977116,764 - Reserve money (end‑of‑period, annual percent change)12.8-25.6-0.610.313.411.011.911.610.511.514.112.612.913.411.2 - Credit to the private sector (annual percent change)-9.45.216.77.57.97.96.26.97.110.113.113.014.414.412.5 - Credit to the private sector (percent of GDP)12.111.211.511.010.610.410.19.89.611.512.012.413.013.613.9 - Gross foreign exchange reserves of the Bank of Zambia (millions of U.S. dollars) 2,3662,0811,5691,2851,0227665084904731,5871,7512,0202,1172,3282,475 ### Selected projections and macro aggregates (from tables) - GDP growth at constant prices3.83.53.72.01.71.71.61.51.51.61.92.12.42.83.3 - GDP at market prices (millions of USD)20,94125,86826,72023,94623,34223,41523,63623,95124,40124,91425,87427,13728,58730,25132,119 - Consumer prices (average)17.96.67.09.910.08.08.08.08.08.78.57.37.07.07.0 ### Financial soundness (high‑level findings) - Capital adequacy ratios remain elevated historically: Regulatory capital to risk‑weighted assets and Tier 1 ratios show high levels across 2008–18. - Asset quality: Past due advances (NPL) to total advances rose to double digits in 2016–18. - Liquidity indicators: Liquid assets to total assets and to total deposits increased in 2017–18. - Exposure to foreign currency: Foreign currency loans to total gross loans and foreign currency liabilities to total liabilities show significant foreign currency exposure, with foreign currency loans to total gross loans reaching 44.5 percent in 2018. Selected financial soundness indicators (as presented) - Regulatory capital to risk-weighted assets: 18.6 22.3 22.1 19.2 21.3 26.8 27.0 21.2 26.2 26.5 22.1 - Past due advances (NPL) to total advances: 7.2 12.6 14.8 10.4 8.1 7.0 6.1 7.3 9.7 11.5 11.0 - Loan loss provisions to nonperforming loans: 104.6 86.6 80.3 76.7 73.5 83.2 76.5 70.5 71.5 69.2 86.4 - Liquid assets to total assets: 35.5 38.0 43.8 40.3 36.0 38.9 35.8 34.8 39.1 45.5 47.0 - Foreign currency loans to total gross loans: 42.1 36.4 32.8 39.1 28.7 25.6 29.0 36.9 35.7 41.6 44.5 - Net open position in foreign exchange to capital: 6.9 2.5 4.1 5.5 2.8 3.6 1.6 4.7 0.8 1.4 1.7 *1zmbea2019002 - Section 2(a) (see Informational Annex).* ### Annex I. Main Recommendations of the 2017 Article IV ### Annex I. Main Recommendations of the 2017 Article IV Consultation and FSAP ### Fiscal Policy: recommendations and implementation status - Debt sustainability - Recommendation: Lower the debt level, including by restraining external non-concessional borrowing, in order to move from high to moderate risk of debt distress rating. - Status: Not implemented. The debt stock increased by about 10 percent of GDP in 2018 and DSA continues to show a high risk of debt distress. - Fiscal consolidation - Recommendation: Reduce the overall fiscal deficit. - Status: Not implemented. The fiscal deficit widened significantly as there were large spending overruns on capital outlays, compounded by continued arrears on VAT refunds and suppliers’ credits. - Revenue mobilization - Recommendation: Increase domestic revenues by broadening VAT and CIT tax base, introduce land titling, reducing widespread exemptions/incentives. - Status: Not implemented. - Fuel prices - Recommendation: Recover importation and procurement costs in the supply value chain and reflect changes in international prices and the exchange rate. - Status: Implemented. The Energy Regulatory Board has been reviewing fuel prices every sixty days and has changed the fuel prices when needed to recover procurement costs. - Public investment management - Recommendation: Prioritize infrastructure projects in line with absorptive capacity by setting up an institutional framework for approval of public investment projects, including for large projects. - Status: Not implemented. The government has continued to approve public investment projects without implementing a proper framework for coordinating and managing the identification, preparation, appraisal and implementation of public investment projects to ensure efficiency and value for money. - Public Financial Management (PFM) - Recommendation: 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. - Status: Partially implemented. IFMIS was rolled out. However, purchase orders on goods and services are issued outside IFMIS, and expenditure overshooting and arrears accumulation point to weak expenditure controls. There remain a large number of accounts and significant balances outside the TSA (1-2 percent of GDP) held at commercial banks by government entities. - PFM legislation - Recommendation: Improve transparency and credibility of fiscal policy. - Status: Ongoing. The approval in April 2018 of the new Public Finance Management Act needs to be complemented by approving other critical legislation such as the Planning and Budgeting Bill, the revisions to Loan and Guarantees Act, and the Public Procurement Act. ### Monetary and financial sector policies: recommendations and status - Monetary policy stance - Recommendation: Maintain a relatively tight monetary policy stance and rebuild reserves buffers. - Status: Partially implemented. BoZ kept its tight monetary stance in 2017, but started unwinding its stance in 2018, in line with reduced inflationary pressures. Reserves have continued to decline, largely reflecting higher external debt payments and a widening current account balance. In May 2019, the BoZ increased its policy rate to 10.25 percent. - Monetary policy framework - Recommendation: Grant BoZ formal operational independence to pursue price stability as its primary mandate by amending the BoZ Act. - Status: Ongoing. The amended draft BoZ Act addresses issues related to operational independence of the BoZ and is currently with the Ministry of Finance. - Bank supervision - Recommendation: Strengthen banking supervision capacity and enhance its crisis preparedness. - Status: See FSAP section for detailed actions and progress. ### Energy sector - Cost of Service Study (COSS) - Recommendation: Finalize the energy sector Cost of Service Study. - Status: Not implemented. Government enacted an interim electric tariff increase of 75 percent for 2017 and initiated a COSS in May 2017 to inform the next adjustment to attain full cost recovery. The COSS has not yet been completed. A ZESCO-proposed tariff increase was declined in May. ### Main recommendations from the 2017 FSAP: implementation status - Legal and regulatory framework - Recommendation: Upgrade the BoZ and Banking (BFSA) 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. - Status: In progress. The new BFSA and the amended draft BoZ Act address issues related to operational independence, Basel II/III standards, and licensing. The BFSA has been streamlined and the BoZ is currently working on a number of regulations to operationalize the Act. - Onsite inspections and asset quality review - Recommendation: Complete onsite inspections of all banks and nonbanks and conduct an asset quality review that focuses on the loan classification process. - Status: Largely completed. All banks except three (accounting for 4.7 percent of total banking sector assets) and 60 percent of NBFIs have been examined and asset quality review completed. - Risk-based supervision and data systems - Recommendation: Introduce a regular cycle of onsite inspections on a risk basis, informed by offsite analysis. - Status: In Progress. - Recommendation: Implement a centralized, structured, relational database for banking supervision and stress testing. - Status: Completed. The Bank supervision system is currently in use as a centralized data base system for the Banking and Supervision Department. - Staffing and capacity - Recommendation: Urgently increase staff resources, in number and expertise, in an orderly and manageable fashion. - Status: Largely completed. Several new staff have already been added and recruitment is underway for a few vacant positions. Priority is being given to capacity building. - Consolidated supervision and cross-border cooperation - Recommendation: Introduce a consolidated supervision regime and BoZ implement the new risk-based approach to onsite supervision. - Status: In Progress. - 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. - Status: In Progress. The BoZ has started to engage the home regulators on resolution plans for parent banks by ensuring that it is part of the agenda items for Supervisory Colleges. - Risk management and AML/CFT - Recommendation: Issue risk management directives incorporating concentration and cross-border exposure limits. - Status: In progress. Draft to be issued soon. - Recommendation: Strengthen the Anti-Money Laundering/Combatting the Financing of Terrorism (AML/CFT) legal framework and terrorist financing offense, in line with the Financial Action Task Force (FATF) standards. - Status: In 2017, the BoZ revised and strengthened the AML/CFT legal framework and subsequently issued directives which apply to all reporting entities licensed or designated by the BoZ. - Emergency liquidity assistance (ELA) and resolution - Recommendation: Stipulate exceptional nature of ELA in regulatory texts and establish adequate statutory safeguards to prevent the BoZ from providing solvency support. - Status: In progress. The BoZ Act is undergoing review. - Recommendation: Include purchase and assumption, bridge bank, and bail-in resolution provisions in new BFSA. - Status: Largely implemented. Other than bail-in, the proposed resolution recommendations have been addressed in the 2017 BFSA. However, a request has been made to amend the 2017 BFSA to enable the above measures to be affected without BoZ taking possession of the bank. - Deposit Insurance Scheme (DIS) - Recommendation: Refine Draft Deposit Protection Scheme (DIS) Bill in line with IADI norms and introduce DIS law only once the preconditions for deposit protection are fully in place. - Status: In progress. The BoZ is working on a problem bank resolution regime to deal with banks with supervisory weaknesses and strengthen their performance, as precondition for deposit protection. A Draft problem bank management and resolution framework has been developed and is expected to be finalized before end-2019. *Source: Annex I. Main Recommendations of the 2017 Article IV Consultation and FSAP, IMF.* ### Annex II. External Sector Assessment ### Summary assessment - Staff assessment: External position is moderately weaker than fundamentals and desirable policies based on the deteriorated external balance sheet driven by the buildup of public debt. - Policy implication: A steadfast fiscal adjustment, accompanied by ongoing reforms to improve structural competitiveness, is needed to strengthen external positions going forward and address underlying causes of external imbalances. ### External balance sheet: key findings - Net international investment position (NIIP) - Zambia has been a net debtor since 2011; NIIP registered –106 percent of GDP at end-June 2018 (latest available official statistics). - NIIP composition at end-June 2018: 27 percent of GDP in foreign assets and 134 percent of GDP in foreign liabilities, largely FDI liabilities (76 percent of GDP) and foreign borrowing of the public sector. - Sectoral shift: rapidly increasing public sector external indebtedness replacing private sector foreign liabilities. - Implication: Large negative NIIP poses significant risk to external sustainability and points to need for current account adjustment. Stabilizing NIIP at end-June 2018 level (–106 percent of GDP) would require a real effective exchange rate adjustment over the medium-term assuming no policy adjustment; stabilizing at a lower level (e.g., 2011-14 average of –58 percent of GDP) would imply a larger REER adjustment. - Caveat: Assessment sensitive to assumptions on rates of return on foreign assets and liabilities given scarce data. ### Current account: recent developments and outlook - 2018 outcome: Current account deficit registered 2.6 percent of GDP in 2018. - Drivers: - Copper prices declined during 2018; oil prices broadly unchanged on average -> deteriorated terms of trade. - Rising interest payments on public debt. - Elevated non-oil imports, including imports related to large foreign-financed public investment projects. - Outlook: Current account expected to widen again in 2019 absent policy change before gradually declining as large project-related imports unwind and arrears compression contributes to import compression. - EBA-lite CA approach: - Desirable fiscal policy stance assumed to be -2.2 percent of GDP over the medium-term. - Cyclically adjusted CA norm estimated at -2.9 percent of GDP and an insignificant CA gap of -0.2 percent of GDP in 2018. - Offsetting policy gaps (subdued private credit growth, impaired social safety net proxied by public health expenditure) partly offset fiscal imbalances, explaining broad alignment of CA with fundamentals and desirable policies. - Risk: To rebuild FX reserves (currently well below adequate) against subdued capital inflows absent major change in sentiment, the external position needs to be strengthened; under current policies external imbalances projected to further widen in near-term. ### Real exchange rate (REER) and nominal exchange rate developments - Exchange rate events: - Large exchange rate depreciation of 20 percent against the U.S. dollar in September 2018, reflecting widened fiscal imbalances, deteriorated terms of trade, and confidence effects after sovereign rating downgrades. - Currency stabilized toward end-2018 but weakened further in spring 2019. - Central bank response: Unlike 2014/15 episode, Bank of Zambia did not intervene or tighten monetary stance in response to September 2018 depreciation; BoZ did engage in opportunistic FX purchases and instructed mines to pay mineral royalty directly to the central bank in foreign currency. - REER model results: - EBA-lite REER approach suggests REER roughly 5 percent lower than its equilibrium value at end-2018 (within the 95 percent confidence interval). - Staff estimate of the real interest rate consistent with inflation and output stabilization needs: 3½ percent for Zambia (current difference between policy rate and inflation is about 2¾ percent). - REER found broadly in line with copper price developments. ### Reserves: adequacy and trends - Reserve levels and trends: - International reserves at US$1.4 billion, providing 1¾ month import cover. - Reserves declined by more than $500 million in 2018 and a further $200 million between January and May 2019. - Reserves provide just about a full year coverage of external debt payments. - Reserves coverage relative to broad money: 80 percent. - Non-resident holdings of domestic currency debt: about $670 million (increased rapidly during 2016-17), now susceptible to reversal. - Adequacy assessment: - Current reserves well below levels of several peers and below commonly cited adequacy benchmarks for countries with high export concentration. - Fund staff cost-benefit analysis for low-income countries suggests an optimal reserves range of 3½-4 months of current year’s imports. - Policy implication: Given heavy reliance on copper exports and volatility risk, a higher reserves buffer than the three-month rule may be needed; rebuilding reserves requires strengthening external position and addressing fiscal and balance sheet pressures. *Source: Annex II. External Sector Assessment, IMF.* ### 9. Zambia’s exports are heavily ### 9. Zambia’s exports are heavily concentrated ### Export structure and vulnerabilities - Exports concentration index (UNCTAD) indicates Zambia’s exports are much less diversified than the average Sub-Saharan Africa level. - Copper exports represent around 70 percent of the total exports, making exports highly vulnerable to fluctuations in copper price. - Exports of agricultural products account for most of the remainder (over 20 percent of all exports). ### Implications and recommended structural reforms - Findings: - High export concentration raises vulnerability to external shocks, notably copper price and global demand swings. - Agricultural exports (notably maize) provide potential for diversification given regional demand-side dynamics. - Policy recommendations: - Develop and modernize agriculture to enhance exports and benefit the maize sector. - Establish a more stable and predictible regulation on maize exports by improving the regulation of maize exports and limiting the role of the Food Reserve Agency in the marketing of maize to attract private investors. - Reallocate savings from better management of farm subsidy programs to invest in measures to enhance crop yields and long-term competitiveness. ### Business climate and competitiveness - Recent reforms and outcomes: - Reforms have improved the underlying framework for business in several areas and set a sound basis for improving structural competitiveness with resolution of current pressures. - Notable improvements were registered in Zambia’s Doing Business Indicators in recent years; for 2019, Zambia ranks higher on Overall Ease of Doing Business than the Sub-Saharan Africa (SSA) average and the SSA Low-Income Developing Countries Frontier Markets (SSA-LIDC FM) average. - Earlier reforms helped improve frameworks for credit access and tax payment. - Remaining weaknesses (areas to address): - Trading across borders, registering property, and enforcing contracts. - Perceived main constraints to doing business (World Economic Forum Global Competitiveness, 2017–2018): access to financing, corruption and tax rates. - Specific reform measures undertaken or proposed: - Access to credit: use of moveable collateral to access finance. - Tax payments: introduction of an online platform for filling and paying taxes. - Trading: implementation of a web-based data management system. - Contract enforcement: online availability of commercial matters judgements at the appellate and supreme court levels. - Improve efficiency in the petroleum product procurement system to cut fuel cost and enhance competitiveness. - In mining, establish a mining tax regime in line with international best practices. ### Expected impact if business climate improves - With resolution of current uncertainties, improvement in the business climate will boost competitiveness and attract investment. --- ### Annex III — Risk Assessment Matrix: key domestic and external risks, likelihood, impacts and policy responses ### Major domestic risks, likelihood and impact - Delayed/insufficient fiscal adjustment particularly ahead of elections. - Relative Likelihood: H - Impact if realized: H. Continued accumulation of domestic arrears would increase stress on the financial sector through higher NPLs; hamper private sector activity; increase domestic refinancing risks; hurt revenue collection (uncertainty over VAT status and refunds); weaken incentives for new investment; slow down FDI inflows; non-resident exit from domestic securities market would adversely impact reserves and further pressure the exchange rate; debt sustainability jeopardized; significant downward pressures on growth. - Policy response: Implement credible fiscal adjustment measures; remove unnecessary exemptions to widen the tax base and increase domestic revenue; consolidate capital expenditures by prioritizing infrastructure projects and postponing those with less growth impact; reduce public sector wage bill by restricting new hires to priority sectors. - Continued drought. - Relative Likelihood: M - Impact if realized: H. Adverse impact on agriculture and the poor; higher food price inflation; reduced agricultural exports (maize); higher spending on social safety nets and on subsidies (Farmer Input Support Program); negative impact on hydropower generation; downward pressures on growth. - Policy response: Provide effective support to vulnerable populations; diversify food crops away from maize; consider medium-term strategies such as reservoir dam to regulate water flow to main dams; tighten monetary policy if second-round inflationary effects are significant. - Rising social tensions. - Relative Likelihood: M - Impact if realized: M. Public sector salary arrears could result in strikes; negative impact on investor confidence. - Policy response: Implement orderly fiscal adjustment to avoid arrears; set up arrears clearance plan. ### Major external risks, likelihood and impact - Sharp tightening of global financial conditions. - Relative Likelihood: H - Impact if realized: H. Higher external debt service and refinancing costs; loss of reserves; pressure on the kwacha; worsening debt position. - Policy response: Implement fiscal consolidation measures (increase domestic revenue, cut unproductive spending, prioritize capital spending); rebuild fiscal and external buffers. - Weaker-than-expected global growth (China, EU risks described). - Relative Likelihood: M/H - Impact if realized: H. Reduced demand for Zambia’s exports notably copper, widening trade deficit, loss of foreign reserves, increased pressure on the kwacha; negative impact on debt sustainability. - Policy response: Accelerate reforms to enhance export competitiveness and diversify the economy; enhance regional integration (SADC, AfCFTA); maintain exchange rate flexibility; implement fiscal adjustment to rebuild buffers. - Rising protectionism and retreat from multilateralism; escalating trade tensions. - Relative Likelihood: H - Impact if realized: H. Reduced demand for copper exports; widening trade deficit; loss of reserves; increased pressure on kwacha; negative impact on debt sustainability. - Policy response: Accelerate reforms to diversify the economy; maintain exchange rate flexibility; implement fiscal consolidation to rebuild buffers. - Volatility in global copper prices. - Relative Likelihood: M - Impact if realized: H. Lower export earnings and increased pressure on the exchange rate. - Policy response: Accelerate reforms to diversify the economy; maintain exchange rate flexibility. - Spillovers of the regional security situation. - Relative Likelihood: H - Impact if realized: H. Inflow of displaced population/refugees and higher security and humanitarian costs. - Policy response: Prepare contingency plans for refugee influx in coordination with UNHCR and other humanitarian agencies. --- ### Annex IV — Macro-Financial linkages and financial sector overview ### Financial sector structure and key quantitative features - Sector composition: - 18 registered commercial banks account for about 70 percent of total financial sector assets; the majority are foreign-owned. - The non-bank financial institutions (NBFIs) sector is dominated by National Pension Scheme Authority (NAPSA) which accounts for around 75 percent of NBFI assets. - NAPSA has a growing pool of assets (around 30 billion Kwacha at end-2018). - Other NBFIs: 35 MFIs, 80 bureaux de change, some building societies, leasing companies and development finance institutions. - Placements abroad: - On average, placements abroad constitute about half of the total liquid assets of commercial banks. - Commercial banks’ holdings of government securities: - Commercial banks’ total holdings of government securities increased to around 25 percent of assets in 2018 but have been declining more recently. - Most holdings by commercial banks are shorter maturity instruments (T-bill) yielding an annual real yield of around 10-15 percent. - Private sector credit: - Private sector credit declined from 15¾ percent of GDP in 2015 to around 11½ percent in 2018. - Credit remains concentrated in personal loans and the agricultural sector. - Financial inclusion: - 59 percent of adults make use of financial services (formal or informal). - Around 38 percent of adults have a formal transaction account. - Financing for SMEs remains extremely challenging; access to loans by firms in Zambia remains one of the lowest amongst SADC countries. ### Financial sector stability, vulnerabilities and indicators - Overall assessment: - Financial conditions and performance of the banking sector remain broadly resilient, but stress is emerging. - Capital adequacy ratios have decreased since last year but remain well above minimum prudential requirement of 5 percent (primary) and 10 percent (total regulatory capital). - Earnings performance has been improving. - NPLs have been gradually declining since early-2018 but remain sticky around the 10% prudential benchmark. - Liquidity remains satisfactory, but the high share of placements abroad poses risks; excluding placements abroad, adjusted liquidity ratios would be 28.2 percent (assets) and 23.2 percent (deposits), remaining close to the prudential benchmark of 25 percent. - Foreign exchange exposure: - Share of foreign currency denominated loans in banks’ total domestic loans stood at around 45 percent at end-2018. - Most FX loans are extended to borrowers with FX cash flows; a large share of FX loans is to agricultural and mining sectors. - In case of a large exchange rate shock, defaults on FX loans could increase and capital ratios may decline. - Non-bank financial institutions (NBFIs) vulnerabilities: - NBFIs have low asset quality; NPLs at 17 percent of total loans at end-Feb 2019. - 14 institutions, accounting for about 25 percent of NBFIs assets (excluding NAPSA), have NPL ratio above 20 percent. - Financial Soundness Indicators (selected values) - Banks: Regulatory capital to risk-weighted assets — Jan-18: 26.2; Mar-19: 21.6. - Banks: Tier 1 regulatory capital to risk-weighted assets — Jan-18: 24.3; Mar-19: 19.6. - Banks: Capital to total assets — Jan-18: 12.5; Mar-19: 12.4. - Banks: Past due advances (NPL) to total advances — Jan-18: 12.7; Mar-19: 9.9. - Banks: Loan loss provisions to nonperforming loans — Jan-18: 76.1; Mar-19: 83.8. - Banks: Return on average assets — Jan-18: 0.9; Mar-19: 2.9. - Banks: Return on equity — Jan-18: 4.8; Mar-19: 14.8. - Banks: Liquid assets to total assets — Jan-18: 45.0; Mar-19: 42.4. - Banks: Liquid assets to total deposits — Jan-18: 61.1; Mar-19: 52.6. - Banks: Foreign currency loans to total gross loans — Jan-18: 40.6; Mar-19: 47.0. - NBFIs (ex. NAPSA): Regulatory capital to risk-weighted assets — Jan-18: 39.3; Feb-19: 30.3. - NBFIs (ex. NAPSA): Past due advances (NPL) to total advances — Jan-18: 19.5; Feb-19: 16.8. - NBFIs (ex. NAPSA): Loan loss provisions to nonperforming loans — Jan-18: 78.0; Feb-19: 80.9. - NBFIs (ex. NAPSA): Return on average assets — Jan-18: 13.2; Feb-19: 9.9. - NBFIs (ex. NAPSA): Liquid assets to total assets — Jan-18: 14.4; Feb-19: 13.7. - NBFIs (ex. NAPSA): Liquid assets to total deposits — Jan-18: 24.5; Feb-19: 23.1. ### Sovereign-financial nexus and systemic risks - The sovereign-financial nexus is prominent and a potential source of fragility: - Direct exposures: banks and NAPSA invest in government securities to meet the government’s domestic financing needs. - Indirect exposures: through lending to suppliers and households, pension fund management, and inter-institution relationships. - Civil servants’ pension contributions and salary-backed loan repayments are deducted by the government from wages and remitted to institutions. - Trends and concerns: - Direct sovereign exposures increased significantly in 2017–18 as commercial banks invested heavily in high-yielding government securities following easing of monetary policy, high NPLs, and limited attractive risk opportunities. - Heavy sovereign exposure could leave the financial sector vulnerable to episodes of sovereign stress. - Static analysis indicates some scope to further increase holdings of government debt, but doing so would increase vulnerability. *Source: IMF staff summaries from the Zambia country report content provided.* ### 10. Pressures from indirect exposure have increased significantly in recent months. As ### 1zmbea2019002 - 10. Pressures from indirect exposure have increased significantly in recent months. As ### Financial pressures from indirect exposure - Government domestic arrears to suppliers have risen, reaching around 6 percent of GDP at end-2018. - Delays in remitting some civil servants’ pension contributions and repayment of salary-backed loans to various financial institutions have occurred. - If payment of salary-backed loans is delayed significantly, they could be classified as non-performing loans, with a negative impact on micro-financial institutions, which are already under pressure. - Delays could negatively impact borrowers’ ability to secure future credit arrangements. - These arrears are contributing to keeping NPLs elevated. ### Sovereign–financial linkages and impact on real sector activity - High government borrowing needs are driving higher yields on government securities, which are often used by commercial banks to benchmark private sector lending rates. - Private sector credit is being held back as banks prefer to maintain liquidity given macroeconomic vulnerabilities. - NAPSA’s investments and its deposits in the banking sector have been impacted by the government’s financing needs and delays in remitting pension contributions. - Difficulties at several micro-financial institutions pose challenges to the authorities’ objective of increasing financial inclusion. - In a shallow financial market, deepening sovereign-financial linkages can amplify risks when liquidity conditions tighten. - Banks’ core function of supporting credit to the private sector is being constrained. ### Crisis preparedness and prevention - The 2017 FSAP highlighted the need to update and strengthen the crisis management framework. - The Bank of Zambia (BoZ) has proposed creation of the Interagency Financial Stability Committee (IAFSC) to coordinate BoZ, MoF, PIA, and SEC on crisis preparedness and management. - The IAFSC would address both macroprudential policy and crisis management. - Fiscal and external imbalances constrain the capacity to manage a systemic crisis, placing a premium on crisis prevention and readiness. - Fragilities related to the deepening sovereign-financial nexus bear close monitoring. ### Mining sector: importance and vulnerabilities - Mining generates almost 70 percent of total export receipts. - Mining contributes an average of 11 percent of GDP, making it the third largest sector after wholesale and retail trade and public services. - Considering direct and indirect effects, mining accounts for almost 10 percent of total formal employment and about 25 percent of total private sector employment. - Mining activities account for about half of electricity consumption; hydropower accounts for more than 80 percent of Zambia’s electricity generation. - In 2015 a severe drought caused a 7 percent drop in power generation, contributing to a 17 percent decline in copper and cobalt production. - The current drought represents a risk to mining operations. - A further fall in international copper prices due in part to trade wars and the relative slowdown in China would be another source of risk to the outlook. ### Mining sector fiscal contribution and 2019 policy changes - Mining’s contribution to domestic revenue increased from less than 0.1 percent of GDP in the early 2000s to about 2 percent of GDP in recent years with changes in the fiscal regime. - 2019 budget policy changes: - Mineral royalty rates on copper were increased by 1.5 percentage points. - Royalty rate on cobalt raised to 8 percent from 5 percent. - Mineral royalties made non-deductible for income tax purposes. - An import duty of 5 percent on copper and cobalt concentrates imports was levied to discourage processing of imported concentrates in favor of domestic ones. - A 15 percent export duty on precious metals was introduced. - Intention announced to introduce a nonrefundable sales tax in lieu of the VAT. - Focus on enhancing compliance: audits of mining sector operations were initiated in December 2018; legal action was initiated against one firm in May. ### Institutions, governance, and anti-corruption efforts - Strong institutions, good governance, and low corruption are key drivers of potential and inclusive growth and affect budgetary execution, public financial management, tax collection, market regulation, financial sector oversight, and public order and enforcement. - Zambia’s Worldwide Governance Indicators (WGI) and Transparency International indicators are close to the SSA average but represent a notable deterioration in governance and institutional quality in recent years. - WGI indicators, especially governance effectiveness and control of corruption, declined significantly since 2012. - Transparency International’s Corruption Perception Index (CPI) shows deterioration since 2014-15. - The Financial Intelligence Center (FIC) was established following enactment of the Financial Intelligence Centre Act, No. 46 of 2010 and became operational in November 2013. - The FIC is the sole designated government agency responsible for receipt, analysis and dissemination of suspicious transaction reports to Law Enforcement Agencies (LEAs). ### Trend in suspicious transaction and spontaneous disclosure reports (FIC) - Assessment period for 2018 was from 1st January 2018 to 30th September 2018. - Yearly counts: - 2014: Number of suspected reports 487 - 2015: Number of suspected reports 767; Number of reports disseminated to LEAs 35 - 2016: Number of suspected reports 719; Number of reports disseminated to LEAs 114 - 2017: Number of suspected reports 1,664; Number of reports disseminated to LEAs 425 - 2018: Number of suspected reports 799; Number of reports disseminated to LEAs 80 - The FIC reported a significant increase in total number of suspicious transaction and spontaneous disclosure reports from 719 in 2016 to 1,664 in 2017 and to 799 in 2018. - Most reports received in 2017 and 2018 were related to suspected corruption, tax evasion and procurement violations; in 2017, 425 reports were validated and disseminated to LEAs; in 2018, 80 reports were transmitted to LEAs. - Main procurement corruption method identified: direct bidding and subsequent variation of contracted amount. ### Public financial management and tax administration reforms - Authorities have placed fight against corruption on the political agenda with institutional, regulatory and legal measures (including updating the Anti-Corruption Act). - Weak mechanisms of financial control, ineffectiveness in public financial management, and limited capacity of regulatory bodies have hampered investigation and prosecution effectiveness. - Ongoing initiatives: - Digitalizing customs processes and advancing border coordination and trade facilitation. - Increased uptake of electronic filing and payments in tax administration. - Strengthened practices to manage tax arrears owed by corporations and individuals. - Improvements to the dispute resolution process. - Remaining priorities: - Address the accuracy of the taxpayer registration database, ledgers and customs data. - Boost on-time filing across all core tax types. - Develop a strategy to address low rate of compliance across all taxes and obligations. - Improve monitoring and reporting of performance against desired outcomes. - Recent approval of the Public Financial Management Act provides a basis for further actions to strengthen the procurement process. *Source: 1zmbea2019002 - 10. Pressures from indirect exposure have increased significantly in recent months. As* ### Annex VII. Capacity Development Strategy Note ### Annex VII. Capacity Development Strategy Note ### CD Strategy - Fiscal consolidation to reduce debt-related vulnerabilities and preserve macroeconomic stability is the key policy priority. - The IMF’s CD strategy for Zambia is anchored on assisting the authorities to achieve orderly and adequate fiscal adjustment by: - providing detailed technical policy advice; and - enhancing institutional capacity to implement needed reforms. - CD on budget preparation and execution and debt management supports fiscal consolidation goals. - Following the 2017 FSAP, Fund CD has focused on strengthening the Bank of Zambia (BOZ)’s capacity in bank supervision, systemic risk analysis, and financial crisis management. - Capacity building continues in compilation and timely dissemination of economic statistics. ### Key Overall CD Priorities Going Forward - Tax policy and revenue administration - Objective: Enhance domestic revenue mobilization as part of fiscal consolidation. - Focus: Widening tax base notably for income and consumption taxes and strengthening compliance. - Public finance management (PFM) - Objective: Enhance the budget preparation process; strengthen budget execution and control with the aim to avoid accumulation of payment arrears; strengthen identification and management of fiscal risks; improve public investment system to ensure better alignment of public investment projects with national priorities; strengthen public debt management. - Monetary policy implementation and operations - Objective: Strengthen monetary policy implementation to facilitate transition towards a modern inflation targeting framework; promote a well-functioning foreign exchange market; upgrade BOZ’s legal framework. - Strengthen macroeconomic and financial statistics compilation and dissemination for decision making - Objective: Improve the quality and coverage of national accounts, external sector statistics, and government finance statistics; support the compilation of producer and import price indices. ### Main Risks and Mitigation - Key implementation risks: - Poor coordination between government agencies. - Inadequate staffing at implementing agencies. - Proposed mitigation measures: - Ensure broader engagement and interaction with TA missions at the level of implementing agencies. - Proper sequencing of TA and training delivery. - Longer term TA engagement, notably through longer term/resident experts. - Strengthen communication with various groups/stakeholders to secure proper buy-in. ### Authorities’ Views - The authorities are in broad agreement with the overall assessment, strategy and priorities. ### Technical Assistance and Capacity Building (since 2011) — Overview - Resident advisors and peripatetic advisor engagements included positions in FAD and MCM supporting tax administration, capacity building at BOZ, and related functions. - Technical assistance missions (selected thematic coverage) delivered by IMF departments since 2011 include: - FAD: Mining tax administration; Public financial management; Tax administration; Tax policy; Pension reform; Cash management; Program based budgeting; Mining and large taxpayer administration reforms; Cash basis financial reporting; Treasury single account; PFM legislation; Macro-fiscal management and budget formulation; Customs administration; Tax administration assessments (TADAT); Performance Budget System review; Fiscal risks management; Audit effectiveness for Telecoms; Fiscal risk assessment, cash management and expenditure controls; Fiscal reporting; Tax system assessment and revenue mobilization; Strengthening cash and debt management; Managing cash and strengthening budget process; Wage bill management. - MCM: Monetary policy framework; Inflation targeting framework; Payments system reforms; Central Bank organizational restructuring; Currency management; Macro modeling of transmission mechanism; Stress testing and risk profile of banks; Financial stability analysis; Liquidity forecasting and interbank market; Monetary policy reports and recommendations; Bank supervision and regulations; Markets for government securities; Improving liquidity of the secondary market for Government securities; Deepening interbank money markets; Organizational structure and operational set up; Payment systems development and oversight; Macro-economic modelling and FPAS modeling; Risk based supervision; Deposit insurance system; Monetary policy communications; Systemic risk monitoring; Contingency planning for crisis preparedness and management; Cyber security; Communications; Stress testing. - STA: SRF data development; Price statistics; National accounts; Open data platform; Monetary and financial statistics; Quarterly National accounts; External sector statistics; Government finance statistics; Producer price index; International investment position and External debt statistics; Public sector debt statistics. - The cumulative TA program reflects sustained engagement across revenue, PFM, monetary policy, financial sector supervision, payment systems, macro-financial analysis, and statistical domains. ### Joint World Bank–Fund Work Program, 2019–20 — IMF Work Program Highlights - IMF planned technical assistance in 2019/20 in the following areas: - Foreign operations and foreign exchange policy implementation. - Public financial management. - Revenue administration. - Contingency planning for crisis preparedness and management. - Financial supervision and regulation. - Monetary policy implementation and operations. - National accounts statistics. - External sector statistics. - Producer price index. - Government finance statistics. *Prepared by African Department (in consultation with other departments).* ### 2. DSA for Article IV July 2019 ### 2. DSA for Article IV — July 2019 ### Statistical Issues - General: Data provision has some shortcomings but is broadly adequate for surveillance. Issues with source data and compilation affect most datasets but are particularly problematic in fiscal reporting. - National accounts: - CSO estimates GDP for the current year from benchmark year 2010 using survey and administrative data. - GDP estimates now use VAT and business income tax data from the Zambian Revenue Authority (ZRA). - Since October 2016 CSO publishes quarterly GDP estimates using quarterly source data, including fiscal records from the ZRA. - Priority areas: - (a) develop a Memorandum of Understanding between the CSO and the ZRA to ensure administrative data coverage and quality assurance; - (b) develop a new GDP benchmark within the next three years. - AFRITAC South is providing technical assistance on the ongoing GDP rebasing process. - Price statistics: - CPI classification follows the Classification of Individual Consumption by Purpose. - Current CPI weights are based on 2002 household expenditure data; there is an urgent need for a household expenditure survey to update CPI weights. - AFRITAC South project on PPI compilation expected to enhance measurement of GDP volume changes. - Government finance statistics (GFS): - Coverage limited to budgetary central government; intergovernmental transfers of about 2 percent of GDP to extra-budgetary, social security, and local government units are included but the economic nature of these expenses is not known. - Own revenues of these entities are excluded from fiscal data. - Authorities report monthly budget releases to IMF African Department in a timely manner, but data are often subject to substantial revisions. - Reconciliation between fiscal outturns and government accounts in monetary statistics requires significant improvement. - GFS TA mission planned for November 2019. - Monetary statistics: - Bank of Zambia (BOZ) reports monetary data to STA on a timely basis for the central bank and other depository corporations; Other Financial Corporations data reported with long delays. - Monetary statistics reported using standardized report forms consistent with the IMF’s MFSM. - BOZ reports some Financial Access Survey series including mobile money and the two UN Target 8.10 indicators. - Financial sector surveillance: - BOZ submits FSIs for deposit takers regularly and timely; disseminated on IMF’s FSI website. - Balance of payments (BOP): - BOP and IIP compiled per BPM6; compiled quarterly though publication lag longer than 120 days of reference quarter. - New services surveys in compliance with BPM6 improved services series and fob valuation of goods trade. - Coverage of the quarterly investment survey (financial account and primary income) needs improvement and integration in BOP statistics. - External and domestic debt statistics: - Data provision broadly adequate for surveillance. - Recent technical assistance improved consolidation of debt databases for external and domestic debt; further work underway. ### Data Standards and Quality - Participation: Zambia in GDDS since November 2002; implemented e-GDDS recommendations in June 2016 and disseminated a NSDP publishing 14 of 15 e-GDDS data categories; remained in Baseline 2 of e-GDDS. - Since June 2016, updating of the NSDP has not been consistent. - A Data ROSC Assessment published in February 2005. ### DSA Summary and Risk Assessment - Framework: DSA prepared using the revised Low-income Countries Debt Sustainability Framework (LIC DSF). - Risk ratings: - Risk of external debt distress: High - Overall risk of debt distress: High - Granularity in the risk rating: Public debt under current policies is on an unsustainable path - Application of judgment: No - Key drivers of deterioration since October 2017: - Large fiscal deficits used to boost infrastructure spending - Weaker growth and exchange rate - Worsened external environment (terms of trade and financial conditions) - Rising debt service costs (external and domestic) - Large pipeline of contracted and to-be-disbursed loans - Rising budget expenditure arrears - Debt-carrying capacity weakened: - FX reserves’ import coverage declined from 4.7 months in 2015 to 1.7 months in May 2019. - External debt burden indicators: - All four external debt burden indicators breach indicative thresholds, three by large margins and throughout the medium-term under the baseline scenario. - Market and liquidity risks: - Frontier market status with high gross financing needs (GFNs), peaking at 19 percent of GDP over the next three years. - EMBI spreads 1,575 basis points on June 11, 2019. - High domestic borrowing costs and wide spreads expose Zambia to significant market-financing risks. - Near-term liquidity and debt servicing: - Despite pressures, Zambia has remained current on all debt obligations. - Authorities committed to prioritizing debt service and have identified resources to continue meeting obligations in the near-term. - Staff assess the risk of external and overall public debt distress for Zambia as very high and that a large upfront and sustained fiscal adjustment is essential to begin reducing debt vulnerabilities. ### Debt Coverage (DSA perimeter and adjustments) - Public debt definition used in the DSA covers: - Central government direct and guaranteed debt (including budget expenditure arrears) - Nonguaranteed external debt of a fiscally important SOE (ZESCO) for the first time in the DSA. - Official authorities’ debt definition (end-2018): $18.3 billion (78.1 percent of GDP) covering central government direct and guaranteed debt including budget expenditure arrears. - DSA additions: - Nonguaranteed debt of ZESCO added about US$0.7 billion (or 2⅔ percent of GDP) at end-2018. - ZESCO’s net profit (revenue minus cost of sales and operating expense) estimated by staff at roughly 1 percent of GDP in 2018 and assumed constant in GDP terms going forward is included as public sector revenue for liquidity indicators. - Other coverage notes: - Authorities reported no outstanding nonguaranteed external debt of other nonfinancial SOEs. - Central bank external debt (including outstanding Fund credit) included. - Local governments lack capacity to borrow without central government backstop; their outstanding debt (expenditure arrears) captured under central government. - Debt of social security funds is guaranteed by central government and included. - Limited data on domestic debt of SOEs suggest stock is insignificant and is captured via default SOE shock (2 percent of GDP) in contingent liability stress test. - Authorities have started regular collection of SOEs’ financial data to broaden debt coverage over time. - Residency basis: DSA conducted on a residency basis; foreign holdings of local currency debt issued domestically treated as external debt. - Stock of such holdings at end-2018: about US$670 million (treated as external in DSA), representing 14 percent of total outstanding domestic government securities. ### Public and Publicly Guaranteed (PPG) Debt — End-2018 (selected figures) - Total PPG debt: - Official debt coverage: 18.3 (billions of U.S. dollars) - DSA debt coverage: 18.9 (billions of U.S. dollars) - External PPG debt: - Official: 11.3 - DSA: 12.6 - Central government direct external debt: 10.0 (both official and DSA) - Multi/pluri-laterals: 1.9 - o.w. IMF: 0.1 - o.w. WB/AfDB: 1.6 - Bilaterals: 3.0 - Paris Club: 0.1 - Non-Paris Club: 2.9 - Commercial: 5.1 - o.w. Eurobonds: 3.0 - Central government guaranteed external debt: 1.2 - SOE external debt (nonguaranteed): Not included (official); 0.6 (DSA) - Nonresident holdings of local currency debt: Treated as domestic (official); 0.7 (DSA) - Domestic PPG debt: - Official: 7.0 - DSA: 6.3 - Central government direct domestic debt: 7.0 (official) / 6.3 (DSA) - Treasury bills: 1.548 (official) / 1.544 (DSA) - Treasury bonds: 3.3 (official) / 2.7 (DSA) - Others: 2.1 (both) - o.w. budget expenditure arrears: 1.6 (both) - Memo items: - nonresident holdings of treasury bills: 0.004 (both) - nonresident holdings of treasury bonds: 0.70 (both) - total PPG debt to GDP (%): 78.1 (official) / 80.8 (DSA) - Note: Main differences between official and DSA debt coverages attributed to treatment of nonresident holdings of local currency government debt and nonguaranteed SOE external debt. ### Background, Market Pressures, and Liquidity Risks - External debt growth and creditor composition: - External central government and government guaranteed debt has tripled (relative to GDP) over the past five years and estimated at US$12 billion or 51 percent of GDP by end-2018. - Shift toward more non-concessional borrowing. - Creditor shares: Non-Paris Club official creditors about 29 percent of external PPG debt; Eurobond holders 25 percent; foreign banks 19 percent; foreign investors holding local currency debt 6 percent; multilaterals 15 percent; plurilateral creditors and Paris Club together 1.3 percent. - Domestic debt composition: - Largely treasury securities (21 percent of GDP) and budget expenditure arrears on non-debt obligations (7 percent of GDP, including VAT backlogs). - Market-financing risks: - Zambia’s Eurobonds performed worse than most frontier markets since early-2018, with spreads around 1,575 basis points on June 11, 2019. - Widening Eurobond spreads and domestic interest rate pressures coincided with rising GFNs. - Project-related inflows surged to 6.4 percent of GDP in 2018. - New DSF market-financing module flags a high liquidity risk. - Domestic refinancing risks: - Tightened domestic financing conditions with frequent undersubscriptions in auctions and structural PFM weaknesses led to reemergence of budget financing gaps in 2018 and accumulation of budget expenditure arrears. - Private placements with domestic institutions totalled 4.2 billlion Kwacha in 2018, of which roughly half was to NAPSA (state-run pension). - Large external debt payments and reserve pressures: - External debt service (public and publicly guaranteed debt plus foreign-held LC debt) projected to reach $1.6 billion in 2019 (increased from about $1 billion in 2018), larger than current FX reserves level (as of May 2019). - Total of $4.9 billion (principal + interest) due to external creditors over 2019-21, of which US$4.6 billion on already disbursed debt. - To compensate anticipated external debt payments, the central bank has stepped up opportunistic FX purchases from the market. ### Macroeconomic and Debt Outlook (on current policies) - Outlook deterioration relative to October 2017 DSA: - Lower growth projected to remain subdued over medium-term as financing constraints force a disorderly fiscal adjustment and increasingly weigh on activity. - Kwacha depreciated by 30 percent since end-2017. - Fiscal deficits larger than previously anticipated; financing constraints force larger adjustment than envisaged in 2019 budget. - Current account deficit expected to widen due to lower copper exports and higher imports and interest payments associated with foreign-financed public investment before narrowing as large government projects are completed and domestic demand weakens with slowing growth and large forced fiscal consolidation. - FDI ebbing due to uncertain outlook, leaving public sector project flows and FX reserves as predominant external financing sources. ### Key Policy Implication and Recommendation - Staff assessment: Risk of external and overall public debt distress is very high; a large upfront and sustained fiscal adjustment is essential to begin reducing debt vulnerabilities. *Prepared jointly by the staffs of the International Monetary Fund and the International Development Association; July 11, 2019.* ### 8. Large external loan disbursements are envisaged by the 2019–21 MTEF ### 8. Large external loan disbursements are envisaged by the 2019–21 MTEF ### External loan disbursements and projections - Total contracted but undisbursed debt was estimated at around US$9.7 billion (including guarantees) or 40 percent of 2018 GDP as of April 2019. - Projected to be fully disbursed within the next 5 years (6.7 percent of GDP anticipated in 2019) under the baseline scenario. - Roughly 45 percent of the contracted but undisbursed debt is understood to be for projects that had not begun disbursing as of April 2019. - New external borrowing is expected to restart in 2022 to rollover the maturing Eurobonds and to support public sector investment. - Prospective projects under the World Bank’s recently approved Country Partnership Framework (2019–21) for Zambia will be added to the projections as they are incorporated into the authorities’ borrowing plans. - Project loan disbursements (incl. guarantees) annual values (millions of dollars) shown in Text Table 3 include (selected rows): - 2017 DSA: 1269, 1675, 1732, 1494, 1240, 980, 903, 5567 (for 2017–2024-28 aggregate) - Current policies, o.w.: 873, 2189, 2773, 2224, 1740, 1251, 1100, 6095 - Central government: 739, 1709, 1603, 1716, 1384, 1251, 1100, 6095 - Guarantees: 134, 480, 1171, 508, 356, 0, 0, 0 ### Domestic financing and arrears - Domestic financing is expected from net issuance of government securities and further arrears accumulation. - Banks are expected to be the main buyers for bills while pension/insurance funds are the key players in bond markets. - Foreign exposure is expected to remain flat in nominal terms absent an improvement in the outlook. - Any residual financing needs would be met by further accumulation of supplier arrears. - No direct central bank financing is assumed. ### Risks to the baseline scenario - Risks are tilted to the downside under current policies. - Government arrears on domestic payments are adding to economy-wide liquidity strains and risk undermining financial stability through rising NPLs and deepening sovereign-financial linkages. - Realism tools (Figure 3, 4) suggest the forced adjustment envisaged under the baseline is of a large scale. - If the government resorted to additional accumulation of supplier arrears, outcomes could include: - Further delay in fiscal adjustment and sharp rise in debt. - Drag on investor sentiment, trigger large scale capital outflows, and further disrupt private sector activity. - Financing conditions could further deteriorate due to both external and domestic factors, intensifying liquidity pressures. - Staff assess that the macro assumptions underpinning the baseline scenario are already very conservative. - Upside risks stem from: - The positive impact of a large up-front and sustained fiscal adjustment as recommended by staff. - A successful debt operation. - Higher copper production and prices. ### Debt-carrying capacity and External DSA assessment - Zambia’s debt-carrying capacity under the Composite Indicator (CI) rating is assessed as weak. - The weaker capacity is predominantly attributed to the low level of FX reserves on current policies, which lowers debt burden thresholds. - Under the baseline, all four external debt burden indicators breach their indicative thresholds and three of them by large margins and throughout the medium-term. - Even compared to the indicative thresholds for a medium performer, baseline breaches are significant for: - PV of PPG debt to GDP (peaking at 67 percent). - PPG debt service to revenue (peaking above 30 percent, net of Eurobond amortization). - Breaches of the debt service to exports ratio become less pronounced over time. - Staff-proposed adjustment scenario: - Envisages a cumulative 8½ percent of GDP fiscal adjustment (on a commitment basis) over the next five years. - With 4½ percent of GDP front-loaded for 2019 centered on substantial scaling back of the recent surge in foreign-financed capital expenditure. - Expected outcomes: regain investor confidence, improved growth prospects, rebuilding FX reserves, and strengthening debt-carrying capacity. - Despite improvements under the adjustment scenario, the PPG debt service to revenue indicator breach would remain significant and persistent because a large part of external debt payments is associated with already disbursed debt. ### Public DSA assessment and sustainability - Public debt projected path under current policies: - PV of debt to GDP ratio projected to increase from 81 percent in 2018 to 95 percent by 2021. - 95 percent is more than twice the prudent benchmark (35 percent of GDP) for a weak performer. - Rising debt stock and increasing roll-over needs (partly due to a larger portion of short-term bills) would keep the debt service-to-revenue ratio at elevated levels over the projection horizon. - A regularization/clearance plan is needed for the sizeable budget expenditure arrears, which should be accommodated to the extent possible within the budget envelope. - Baseline identifies significant and sustained macroeconomic pressures; the debt situation remains vulnerable to macro-fiscal shocks as shown by stress tests. - The standardized exports shock is the most extreme shock for all external and overall public debt burden indicators in this DSA. - Staff conclusion: Zambia’s public debt under current policies is on an unsustainable path and large upfront and sustained fiscal adjustment is essential to contain debt vulnerabilities. - The staff-proposed adjustment scenario is anchored on substantial scaling back of the recent surge in foreign-financed capital expenditure to put the debt trajectory on a firmly downward path, restore investor confidence, improve financing conditions, and revive FX inflows (including to roll over the 2022 Eurobonds). - Even under the adjustment scenario, the risk of debt distress is expected to remain extremely elevated (with heightened liquidity risks). ### Final risk rating and borrowing ability - Significant near-term breaches of liquidity indicators suggest an elevated probability of a future distress event. - External debt payments weigh heavily on government revenue, averaging 34 percent of revenue over 2019-21. - A standard exports shock would push the external PPG debt service to revenue ratio up to 40 percent. - Zambia’s ability to borrow has been increasingly hampered by the loosening fiscal stance against rising debt vulnerabilities: - The government continues to issue in the domestic debt market. - Auctions have been frequently undersubscribed; private placements have provided some support; the secondary market remains active. - The majority of foreign investment exposure in the LC debt market has so far been maintained, although interest in additional exposure has receded. - Zambia continues to receive very large positive net inflows from commercial banks on contracted project loans. *Source: IMF staff projections and assessments from the referenced content unit.* ### 18. In staff’s judgment, the risk of external and overall public debt distress for ### 1zmbea2019002 - 18. In staff’s judgment, the risk of external and overall public debt distress for ### Staff assessment: overall judgment and immediate risks - Staff’s judgment: the risk of external and overall public debt distress for Zambia is currently very high. - Threshold-based analysis points to: - elevated liquidity risks; and - a relatively high probability of a distress event over the projection horizon. - Despite the above, the government has remained current on its external and domestic debt obligations, with no default or arrears on any debt obligation (footnote 10: "With the exception of the de minimis arrears reported in footnote 5, which are in the process of being cleared."). - The stock of outstanding budget expenditure arrears reflects chronic structural weaknesses in PFM and budget execution; staff judge these arrears are not forced borrowing undertaken to circumvent liquidity constraints and thus are not by themselves a signal of debt distress. ### Near-term mitigating factors identified by staff - Authorities determined to prioritize debt payments over other obligations and are proactively identifying resources (including through central bank FX purchases to replenish reserves) to achieve this, consistent with the constitutional priority of debt service payments. - Authorities are discussing relief measures on a voluntary basis with a bilateral creditor; per LIC DSF guidance (footnote 11), voluntary reprofiling discussions are not to be considered a distress event. - FX reserves appear sufficient to cover the next 12 months’ external debt payments, provided there is no sharp reversal in capital flows. - In domestic markets, some “nonmarket” players (e.g., pension funds) still possess resources to continue participating in government debt auctions and have space to augment their portfolio allocations in the near-term. - Staff assessment summary: the risk of debt distress is elevated in Zambia, with strong actions needed to begin reducing debt-related vulnerabilities. ### Authorities’ views and planned actions - Authorities agreed with staff’s assessment of the current debt situation and the sustainability of the debt position under current policies. - Authorities concur on the need for large upfront adjustment targeted at reducing external debt accumulation to contain debt vulnerabilities. - Authorities expect large infrastructure investment to pay off over the long-term and raise medium-term growth relative to staff projections, but recognize near-term debt service pressures must be carefully managed. - Following a Cabinet meeting in May 2019, authorities announced plans to prepare a list of projects to be slowed down, postponed, or cancelled in accordance with contract provisions. - Authorities stressed: - the importance of dismantling budget expenditure arrears to release liquidity; and - revenue mobilization in strengthening debt repayment capacity. - Revenue-enhancing initiatives underway, notably the planned introduction of the new sales tax. ### Stress tests, scenarios, and market-financing indicators (summary of analytical findings) - Stress-test framework: staff present multiple stress tests (historical scenario; most extreme shock; tailored and bound tests) and report indicators including: - debt service-to-revenue ratio; - PV of debt-to-exports ratio; - PV of debt-to-GDP ratio; and - debt service-to-exports ratio. - Market-financing risk indicators highlight potential heightened liquidity needs: - EMBI spreads noted in figure/data: 570 (as presented under Market-Financing Risk Indicators). - Gross financing needs (GFN) breach of benchmark: Yes (figure shows "Breach of benchmark: Yes"; "GFN Benchmarks14"). - In stress-test tables and figures, several scenarios yield breaches of thresholds (bold values in original tables indicate breaches). ### Key quantitative indicators from DSAs and projections (selected items extracted verbatim) - Staff note: FX reserves appear still sufficient to cover the next 12 months’ external debt payments (verbatim statement). - Table indicators and projections (as presented in the text and tables): - Real GDP growth (in percent): 3.8, 3.5, 3.7, 2.0, 1.7, 1.7, 1.6, 1.5, 1.5, 1.6, 1.8, 5.6, 1.6 (series shown in Table 1 under "Real GDP growth (in percent)"). - Government revenues (excluding grants, in percent of GDP): 18.0, 17.3, 19.8, 20.1, 20.5, 20.6, 20.6, 20.5, 20.6, 20.5, 20.6, 17.0, 20.5 (series shown in Table 1). - PV of PPG external debt-to-exports ratio (selected projected values as presented): 127.2, 150.5, 158.7, 159.9, 156.2, 153.0, 150.0, 124.2, 101.0 (series shown in Table 1 under "PV of PPG external debt-to-exports ratio"). - PPG debt service-to-exports ratio (selected projected values as presented): 10.1, 8.8, 11.7, 16.7, 16.6, 17.3, 23.2, 15.1, 24.4, 18.5, 14.5 (series shown in Table 1). - Public sector debt (percent of GDP), historical and projections (Table 2): 60.7, 65.6, 80.8, 94.2, 97.7, 100.0, 99.3, 98.2, 96.4, 84.4, 76.3, 40.0, 93.5 (series shown under "Public sector debt"). - PV of public debt-to-GDP ratio (Table 2, selected projected values): 81.3, 93.5, 95.5, 96.7, 95.1, 93.4, 91.6, 80.6, 73.3 (as presented). - Sensitivity analysis tables show numerous scenario outcomes (A. Alternative Scenarios; B. Bound Tests; C. Tailored Tests) with several bolded threshold breaches (see Table 3 and Table 4 for full matrices). ### Policy implications emphasized by staff and authorities - Immediate need for strong policy actions to reduce debt-related vulnerabilities, with emphasis on: - large upfront fiscal adjustment targeted at reducing external debt accumulation; - strengthening public financial management and budget execution to dismantle arrears and release liquidity; - revenue mobilization measures, including introduction of the new sales tax; - careful management of near-term debt service pressures, including reprioritization or slowing/postponement/cancellation of selected projects in line with contract provisions; - continued engagement with bilateral creditor(s) on voluntary relief measures (reprofiling) to ease near-term liquidity pressures. - Preservation of FX reserves and avoidance of sharp reversals in capital flows are critical to maintain the capacity to meet external debt payments over the next 12 months. *Source: 1zmbea2019002 (IMF staff text; includes Statement by Mr. Dumisani Mahlinza, Ms. Mmatshepo Maidi and Mr. Ted Sitima-wina, July 24, 2019).* ### Introduction ### Introduction ### Authorities’ assessment and policy stance - The authorities "appreciate the candid and constructive policy dialogue" during the recent Article IV consultation and "broadly concur with the staff assessment and key policy recommendations." - Long-term development pursued through the Seventh National Development Plan (7NDP) and Economic Stabilization and Growth Programme, prioritizing diversification via "agriculture, tourism, manufacturing and mining" and public infrastructure investment financed largely by foreign borrowing. - In May 2019 authorities announced measures to contain spending, including "the indefinite postponement of the contraction of new non-concessional loans; cancellation of some committed but undisbursed loans; and increased control and management of disbursements on foreign-financed loans." - Authorities "recognize the need for an urgent policy adjustment to entrench macroeconomic stability and bring debt to sustainable levels." ### Recent Economic Developments and Outlook - Real GDP growth: "3.7 percent in 2018" from "3.5 percent in 2017"; growth drivers included "telecommunications, financial and insurance activities, wholesale and retail trade, and mining." - 2019 growth risks: expected to be weighed down by drought in southern and western parts of the country affecting "agricultural output and electricity production" and by weak domestic demand. - Medium-term outlook: growth expected to recover following completion of large public infrastructure projects. - Inflation: rose from "6.6 percent in 2017 to 7.0 percent in 2018", remained within Bank of Zambia target band "(6-8 percent)"; expected upward trend due to "an increase in food and fuel prices as well as exchange rate depreciation." - Current account: deficit declined to "1.3 percent of GDP in 2018" from "1.7 percent of GDP in 2017", reflecting recovery in copper exports at higher prices. - Foreign reserves: declined from "2.4 months of import cover in 2017 to 1.9 months in 2018." ### Fiscal Policy and Debt Sustainability - Fiscal adjustment targets: reduce budget deficit to "6.5 percent of GDP in 2019" and reach "3 to 4 percent of GDP in the medium term." - Revenue measures: broaden tax base, reduce tax expenditures and exemptions, simplify tax system, strengthen compliance, enhance tax audit capacity; auditing of large taxpayers, particularly in mining, underway. - Tax reform: "The switch from VAT to Sales Tax, announced as part of the 2019 budget, is expected to result in large windfall gains." - Expenditure controls: align cash spending with available financing; measures include: - prioritize funding of projects "that are at least 80 percent complete"; - delay implementation of "non-growth supportive projects"; - control foreign financed disbursements; - curtail personal emoluments (PEs) related expenditures, restrict leave commutation and oblige all Government officials to take leave; - suspend both foreign and domestic travel for top Government officials; - enforce strict adherence to the Public Finance Management Act (PFMA). - Arrears and cash management: tighten commitment control system to curb domestic arrears accumulation; plan to "steadily clear the existing stock of arrears" to ease market liquidity and improve financial sector performance. - Public investment management reforms: review Zambia Public Procurement Act (ZPPA); establish a Public Investment Board (PIB); work on the Planning and Budgeting Bill and revise the Loans and Guarantees Act to provide framework for medium-term debt management. - Debt actions and targets: - Decision to "indefinitely postpone contraction of all new non-concessional debt." - Plan to "re-scope, cancel or postpone some projects with a view to free up $500 million annually over the medium term." - Discussing some debt reprofiling. - Determination to remain current on debt service with "no default or arrears on either external or domestic debt." - Debt management capacity measures: improve monthly cash flow forecasts to facilitate domestic debt auction flexibility; enhance oversight of state-owned enterprise (SOE) debt; look forward to debt management TA jointly delivered by IMF, World Bank, and MEFMI. ### Monetary and Exchange Rate Policies - Monetary tightening: Monetary Policy Committee (MPC) "increased the policy rate by 50 basis points to 10.25 percent in May 2019." - BoZ stance: will use monetary policy instruments to keep inflation within target band; current framework considered adequate when supported by fiscal reorientation. - Technical support: look forward to completion of the forecasting and policy analysis system (FPAS) being developed with Fund TA. - Exchange rate policy: authorities reiterate commitment to "a flexible exchange rate"; FX market interventions limited to smoothing excessive volatility and opportunistically building reserves, consistent with staff recommendation. ### Financial Sector - Priority to safeguard financial sector stability and resilience; progress made implementing 2017 FSAP recommendations. - Legal and regulatory updates: amended BoZ Act to enhance operational independence; new Banking and Financial Services Act (BFSA) with implementing regulations being finalized. - Banking system and risks: "banking system is well capitalized" but macro-financial linkages could keep NPLs above prudential norms; ongoing enhancement of supervision to mitigate risks. - AML/CFT framework: revised and strengthened in 2017 in line with FATF; Zambia recently underwent an evaluation "which was largely positive, and recommendations thereof are being undertaken." ### Structural Reforms - Structural reforms seen as necessary to complement macroeconomic policies and promote inclusive growth under 7NDP priorities "agriculture, tourism, energy, and mining." - Agriculture initiatives: development of Zambia Integrated Agriculture Management Information System (ZIAMIS); measures to raise productivity, build resilience, and improve delivery of the Farmer Input Support Programme (FISP). - Infrastructure and energy: focus on access to markets, ICT, and transport; energy supply and transportation prioritized to address bottlenecks; ongoing and pipeline projects including solar energy to reduce reliance on hydroelectric power. - Electricity pricing: ongoing cost of service study to inform tariff adjustments "with appropriate protection for the vulnerable groups." - Human capital: investments in quality education and healthcare to promote inclusive growth. - Business environment: despite favorable comparisons with SSA average on several 2019 Doing Business Indicators, measures continue to improve the business environment. ### Conclusion - Authorities reiterate commitment to preserving macroeconomic stability and "bringing public debt on a sustainable path." - Continue efforts to create a diversified and resilient economy for sustained growth and socioeconomic transformation; look forward to continued collaboration with the Fund, including advice and technical assistance. ### Statement by the Staff Representative on Zambia (July 24, 2019) — subsequent information - Ministerial change: "The Honorable Dr. Bwalya Ng’andu was sworn in as Minister of Finance on July 15th, replacing the Honorable Margaret Mwanakatwe." - Update on economic developments (July 17th): - Preliminary Q1 2019 GDP growth: "2.6 percent" year-on-year. - Inflation: "rose to 8.6 percent (year on year) in June." - External debt stock at end-June: reported at "$11.5 billion (inclusive of guarantees)." - Domestic government securities and bonds: "60.3 billion Kwacha." - Gross international reserves: "$1.41 billion at end-June, the same level as at end-March." - Revised 2018 current account deficit: "$341.4 million (1.3 percent of GDP)" compared to previously estimated "$708 million (2.6 percent of GDP)"; change mainly due to more favorable primary income performance. - Sovereign market indicators and arrears: - Eurobond spreads: "stood at 1,442 on July 18th." - Authorities reported having cleared "the de minimus arrears earlier reported by France to the Paris Club," and had begun clearing de minimus arrears to Belgium. *Source: 1zmbea2019002 - Introduction* --- _Source: https://www.imf.org/-/media/files/publications/cr/2019/1zmbea2019002.pdf_