A recent policy note from the World Bank examines Zambia’s fiscal vulnerabilities and the costs associated with its expansionary, subsidy-oriented fiscal policy. It then sets out the benefits of coordinating fiscal policy with monetary policy in a way that is mutually reinforcing and beneficial to private sector investment, instead of having the two pull in opposite directions, as is currently the case. Finally, it makes recommendations to help shift the fiscal position to a more sustainable path and in turn improve market confidence and the prospects for sustainable economic recovery.

1. Beating the Slowdown
in Zambia:
Reducing Fiscal
Vulnerabilities for
Economic Recovery
Dr Gregory Smith
World Bank, Zambia
September 2016

2. Three economic shocks hit in 2015
Poor 2014-15 Harvest:
• Agricultural output fell by 8% in
real terms in 2015
• Food prices rose by 11.2% in
2015 and later soared.
Slide 2
#1
Power Crisis
• Generation capacity insufficient to
meet demand (8 hour outages).
• 95% generation from hydropower.
• Low rainfall exacerbated the existing
power deficit.
Copper price plummeted
• Copper prices fell 30% in 2015
• Production affected by uncertainty
over power and tax/ royalty regime.
• Mine closures and delayed
investment (7,700 jobs lost)
#3#2
Food and
non-food
prices soar
Emergency Power is imported
at great cost
Copper prices
soften

3. II: Further Fiscal Pressure
• Public finances weaken: lower revenues and increasing
expenditures.
• Fuel subsidies (K 2.6 billion), not budgeted for.
• Emergency power (K 0.4 billion), not budgeted for.
• Interest costs on debt (K 1.9 billion), 52% above budget.
• Farm inputs and grain purchase subsidies (K 4.0 billion).
The three shocks had two main impacts
I: Volatile Kwacha and
high inflation
• Kwacha lost 1/3 value Jan-Jun 2015
• Jan 2015 to June 2016 Kwacha
depreciation = 62%
• Pass through: Sep-15 monthly
inflation = 0.7%, Oct-15 = 6.2%
• Nov-15 annual inflation = 19.5%,
similar rate in Sep-16
Slide3
Extreme exchange rate
volatility
Tax down, spend up And larger fiscal deficits
Huge spike
in monthly
inflation

4. As fiscal restraint was absent, monetary policy was applied with vigour
• Increasing the reserve requirements of
Commercial Banks from 14% to 18% (up
from 8% in February 2014.
• Raising the policy interest rate from
12.5% to 15.5%, and removing caps on
commercial bank lending rates.
Slide4
Credit growth
stalls
• Reduced the amount of funds available for
lending, dampening credit growth.
• increased the cost of borrowing, in turn
reducing momentum for credit growth.
Calmed inflation
and ER volatility
but not without
consequences

5. The lack of fiscal restraint had three main costs
• Cost 1: Lower Government demand
for foreign exchange: if more cost-
reflective pricing for fuel, emergency
power and farm inputs, required
foreign exchange would have been
lower.
Slide5
#1
• Cost 2: Lower Government injections
of money into the domestic market;
If Government had reduced domestic
spending in line with the fall in
revenues, the increase in domestic
liquidity (i.e. money creation) arising
from its fiscal operations would have
been lower.
• Cost 3: Less need for costly external
borrowing; as Government’s deficit
would have been smaller.
#3#2
If Government had cut spending
during 2015 to remain within its
programmed budget deficit, it
would have not needed to make
a third Eurobond issuance?

6. Fiscal restraint would also have had benefits
• Reduced pressure on the Kwacha, with
lower exchange rate pass through, less
requirement for Bank of Zambia to sell
forex to stabilise the currency.
• Less need for Bank of Zambia to issue
domestic securities and raise interest
rates in order to tighten domestic
liquidity conditions, with positive knock-
on effects for the availability of private
sector credit at more affordable rates.
• Reduced fiscal cost of debt service, as
Government would have been paying
lower interests rate on a lower volume of
debt, and, for debts denominated in
foreign exchange, at a less depreciated
exchange rate.
Slide6
• Lower risk of future sovereign debt distress, would not have
increased its indebtedness to finance additional spending.
• A better Bank of Zambia reserve position, as Government
demand for foreign exchange would have been lower, as
would Bank of Zambia’s need to sell forex to the market to
ease pressure on the Kwacha.
Reserves
plummet in
2015-16
Peaks from
Eurobond
issuance

7. Ideas to fix it: Coordinated fiscal and monetary policy with fiscal restraint
• Commitment to sustainable spending needed.
• Alignment of fiscal and monetary policy in medium term.
• What remains critical is that any reduction in the fiscal
deficit is planned and managed carefully.
A disorderly and incomplete adjustment will not
restore market confidence.
A too severe or too quick adjustment will undermine
growth.
• Zambia was not well positioned to manage the economic
impact of the 2015 shocks, in spite of ten years of strong
growth.
• Increased indebtedness and expanded consumption
spending, rather than using the growth years to build
fiscal resilience, particularly from 2011 onward
Slide7
#1
Zambia’s Charter
of Fiscal Responsibility
Objectives for fiscal policy in
the coming five years
Signed by MPs
Political commitment to fiscal discipline is needed
before any fiscal rules or debt ceilings can be
effective.

8. Ideas to fix it: Coordinated Fiscal and Debt Policy
• Borrowing decisions must be linked better with spending decisions. A
debt strategy is needed (many drafted never finished).
• Market access has changed the game, new skills are needed. Expensive
mistakes are a real risk.
• Market communication needs to be slicker.
• The only constraint on over-borrowing is the debt ceiling, but as recent
increases have shown it can be swiftly lifted ahead of any borrowing.
• Debt management reforms have stagnated as debt has soared.
• Medium-Term Debt Strategies have been developed but never published.
• Why does Zambia not publish quarterly and annual debt reports? (data
issues?)
Slide8
#2
Debt service
costs soar

9. Ideas to fix it: Making every kwacha count
• The content of public spending also matters.
• Recurrent spending has risen almost as rapidly as
investment spending.
• Efforts are needed to ensure that any under-utilized
resources are reallocated to where they can have a
greater impact.
• Where subsidies are provided the Government should
introduce rules that govern the public provision of
subsidies; for example, by better targeting of
beneficiaries.
• Any reduction of removal of subsidies should be
accompanied by measures to protect the poor during
the transition.
• Other middle-income countries have systems to plan
for and manage public investment .
Slide9
#3
Does borrowing US$ at 8.98% make sense
when resources are used to subsidize the
richer parts of the population to drive their
cars around town?

10. Ideas to fix it: More efficient revenue collection
• A middle-income country needs to raise more domestic
revenue.
• Sustained efforts will help shift some of the recent reliance
on external and non-concessional borrowing to a more
sustainable footing.
• Key revenue areas to explore relate to the mining sector and
efforts to ensure the legislation governing transfer pricing is
strengthened to ensure that illicit transfers are minimised.
• A framework for the granting of tax incentives should be put
in place and published.
Slide 10
#4
Domestic revenues can be boosted by broadening
the tax base and ensuring the continuity of revenue
administration reforms.

11. None of the paths are easy, but we’re here to support
Global Practice for Macroeconomics and Fiscal Management
• Lusaka based team who can call in global experts as per
demand
• Demand driven technical assistance
• Macroeconomic modelling and forecasts
• Bi-Annual Economic Briefs
• Long-term growth model
• Policy notes: what areas would you like us to look into?
• Budget support? (Can to be requested by letter to start ball
rolling)
Slide11
Economic briefs, forecasts and other documents can be
found at: http://www.worldbank.org/en/country/zambia