Zambia Sets Out Economic Policy Objectives for 2010

Zambian economic policy highlights for 2010 centre on a shift in the government's domestic debt portfolio combined with the development of a public private partnership framework.

IHS Global Insight Perspective

Significance
Fiscal and monetary policy in Zambia will continue to be dictated by the government's diversification agenda and the maintaining of single digit inflation and limited exchange rate volatility. Electricity provision and public private partnerships are also medium-term objectives.

Implications
Financial deepening forms part of the government's economic diversification drive. A shift in the government's domestic debt portfolio aims to increase private-sector credit participation and narrow commercial bank interest rate margins.

Outlook
Private-sector credit participation has been disappointing in recent years and the latest developments could deepen the financial market. Risk factors include currency risk on rising international concessional borrowing and short-term pressure on commercial bank profit margins.

The Zambian government's latest Letter of Intent, a document outlining short-term policy objectives to secure financial support from the International Monetary Fund (IMF), shows the government's continued commitment to prudent monetary and fiscal policies, while infrastructural development-particularly in the energy sector-is pursued within a debt-sustainability framework. Policy highlights to watch during 2010-2011 include the possible redemption of domestic debt securities through a drawdown in reserves and the development of a public private partnership (PPP) framework in the current limited concessional financing environment.

The net result of the proposed policies, combined with the anticipated reopening of mining operations and a recovery in the tourism sector on the back of the 2010 World Cup football tournament, hosted by South Africa, is expected to push Zambia's overall GDP growth rate to an estimated 5.5% in 2010 from 5.3% in 2009. The biggest downside risk factors to the 2010 growth expectations include uncertainty over the strength of the global recovery and steadily rising oil prices.

Policies for 2010

Fiscal Policy
Fiscal policy objectives will continue to be dictated by the government's diversification agenda. In this regard, fiscal space for capital spending will be opened up by curtailing current expenditure by an estimated 1.2% of GDP during 2010, and at the same time increasing the public capital spending budget to 4% of GDP. The capital spending objective has been set despite the Zambian authorities' realisation of an expected decline in co-operating partner support over the period, therefore necessitating the cut in the current expenditure. Overall, the fiscal deficit as a percentage of GDP is expected to remain at around 2.4% and domestic financing is expected to be about 2% of GDP.

Zambia's energy sector will receive significant budget commitments in the short to medium term to address electricity generation constraints on the economy. The completion of the rehabilitation project at state-owned electricity provider ZESCO will improve the reliability of electricity generation during 2010; however, government efforts will continue to focus on increasing generating capacity over the medium term. This objective is expected to be reached by adjusting electricity tariffs to cost-recovery levels and the commissioning of new power plants. A 35% electricity tariff adjustment was announced in 2009 and concurrently an indicative increase of 26% was announced for 2010. The extension of the Kariba North Bank project has already commenced and is expected to add 360 megawatts (MW) of additional capacity over the medium term. Financial negotiations for the Kafue Gorge Lower (KGL) project are also under way. KGL will add another 600-750MW of capacity by 2017.

These large infrastructural projects of high economic return for Zambia will increase the demand for financing. Given the narrow concessional financing environment, the government has moved to develop a PPP framework through which the private sector, in some cases in conjunction with the government, could engage in these projects. Access to non-concessional financing will also be required to finance such government participation in the future. All this will be done within a debt-sustainability framework.

Monetary and Exchange Rate Policy
Monetary policy objectives will aim to keep inflation in single digits while strengthening the framework that minimises exchange rate volatility without targeting the level of the exchange rate. The Bank of Zambia (BoZ), the central bank, has set an inflation target of 8% for end 2010, with the intermediate target objective, namely reserve money growth, set at 19% over the same period. Foreign-exchange market intervention will be limited to smooth out currency fluctuations while allowing for a gradual build-up in international reserves.

During 2010, the government will also investigate the option to restructure public debt by reducing costly domestic borrowing and increasing concessional external financing. The possibility of redeeming domestic debt securities by the drawdown of reserves will be investigated during the year. This portfolio swap will lower the government's overall debt-service obligations and create additional room for private-sector credit growth through lower government borrowing in domestic markets. The lower demand for credit by the government sector is also expected to narrow interest rate spreads in the commercial banking sector.

Outlook and Implications
Financial deepening and intermediation forms part of the government's strategy to enhance economic diversification in the near term. The shift in the government's domestic debt portfolio will enhance bank lending to the private sector, which has been disappointing in the past. The latest IMF data shows that private sector credit as a percentage of GDP has shown a modest increase to 14.8% of GDP in 2008 from 8.5% of GDP in 2000. The government's active involvement in the relatively small financial sector has left commercial banks reliant on government deposits while borrowing to the same risk-free investor at a high interest rate. During 2010, the government will also establish a single treasury account, closing most of its accounts at commercial banks. These moves could increase market liquidity while narrowing the spread between lending and deposit rates as commercial banks compete for the savings and lending market. The BoZ has also announced its intention to investigate the introduction of a fixed benchmark interest rate in 2010 in support of the government's domestic debt policy shift. To date, Zambian commercial banks have determined their own lending rates without any official reference point. Risk factors include possible pressure on Zambian commercial banks' profit margins due to the current high and uncompetitive cost structures in an environment of a lower future interest rate spread. A shift towards international concessional financing will also have a currency risk that should be incorporated in the government's debt-sustainability framework. Prudent fiscal policies, centring primarily on a small budget deficit, will remain an overriding condition to keep Zambia's future debt burden on a sustainable level.