Lack of External Financing Leaves Zimbabwe's Budget Execution Problematic

The lack of fiscal space because of benign external support has left most of the infrastructural programmes in the 2010 budget in jeopardy, resulting in a significant growth downgrade for the year.

Mid-Year Budget Review
Mounting challenges including a lack in medium- to long-term financing have left the execution of the 2010 budget for the first half of the year problematic. Actual financing of the projected US$810-million budget deficit was significantly lower than expected. Limited co-operating partner support has meant that as of 30 June 2010 only US$207 million has been made available for various programmes budgeted under the "Vote of Credit". UNICEF proved to be the biggest contributor to this segment of the budget. The lack of external support left most of the infrastructural development and maintenance programmes proposed in the original 2010 budget on hold. "Cash-budget" spending was skewed towards recurrent expenditure, of which the bulk of the total spending of US$813.4 million for the six months January-June 2010 was on employment costs inclusive of pension, goods and services, and transfers to grant-aided institutions (US$720.5 million). "Cash-budget" revenue flows exceeded budget expectations and amounted to US$930.7 million for the first six months of 2010. Strong growth in value-added tax (accounting for 37.6% of total revenue) and customs duties (accounting for 14.3% of total revenue) was primarily responsible for the revenue bonanza.

GDP growth projections have also been downscaled: the Finance Ministry now expects economic growth to average 5.4% in 2010 from the original estimate of 7.0%. Underperformance in the manufacturing, tourism, and mining sectors during the first half of 2010 is primarily responsible for the lower growth expectation.

Short- to Medium-Term Policy Direction
The austere reality that the coalition government is still unsuccessful in securing much-needed external financing for the country's economic revival is apprehended in the review. "Zimbabwe is virtually on its own, and requires 'embracing a business-unusual approach' in addressing current development challenges by leveraging its own potential and available resources," the mid-year review reads. Strengths earmarked by the Zimbabwean government that could assist in the budget financing needs in the short-to-medium term include the country's vast mineral resources potential as well as potential proceeds from privatisation and "other sources". These finance policies will be augmented by a focused export strategy that prioritises value-added exports in which the county has comparative advantages. Such sectors include platinum, gold, diamonds, tobacco, and cotton. The government acknowledges, however, "that concurrent reengagement with the international community will be pursued to accelerate the development process". Other essential policies that integrate with the previous mentioned revenue- and financing-enhanced policies include the increase of foreign direct investment, the overhaul of public utilities, pursuing public-private partnerships, and central bank reforms.

Leveraging from the mining sector as outlined in the review suggests an exploration and crafting policy overhaul, a "use it or lose it" principle that will limit the hoarding of claims and continuous renewal of un-mined mining claims and an overhaul of the mining taxation policy that will result in a more "equitable mining taxation model that is not offensive to rational market principles". Diamond mining is also prioritised by the Zimbabwean government as a significant future revenue source.

Other Budget Highlights

• The current multiple currency regime will prevail until 2012, after which currency reforms will be dictated by macroeconomic fundamentals.
• The Treasury will ring fence resources to on-lend to the Reserve Bank to enable it to resume its "lender of last resort" function. The objective is to re-establish the overnight lending rate as the benchmark for market rates and revive the inter-bank market. This will bring down banking risks that emerged in recent months and also high prevailing interest rates.
• Zimbabwe's current external debt holdings amount to US$6.7 billion. Creative leveraging of the country's natural resources combined with efforts to remove sanctions will be pursued to address the country's mounting debt overhung.

Outlook and Implications
Taking stock of mid-year fiscal developments shows similar disappointing results witnessed on the macroeconomic front. Continued political tensions and increased uncertainties regarding implementation of the Indigenization and Empowerment Act caused a significant decrease in private capital flows during the first half of 2010. This follows increased short-term capital inflows and foreign direct investment during 2009, financing a widening current-account deficit that is estimated at around 30% of GDP. Foreign donors furthermore provided significant off-budget financing for social services and humanitarian assistance, amounting to 12% of GDP during 2009.

The slowdown in both short- and long-term capital flows will force an adjustment in the current account over the short-to-medium term, curtailing imports, while banks' foreign assets-their main source of liquidity-could decline, coinciding with less financial intermediation, increased banking risk, and weaker GDP growth. Special Drawing Rights (SDR) holdings drawdown and arrear accumulation will prevail as a primary source of deficit financing during the second half of the year, given the government's limited room for manoeuvre and unchanged spending commitment. Some fiscal space created by the revenue overrun during the first half of the year could, however, be channelled towards much-needed infrastructural programmes (instead of financing higher recurrent expenditures), alleviating the impact on SDR holdings and arrear accumulations.

Political polarisation, loss of confidence, and heightened uncertainty regarding the Indigenization Laws, the banking liquidity crunch and high cost of money, debt overhang, skills and energy gaps, high costs of utilities and other tariffs, lack of fiscal space, and with high labour costs will continue to be a drag on Zimbabwe's near-term growth prospects. IHS Global Insight expects GDP growth to average 3.3% in 2010.