Zambia after the Completion Point: Will one swallow make a summer?
Zambia’s C.P. document is strongly driven by the positive developments of the country’s economy in the year 2004. Performance in the years 2000-2003 falls way short of decision point projections, and Zambia would have appeared a likely candidate for topping-up, had the slow improvement persisted for another year. 2004, however, was marked by an impressive boom in export income, based on higher than expected copper prices and some other factors.
The IFIs, who wrote the C.P. paper, seized this opportunity, and painted a very positive picture by building on the 2004 successes. All projections they make for the coming years, start from 2004 as a base-year, thus claiming implicitly and explicitly that the extraordinary boost in export earnings and GDP growth was not an episode, but rather the beginning of a trend. The crucial question for Zambia’s debt and financial sustainability therefore is, if this positive outlook will materialize or if – once again – the country will fall short of IFI projections, debt reduction thus turn out to be insufficient and Zambia again will receive insult upon injury by being accused of not having implemented reforms to a sufficient extent.
1. The IFI’s setup and the strength of the argument
At the decision point the IFIs had projected Zambia to reach the HIPC threshold of 150% present value of debt stock to annual export earnings (NPV/XGS) at the completion point through an overall cancellation of 62.6% of its debt stock. The present value of total external debt (PV) would thus be brought down from 432% after full application of traditional relief to 150% of export earnings (XGS). In the CP document the IFIs had to admit that decision Point projections regarding export growth had been unrealistically high: GDP growth had come close to the 5% rate assumed (4.6% on average between 2001 and 2004) ; but annual export earnings, which had been assumed to reach 1386m US-$ by end 2003; grew only to 1127m, i.e. some 20% less. Correspondingly the NPV/XGS rate after full application of HIPC relief would not be 150%, but 184%.
In fact, the decision point calculations had never foreseen 150% to be reached, but already anticipated that at a virtual CP end 2003 new borrowing would contribute to a rise from the 150% level calculated at end 1999 by 74.5%-points, while forecasted export growth in the same period would in turn lower it by 63.5%-points over the same period. Lowering the ration only to 161% is a deviation from the HIPC parameters at the outset, as the Initiative’s promise had been to bring the ratio to 150% (and then have additional bilateral relief on top of that). Correspondingly the starting point for the CP document was an assumed ratio of 161%. In retrospect, new borrowing had then been less, while export growth was considerably lower than forecasted Additionally, changes in the assumed discount and exchange rates also worked against Zambia, which was, however, compensated by enhanced interim relief . The weaker export outturn was “in large measure due to a substantial shortfall in metals exports receipts” These were due to “soft” copper prices and even weaker price levels of other metals between 2000 and 2003. No explanation is given for the obvious projection error of copper prices in the DP document.
The document’s authors do not bother much about this weaker performance, but rather proceed rapidly to the 2004 performance, which shows an extra ordinary improvement. Export earnings grow 2003-2004 by some 50%, half of which is attributable to a more than 50% increase in the copper revenue, caused by a correspondingly soaring copper price, which for the first time exceeds the decision point forecasts. Volumes, however, have been below the forecasted levels during the whole period including 2004.
This positive development is considered “robust” by the IMF, because during 2000-2004 Zambia has managed to weather considerable shocks, including the 2002 drought, without returning to the zero- or even negative growth rates of previous decades. This, however, is based on wrong and inconsistent figures: Fig.1 on p.8 and Table 1 in the annex indicate GDP-growth figures for 2000 to 2004 as 3.6, 4.9, 3.3, 5.1 and 5.0% respectively, the average for the period being 4.6%. The actual figures in Table 12 in the annex however show a different picture: based on the export income growth, the GDP growth rate for 2004, which is wrongly put at the 5.0 of the original forecast, in reality is 25.27%. The real average for the period therefore is 7.8%.
From there on, the IFIs feel legitimised to base all the upcoming calculations on the 2004 results – even if mitigated by the application of the usual three-year average in the denominator, i.e. the annual export income. This serves to level off high/low peaks, while however serving to make a possible one-off improvement look more lasting over a three year period. As we already have seen with regard to the GDP-growth, the crucial table 12 of the document, which reveals assumptions for the period 2004 to 2023 is again inconsistent by indicating an export volume growth of 5% in 2004, while in reality the absolute figures in the same table reveals that 2003 on 2004 growth has been 48.5% .
The validity of the friendly outlook for Zambia, which the document presents, including the relevance of the stress tests, is therefore based on one crucial question: Is it realistic to assume that the 2004 result is a “normal” development for Zambia, or would it be advisable to assume that export income growth will rather return to “normal” levels any time soon and then continue at the more modest trend 2000-2003, while 2004 has been an exceptional year? The IFIs decide that the former is the case, and calculate a constant 5% export increase from the 2004 levels onward. The reasons they give for this is the “ongoing investment in the export sector”. This, however, is not a convincing argument, as we have seen that the extraordinary rise in 2004 has not been due to enhanced production capacity or any discernible productivity increase. Its major reason was the rise in world market prices for copper and other metals –which Zambia can not influence favourably by its investments . Rather to the contrary, investment into production capacity by one of the world’s largest producers, which Zambia is, will rather tend to exert pressure on prices and thus compensate any quantity effect. Major market experts do indeed expect a cooling down of the copper market. While prices are expected to remain at high levels above 1 $/lb, it is expected that the build-up of considerable surpluses, after huge shortfalls in the last years, will make any rise in export quantities rather unlikely.
In line with the Bank’s and Fund’s assumption, the NPV of Zambia’s external debt, which stabilizes around nominal 2.1 bn US-$ beyond 2010, will decline constantly in relation to export earnings, after having reached close to 100% through the export increase in 2004.
The IMF undertakes, as usual, a series of “stress tests” simulating three “relatively severe” shocks: (1) a fall in copper prices by 20% and a permanent fall in production by 10%; (2) real GDP growth and non-traditional export volume growth are 3% p.a. instead of 5% and 7% respectively; (3) grants fall short of expectation by one quarter, which is then compensated for by additional borrowing.
Not surprisingly, all of these scenarios will only modestly impact upon the NPV/XGS and debt service ratios. This is due to two major factors:
· All scenarios factor in the 50% increase in export income, which has brought the debt ratio to a manageable level for the last year, and assume no return to the earler growth path.
· The chosen shock scenarios do not appear really “severe”. Except for the 2001-2004 period, Zambia has never experienced a continuous GDP-growth rate of 3% (as assumed here as a “shock”) in the last 25 years. In other countries, the IFIs have occasionally based their shock scenarios and sensitivity analyses on historical records. No reason is given, why this is not done in the Zambian case.
2. Additional aspects
In the first paragraph we have seen that building the prospects for Zambia’s debt sustainability on the 2004 performance or rather on a longer term historic and generally more conservative record is the crucial question for assessing the validity of the C.P. arrangement for Zambia. However, there are a few more quite interesting aspects in the document, which merit our attention:
· As ever, Bank and Fund build their sustainability consideration on the debt stock after the application of full HIPC assistance, including additional bilateral relief beyond the multilateral arrangements. This has become common practice, although it effectively deprives the debtor country of a part of the relief promised at the Cologne 1999 G7 summit. There, the G7 had solemnly declared that HIPC relief would be supplemented by those additional contributions, which generally consisted in cancelling the remainder of bilateral debt after a 90% Cologne terms stock reduction and proportional HIPC relief. These were normally small or even minuscule amounts, which often would have been absurd to keep in the books and administer any way. However, in some countries, they could be substantial in absolute terms. In the case of Zambia, these additional benefits amount to some 10%-points of PV/XGS. Without any explanation the IFIs have proceeded to factor this bilateral contribution into the overall HIPC relief, thus diminishing their own contributions, which they have to provide under the HIPC burden sharing approach. Unfortunately all the G7 governments have tacitly accepted this procedure. The only country, which has constantly opposed it, including in the World Bank board, has been Norway. As other creditors were not prepared to stop this malpractice, Norway has decided, to postpone its own additional relief until after the full implementation of HIPC. As Norway is only a minor creditor to Zambia and other affected countries, the quantitative aspect of this brave act of honesty is limited. Would all bilateral creditors act the same way, Zambia would have been entitled to another 120m US-$ of debt stock reduction.
· Domestic debt is only mentioned in the context of technical debt management problems , although it constitutes a major problem to fiscal sustainability. In 2002 domestic public debt amounted to 4.155 trillion kwacha (some 950m US-$). As average interest is extremely high (35% in 2002, down from 180% in the mid-nineties), internal debt constitutes a heavier burden on the public budget than external debt. Domestic interest has been rising from 207 bn Kwacha in 2001 to 927bn in 2004, i.e. from 6.35% of revenue to 14.74%. In 2004 interest on domestic debt was 80% of total government interest payments. In 2004 a slight improvement could be observed.
It is, of course, true that domestic debt cannot be dealt with under the same mechanisms as foreign debt under HIPC. Discussing debt sustainability, however, and simply ignoring 80% of public liabilities, necessarily leads to a distorted view on reality. Moreover, it contrasts with the World Bank’s own efforts to raise awareness towards this new global phenomenon.
· Quite surprisingly, the very positive outlook, which the IFIs provide on the basis of their extrapolation of the 2004 data, still identifies a major financing gap for Zambia from 2006 onward, its main reason being the continuous current account deficit. This deficit, on its part, is surprisingly unimpressed by the soaring export earnings, for which there is a simple reason: While export income grows, so do import costs particularly those of oil . The huge trade balance deficit improves only slightly in the boom year 2004 and is predicted to rise steadily after that. The financing gaps, which persist and grow beyond 2020, need constantly to be filled with grants and new borrowing. Two important structural questions emerge out of this fatal experience:
o In the 1990ies Zambia has shown an impressive record of liberalization of its economy. Has it been adequate for such a vulnerable country to dismantle instrument to regulate and, if necessary, restrict imports?
o Does it make sense in the context of a debt sustainability analysis, to exclusively orientate it on the income side, without considering import costs (at least if and when imports are beyond public control)? Were the sustainable debt stock defined in terms of net income, a lasting exit could be much more realistically expected. However, in the Zambian as well as a number of other cases, this would then have to lead to full cancellation of existing debt stocks.
The IFI’s high gambling may be successful. Extraordinarily high export income may translate the 2004 episode into a trend. For the sake of Zambians, who have been at the receiving end of futile debt reduction efforts since 1983 , this is highly desirable. In reality, however, there is not much reason to hope for this to happen: Never in Zambia’s history have the high growth rates assumed until 2023 materialized over such a long timeframe. Moreover, the failure to not base debt relief on more conservative assumptions, aligns with the ignoring of major risk factor in Zambia’s foreign financial and fiscal positions: notably the long-term effects of the domestic debt burden.
It seems therefore likely that Zambian authorities will remember quite soon the HIPC Finance Ministers’ statement at the Maputo conference in March 2005. Ministers, including the Zambian Finance Ministers have demanded there that HIPCs should have the opportunity to conduct their own debt sustainability analyses. It seems advisable to not wait until the copper price again collapses and World Bankers start to recalculate their recalculations. UNDP is prepared to support this urgent process now.
Jürgen Kaiser, May 30th 2005