Wednesday, 7 September 2022

IMF Deal: Cry, My Beloved Zambia

By Grieve Chelwa

The International Monetary Fund (IMF) yesterday published the conditions attached to the newly agreed programme with the Zambian government. The conditions are incredible, unbelievable, heartless and basically make for very sad reading. They are even more incredible than I predicted in my radio appearance on Hot FM last December. I spent this morning reading the IMF's document. Below, and typed up pretty quickly because of work pressures, I summarise some of the most concerning aspects of the "deal". 

The centerpiece of the deal is that the IMF is targeting in their words, "a large, front-loaded, and sustained fiscal consolidation." Specifically, they want the fiscal deficit to decline from 6% of GDP in 2021 to a surplus of 3.2% of GDP by 2025. And this is largely to be achieved by drastic cuts in government spending over the period 2022 to 2025. Basically, the IMF wants our government to reduce expenditure in the billions of dollars between now and 2025. This, my friends, is the definition of austerity.  

How is this reduction in the fiscal deficit going to be achieved? By reducing expenditure on the following: 

1. Fuel subsidies are going to be fully eliminated by the end of this month (September 2022). What this means is that our government will no longer protect its people from the vagaries of swings in the international price of oil. What then, is the role of government if not to protect its people from shocks, of which oil price dynamics are some of the most consequential?  

2. Electricity tariffs will have to increase (via subsidy removal) and the IMF wants the Zambian government to publish a plan for doing this by December 2022. As I have argued before on this blog, this is going to cause pain among our people.

3. The hugely successful Farmer Input Support Programme (FISP) will be "reformed" beginning    farming season 2023/2024. "Reform" is IMF speak for drastic cuts. In this instance, the envisaged cuts are large between now and 2025. My heart bleeds for the hundreds of thousands of small-scale farmers who have largely made our country maize-secure over the last two decades. (Funny thing is that the IMF, in their document, are full of praise for our self-sufficiency in maize production and yet they want us to effectively kill the goose that's been laying our golden eggs!). 

To achieve the fiscal consolidation described above, the IMF also has a plan for increasing revenues. And I imagine you are expecting that their plan is anchored on increases to corporate income taxes (especially on the mines). The answer is no. Their plan is largely anchored on the following, which will largely impact the poor and the middle class:

4. Value Added Tax (VAT): The IMF wants us to "broaden our VAT base" which essentially means limiting the number of goods that are VAT exempt. The VAT is one of the most regressive taxes in the world because it impacts the poor much more than the well-off. Because of this, governments often exempts many products from VAT to protect the poor. The IMF now wants us to do the reverse and do so in quite a drastic way. A table on revenue measures on page 12 shows that VAT is going to be the champion of revenue increases over the medium term -- much more so than corporate income taxes and mineral royalty taxes. (Also funny that the IMF is concerned about the  regressivity of fuel and electricity subsidies, yet they don't seem to worry about the regressivity of the VAT!). 

5. Table 3a on page 35 shows that taxes on labour income are also likely to go up in the medium term, and go up at a rate faster than taxes on profits (mining and non-mining). 
The revenue measures in points 4 and 5 above are really pro-rich measures. Difficult to conclude otherwise.

There's been lots of talk about how the IMF has reformed from who they used to be in the past and that they now care about the poor because they want us to increase expenditure on the social cash transfer (SCT). I am sure what I have written above should already cast doubt on the "reformed IMF thesis". Anyway, how much is the envisaged increase in the SCT -- a monthly allowance given to the very poor? Well, they advise that the SCT increases from K90 currently to K110 per month. That is an increase from $5 per month currently to $7 per month! I leave it to you, enlightened reader, to conclude whether these amounts are sufficient to protect the poor from the subsidy removals in points 1, 2 and 3 above and from the expansions in the VAT base in point 4.  

Oh, on page 1, the IMF says that this agreement will immediately result in a disbursement of $185mn from them to us. A signing bonus of sorts for all our troubles. And it's quite funny how this "recovery plan" is continuously referred to as a "homegrown plan" when the IMF's fingerprints are all over it. 

Before I sign off, I would like to address my colleagues in Zambian civil society who went along for the ride with the IMF, appeared in many photo ops with IMF staff and largely gave credence to the opaque process that gave birth to such an anti-poor deal. This, my friends, is on your hands and you went to sleep on the wheel when your role was and historically has been protecting the interests of the Zambian people, especially the least among us. Posterity will be the judge, and I am wagering that the judgement will be one of disappointment. 

Tuesday, 30 August 2022

Skepticism with securing the BoZ Governor's Tenure

Last week, it was widely reported that president Hakainde Hichilema had signed into Law the Bank of Zambia Act of 2022. The new law replaces the Bank of Zambia Act of 1996. According to the accompanying memorandum from the Attorney-General, the new law has many objectives including providing for the establishment of a Monetary Policy Committee and a Financial Stability Committee -- both laudable initiatives. 

However, one amendment that caught my attention, widely discussed and praised on social media, is the introduction of new clauses that guarantee security of tenure of the governor, who is the head of the Bank of Zambia. In the 1996 Act, the governor (and his/her deputies) did not have such security and could be summarily dismissed by the president. Article 10(7) of the 1996 Act read:

The Governor may resign from office by giving three months notice to the President and may be removed by the President. 

Essentially this meant that the president could dismiss a governor at a moment's notice without the need to provide cause. 

The new Act introduces security of tenure in Article 13 (in subsections 3 to 7). The basic gist of the amendment is that the president is now required to constitute a tribunal should he/she see the need to remove a governor (or any of the deputies). The tribunal is then required to carry out its investigations and submit a report with a recommendation to the president in about a month. 

This amendment gives the governor the kind of security of tenure that is enjoyed by the likes of judges and the Director of Public Prosecutions (DPP) although interestingly (and perhaps curiously) the security of tenure of the governor is not guaranteed in the Constitution, as it is for judges and the DPP, but in subsidiary legislation (more on this below).  

On the face of it, this amendment seems like a good thing as it buttresses the so-called independence of the central bank. According to the "independence thesis", central banks are sacred institutions that ought to be staffed by computer-like technocrats that are insulated from the vagaries and emotions of politics, leaving them to focus almost exclusively on technocratic concerns with price stability. (As a matter of fact, Article 5(2) of the new Act makes it explicit that price stability is the new god of our central bank and little else should sway their decision making).

But as careful scholars have demonstrated, central bank independence and its hyper-focus on price stability is a terrible policy constraining the ability of developing countries to fully transform their economies via, for example, large-scale industrialisation. Lots of scholars have documented how the now-developed and industrialized countries have historically used their central banks as tools of industrial policy that have deliberately directed financing towards strategic sectors of the economy. Writing in 2006, the economist Gerald Epstein had this to say:

…virtually throughout their history, central banks have financed governments, used allocation methods and subsidies to engage in ‘sectoral policy’ and have attempted to manage the foreign exchanges, often with capital and exchange controls of various kinds. The current ‘best practice recipe [of central bank independence with a narrow focus on price stability]’...goes against the history and tradition of central banking in the [developed] countries now most strongly promoting it…

And the distinguished Malawian economist Thandika Mkandawire writing about the South Korean experience had this to say:

[V]irtually all central banks have engaged in ‘industrial policy’ or ‘selective targeting’. In the credit allocating functions central banks have been “most effective in helping to foster development, especially in ‘late developers’ [such as South Korea], where they have been part of the governmental apparatus of industrial policy” (Epstein 2006). In South Korea, the Central bank was subservient, “nearly an administrative arm of the Economic Planning Board and the Ministry of Finance” (120)

 Central banks, in the now-developed countries have historically viewed their societal roles as going beyond narrow and technocratic concerns with price stability. In so doing, these central banks have not been independent of the body politic but have been every bit a part of it, and in most cases subservient to it. 

At this point in our country's development, the Bank of Zambia ought to be a vital engine of industrialization directly providing and directly facilitating the type of long-term capital required for meaningful (and not lip service) industrialization. We need the central bank to not shield itself from the people, but to be with the people and answerable to them as the "People's Bank". 

Additionally, new academic work has shown that "independence" is often only in name. As a practical matter, so-called independent central banks tend to be beholden to the moneyed classes, a situation that has led to rising inequality in those parts of the world that have institutionalized such "independence". 

In the Zambian case, it is also interesting to note that central bank governors have largely enjoyed sufficiently long tenures even in the absence of formalized security of the sort contained in this new amendment. For example, since 1992, the average tenure of office of a governor has been a healthy 5 years. If we exclude the lone year served by Christopher Mvunga, the average tenure rises to 6 years. In many ways, Zambian central bankers have enjoyed lengthy stays in office -- a situation suggestive of a healthy dynamic with their principals. For example, current governor Denny Kalyalya, during his first stint as governor, enjoyed a five year tenure in spite of his public disagreements with the policy positions of government. So why the need to secure tenure at this point in our country's development trajectory?

Lastly, my good friend Goodwell Mateyo, who recently appeared on Capital FM with Frank Mutubila, and a lawyer by training, has made the rather interesting argument that the new amendment might be in violation of the Constitution. Additionally, Mateyo has argued that matters around security of tenure ought to be reflected in the supreme law of the land, the Constitution, as opposed to subsidiary legislation as is the case with judges and so on. Also, the threshold to make a constitutional amendment is much more stringent than an amendment to an Act. Something as heavy as safeguarding the tenure of office of the governor ought to have been subjected to such a stringent criteria. You can listen to a recording of Mateyo's insightful interview with Frank Mutubila by clicking here.      

Comments welcome: 

Wednesday, 20 January 2021

Some initial thoughts on the Mopani Deal

 Yesterday, Minister of Mines Richard Musukwa announced that the Zambian government had decided to fully take-over Mopani Copper Mines (MCM) by purchasing Glencore's and First Quantum Mineral's combined 90% stake in the mine. Prior to this, government's shareholding in the mine was 10%. Specific details on the transaction are still very vague. However, the clearest statement on the deal so far is from Minister Musukwa's speech on the transaction (pdf available here). In this hurriedly written post, I want to recount the main points of the transaction as detailed by the minister and provide some reflections on the same. I hope to write more substantively about this in the coming days when more details are hopefully made available.   

Before engaging with the minister's points, I want to say that I wholeheartedly agree in principle that we as a country need to fully own and run our copper mines. One of the biggest policy mistakes of the last 25 years or so was the decision to privatize the copper industry. In his 2015 Goma Lecture presented in Lusaka, the late economist Thandika Mkandawire estimated that Zambia would have accrued national savings of about $20bn had we never sold the mines. And these savings would have been deployed towards productive investments and large-scale social spending negating the need to borrow from external sources. Selling the mines was a big mistake. 

The three main features of the transaction announced yesterday are the following (this is taken verbatim from the minister's statement): 

1. The $4.8bn loan owed by MCM has been agreed to be reduced to $1.5bn. MCM as an asset was owing loans amounting to $4.8bn from Glencore (Bermuda), Glencore International and Carlisa. 

2. The sale price is $1 

3. The [$1.5bn] loan [mentioned in point 1] is to be repaid through an off-take agreement granted to Glencore International using 10% of the production. That means the loan will be repaid between 10 and 17 years depending on the price of copper. You may wish to know that prior to this transaction Glencore already had an off-take agreement with MCM and this is expected to continue. 

Point 2 is merely academic and so I won't spend time on it. Points 1 and 3 are where the action and the controversy is in my opinion. Let's start with point 1 and then go to point 3. 

On Point 1 

The point basically says that MCM, itself a Glencore entity, had over the years received financing of upto $4.8bn from three Glencore entities (Carlisa is majority-owned by Glencore with minimal shareholding from First Quantum Minerals. From the look of things, Carlisa, based in the British Virgin Islands, was set-up to manage Glencore's and First Quantum's investments in MCM). As part of yesterday's transaction, Glencore (or Carlisa which is really the samething) want the Zambian government to assume this loan which the previous owners have "graciously" written down to $1.5bn. 

There are several issues that are problematic about this. First, is there anyway to prove that this was an actual loan and not a notional one? This is not an easily dismissible question given the overwhelming evidence showing that multinationals, especially those in the extractive sector, often use intra-company loans as an effective mechanism for tax avoidance. 

Second, the $4.8bn was a loan from the parents to the subsidiary. In other words, the parents invested in their child and these investments did not work out. Why should the Zambian people pick up the tab of the parents' misjudged investments? The discussion would be different if the loan had been issued by, say, an independent bank with limited control over MCM. Glencore were fully in-charge of MCM when these loans were being granted. It appears that the investments amounted to nought. Glencore should completely write-off these loans and consider them bad loans.   

Third, the implication of all this is that the actual/effective selling price of the 90% shares in MCM is $1.5bn (the so-called $1 selling price is a distraction). The Financial Times reports that Glencore had in August 2020 valued MCM at $700mn. 90% of $700mn is $630mn and not $1.5bn. We are clearly overpaying (and possibly over over over paying if it turns out that the $4.8bn was a notional loan).  

On Point 3

This point basically says that Glencore wants to guarantee the payment of its loan by guaranteeing for itself 10% of MCM's copper output from now until the $1.5bn loan is repaid. The minister reckons that this arrangement might be in place for about 12 to 17 years depending on the performance of the copper price. All this assumes a healthy outlook for the copper industry over the medium to long-term. But what happens when the copper price plummets below healthy? What will Glencore do? Sell the loan onto Vulture Funds? Repossess Zambian assets? 

These are not unreasonable questions given the well-known history of boom and busts in the commodities markets. (As an aside, the current debt crisis engulfing the African continent is partly the result of rosy commodity price forecasts that were floating around circa 2009/2010).   

Second, between points 1 and 3, point 3 is the vaguest in terms of actual details. What, for example, is the implied interest rate for this loan? We need to know this so that we can compare whether it would have been cheaper to borrow the $1.5bn via another vehicle (bank, capital market, etc...) and immediately pay-off the Glencore loan. I suspect that the implied interest rate on this loan is exorbitantly high. It is even higher if you include the opportunity costs associated with being forced to sell 10% of your copper output for the next 2 decades to a private entity. For instance, MCM would have to turn down some other buyer wanting 100% of its copper at a price offer above the market price. This would be a loss to MCM and the country. 

We really need more details on point 3 given all this. 

Can Zambians Run Mines?

Before concluding I want to deal with the age-old question of whether Zambian's can run the mines. 

As I stated at the outset, I am all for the country owning the mining industry. An objection often raised when I make this point is that Zambians do not have the know-how to run mines. The evidence those arguing this way produce is the performance of copper production under ZCCM in the 30 year period (1970 to 2000) that Zambia had a controlling stake in the entire mining industry (ZCCM which stands for Zambia Consolidated Copper Mines was the conglomerate that ran the mines). For those arguing this way, the relative success of the industry under private hands (since about 2000) is further evidence in their favour. 

As I argued in a piece for Africa Is A Country in 2015, the story of Zambia's copper production is really a story of the copper price. In times when copper prices have been high, so have been production and profitability. In times when prices have been low, so has production and profitability. Specifically in 2015 I wrote

In the decade running up to nationalization (1960 to 1968), real (inflation-adjusted) copper prices increased by 69%. In the three decades after nationalization but before privatization, copper prices performed as follows: a 45% decline in the 70s, a 7% increase in the 80s and a 39% decline in the 90s. Over the entire period 1970 to 1999, the real (inflation-adjusted) price of copper declined by an incredible 70%!...Between 2000 and 2010 [after the mines had been sold to private hands], real (inflation-adjusted) copper prices increased by a whopping 230%! Anybody, be it a state-run entity or private entity, would have responded to this incredible rise in copper prices by producing more [and registering healthy profits].

Our prayer then is that copper prices should be in our favour as we enter this new era of "re-nationalization". Our second prayer is that the Patriotic Front government manages this God-given resource prudently and for the benefit of all Zambians. This is a big prayer given recent corruption scandals that have hit the party. 




Thursday, 15 October 2020

The "Truth" About Zambia's Debt

 Zambian social media platforms, especially WhatsApp groups, were very active yesterday sharing and discussing the publication of the World Bank's latest International Debt Statistics Handbook. I've lost count of the number of friends on WhatsApp who sent me the hyperlink to the download page of the book. Ordinarily,  the publication of the Debt Statistics Handbook goes without notice in much of the world and especially in Zambia. So why all this interest this time around?

Well, in the last couple of weeks, "Zambia and its debt" has been a topical issue with prominent coverage in the Financial Times and Bloomberg among other international outlets. The latest round of interest comes on the heels of an official request from the Zambian government for a payment holiday on upcoming debt service obligations. So this week's publication of the World Bank's International Debt Statistics Handbook (hereafter IDSH) fell into this milieu of strong emotions around Zambia and its debt. 

So why all the fuss? Well, all the commentary on WhatsApp, Twitter and Facebook on the the IDSH zeroed in one single statistic reported at the top of page 150: Zambia's external debt at the end of 2019 was $27 billion dollars! This is certainly a huge number and would suggest that the country's external debt was almost equal to the size of the country's GDP. And for many of yesterday's commentators, this number was evidence that the Zambian government was understating the true nature of its external debt. For example, Finance Minister Bwalya Ng'andu recently told parliament that external public debt was $11.97 billion dollars, a number that is about $15 billion lower than the World Bank's number.   

So what is going on here? The confusion stems from the conflation of Total External Public Debt with Total External Debt. The two aren't the same thing even though they seem like they are. 

Total External Public Debt (the first one) refers to all foreign denominated debts that are owed by the Zambian government. This includes external debt directly owed by the government and debt guaranteed by the government but contracted by government or quasi-government entities. For example, Total External Public Debt would include the (in)famous Eurobonds and/or any guarantees issued by the government in favour of, for example, the Zambia Electricity Supply Corporation (ZESCO).   

Total External Debt, on the other hand, is the sum total of all the external debt owed by entities domiciled in Zambia. This includes debt owed by the Zambian government (as defined above) and that is owed by Zambia's private sector. Total External Debt would include external debt owed by the government plus external debt owed to foreign creditors by, for example, the privately-run mining industry. 

By definition, and given the above, Total External Public Debt can never exceed Total External Debt. The two can be equal which would imply that all external debt is government debt. In practice, Total External Public Debt tends to be lower than Total External Debt primarily because the private sector also borrows from foreign creditors.  

So what does all this mean for the publication of the IDSH and the commentary that followed? Well, the first thing is that the World Bank and the Zambian government are saying the same thing. The fourth line item on page 150 of the IDSH says that Total External Public Debt at the end of 2019 was $11.1 billion [1]. Minister Ng'andu told Parliament on 25th September 2020 that "[total] external public debt stock increased to US$11.97 billion as at end-June 2020 from US$11.48 billion at the close of 2019...". As one can see, these numbers are pretty much around the same ballpark. 

The June 2020 number, as reported by the Minister, is slightly greater than the 2019 numbers (from the government itself and the World Bank) because of the likely accrual of additional external public debt in the first 6 months of 2020. The 2019 numbers by the World Bank and from the government are slightly different from each other because of likely accounting/reconciliation issues. Interestingly, government's number for end 2019 is greater by about $300million. This might be the result of one public guarantee or the other that was not captured by World Bank statisticians. 

So in many ways the World Bank's IDSH is telling us nothing new beyond what the government has already told us regarding the country's external public debt. 

As to whether the $11 billion number (from both the World Bank and the government) is to be believed is a different question altogether. I have good reason to believe that the "true" external public debt is around this figure. Margaret Mwanakatwe, Ng'andu's immediate predecessor at Finance, instituted a debt reconciliation drive about two years ago and committed the Ministry of Finance to issuing quarterly debt briefings (although the frequency of the briefings has reduced lately). This was in response to heavy domestic and foreign criticism that the Zambian government did not know the true extent of its debt obligations. It appears the Ministry of Finance has gotten on top of this issue and, for example, recent IMF statements on the country are no longer broaching the subject of debt reconciliation as they did a couple of years ago. Economist Trevor Simumba, however, believes the true extent of external public debt might be higher owing to the opacity around debt contraction from China. He might very well be right. 

Before concluding, I want to briefly talk about one aspect that struck me from the IDSH that few talked about yesterday and that I had been unaware of. According to page 150 of the IDSH, Zambia's private sector owes a whopping $14.7 billion to foreign creditors! In other words, private multinational corporations, private companies and private individuals all domiciled in Zambia collectively owe about 54% of Zambia's Total External Debt (recall the definition of this from above). This implies that Zambia's private sector is just as indebted to foreign creditors as the Zambian government is. In actual fact, the private sector owes much more. 

As a country, we have not debated and thought about private sector debt as much as we should. It's worth engaging with this issue because, for one thing, economic crises can result from the unsustainable buildup of external debt by the private sector (see the Asian Financial Crisis) just as much as they can from unsustainable buildup of public debt. Second, pressure on the domestic currency (the Kwacha) can also arise from the demand for foreign currency by the private sector to meet its external debt obligations just as it can from demand by the government. So in a nutshell, any talks about devising a strategy for Zambia's external debt should include discussions about external debt held by the private sector. 


[1] The IDSH refers to it as "Public and Publicly Guaranteed Debt"


Thursday, 5 December 2019

Problems with Central Bank's take on Bill 10

Readers of this blog will recall that in July I raised concerns about a proposed amendment to the functions of the Bank of Zambia (BoZ). The proposed amendments are contained in the infamous 2019 Constitution Amendment Bill (aka Bill 10).

Specifically, Bill 10 proposes to delete clause (2) of Article 213 of the current Constitution and replace it with a new clause. Article 213 (2) of the current constitution spells out BoZ's functions as follows:

"(2) The functions of the Bank of Zambia are to— (a) issue the currency of the Republic; (b) determine monetary policy; and (c) regulate banking and financial services, banks, financial and non-banking institutions, as prescribed."

Bill 10 proposes that Article 213 (2) be replaced with:

"(2) The function of the Bank of Zambia is to formulate and implement monetary policy."

The concluding section of my July blog post read as follows:

"So it seems that the Draft Amendment Bill seeks to strip away from the Central Bank the functions of issuing currency and the regulation of the financial sector. These two functions are pretty core to what central banks do across the world. And I can't see how another entity would logically takeover these functions, particularly the one to do with issuing currency. And the Draft Amendment Bill is silent on where functions (a) and (c) will now sit.

This is a strange amendment and one hopes that Members of Parliament will probe for details and justifications once the Bill is tabled in the National Assembly."

Yesterday, BoZ issued a belated press statement seeking to explain the reasons for the proposed amendment. Below is an excerpt of the most important parts of their press statement:

"The proposed provisions relating to the Central Bank were motivated by the Bank which is of the view that the Constitution should only contain broad constitutional principles which are operationalised through detailed legislation passed by Parliament. In this regard, the Bank submitted proposals for amendment of the Constitution regarding the Central Bank's functions to be restricted to the primary function, while additional functions, objectives and powers will continue to be subject of an Act of Parliament as envisaged under Article 215 of the Constitution of Zambia, Act No. 2 of 2016. 
The Bank has thus submitted to the Government that the primary function of the Bank should be to formulate and implement Monetary Policy. This submission is consistent with best practice on central banking and also complies with the SADC Model Law for Central Banks which stipulates that all Central Banks in the region should move towards adopting a single primary objective."

BoZ's press statement revealed that they are the originators of the proposed amendment. Further, the proposed amendment, according to BoZ, has two objectives: 1. Maintain broad principles in the Constitution but have specifics spelled out in subsidiary legislation and 2. Bring the Bank's "primary function" in line with "best practice" and in line with SADC Model Law for Central Banks. 

I find the Central Bank's motivations to be highly problematic and also confusing. First, the issuance of currency is no ordinary function such that its specifics can be left out of the Constitution. Relegating specifics about currency issuance to subsidiary legislation leaves them wide open to manipulation. The requirements to amend subsidiary legislation are much less demanding than those required to alter sections of the Constitution. Suppose the specifics about currency issuance were only spelled out in subsidiary legislation such as the BoZ Act, nothing would stop a government with sinister aspirations from proposing an easily achievable amendment to remove this function from BoZ and give it to some other less competent entity. And these kind of things are very much possible given the current political context in the country.

Second, BoZ argues in their press statement that they are proposing the amendments to meet "best practice" and SADC objectives. This is the bit that is confusing. The Constitution is a document meant for the people of Zambia and should only contain the aspirations of the people of Zambia and no one else. Any "best practice" or regional norms should be reflected in our Constitution to the extent that they are in line with our aspirations and our own unique set of circumstances. The latter point is important because the current political climate teaches us every day that we need to make our Constitution ever more specific in its contents rather than make it vague with dilutions. This may not be the case with other countries in SADC who might have better political contexts where such vagueness may not pose existential threats. In any case, the same objective of satisfying "best practice" and SADC norms can still be met by spelling those out in subsidiary legislation and leaving the current Constitutional provisions intact.

In a nutshell, I don't find BoZ's justifications convincing and I am still of the opinion that this proposed amendment should be withdrawn and Article 213(2) should remain as is. Many countries have come asunder due to the careless handling of the printing press.


Wednesday, 18 September 2019

Electricity tariff hikes will harm the poor

Zambia is once again experiencing crippling power outages with load-shedding of at least 6 hours a day in many parts of the country. The last time load-shedding was this heavy and this widespread was 2015. ZESCO, the electricity utility, says this year's load-shedding, just as the one in 2015, is due to low water levels at the country's main hydro power plants. Zambia generates most of its electricity from hydro sources.

The Zambian government is considering importing up to 300MW of emergency power from South Africa as a coping mechanism. Given the strained state of the country's finances, the Minister of Energy has suggested that electricity tariffs could be increased by as much as 75% to pay for the imports.

Research that my colleagues and I have conducted suggests that such a tariff increase would have grave consequences for the poor.

In 2017, ZESCO was allowed to implement a tariff hike of 75%. The motivation was that local tariffs were not cost reflective and needed to be adjusted upwards. Such an upward adjustment would make investments in electricity generation attractive for private sector players (the jury's still out on whether this has actually happened).

In a research paper that Mashekwa Maboshe, Akabondo Kabechani and I published this year in the journal Energy Policy, we simulated the likely impact of the 2017 tariff hike on different income groups in Zambia (published version here; ungated version here).

We found that the poorest 10% of Zambian households (the poorest decile) were likely to experience a 9.4% reduction in real household expenditure as a result of the tariff hike. In comparison, the real household expenditure decline for the richest 10% (richest decile), was only going to be 3.2%. In other words, the poorest 10% were going to see their real household expenditure decline at 3 times the rate that it would decline for the richest 10%.

An increase in electricity tariffs has the same impact on our incomes as inflation. Inflation, which is the general increase in prices, reduces the number of goods we can really (or actually) buy with our incomes. In other words, inflation reduces our real incomes or real expenditures. Electricity tariff increases have the same effect. Firstly, the tariff increase immediately affects the price of electricity (the direct effect). Second, because electricity is a vital input into the production of other goods, the prices of other goods also increase (the indirect effect). The poor are hardest hit because electricity and goods produced with electricity occupy bigger shares of their household budgets than the well-off. 

Lastly, our simulations showed that an additional 100,000 people would become poor as a result of the tariff increase. This is because their real expenditures would fall below the poverty line as soon as electricity prices went up.

Our work shows that the burden of increased electricity tariffs in Zambia falls overwhelmingly on the poor. One hopes that Cabinet and the public will take this into consideration as they debate the next round of tariff increases. 

(This piece has benefited from discussions with my coauthor Mashekwa Maboshe)

Monday, 16 September 2019

Yes, debt payments are high and rising

This past Friday president Lungu delivered his annual address to the National Assembly. The address is meant to provide policy guidance for the year ahead as well as signalling the start of a new session of parliament. One of the most striking paragraphs from the president's address to the House was this one:
Our non-discretionary expenditure, which comprises personnel emoluments and debt stands at 50.1% and 40% respectively, giving a total of 90.1% of our annual budget. This leaves the discretionary expenditure amount to stand at 9.9% of our annual budget. This Mr. Speaker is an alarming ratio.

I initially thought that the president's speech writers had gotten their facts wrong around debt expenditure  -- surely our debt service payments weren't as high as the president was making them out to be?

I was compelled to factcheck this statement all the while hoping against hope that the president, or his speechwriters, were wrong.

The most sensible way of fact checking this is to compare the president's statement with the official position on debt expenditure as contained in the 2019 Budget Address. According to the budget, the total amount of money set aside for debt service payments for 2019 was K24billion (K9billion for domestic debt and K15billion for external debt). Total expenditure for the budget as a whole was K87billion. This gives a debt expenditure share of 28%.

So did the president exaggerate the budget's debt share by a whole 12 percentage points? Not exactly.

Recall that in August of this year, the new Minister of Finance Dr. Bwalya Ng'andu asked parliament to approve a supplementary budget of K9.8billion. Dr. Ng'andu wanted the extra money to mostly pay for unexpected increases in debt service payments as a result of a weaker Kwacha among other reasons. Adding the amount that Dr. Bwalya asked for brings the total debt expenditure for 2019 to K34billion, representing a budget share of 35%. A number that's very close to what the president said in the National Assembly. (I invite better informed readers to figure out what might account for the 5 percentage points difference between what the president said and what I have estimated here).

Have we always spent this much of our budget on servicing debt? Figure 1 below shows that debt service payments were only 9% of the budget in 2009 and began to grow at alarming rates starting about 2015. By 2019, the debt service share in the budget was 28% (35% if you add the supplementary expenditure). So the share of the national budget dedicated to debt has grown by over 200% from 2009 to 2019 and is now at least a third of the budget if not more!

Figure 1: Total Debt Service Share in the National Budget
Source: Various National Budgets

It's also interesting to figure out what the structure of debt payments has looked like over this period. In other words, what has been the share due to domestic debt payments versus external debt payments?

Figure 2 provides this split. From 2009, the external debt expenditure share in the budget was very small (at 2.4%) and less than the domestic share (at 6.4%). However, beginning in about 2013, the external debt share began to increase rapidly so that by 2019, the budget was spending 17% on servicing external debt and spending 10% on domestic debt service. And servicing external debt is a Herculean effort because you need to use precious, and hard to earn, foreign currency to do it.

Figure 2: Total, Domestic and External Debt Shares in National Budget
Source: Various National Budgets

Finally, it's worth comparing the budget's expenditure on debt payments versus expenditure on what most citizens would deem as desirable expenditures over this period.

Figure 3 provides this information. In 2009, the shares of the budget dedicated to education (17%) and health (12%) were both greater than the share allocated to total debt service (9%). Today, the opposite is true -- the total debt share in the budget far exceeds the shares allocated to education and health combined!

Figure 3: Total Debt Share, Education Share and Health Share in National Budget
Source: Various National Budgets

A closer inspection of Figure 3 suggests that the health share, for example, begins to decline around about the time that the total debt share begins to explode (the response in the education share is a little bit delayed). Any student of social sciences, however, knows that correlation is never proof of causation -- in other words, the declines in the health and education shares may have nothing to do with the increase in the total debt share even though they both happen at the same time.

We do, however, have some very good scholarly evidence that the relationship depicted in Figure 3 is likely to be causal especially in sub-Saharan Africa. In other words, the declines in the health and education shares in Figure 3 are very likely caused by increases in debt service payments. And this is likely to get worse as debt service payments continue to occupy ever bigger chunks of the national budget going forward.

Monday, 15 July 2019

A curtailment of the Central Bank's powers?

Like everyone else, I have been reading through the draft of Zambia's 2019 Constitution Amendment Bill.  The Bill, which is yet to be tabled in the National Assembly, proposes a host of amendments to the current constitution. Many of the proposed amendments have been condemned by different sections of Zambian society including, and surprisingly so, the ruling Patriotic Front. One of the things that's caught my attention in the Bill, and that hasn't been touched on yet, is what appears to be a curtailment of the Bank of Zambia's powers.

The memorandum that accompanies the Draft Amendment Bill from the Attorney General lists a series of objectives of the Bill. Objective (n) reads: " revise the functions of the Bank of Zambia". Article 71 of the Bill spells out the exact revision that is sought as follows:

71. Article 213 of the Constitution is amended by the deletion of clause (2) and the substitution therefor [sic] of the following: (2) The function of the Bank of Zambia is to formulate and implement monetary policy. 

However, clause (2) of Article 213 in the current Constitution (the clause to be replaced) reads [for completeness I am also reproducing clause (1)]:

213. (1) There is established the Bank of Zambia which shall be the central bank of the Republic. (2) The functions of the Bank of Zambia are to— (a) issue the currency of the Republic; (b) determine monetary policy; and (c) regulate banking and financial services, banks, financial and non-banking institutions, as prescribed.

So it seems that the Draft Amendment Bill seeks to strip away from the Central Bank the functions of issuing currency and the regulation of the financial sector. These two functions are pretty core to what central banks do across the world. And I can't see how another entity would logically takeover these functions, particularly the one to do with issuing currency. And the Draft Amendment Bill is silent on where functions (a) and (c) will now sit.

This is a strange amendment and one hopes that Members of Parliament will probe for details and justifications once the Bill is tabled in the National Assembly.

Wednesday, 5 June 2019

Audio: Panel on the AfCFTA at the Norwegian Council for Africa

Last week Wednesday, I was part of a panel discussion in Oslo organized by the Norwegian Council for Africa on the prospects of the African Continental Free Trade Area (AfCFTA). The AfCFTA came into force last Friday and is being billed as the biggest Free Trade Area in the history of the world. The overarching objective of the AfCFTA is to increase the level of intra-African trade which has been estimated to not be more than 20% of all Africa's trade. The United Nations Economic Commission for Africa reckons the AfCFTA could increase this number by 50%! Our panel engaged with various aspects of AfCFTA particularly the prospects for success. You can listen to the audio of the panel discussion below. My co-panelists were Andreas Moxness, professor of economics at the University of Oslo and Cathrine Jahnsen of the Norwegian-African Business Association. The moderator was Celina Bright-Taylor of the Norwegian Council for Africa. 

Thursday, 23 May 2019

Audio: Sishuwa Sishuwa at the University of Cape Town

This past Wednesday, Dr. Sishuwa Sishuwa of the University of Zambia gave a lecture at the University of Cape Town's Graduate School of Business under our Distinguished Speakers Series. The title of his lecture was "Africa Day in the Age of Xenophobia: Another Perspective". The lecture was given in honour of Africa Freedom Day (Africa Day) which falls on 25th May. I moderated his talk and recorded it for posterity. You can listen to the recording below.

Thursday, 7 February 2019

Audio: Goodwell Mateyo at the University of Cape Town

This past Tuesday, the Graduate School of Business at the University of Cape Town hosted Goodwell Mateyo as part of our Distinguished Speakers Series. Mr. Mateyo is currently president of the Zambia Chamber of Mines and General Counsel of Mopani Copper Mines in Zambia. The title of Mr. Mateyo's talk was "Challenges and Opportunities of Mining in Africa: The Case of Zambia". Mr. Mateyo spoke for about 25minutes and thereafter I engaged him in a conversation. This was followed up with a Q&A session with the audience. 

We were delighted to have in attendance Dr. Situmbeko Musokotwane and Mr. Bradford Machila, former cabinet ministers in the Zambian government. Dr. Musokotwane, who was a Minister of Finance, also made some remarks in the Q&A session. 

The audio recording of the event is below (unfortunately the recording started about 10mins into Mr. Mateyo's talk). 

Sunday, 30 September 2018

Is the re-introduction of a sales tax a good idea?

[This post has greatly benefitted from conversations with Mwansa Mushinge on the practical aspects of the VAT]

This past Friday, the Minister of Finance, Margaret Mwanakatwe, presented her maiden budget address to the National Assembly of Zambia. One of the biggest announcements of her address was the proposed re-introduction of the Sales Tax to replace the Value Added Tax (VAT). The VAT was introduced in 1994 to replace the then Sales Tax (so we are about to go full circle). Given that the VAT finances about 17% of the national budget, it is important to think through the implications, if at all any, of what appears to be a fundamental shift in tax policy.

A VAT and a sales tax are all consumption taxes and are paid by the final consumer of goods. In theory, it doesn't matter whether a country levies a VAT or a sales tax because they raise equivalent amounts of revenue if levied at the same rate. Their only theoretical difference has to do with the way they are collected.

With a sales tax, the tax is only collected at the final stage of the production process (at the retail stage). The VAT, on the other hand, is collected at every stage of the production process but is only paid by the final consumer of the good.

An example to illustrate: suppose Zambia levies a sales tax of 10% on bread. And suppose, for the sake of argument, that the final retailer of bread wants a sales revenue of K20 from every loaf of bread. Given a sales tax of 10%, a loaf of bread will retail for K22 (K20 + 10% of K20). The retailer will keep their K20 and remit the K2 sales tax to the Zambia Revenue Authority (ZRA).

Given that the sales tax is only supposed to be paid by the final consumer, businesses that buy goods that are inputs into their production processes need to obtain exemption certificates that exempt them from paying the tax. So in our bread example, the bakery where the bread is baked and the retail shop where the bread is finally sold will need to obtain such exemption certificates.

Now suppose that the country does away with the sales tax and introduces a VAT of 10% on bread. To see how the VAT is collected, we will have to break up the production of bread into different stages.

At each stage, "value is added" and the VAT is then levied on the value added. Suppose at the first stage, the baker buys flour from a miller for K5.50. The miller returns K5 as sales revenue and remits K0.50 (10% of K5) to ZRA as VAT. The baker uses the flour to bake bread which he/she sells to the retailer for a VAT inclusive price of K11 (K10 sales revenue and K1 VAT). The baker, however, doesn't remit the full K1 to ZRA but nets-off (recovers) the K0.50 that he/she paid as VAT to the miller. So the baker ends up remitting K0.50 to ZRA as VAT. The baker is allowed to net-off precisely because the VAT, being a consumption tax, should only be paid by a final consumer. The retailer then retails the bread for K22 (K20 sales revenue and K2 VAT). The retailer, given that he/she is also not the final consumer, does not remit the full K2 but nets-off (recovers) the K1 that he/she paid to the baker as VAT. So the retailer remits K1 to ZRA.

In this VAT example, the total money paid to ZRA is K0.50 from the miller + K0.50 from the baker + K1 from the retailer = K2. So the same amount of money is raised with the VAT as with the sales tax! Notice, however, that the only person who doesn't net-off is the final consumer. Therefore, just like in the sales tax scenario, the final consumer is the only one who pays the tax [1].

So if the VAT and the sales tax raise the same revenue why do so many countries prefer a VAT over a sales tax? For example, the Organisation for Economic Co-operation and Development (OECD) counted about 165 countries as operating a VAT in 2016.

The reason for the popularity of the VAT over the sales tax has mainly got to do with the fact that tax payers are more likely to comply with a VAT than with a sales tax. Tax compliance rates with a VAT tend to be higher than those with a sales tax precisely because of the netting-off process described above. For example, in netting-off K0.50 from the K1, the baker is saying to ZRA that they paid K0.50 to the miller as VAT which they are claiming back. Knowing that the baker will likely claim from ZRA forces the miller to remit the K0.50 to ZRA instead of holding on to it. Similarly, the retailer has an incentive to claim the K1 that was paid to the baker as VAT. Knowing that the retailer will likely claim forces the baker to comply by correctly remitting their portion to ZRA. With a VAT, ZRA can easily uncover tax evaders because the system self-enforces. A netting-off not backed by an earlier remitting of funds sets off red flags.

This is not entirely the case with a sales tax. The only time taxes are collected with a sales tax is at the final stage with the consumer. And the consumer, being the last person in the chain, cannot net-off from someone else. Therefore, the retailer faces a huge incentive to not remit the sales tax collected from the final consumer. The retailer also faces an incentive to not charge the final consumer a sales tax because doing so makes his/her products cheaper.

So if compliance rates are higher with a VAT than a sales tax, why is the Zambian government re-introducing a sales tax? The Minister of Finance in her address did not give the reasons for the re-introduction of the sales tax. However, in reading between the lines, it appears that the system of "VAT refunds" has not only been a headache for ZRA to administer but has also added unpredictability to the country's revenues.

The question is how do VAT refunds arise in the first place? In the scenario presented above, refunds do not arise because every producer nets-off what they pay along the value chain. However, instances do arise where what a producer pays in VAT is greater than what they collect in VAT when their product is sold to the next person in the chain. In such a scenario, netting-off will not be sufficient to fully recover what was paid in VAT.

The mines particularly suffer from this. Often the mines might buy lots of expensive capital equipment on which they pay VAT but for one reason or the other the copper exported may not result in VAT to the same extent. In this case, the difference will have to be refunded from ZRA. The same is also true for entities that sell products that are zero-rated or exempted from VAT. These entities might buy inputs that attract VAT but their products are not allowed to attract VAT. So netting-off will not lead to a full recovery hence the need for refunds from ZRA.

In theory, processing refunds shouldn't be a headache -- the mines paid VAT on some equipment. This VAT was remitted to ZRA by the mines' equipment supplier. All the mines are asking for is for this VAT, which they paid, be refunded. In practise it tends to be a headache. Audits have to be performed to track whether VAT was actually paid or not. Second, this situation creates instabilities in the country's tax revenues. ZRA receives VAT from equipment purchased by the mines hoping that the mines will recover this money on their own in the value-chain. ZRA then sends this money to Central Government and Central Government spends it. The mines later come back asking for this money given that they are unable to recover it in the value chain. Government is now out-of-pocket and has to find this money somehow.

The Zambia Chamber of Mines estimates that the mining industry is owed some US$300mn in VAT refunds. And it is possible that the country has already spent this money!     

So the need to do away with refunds seems to be what has motivated the Minister's proposal to re-introduce the sales tax. But one hopes that the Minister and her team have properly weighed the headaches involved with the VAT refunds against the real risk that tax compliance will be lower with a sales tax, possibly resulting in lower tax revenue.


[1] As a technical point, note that that at each stage, the VAT is levied on the value-added, hence the term "Value Added Tax". The miller added K5 of value to wheat to make flour. Therefore the VAT at this stage is 10% of the value-added = K0.50. The baker obtains a sales revenue of K10 from the bread implying he/she added value of K5 -- this once again attracts a VAT of K0.50. The retailer then obtains a sales revenue of K20 implying a value addition of K10 and consequently a Value-Added Tax of K1 (10% of K10). So the total value-added in the production chain is K20 hence a VAT of K2.

Wednesday, 19 September 2018

How important is foreign "assistance" to Zambia?

Yesterday Zambians woke to the news that the United Kingdom had frozen aid funding to the country. This follows allegations of corruption amounting to some $4mn in the administration of the country's Social Cash Transfer (SCT) programme. The SCT is meant to benefit the poorest of the poor in Zambia. Other donor countries (known formally as "cooperating partners") have since followed suit. Ireland, Finland and Sweden have announced the suspension of their own aid initiatives to the country. The president has since called for a speedy inquiry and in the interim dismissed the Minister responsible for overseeing the SCT. 

The diversion of money meant for the poor is definitely something to be upset about. And I, like many other Zambians, are angry that something like this happened. My intention, however, with this post is not to defend the despicable acts of those who were involved in the spiriting away of SCT money. Rather, my intention is to take the opportunity presented by this week's happenings, as ghastly and as indefensible as they are, to engage a long-running narrative on the importance of foreign assistance to Zambia.

Discussions about "cooperating partners" in Zambia often take place under the presumption that foreign aid is gravely important in funding our day-to-day operations as a country. For example, the huge sense of public panic seen this week following withdrawals and threatened withdrawals of donor funding betrays a presumption of such importance. Some are arguing that the president's uncharacteristically swift reaction to the SCT scandal is itself illustrative of the degree of the financial importance of our cooperating partners.

But how important are donor funds for our finances? To get a sense of the orders of magnitude, I have looked at each and every budget address since 2007 (2007 being the earliest date for when budget addresses are available on the National Assembly's Website).

In presenting the national budget to parliament, the Minister of Finance, among other things, presents estimates of expenditure for the year ahead in addition to estimates of revenue that will support such expenditures. Revenue sources are split into two major parts: (1) Total Domestic Revenues and Domestic Financing and (2) Total Foreign Grants and Financing. It's the latter segment that is of importance to this post.

Below I construct several series showing percentage shares of different segments of donor assistance in the total budget. [Ideally I should construct these series using realized quantities as opposed to forward looking estimates (2018 appears in the below series because it's an estimate made in 2017). Sadly, the budget speech rarely contains information detailing expenditures and revenues for the previous year. Information on realized quantities is supposed to be contained in the Annual Financial Reports prepared by the Ministry of Finance. Sadly only 4 of these are available on the Ministry's website. In any case, looking at the 4 available financial reports, one gets the sense that any differences between estimates and realized quantities are small].

Figure 1 below shows the percentage of the total national budget that is due to the donors. The figure shows that in total, donors supported about 30% of the budget in 2007 and this has come down somewhat to settle at around 20% -- which is the average over the 11 year period. Stated differently, the information in Figure 1 shows that the people of Zambia, on average, funded 80% of their country's operations over the period 2007 to 2018.

Figure 1: Total Foreign Assistance as a percentage of the total budget
Source: National Budget Speeches, 2007 to 2018

The information in Figure 1 is a little misleading. Total foreign assistance is made up of two parts -- a part that is given as a grant to government (given "free of charge") and another part that involves loans that are to be paid back. So we shouldn't really think of the loans as "assistance" because we are borrowing that money ourselves and are going to pay it back in the future -- and it's presumably a win-win because the donors stand to earn a return on the transaction. (You wouldn't say your bank was "assisting" you in granting you a mortgage to buy a house).

Figure 2 disaggregates total assistance into a grant component and a loan component. As before, the blue line is total assistance. The orange line shows the pure grant component (given "free of charge") that one can think of as pure assistance. The gray line shows the loan component that I argue is quid pro quo and is not to be thought of in the same way as one would think of a grant.

Figure 2: Different components of total assistance as a % of the total budget
Source: National Budget Speeches, 2007 to 2018

Figure 2 shows that the grant component of aid in the total budget has declined from about 20% in 2007 to 3% in 2018. Subsequently, the component due to donors loaning us money that we will eventually pay back has increased from about 10% in 2007 to somewhere between 15% and 20% in 2017/18. Figure 2 shows that increasingly we are largely effectively self-financing our budget  -- the grant component in the national budget has come down to very low single digits. And it's also quite likely that we could do away with the entire grant component if we set our spending priorities right as a country.

Figure 3 below is a different representation of the information in Figure 2. It shows the percentage split between grants and loans in the total donor "portfolio". Figure 3 shows that the loan component has become increasingly important for donors in their dealings with the country. They've reduced the share of grants in their "assistance" programmes and ramped-up the loan component -- a component that we as a country will eventually pay back. This can hardly be thought of as assistance or aid in the everyday usage of these terms. 

Figure 3: Components of the portfolio of donor "assistance"
Source: National Budget Speeches, 2007 to 2018

To conclude, donor assistance, in as far as funding our national budget is concerned, is not as significant as implied by every day conversations around this topic. The part of such assistance that can be thought of in purely altruistic terms (the grant component) has declined from a double digit budget share in 2007 to a very low single digit share in 2018. It's very likely that we can do away with this component if we got our spending priorities right as a country. 

I also acknowledge that donor assistance, in as much as it may not be important for the overall budget, is important for certain sectors. Anecdotal evidence suggests that a non-trivial portion of public expenditure on education and health is funded by the donors (difficult to pin down exact magnitudes given the aggregated nature in which this information is presented in the budget). Second, donors are also important in funding civil society organisations that play a vital role in safeguarding democratic tenets in the country.

Sunday, 27 May 2018

In praise of Denny Kalyalya

On September 28, 2015, the Kwacha slipped 20% against the US dollar. It had started the day trading at K10 to the dollar and closed at K12. At some point during the day, some bureaux de change were quoting rates as high as K15 -- a reflection of that day's panic, confusion and speculative buying (my sister, who cares little for finance, called in the afternoon asking if dollars were a good investment). This was the biggest single day drop in 14 years.

That day's events were a culmination of the currency's very weak performance from the beginning of the year. Between January and September of 2015, the Kwacha's value had reduced by more than half against the US dollar making it the worst performing currency in the world.

Given Zambia's heavy reliance on imports, prices of goods and services began to rise at an alarming rate not long after September. After registering single-digit inflation for much of the post-HIPC era, the annual inflation rate reached 14% in October 2015 from 7% that January and by year's end it was just above 20%. The inflation rate had tripled in a single year!

As 2016 was starting, the expectation was that the Kwacha would continue its free-fall and along with it prices of goods and services would go through the roof. After all the country was in the midst of a catastrophic fiscal crisis and potentially divisive presidential elections were slated for the second of half of the year.

Unexpectedly, the Kwacha's wild gyrations of 2015 stopped in 2016. Granted, there was a slight depreciation in January with the local currency starting the year at K11 to the dollar. But by year's end the Kwacha had actually gained closing at K9.

As for inflation, it peaked at 22% in March of 2016 and thereafter began a slow and steady decline. By October the inflation rate was back to single digits, at 8%, and has been in single digits ever since.

The turnaround of 2016 was nothing short of miraculous. Had the country carried on with the pattern of inflation seen at the end of 2015, food prices would have doubled by 2018!

But calling it a miracle would render the turnaround inexplicable and that would be the furthest thing from the truth.

Even though the originator of the crisis of 2015 was far away at the Ministry of Finance, the job of putting out the fire was placed at the foot of the Central Bank. In February of 2015, president Edgar Lungu announced the appointment of Dr. Denny Kalyalya as the new governor of the Bank of Zambia. Dr. Kalyalya would be taking over from Dr. Michael Gondwe, whose short tenure at the bank had been underwhelming.

No sooner had Dr. Kalyalya settled into his new role than the bottom fell out of the Kwacha. The local currency, whose job it was for him to defend, was now the laughing stock of many across the world.

Dr. Kalyalya and his team correctly diagnosed that the proximate cause of the Kwacha's problems was a chronic shortage of US dollars on the local market stemming from "flight-to-quality" concerns. Consequently, the Central Bank engaged in one of the most audacious interventions in the foreign exchange market in Zambia. The evidence for this is in the dramatic draw-down of the country's reserves between January and December of 2016 (see the blue line in the figure below).

Reserves went from US$2.9billion in January to US$2.3billion in December -- a decline of some US$600million in a space of 12 months! Half way into the year (about July), the Kwacha somewhat stabilized (see the orange line in the figure below) and the Central Bank slowed down the rate at which reserves were being depleted.

Note: Forex Reserves (blue line) and Exchange Rate (orange line), 2016
                             Source: Bank of Zambia

What about inflation? Given Zambia's reliance on imports, inflation was always going to be tamed once stability in the foreign exchange market had been re-established, something that Kalyalya and team succeeded in doing in the latter part of 2016. But it must have occurred to the Central Bank that upward pressures on inflation were also the result of excess Kwacha liquidity in the domestic money market. That is, some upward pressure on prices was due to excess demand in the economy.

Consequently, the Central Bank in November of 2015 hiked the Bank of Zambia Policy Rate, the rate that influences access to credit in the wider economy, from 12.5% to a record high of 15.5% and kept it at that level throughout 2016. The rate hike immediately followed the emergence of double digit inflation in October of 2015.

By October of the following year, the Central Bank's interventions had borne fruit and the inflation rate slowed down to a much more respectable 8%. In February of 2017, after being comforted that inflation had been tamed, the Central Bank began a process of reversing their "tight money" policy and reduced the Policy Rate to 14% and subsequently to 12.5% in May.

In addition to the interventions outlined above, Dr. Kalyalya has successfully used "softer" measures such as holding regular and transparent press briefings to communicate the bank's future course of action  (technically known as providing "forward guidance"). This is in a bid to reduce policy uncertainty.

The interventions outlined above were certainly not without their costs. Foreign exchange reserves are not free and the hikes in the Policy Rate must have drastically affected the ability of businesses, particularly SMEs, to obtain credit. But there was a general sense of armageddon in the dark days of late 2015 and early 2016 and the heroic efforts by Dr. Kalyalya and his team brought the country back from the brink.

Knowing that the origination of the crisis was in the Ministry of Finance, Dr. Kalyalya has openly castigated government on their reckless and uncoordinated borrowing and spending policies, showing unusual independence of thought by a public servant in Zambia.

In a country where there is currently wide-scale erosion of public institutions, it is a wonderful thing to see that there are still a few good men and women who are doing the job that the people of Zambia pay them to do.

Dr Denny Kalyalya (Center) in a jovial mood after a meeting at State House

Sunday, 1 April 2018

The ZRA-First Quantum Tax Story

About two weeks ago, the Zambia Revenue Authority (ZRA) announced that a preliminary assessment had uncovered tax irregularities involving a prominent copper mining company in the country. In an interview with News Diggers, ZRA communications manager Topsy Sikalinda gave the following additional information:

we [ZRA] are announcing the preliminary assessment of K76.5 billion (U$7.5 billion) issued to a prominent mining company for misclassifying consumables and spare parts at importation for the last five years. The said items were declared as mining machinery -- which attract customs duty at zero percent -- when in fact not. The applicable duty rate for the items ranges from 15 to 25 percent.

ZRA did not reveal the name of the company in question. However, an inside source from within the company itself told News Diggers that Kalumbila Mine was the company in question. Kalumbila is owned by Canadian company First Quantum Minerals Limited (FQM) -- its Canadian owners like to refer to it as Sentinel Mine.

Following ZRA's statement and news confirmation that an FQM subsidiary was at the center of a tax investigation, FQM quickly organized a conference call from Canada to give their side of story and to basically refute ZRA's assessment. In the call, FQM acknowledged receiving a letter from ZRA itemising moneys owed as follows:

                1. US$150 million as ZRA's assessed taxes due
                2. US$2.1 billion as penalties
                3. US$5.7 billion as interest on possibly the penalties and taxes due.

All this seems to be traced to some US$540 million worth of imports by Kalumbila that were declared as capital equipment or raw materials or intermediate goods instead of finished goods. According to ZRA's Schedule of Customs Taxes, capital equipment, raw materials and intermediate goods attract lower customs duties of between 0% and 15%. Finished goods attract a duty of 25%. The rationale for such tax differentials is to encourage the importation of productive goods (capital equipment, raw materials, etc...) and to disincentivize the importation of finished goods.

ZRA thinks all of the US$540 million imported by Kalumbila were, in actual fact, finished products. In other words, ZRA believes Kalumbila made false declarations. And false declarations, as per the Customs and Excise Act, attract hefty penalties.

Interestingly in their conference call, FQM acknowledges that a "high level analysis" by themselves following ZRA's letter had revealed some "incorrect assignments" of imports but such mis-assignments were minor. In other words, even they themselves acknowledge that false declarations might have been made even though they believe these to be minor (their choice of language is to refer to these as "incorrect assignments", i.e. innocent errors).

Now this is nothing but a plain-vanilla tax dispute involving a taxable entity and a tax authority. Kalumbila, even though it acknowledges some minor "errors", refutes the substantive aspects of ZRA's accusations. On the other hand, ZRA thinks Kalumbila has systematically been evading taxes by falsely declaring imports. Tax disputes of this nature are legion across the globe. But you would not get the sense that this was a run-of-the-mill tax dispute by reading international reactions to the story.

For example, frequent international tax commentator Maya Forstater of the Washington-based Center for Global Development in a guest post for a Zambian mining industry-aligned website rubbishes ZRA's claims. In the post, she relies heavily on FQM's version of events and succeeds in painting ZRA as an incompetent third world tax authority lacking in capacity to properly perform its functions. ZRA's incompetency is severally implied, for example when she says:

1. The disputed entries in question were previously signed-off by FQM and ZRA (FQM also, unsurprisingly, stress this point in their conference call)
2. ZRA irresponsibly placed the fact that FQM was being investigated in the "public domain"
3. ZRA has been receiving self-improvement help from the likes of the EU, World Bank and Norwegians.

As for point 1, yes ZRA agents might have previously signed-off the transactions but the duty (excuse the pun) is always on the taxable entity to make correct declarations. Nobody suggests incompetence on the part of the Internal Revenue Service in the US every time it's revealed that some hollywood actor has been evading taxes (see this long list of hollywood tax evaders). Also, are we ruling out FQM-induced corruption of agents in the field? 

As for point 2, ZRA in their press statement didn't mention Kalumbila or FQM by name. They merely informed the nation that some mining company (and there are many in Zambia) had been written a letter notifying them of a tax assessment. Someone within Kalumbila revealed that the letter in question had been addressed to Kalumbila. This is hardly an indictment of ZRA.

As for point 3, many of my very competent friends within ZRA will tell you about how such "capacity-building" jamborees are time wasters. My friends know what's to be done but often they find themselves entangled/constrained in their efforts by that age-old dalliance between foreign capital and the local elites who facilitate extraction. Many of those sponsoring capacity-building initiatives have ironically at one time or the other furthered the interests of foreign capital at the expense of the local population.

It's quite likely that ZRA has gotten this entire thing wrong. It's quite likely that ZRA has gotten a small portion of it wrong. But the important thing to note is that this is a standard tax dispute which the two sides will hopefully resolve amicably in due course. And the country will be the better for it because we will know and learn from the exact circumstances that led to this dispute. In other words, we will know the truth. But calling it a mafia style "tax shakedown" as some outsiders have is completely irresponsible.