Zambia’s 2016 National Budget tabled on the 9th of October 2015 featured the usual commitments to growth and poverty reduction. Looking through the rhetoric, it is apparent that Zambia faces major fiscal risks. We are concerned that these risks are not adequately dealt with in the budget, which claims to be one of consolidation, but remains too expansionary for the current environment.
Zambia’s government has acknowledged that GDP growth will shift down a gear this year. It forecasts 4.6% in 2015, down from a 7% target in last year’s budget. Next year’s growth target is set at 5%. FNB expects 4% this year and 3.7% next year. The Budget references external shocks including low commodity prices and poor weather conditions as the causes of slowing growth. However, it fails to mention the policy uncertainty, excessive government spending (driving up interest rates and weakening the exchange rate) and poor management of the electricity infrastructure. These domestic issues place Zambia in a more vulnerable position than many other commodity exporting countries.
In terms of the budget itself, Finance Minister Chikwanda expects a 2015 deficit of 6.9% of GDP, relative to the 4.6% that was originally projected in the 2015 budget. This massive fiscal slippage is due to lower revenues from the mining sector and higher interest payments (largely related to new US Dollar denominated debt). Zambia’s government aims to reduce its budget deficit to 3.8% of GDP in 2016. We think that this is optimistic and our forecast is for a deficit of 6.5% of GDP.
Expenditure in the 2016 budget is projected at K53.1 billion. Whilst this is a 13.8% increase on the original 2015 budget, it represents a 13% decline on the mid-year 2015 budget (from June) when government overspending for the year had been taken into account. We think that this will be a difficult task as 2016 is an election year and there will be a strong temptation to boost spending in order to revive support for the ruling party. Signs of this are present in the budget and include a substantial increase in the social cash transfer programme. Due to the opaque nature of the Mid-term budget, it is difficult to see where spending cuts will come from when compared to the actual amounts that have been spent this year. However, we can see that compared to the original 2015 budget, allocations for defence, public safety, health, housing and education are all lower. The clear area in which spending will increase is debt service costs, the allocation for which is 85% higher than in last year’s budget.
In the 2016 budget we can see how overspending of
the past is becoming self-reinforcing by creating
more debt and pushing up future interest costs. In
any country this would be a concern, but Zambia’s
case is particularly worrying because government
has recently begun to favour funding in the form of
long term US Dollar denominated debt. Dollar debt is
favoured because a lack of liquidity in the domestic
market means that it is very expensive for
government to borrow domestically and very difficult
for it to borrow for long durations. The problem with
forex denominated debt is that it magnifies the
feedback loop between present day fiscal ill
discipline and future fiscal risks by adding currency
risks into the mix. A perfect example is the change in
the value of Zambia’s external debt since the start of
the year. After issuing a Eurobond in July and
attracting other foreign funding, Zambia’s external
debt increased by 31% in Dollar terms from $4.8
billion in December 2014 to $6.3 billion in August
2015. However, the kwacha value of this debt has
increased by about 150% assuming a current
exchange rate of K12 vs USD. This is because the
kwacha has weakened dramatically against the
Dollar this year, partially because investors are
concerned about Zambia’s ability to continue to
service its public debt. This situation is similar to a
run on a bank in which concerns can become selffulfilling.
Even if government is able to meet its 3.8%
of GDP deficit target for 2016, it aims to raise 2.9
percentage points of this externally meaning that
forex debt will continue to rise strongly.
On the revenue side we were disappointed to note
that new tax proposals will actually result in a net
reduction of revenues compared to a baseline
scenario in which taxes are unchanged. This is
because incentives to boost electricity generation
and manufacturing will negate higher excise taxes in
certain areas including cigarettes and oils. However,
government did propose an increase in fines and
fees, which is expected to boost non tax revenue by
K5 billion. This is due to come from a higher
surcharge on the purchase of vehicles older than 5
years and higher fees on land purchased by
foreigners. We believe that government should have
increased the VAT and/or PAYE tax rates in order to
boost revenues, lower the budget deficit and mitigate
the risk of higher interest expenditure in the event of
further currency weakness.
The budget did not contain information on the public
debt-to-GDP ratio. This is a further indication of the
opaqueness of the document, but is also concerning
in that without this data government cannot
communicate a target for this key variable. Based on
the data available and our own nominal GDP
forecasts, we project that external debt will stand at
approximately 41% of GDP and domestic debt at
14.5% of GDP at the end of 2015. This adds to total
gross government debt of 55.5% of GDP, up from
about 30% in 2014. These assumptions hinge on an
exchange rate forecast of K12 vs USD. If it is weaker
than this, debt levels will be higher and vice versa.
In conclusion, we think that Zambia is moving quickly
towards an unsustainable fiscal position for three
reasons. First, three quarters of public debt is
external, which means the size and cost of servicing
debt is determined by exchange rate movements.
Second, public spending forecasts for 2016 are
optimistic based on government’s previous track
record and the fact that it will be an election year.
Third, the tax base is too narrow and significant
revenue mobilisation will be challenging unless major
changes are made to the tax rates of the important
tax items such as VAT and PAYE. Zambia
desperately needs better fiscal management and
improved accountability. This means setting fiscal
targets that go beyond budget deficits and include a
debt-to-GDP target, which would then internalise the
risks that forex denominated debt pose. Furthermore,
in this time of stress, greater attention needs to be
paid to the microeconomic issues of corruption,
inefficient spending and project prioritisation. Given
the current outlook, we believe that there is a
significant risk that the Zambian government will be
forced to approach the IMF for financial assistance in
the next 1-2 years.