It has been a tough couple of months for Edgar Lungu, Zambia’s relatively new president. Mr. Lungu was elected on a slim margin in a presidential by-election in January following the death of Michael Sata. In the nine months or so he’s been in charge, the Kwacha (Zambia’s currency) has depreciated by about 80% to the dollar, making it the world’s worst performing currency according to Bloomberg.
Secondly, an electricity crisis that was merely lurking beneath the surface has become full blown during his presidency. Since about June this year, and probably for the first time since independence, households and industry have had to contend with power outages of up to 12 hours a day as a result of a 50% electricity supply deficit. The Minister of Energy thinks the power generation short-fall will worsen towards the end of the year and into early next year.
Several reasons account for the Kwacha’s poor performance this year. Firstly, the price of copper has declined by about 11% in 2015 on the back of a slowdown in demand from China. Copper is Zambia’s most important export – 80% of all foreign exchange earned from exports comes from copper.
Secondly, the Zambian government has over the last four years struggled to keep its expenditure within manageable limits. The fiscal deficit widened to 6% of GDP at the end of 2014 from 1% in 2011. This year, the government expects the deficit to widen further to 7% of GDP. Practically, this means that the government has a $1.9 billion shortfall in revenues in 2015. Uncertainty about how the deficit will be plugged is likely driving volatility in the foreign exchange market.
Thirdly, the government has since 2012 borrowed heavily from external sources to finance an ambitious infrastructure programme. For example, the “Link Zambia 8000” project was launched in September 2012 with a target of constructing 8,000 kilometres of roads across the country. Three sovereign bonds totaling $3 billion have since been issued over the last three years to pay for the project leading to a substantial increase in the country’s external debt stock. Total external debt has increased by 300% between 2011 and 2015. Concerns about the sustainability of this debt are driving volatility in the foreign exchange market. By some estimates, the country needs to find $1.7 billion over the next seven years just to pay interest on the debt.
Lastly, the government has been inconsistent in implementing economic policies. No fewer than three significant policies have been implemented over the last three years only to be hastily reversed thereafter. For example, the mining taxation regime was overhauled in January this year by scrapping the corporate income tax and replacing it with a purely mineral royalty-based regime. A few months later, the corporate income tax had made a comeback! Inconsistent policies can result in outflows of foreign exchange as investors take precautions to protect their money.
The impact of the falling Kwacha have not been benign given Zambia’s dependence on imports. The country’s statistical agency reported that the annual inflation rate, had doubled to 14% in October from 7% in September, the first-time in six years that double digit inflation has been experienced.
The country’s central bank, the Bank of Zambia, has tried to stem the fall of the Kwacha but with little success. An official confirmed to Bloomberg that $500 million of the country’s foreign exchange reserves had been spent this year in trying to defend the currency.
Enter the IMF
It’s against this background that a team from the International Monetary Fund (IMF) was invited by the government for talks starting Nov. 11. Most observers expected the visit, since it was initiated by the Zambian government, to result in some agreement on budget and balance of payments support—similar to the deal struck by Ghana earlier this year. The Ghanaian Cedi has since stabilized following the IMF’s intervention.
The IMF’s press statement issued on Friday the 20th of November was surprisingly mute on whether a deal on some form of support had been reached. The following day, a highly trusted local newspaper, citing credible sources within government, reported that the IMF had proposed a $1 billion facility which the president had turned down. A sticking point for the president was the insistence by the IMF that government commit to drastic reductions in expenditure, particularly on road construction. The president’s response is to be expected given that the country will be going to the polls sometime next year to elect a leader. Implementing austerity measures right before an election is not the smartest way of enhancing one’s chance of victory.
The country is clearly in need of foreign currency to help plug the fiscal deficit (and avoid monetizing it) and for balance of payments support. The president will have to look elsewhere if he indeed turned down the IMF. But where?
One option would be for the country to issue a fourth sovereign bond. But this option is unlikely to be an attractive one because (1) it’s likely to be undersubscribed given the country’s macroeconomic picture and (2) interest rates are likely to be prohibitively expensive (already, interest rates on the 10-year bond issued this past July had increased from 9% at the time of issue to almost 12% in early November). A final disadvantage with this option is that it will be a tough sale for the president. Debt sustainability is increasingly becoming an election campaign issue ahead of next year’s elections.
A second option is for the president to look towards China for help. $1 billion would really be pocket change for China given its stock of $3.6 trillion worth of reserves. The trouble with this option is that the money would come without a credible commitment from the government for fiscal consolidation, something that an IMF loan would have guaranteed. In other words, resolving the current crisis requires money but also a commitment from government that the money will be well spent.
All this suggests that the IMF might be back sooner than we expect.