2003 Budget Will Not Save Economy

UNCLAS SECTION 01 OF 02 HARARE 002821

SIPDIS

STATE FOR AF/S
NSC FOR SENIOR AFRICA DIRECTOR JFRAZER
USDOC FOR 2037 DIEMOND
PASS USTR ROSA WHITAKER
TREASURY FOR ED BARBER AND C WILKINSON
DEPARTMENT PASS USAID FOR MARJORIE COPSON


E. 0. 12958: N/A
TAGS: ECON EFIN ETRD ZI
SUBJECT: 2003 Budget Will Not Save Economy

Ref: a) Harare 2546 b) Harare 2679


1. Summary: Through its 2003 interventionist budget
proposal, the GoZ hopes to revive the country's economy.
It seeks to expand price controls, shut down the paralle
exchange, curb the informal export sector and raise most
taxes. We believe this approach will have the opposite
effect, ensuring high inflation and a continued business
exodus to the informal economy. End Summary.

The fiscal equation
--------------

2. The GoZ proposes:

revenue - Z$ 541 billion (US$ 338 million)
spending - Z$ 782 billion (US$ 489 million)
--------------
deficit - Z$ 242 billion (US$ 151 million)

Admittedly, the GoZ is making an effort to restrain
domestic spending. It limits assistance to "new farmers
-- an impassioned funding priority -- to a nominal 50
percent increase (and significant decrease in real
terms). It raises total Zimdollar expenditures by "only
95 percent over 2002, shy of its own optimistic inflatio
expectation of 96 percent (the IMP forecasts 522
percent).


3. But by disclosing Zimdollar but not forex
transactions, the GoZ conceals an external shortfall tha
exceeds the US$ 151 million deficit many times over.
Specifically, the GoZ does not reveal how much it expect
to earn by withholding export proceeds, or how much it
will have to spend on imported food, fuel and energy.
This lapse in transparency makes it difficult to gauge
the GoZ's 2003 deficit. An internal Reserve Bank workin
paper suggests the GoZ will have to spend US$ 506 millio
next year on the food, fuel and energy imports alone, an
another US$ 426 million on other essential external
payments. With.foreign exchange inflows projected at
only US$ 350 million, we arrive at an external accounts
financing deficit of US$ 678 million, or four-and-a-half
times the US 151 million domestic deficit. The total
shortfall may thus be as high as US$ 829 billion.


4. Most problematic is that the GoZ will suffer from a
very restricted revenue base in 2003, despite raising
import duties and effective income taxes. Finance
Minister Herbert Murerwa characterized revised brackets,
which exempt twice as much income in Zimdollar terms, as
tax relief and a boost to aggregate demand. In all
likelihood, however, inflation-induced bracket creep
means most Zimbabweans will pay more taxes.

The death of exports?
--------------

5. The GoZ has been addressing huge budget deficits in
two ways: a) printing more money (supply is now growing
by about 120 percent annually) and b) importing less
food, fuel and energy than its population needs. In the
2003 budget, the GoZ proposes two additional measures:

- Eliminate the parallel exchange market. If the
Zimdollar traded at the official rate of 55:1 rather tha
the present 1580:1 parallel rate, imports would suddenly
cost 96 percent less. Hence the wishful GoZ believes it
can end parallel trading by outlawing exchange dealers
.while ignoring the fundamentals behind the Zimdollar's
demise.
.
- Tax a larger portion of export revenue. The GoZ will
now collect as much as 100 percent of an exporter's fore
revenue, versus the previous 40 percent. Exporters will
surrender 50 percent of revenue for exchange at the
official rate upfront and deposit the other 50 percent
into a Reserve Bank forei
gn currency account (FCA). The
exporter petitions the Reserve Bank for the right to
spend the remaining portion of earnings with a 60-day
deadline. If he fails to beat the 60-day clock, the
Reserve Bank keeps the other half of his revenue.
Assuming an exporter needs to take a trip 65 days after
receipt of earnings, for example, he would not be able t
tap his revenue. (Comment: On a brighter note, exporters
no longer have to dread future tax hikes, since the
effective rate has reached nearly 100 percent of
revenue.) The GoZ will also begin pre-inspecting
exports, making it harder for firms to underinvoice and
dodge these onerous taxes.

New Price Controls
--------------

6. The GoZ announced a wide range of new price freezes
geared mostly to agricultural inputs such as seeds,
chemicals, machinery, fertilizers. Recognizing that it
can only spend a small amount on new farmers -- Z$ 4.1
billion (US$ 2.6 million) for irrigation development and
Z$ 1 billion (US$ 625,000) for mechanization -- the GoZ
is trying to get more bang for its buck by holding costs
down. If present policies are any indication, these new
price controls will only lead to shortages and black-
marketeering.

Comment
--------------

7. The budget is laden with inconsistencies, perhaps
because it amalgamates the views of civil service
economists and socialist politicians. In general, the
economists give the diagnosis and the politicians the
remedy, making for some interesting disconnects. The Go
both subsidizes exporters through ultra-low borrowing
rates (ref b),then knocks them back down many times ove
through additional revenue withholding. Export earnings
will be US$ 1.4 billion in 2002, down from US$ 3.1
billion in 1997 but still too large for the GoZ's
heralded Z$ 25 billion (US$ 16 million) exporters' loan
fund or Z$ 250 million (US$ 281,000) mining sector fund
to have an impact. As a result, the Zimbabwe will
continue to destroy its exporters, one of the only
remaining sources of forex.


8. The Finance Minister made much of his goal to reduce
inflation to double-digits, but the GoZ offered only mor
price freezes as a plan. They have caused rather than
alleviated inflation, whether or not the GoZ's consumer
price index recognizes it. Without a commitment to
tighten money supply, the 96 percent inflation rate for
2003 is no more plausible than a banner tobacco harvest
and a 55:1 exchange rate.

Sullivan

.