IMF GIVES ZAMBIA PASSING MARKS, BUT GROWTH PLATFORM "NEEDS

UNCLAS SECTION 01 OF 02 LUSAKA 001109 SIPDIS SIPDIS SENSITIVE E.O. 12958: N/A TAGS: ECON EAID PGOV EINV ENRG ZA SUBJECT: IMF GIVES ZAMBIA PASSING MARKS, BUT GROWTH PLATFORM "NEEDS IMPROVEMENT" Ref: A) Lusaka 1029; B) Lusaka 903 ¶1. (SBU) Summary: Zambia's macroeconomic performance continues to receive good reviews from International Monetary Fund analysts, but budget execution remains a challenge, and may generate excess liquidity and inflation later in 2007. To achieve higher rates of growth that lift more Zambians out of poverty, Zambia will need to improve infrastructure (the energy sector in particular will need to become more effective),diversify its economy (which remains over-reliant on copper production),and enact more structural reform. Zambia's Poverty Reduction and Growth Facility (PRGF) is coming to an end and the Government of Zambia (GRZ) has not yet decided how it will continue to engage with the IMF in future. End summary. ¶2. (U) Background: An IMF mission visited Zambia September 12-26, 2007 to conduct Article IV consultations and to discuss future engagement by the Fund in Zambia. Mission leader Francesco Caramazza and other members met with cooperating partner (donor) representatives on September 13 and on September 26 to discuss the visit and its results. GRZ'S ECONOMIC MANAGEMENT SOUND... ¶3. (SBU) Caramazza commended the sound performance of the Zambian economy, noting improved fiscal management and a prudent monetary policy that has caused inflation to fall and remain at historically low levels. (Note: the GRZ announced on September 26 that in September 2007 the annual inflation rate was 9.3 percent, down from 10.7 percent a month earlier.) He added that debt relief and high world copper prices had played a positive role in strengthening Zambia's external position. At the start of the PRGF, Zambia's foreign exchange reserves were equivalent to 1 month of imports, and they currently are at 2.5 months of imports, he told cooperating partners. ...BUT IT NEEDS TO DO MORE, FOR HIGHER GROWTH ¶4. (SBU) For 2007, the IMF expects economic growth of approximately 6.2 percent. The rate of 7.0 percent projected in the Government of Zambia's Fifth National Development Plan (FNDP) may not be reached until 2009 or 2010, in the Fund's view. To attain higher levels of growth, the GRZ will need to create a stronger platform to support growth. Caramazza emphasized that the GRZ must improve infrastructure, with a particular emphasis on the reliable and affordable supply of energy (both power and fuel). Also, the GRZ will need to take steps to diversify the economy further. Copper prices are expected to fall in the future, and the GRZ must be in a stronger position to deal with the economic consequences of the copper price cycle, Caramazza stressed. He also noted the importance of structural reforms to improve public sector management and the environment for private sector growth. In discussions with cooperating partners, the mission members stressed that infrastructure, diversification into agricultural production and other sectors, and structural reform are beyond the IMF's scope of engagement and influence. Cooperating partners expressed frustration over the GRZ's continued emphasis on distortionary fertilizer subsidies and its lack of progress in promoting private sector development. ¶5. (SBU) The FNDP also requires additional resources to obtain poverty reduction goals through the provision of health services, education and more infrastructure. Caramazza said that Zambia needs more "fiscal space" to implement the FNDP. He encouraged donors to consider providing more assistance to Zambia, and noted that expected increases in revenues will help as well. Improved tax collection may lead to a rise in revenues for 2007, to an expected 18.1 percent of GDP -- stronger than in 2006, Caramazza noted. IMF technical assistance on mining sector issues should help the MOFNP's efforts to negotiate new tax and royalty terms in development agreements with mining companies. CHALLENGES: BUDGET EXECUTION, MANAGING INCREASED LIQUIDITY ¶6. (SBU) The IMF remains concerned about Zambia's weak budget planning and execution capacity. Caramazza noted that at the end of August 2007 there was a considerable surplus of funds in the GRZ fiscal account. Caramazza also warned that because of poor budget execution to date, there is a possibility for a large injection of liquidity into the economy in the last months of 2007, as the pace of government spending accelerates, especially on capital projects that faced delays. The GRZ will need to be diligent in its monetary policy, to avoid inflationary pressures of the possibly large amounts of spending expected. The Fund suggested allowing government agencies to issue tenders based on budget allocations rather than wait for the MOFNP to release funds. Caramazza also told partners that the 2008 budget was at a very preliminary stage and that the Fund will discuss budget issues with the MOFNP later in the year. LUSAKA 00001109 002.2 OF 002 GRZ DEALS WELL WITH EXTERNAL AND DOMESTIC DEBT ¶7. (SBU) The MOFNP has developed a draft debt management strategy that the IMF is currently reviewing. The Fund has advised the GRZ to seek concessional loans on a case-by-case basis, following the parameters of the strategy and linking loans to economically viable projects. The Mission also reported that the GRZ will not give a sovereign guarantee for any loans to public enterprises. Caramazza noted that the external debt data does not reflect the debt of public enterprises such as power utility ZESCO or communications service provider ZAMTEL. Comment: Without sovereign guarantees, some of the new hydropower generation projects planned by ZESCO (Ref B) may not be finalized quickly or easily, further limiting economic growth prospects. End comment. ¶8. (SBU) Although the MOFNP takes a fairly cautious position on incurring new external debt obligations (Ref A),it may come under political pressure at higher levels to allow new loans, IMF's resident representative commented. Local press reported on October 1 that Finance Minister Ng'andu Peter Magande said that the GRZ would soon contract a new debt of $39 million from China, to purchase equipment for road maintenance. Such a loan deal, although not project-oriented, is consistent with the goal to improve transport infrastructure, in support of economic growth. The GRZ also has plans to address the continued high levels of domestic arrears over the next two years. The MOFNP will make allocations in the 2008 and 2009 budgets to pay off all outstanding domestic debts. Next steps with IMF still undecided ¶9. (SBU) As the current PRGF expires this month and a final disbursement is made, the Fund is discussing two options with the MOFNP, a low access PRGF of USD 70 to 80 million, or a new option, a Policy Support Instrument or PSI. The PSI comes with similar conditionalities and reviews as with a PRGF, but with no funding attached. At the inbrief with cooperating partners, Caramazza said that the GRZ was leaning towards the PRGF, mainly because it was the option with which the GRZ was familiar and more comfortable. Caramazza also noted that the Fund expected that any new program would retain the focus of the expiring PRGF, namely public expenditure management, tax administration and policy, and financial sector development. At the outbrief, he indicated that no final decision had been made. Caramazza told partners that the work program will go to the IMF board in December and that the Fund expects its next mission to come to Zambia in February 2008.