IMF GIVES ZAMBIA'S ECONOMIC MANAGEMENT HIGH MARKS AGAIN

UNCLAS SECTION 01 OF 02 LUSAKA 000429

SIPDIS

SIPDIS

E.O. 12958: N/A
TAGS: ECON EFIN EINV EAID ZA
SUBJECT: IMF GIVES ZAMBIA'S ECONOMIC MANAGEMENT HIGH MARKS AGAIN

REF: A) LUSAKA 171; B) 06 LUSAKA 1523


1. (SBU) Summary: Zambia's Poverty Reduction and Growth Facility
program is "on track" and its macroeconomic performance has been
good, according to a recent International Monetary Fund assessment
team visit. The Zambian Government (GRZ) adequately addressed the
team's concerns about fiscal accounts and potentially large
carry-overs of unspent funds from year to year, and gave assurances
regarding its plans to improve cash management and establish a
single treasury. The team observed the slow GRZ movement on private
sector development reform, but maintained a "big picture" focus that
was largely positive. The IMF team's disregard over both an
improved environment for private sector growth and the GRZ's active
involvement in the agriculture sector, and its misplaced emphasis on
mopping up excess liquidity are disappointing. End summary.


2. (U) Introduction: An IMF mission visited Zambia from March 14 to
28, 2007 to complete the fifth review and conduct a sixth review of
Zambia's performance under the Poverty Reduction and Growth Facility
(PRGF). The mission chief, Francesco Caramazza, briefed donors at
the start of the mission and at the mission's end, on March 28. He
explained that the report of the previous mission (the start of the
fifth review) in October 2006 (Ref B) was never finalized or
approved by the Board because of key outstanding fiscal issues,
which ultimately were resolved. Highlights of the briefing are
provided below.

Overall Picture Good, Concerns Being Addressed


3. (SBU) The Fund was pleased with the almost 6 percent real GDP
growth in 2006, a result of continued mining sector expansion and a
strong construction sector, Caramazza told donors. He did raise
concerns at the in-brief over reconciliation of a large discrepancy
in the 2006 fiscal accounts. He reported that there was
over-financing of about Kwacha 525 billion (USD 125 million) and
this was linked to large levels of "carry-over funds" (unspent
budget allotments). From 2005 to 2006, carry-over funds amounted to
almost Kw 600 billion (USD 143 million),while carry-overs from 2006
to 2007 were possibly as much as Kw 360 billion (USD 86 million).
However, during the course of the visit, Ministry of Finance and
National Planning (MOFNP) officials provided information and
explanations that showed the IMF that the carry-over was lower than
originally thought, at Kw 166 billion (USD 40 million).


4. (SBU) Caramazza said that large carry-overs were not efficient
and reflected cash management difficulties. He said that the MOFNP
is well aware of the problems and taking steps to address them,
including through establishment of a national treasury and by
enacting constitutional changes to the budget cycle, which should
make a significant difference. The GRZ maintains many accounts in
commercial banks that earn no interest, he noted, and it is
essential that these accounts be centralized for better management
and accountability. He added that there is a desperate need to
strengthen the cash management system and that technical assistance
from donors would be welcome.

Inflation Outlook Positive


5. (SBU) Caramazza noted that there was a surge in monetary
expansion at the end of 2006 that the Bank of Zambia tried hard to
absorb. Comment: We understand that the IMF strongly pressured the
BOZ to mop up this excess liquidity, although Caramazza did not
divulge this to the donors. This impacted the short-term government
securities market in two ways. The BOZ's open market operations
(OMO) competed directly with the 91-day Treasury bill market, and
the BOZ accepted higher interest rates in the drive to absorb
liquidity, thereby causing demand for 91-day T-bills to evaporate.
Also, OMO has set the benchmark rates that the government securities
market is now following, which is the opposite of normal (and good)
practice, in which the T-bill is the reference rate. Given its
singular monetary policy focus on targeting excess reserves, the IMF
is not concerned with these unintended consequences, which will
ultimately have a negative impact on government spending, due to
higher debt service costs. End Comment.


6. (SBU) The IMF believes that the GRZ's goal of 5 percent inflation
by the end of 2007 is reachable in the "medium term" (by the end of
2008); Caramazza was not willing to comment specifically about
expected results by the end of 2007, because of uncertainty around
oil and food prices. Caramazza admitted that the IMF and GRZ need a
better understanding of the various factors driving inflation in
Zambia, and said that GRZ talk about targeting inflation was
"premature."

Budget 2007 -- Some Concerns Over Revenues


7. (SBU) Caramazza noted that the 2007 national budget (Ref A) was
more expansionary than was indicated by the GRZ's Medium Term
Expenditure Framework. The IMF has concerns regarding the revenue
projections, he said. He expressed reservations about the way that
the GRZ was offering tax incentives, in particular how broadly the

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GRZ defined incentives, tax holidays, and its Multi-Facility
Economic Zone program. Extensive global experience shows that
governments must take measures to ensure that the tax base is not
eroded and that sufficient revenues are generated, Caramazza
commented, and there are other, better ways to offer incentives to
investment. He also credited the Zambia Revenue Authority with
better results in collecting Value Added Tax and noted the positive
impact of a data base that captured external financing more
effectively, thanks to greater information from donors.

Private Sector Development (PSD) Still Lagging


8. (SBU) Caramazza had noted in October 2006 that the GRZ had been
very slow to implement agreed-upon PSD reform measures (Ref B). He
said that GRZ movement on PSD reforms continued to be "slow" and
that private sector representatives with whom the mission met raised
concerns of GRZ bureaucracy and regulations, the lack of skills in
the workforce, and high transport and telecommunications costs. He
characterized progress on PSD as "insufficient" and said that the
GRZ needed to step up its efforts in this area.

Donor Concerns: Mineral, Agriculture Sectors


9. (SBU) Some donors questioned how aggressively the GRZ would seek
dialogue with mining companies over new tax and royalty arrangements
for mining that were announced in the 2007 budget. They noted that
it was hard to get approval for additional budget support in their
capitals as long as companies here earned windfall profits from high
world copper prices while the GRZ received very little from them in
terms of direct revenue. Caramazza reminded donors that the new
provisions did not apply to existing contractual commitments, and
that given the contributions of the mining sector to the economy and
the sector's turnaround in recent years thanks to the new investment
inflows, the GRZ should continue to respect contracts. He noted
that the largest tax contributor, Mopani Copper Mine, already paid
USD 75 million in taxes to the GRZ. He said that some of the mining
companies had indicated a willingness to enter into negotiations on
their contract terms, but the GRZ had not yet approached them.


10. (SBU) When asked about the distorting effect of announced export
bans on maize, Caramazza said that the GRZ told the mission that it
wasn't actually banning exports and had already approved the export
of 40,000 tons of maize, and that it would be monitoring the
situation closely and considering further exports. With respect to
a question of (overpriced) maize purchases by the government's Food
Reserve Agency (FRA),he said that the GRZ maintains that it will
end budget support to the FRA in 2008, at which point the FRA will
have to become self-financing. He said that the IMF mission had not
discussed fertilizer subsidies with the GRZ.

What's Next?


11. (SBU) Due to the delay in completing the fifth review, the PRGF
timeframe will be extended by three months. PRGF completion will be
in September 2007, rather than June 2007. The IMF and GRZ are
discussing two possible options for what comes next: one is another
PRGF with a lesser amount of financing; the other is a Public
Support Instrument, which involves similar reviews of economic
performance, but without the loan facility.

Comment


12. (SBU) The IMF team's apparent disregard over lack of progress in
PSD reforms and the GRZ's meddling with the agricultural market is
disappointing, but it was clear that the team members consider these
issues to be outside of their scope of influence. Similarly, the
IMF's insistence on the BOZ's addressing excess liquidity regardless
of other costs is unfortunately myopic. End comment.

PASSEN