ZAMBIA: ECONOMIC WOES IN 2009

C O N F I D E N T I A L SECTION 01 OF 03 LUSAKA 001173 SIPDIS E.O. 12958: DECL: 12/16/2018 TAGS: ECON EAGR EFIN EINV EMIN ZA SUBJECT: ZAMBIA: ECONOMIC WOES IN 2009 LUSAKA 00001173 001.2 OF 003 Classified By: Ambassador Donald Booth for Reasons 1.4(b) and (d). ¶1. (C) Summary. Zambia's Gross Domestic Product (GDP) grew by just under six percent in 2008, according to the Ministry of Finance. Although the Zambian Government (GRZ) forecasts five percent growth in 2009, its economic prospects are likely to be challenged by external shocks and unhelpful populist GRZ policies. Inflation, currently at over 15 percent, is apt to remain high. The Zambian economy is beginning to feel the consequences of the global economic crisis in the form of lower copper prices, reduced access to credit, currency depreciation, and decreased foreign direct investment. End Summary. ¶2. (U) On December 10, Minister of Commerce, Trade, and Industry Felix Mutati announced that Zambia will achieve seven percent growth in 2008. He attributed the health of Zambia's economy to increased investment, particularly in the Northwestern Province, where Lumwana Copper Mine -- Africa's largest copper mine -- will open in early 2009. The Ministry of Finance, however, puts 2008 GDP at 5.8 percent, citing food and fuel price shocks, as well as reverberations from the global economic crisis, as impairments to meeting the GRZ's 2008 macroeconomic targets. ¶3. (C) A visiting International Monetary Fund (IMF) delegation met with GRZ officials in early December to evaluate Zambia's economic performance and the government's fiscal plans. Overall, the IMF representatives were satisfied with Zambia's macroeconomic performance and expressed confidence in the GRZ's 2009-2011 expenditure framework and 2009 budget. They noted overall lower-than-expected revenues that were compensated for by GRZ under-spending, primarily in the area of capital expenditures. Although they concurred that 2008 GDP growth would be 5.8 percent, one IMF team member separately expressed some skepticism to emboff about GRZ data quality. ¶4. (U) The GRZ has adjusted its economic forecasts in light of global economic instability, projecting five percent GDP growth in 2009 and ten percent inflation (annual average). These figures, however, are based on a "normal agricultural season," according to IMF, of 1.5 percent growth in agricultural production and an adequate maize harvest. The outlook is also contingent on more efficient GRZ capital expenditures to stimulate the economy and encourage economic diversification. ¶5. (SBU) Despite adjusting its growth expectations downward, the GRZ's forecasts may still be overly optimistic. The Government's efforts to mitigate food and fuel prices -- by reducing fuel tax and increasing spending on fertilizer subsidies -- are unlikely to reduce inflation. Petrol prices at the pump in November remained high, at Kwacha 7,699/liter (approximately 6.85/gallon at the November closing exchange rate),compared to K7,207/liter on year earlier. Fuel prices in Zambia (among the highest in Africa) are likely to remain high due to intermittent procurement-related fuel shortages, high transportation costs, currency depreciation, and the operational inefficiency of Zambia's sole oil refinery. ¶6. (U) Donors agree that the GRZ's Fertilizer Support Program causes more harm than good to agricultural production. According to the Jesuit Center for Theological Reflection, a well-reputed local think tank, the cost of basic food items in Zambia over the past 12 months has actually increased by over 50 percent. Early indications suggest that the maize crop in 2009 will be insufficient to meet domestic needs. Large-scale commercial farmers have experienced difficulties securing production credit and are shifting from the staple maize to other crops. The high price of fertilizer will diminish smallholder usage, and the GRZ's subsidized fertilizer support has once again arrived too late to have its intended effect. ¶7. (U) The global economic crisis is having a direct impact on Zambia. Both the price of and demand for copper are falling (copper prices are down 60 percent from early 2008). Foreign direct investments and access to capital are also declining. The Lusaka Stock Exchange (LuSe) all-share index fell by 24 percent between January and November 2008, suggesting less investor confidence and declining levels of portfolio investment. According to Denny Kalyalya, the Deputy Governor of Zambia's central bank, the Bank of Zambia (BoZ),year-to-date foreign portfolio investment declined by USD 134 million (an estimated three percent of the LuSe market capitalization). ¶8. (SBU) The appreciation of the Dollar versus the Kwacha is an area where the financial and economic externalities are LUSAKA 00001173 002.2 OF 003 felt acutely. The Kwacha has dropped from about 3,500 to 5,000 against the Dollar since late September, a very expensive turn of events for an import-dependent country, even as it creates opportunities for exporters, particularly commercial farmers if they can increase productivity. The depreciation has led to dollarization among some vendors. Kalyalya said the BoZ targets foreign reserves to guide its monetary policy. BoZ Governor Caleb Fundanga told Ambassador that the central bank intervenes to even out exchange rate fluctuations but realizing that it cannot influence either the exchange rate trend or the rate of inflation. ¶9. (U) Lower copper prices and higher copper taxes (some, i.e. the new windfall tax, do not apply at current price levels) have reduced profitability in the mining sector. Long-term capital investments have been trimmed, delayed, and cancelled, and access to financing has been reduced within this capital-intensive sector. A World Bank representative predicted that job losses could rise to 7,000 (approximately one-third of the mining labor pool). The Democratic Republic of Congo's export ban on copper ore and concentrate has a negative impact on companies that had been processing DRC copper at smelters in Zambia. In early December, Chambishi Metals shut down its copper smelter following further drops in world metal prices. Luanshya Copper Mine relieved 800 workers and put its mine on "care and maintenance," essentially closing its operations. ¶10. (SBU) Delays in the rehabilitation of Zambia's three main power plants mean that electricity shortages will persist. Inadequate power supply will continue to deter investment and constrain ongoing commercial enterprises. Slower growth also may harm the construction, tourism, manufacturing, and transportation sectors, and result in significant job losses. The privately owned Zambian Airways already is facing liquidity problems due to its high fuel costs and its difficulty in accessing lines of credit. ¶11. (SBU) In short, the GRZ may be underestimating the external shocks that its economy will face in 2009 and overestimating its ability to address them. In the face of rising inflation, the GRZ will be under considerable pressure to offer short-term, populist solutions, like fuel or fertilizer subsidies. IMF staff expressed concern about new legislation that will increase civil servants' wages and other benefits. They described the GRZ's implementation plans for the wage bill (and its actual cost) as "the most difficult aspect" of their visit. Nevertheless, the GRZ acknowledged forthcoming economic difficulties on December 12 when it withdrew its offer to host the 2011 All Africa Games, citing the need to direct resources to investments that contribute to food security "in the wake of the global economic crisis." ¶12. (SBU) At present the GRZ's 2009 strategy involves maintaining stability by keeping GRZ spending constant in proportion to GDP, while increasing capital expenditures. Although this will result in a larger deficit (about two percent of GDP) and an increased domestic financing requirement, the GRZ is confident that it can achieve this. Given the GRZ's procurement inefficiencies and its past record of under-spending on capital investments, it will be hard-pressed to carry out the strategy for underpinning projected growth. ¶13. (SBU) It also appears that the GRZ's budget proposals do not reflect its stated priorities of infrastructure development and economic diversification. The GRZ's 2009-2011 Medium-Term Expenditure Framework ("Green Paper") shows that it will spend over three times as much on "recreation, culture, and religion" as it will on rural electrification, despite the fact that only one quarter of Zambians have access to electricity. Although the transport sector "will continue to be key in the nation's development agenda," road building allocations in 2009 are only marginally larger than the fertilizer support program and less than what the GRZ anticipates spending to defend itself in lawsuits against the government between 2009 and 2011. GRZ spending increases on health and education as a percentage of GDP are negligible. ¶14. (C) In the event that the global economic crisis affects Zambia's banking sector, Kalyalya told emboffs that the BoZ lacks the resources to serve as a lender-of-last-resort. He added, however, that Zambia's banking system was on sound footing because "ingenious" financial products have not yet "snuck in." Separately, Fundanga told Ambassador that the GRZ does not have the capacity to administer a government financial stimulus package, like those being debated in the United States. Either way, the GRZ's fiscal planning and LUSAKA 00001173 003.2 OF 003 budget execution do not inspire confidence in its ability to weather the storm, let alone grow the economy. High inflation, low copper prices, reduced access to capital, currency depreciation, and declining investment are all likely to dampen Zambia's prospects for economic growth. BOOTH