ZAMBIA BURDENED BUT NOT OVERWHELMED BY IMPACT OF

C O N F I D E N T I A L SECTION 01 OF 03 LUSAKA 000339

SIPDIS

E.O. 12958: DECL: 05/17/2019
TAGS: ECON ZA
SUBJECT: ZAMBIA BURDENED BUT NOT OVERWHELMED BY IMPACT OF
GLOBAL ECONOMIC CRISIS

REF: A. LUSAKA 322

B. LUSAKA 295

C. LUSAKA 31

LUSAKA 00000339 001.2 OF 003


Classified By: Ambassador Donald Booth for Reasons 1.4(b) and (d).


1. (SBU) Summary. Although its financial sector is largely
unscathed by the global economic crisis, Zambia's prospects
for growth are diminishing due to decreased foreign
investment, layoffs in the mining sector, and rising
unemployment. Lower (from brief, speculation-driven highs in
mid-2008) world copper prices mean decreased mining sector
profitability, lower mining tax revenues, and limited fiscal
space for the Zambian Government (GRZ) to implement its new
economic diversification strategy. Through relatively sound
fiscal and monetary policy, the government has been able to
steady its macroeconomic indicators -- at 15 percent, the
inflation rate is high but not climbing, the Zambian Kwacha
has depreciated by 50 percent (from a two-year high in
mid-2008) but is now stable, and foreign currency reserves
are diminishing but are being replenished through IMF loans
and perhaps expanded Special Drawing Rights. Many Zambian
critics have heaped the blame for Zambia's economic hardships
on President Banda, who came into office in October 2008,
just as the crisis began to be felt in Zambia. This has
weakened the President's already fragile support base. End
Summary.

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Impact of Crisis
--------------


2. (SBU) The global economic downturn's impact on the demand
for and price of copper is where Zambia's commodity-driven
economy (Ref C) is feeling the most pressure. Although some
mining companies increased their copper production in 2008,
the mining sector's overall profitability decreased due to
lower world metals prices. In the past six months, most
mining companies suspended new projects or
consolidated/streamlined existing ones to cut costs in the
face of scarce credit and unprofitable commodity prices.
Some shut down operations completely for short periods, and a
larger number of mine service companies have been forced out
of business. According to recent GRZ estimates, the mines
have shed two to four thousand jobs, resulting in
sector-related job losses exceeding ten thousand.


3. (C) Zambia's tourism sector has also been hit by the
economic crisis. According to the Livingstone Tourism
Association, hotels and lodges near Victoria Falls (Zambia's
premier tourist attraction) have seen a 50 percent drop in
bookings this year, resulting in some downsizing in the
sector. Tourism associations are unaware of the actual
number of job losses that the sector as a whole has
sustained, but appear to be more concerned about lack of
investment and sectoral growth than in actual unemployment.
According to the World Travel and Tourism Council, employment
in Zambia's tourism sector will "level off" at 72,000
employees this year. A well intentioned but misplaced
tourism policy (Ref A) will do little toward helping the
government support the tourism sector, let alone to
attracting foreign investors and tourists.


4. (U) These factors, combined with declining levels of
foreign direct and portfolio investment in 2008 contributed
to the depreciation of the Kwacha, which slid from a 2008
high of 3,500 Kwacha per USD to its current rate of 5,200 per
USD. Zambia's weak Kwacha will exert additional pressure on
the inflation rate, making it difficult for the GRZ to return
to single-digit inflation from its current (year-on-year)
level of 15 percent. To hedge against currency volatility,
many vendors have begun pricing their goods in USD. Although
mining tax revenues constituted only five percent of
government revenue in 2008 (due to the extremely favorable
tax conditions granted to the mining companies during
privatization),reduced tax receipts nevertheless will have
an impact on government spending. Perhaps more
significantly, reduced mining revenues, which account for
eight percent of GDP and over 70 percent of Zambia's export
earnings, are likely to worsen Zambia's current account and
trade deficits.


5. (U) Following almost a decade of real gross domestic
product (GDP) growth in excess of five percent, the Economist
Intelligence Unit predicts the Zambian economy will contract
by about one percent in 2009. International Monetary Fund
(IMF) analysts are less pessimistic, putting growth at
between two to three percent. Given rebounding copper prices
and projections for a good harvest year, IMF estimates may be

LUSAKA 00000339 002.2 OF 003


more reliable. Zambia's GDP/capita will continue to be
constrained by its high birth rate (at 40.2 births/1,000
population) and declining death rate (at 21.4 deaths/1,000
population due to PEPFAR and other foreign aid to the health
sector). Ultimately, the crisis means that fewer Zambians
will be supporting larger families with less money (due to
inflation and the depreciating Kwacha). Experts estimate
that each Zambian worker typically supports an average of ten
family members; mining layoffs are therefore likely to result
in food insecurity to over one hundred thousand Zambians.
The global economic crisis, within the context of higher
global food and commodity prices (corn meal prices have
increased over 55 percent in the past year) places tremendous
pressure on the government to mitigate the social impacts of
this economic insecurity.

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GRZ Response
--------------


6. (C) On occasion, the GRZ has responded positively to this
pressure. President Banda is evaluating ways to improve the
GRZ's inefficient fertilizer support program, the GRZ has
cancelled its potentially onerous mining windfall tax, and
Cabinet members have expressed openness to removing bans on
biotechnology. The GRZ has also shown some commitment to
expediting its capital expenditure spending procedures, which
in the past have been slow and unwieldy and the cause for
failing to spend large portions of the GRZ annual budget as
allocated. In general, however, the GRZ has moved slowly and
timidly to mitigate the effects of the crisis. For example,
following the closure of Luanshya Copper Mine (LCM),the GRZ
pursued new investors ham-handedly and with no transparency,
finally awarding the concession to a Chinese company five
months after LCM's closure. Additionally, the absence of a
Transport and Communications Minister (who resigned after a
tribunal showed that she had circumvented government tender
procedures) and the lack of an independent procurement
authority (Ref B) are likely to limit the GRZ's ability to
carry out its rural infrastructure development program that
is key to promoting agricultural expansion and economic
diversification.


7. (C) The Bank of Zambia has been the GRZ's saving grace
thus far, conducting a monetary policy that has steadied
inflation and cushioned Kwacha volatility. Although the
Finance Ministry has shown signs of fiscal prudence, recent
decisions to borrow for extravagant and extraneous purchases
(e.g. a proposed no-bid USD 53 million contract to a Chinese
company for nine mobile hospitals in a deal so controversial
that the Chinese Embassy had to publicly claim it had no
involvement in it) at the expense of basic needs like school
classrooms and hospital beds, has cast a shadow on the
current government's sense of judgment and accountability
(the GRZ eventually stepped back from the mobile hospital
deal under pressure from donors). At the same time, GRZ
funding to the Anti-Corruption Commission and Task Force on
Corruption almost has slowed to a halt, fueling speculation
among civil society organizations and the independent media
that the GRZ is not only turning a blind eye to corruption,
but actually participating in it. According to the Jesuit
Center for Theological Reflection, a prominent local
non-profit organization, representatives from the Auditor
General's office as well as the Parliamentary Public Accounts
Committee are alarmed about government's indifference to
recent findings of misappropriation and theft.

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Signs of Recovery
--------------


8. (SBU) Despite the albatross of corruption, there are
indications that Zambia's economy may be improving. A broker
on the Lusaka Stock Exchange (LuSE) told emboff that foreign
portfolio investment on the LuSE is beginning to see an
upswing, including renewed interest from U.S. fund managers.
She projected that the Kwacha would slowly strengthen in
response to rising copper prices. Despite this development,
recovering investor confidence may not translate to
pre-crisis levels of foreign direct investment or result in
increased foreign participation in Zambia's bond market. An
April treasury bond tender was under-subscribed by over 50
percent, marking a significant change from one year earlier
when treasury bond tenders were over-subscribed by over 200
percent (for two-year bonds). Investors almost entirely
ignored a February Treasury tender on 15-year bonds,
suggesting lack of investor long-term confidence,
particularly in the absence of a formal secondary bond market
that would increase asset liquidity.

LUSAKA 00000339 003.2 OF 003




9. (C) A corporate banking representative also expressed
his positive outlook to emboff, noting that he is beginning
to see some signs of economic recovery, due in part to
rebounding copper prices (now at USD 2/lb, up from about USD
1.20/lb in January). He acknowledged the increased
likelihood that his clients will default on loans but
projected optimism about the private sector's resiliency. He
predicted that scaling back by some mining companies would be
offset by production increases among others. Indeed, the
Chinese economic counselor told emboff that his government is
viewing the current downturn with a long-term perspective and
encouraging Chinese companies to maintain their presense in
Zambia and to avoid firing employees or delaying investments.
At least one Chinese company is abiding by this advice and
its announcement to move forward on existing mining projects
has curried much favor with the GRZ.


10. (SBU) In general, the global economic downturn has had a
modest effect on Zambia's financial sector, due to its
limited integration with global financial markets, its
relatively high liquidity, and its risk-averse lending
practices. Interest rates on USD loans are high (ten to
twenty percent) and Kwacha loans are even higher (twenty to
thirty percent). Neither is likely to become more
competitive until inflation rates (about fifteen percent and
heavily pressured by the weak Kwacha) subside. Zambians are
more prone to complain about the availability than the cost
of capital. Limited access to financing will continue to
constrain private sector led growth as well as agricultural
investment, but not much more so than before the global
financial crunch. Most importantly, credit lines will
continue to be available to existing clients so that the
operations of already profitable companies will not be
constrained by liquidity shortages as in other financial
markets.

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


11. (C) In addition to these economic impacts of the global
economic crisis, there may be political implications to
Banda's government. Opposition leaders have been quick to
blame Banda for the country's economic turmoil and their
arguments seem to be resonating with much of the Zambian
public. If the economy experiences little improvement before
the 2011 presidential election, Banda may fail to secure his
party's nomination and/or the party could see an end to its
20-year rule. During Foreign Minister Pande's upcoming visit
to Washington, we should reiterate that progress on
corruption is critical to Zambia's continued eligibility for
Millennium Challenge Account compact funding, a potentially
critical resource to support poverty-reducing investments in
Zambia's economic growth.


12. (C) We should also underscore that there is much that
the GRZ can do to improve the country's economic prospects,
particularly by accelerating policy reforms that will
stimulate domestic investment, open export markets, and
promote entrepreneurship. The GRZ deserves some praise for
resisting pressure to intervene to strengthen its Kwacha.
With a little encouragement, it might more actively seek ways
to promote exports (agricultural products in particular) that
its weakened currency has made more competitive.
Additionally, by expediting the movement of goods at its
ports of entry, the GRZ could bring down transportation
costs, thereby making imports more affordable to domestic
consumers despite the Kwacha's depreciation.
BOOTH