WHY THE IMF DEAL IS IMPORTANT – ALTERNATIVES TO THE IMF DEAL ALSO BADLY NEED THE IMF DEAL!
By Alexander Nkosi
1. WHAT IS THE PROBLEM?
Zambia’s external debt is $12.9 billion, domestic debt is K189.7 billion and domestic arrears stand at K46.9 billion. In 2022 budget, government projects to mobilise K98.9 billion domestic revenue and a total of K78.6 billion will go to debt service. When we add civil service wage bill, all the domestic revenue is exhausted. This debt crisis is at the heart of our economic crisis and it has left us in a situation where the we allocate to debt service, the more we have to borrow to run the economy.
2. HOW SERIOUS IS THE DEBT CRISIS?
To illustrate how serious the debt crisis is, let us look at the growth in allocations to debt service compared to total domestic revenue for the period 2018 to 2022. In 2018 the allocation to debt service was K14.2 billion out of domestic revenue of K49 billion, representing 29%. In 2019, the allocation to debt service was K23.5 billion out of domestic revenue of K56 billion, representing 42%. In 2020, the allocation to debt service was K33.6 billion out of domestic revenue of K71.9 billion, representing 47%. In 2021, the allocation to debt service was K46 billion out of domestic revenue of K66 billion, representing 70%. In 2022, the allocation to debt service is K78.6 billion out of domestic revenue of K98.9 billion, representing 79%.
3. WHAT DOES THE FUTURE LOOK LIKE IF THIS DEBT CRISIS IS NOT RESOLVED?
From the analysis presented above, allocations to debt service in absolute terms have grown from K14.2 billion in 2018 to K78.6 billion in 2022. As a proportion of domestic revenue, allocations to debt service have grown from 29% in 2018 to 79% in 2022. If this is not addressed, in a few years time, allocations to debt service will surpass domestic revenue. This means that we will have to borrow heavily to pay civil servants and keep all sectors of the economy running. Under such circumstances, economic activities will remain depressed and investments will further go down. This is simply unsustainable. What local solutions can we implement in such a bad economic environment? Local solutions also require that we address the economic fundamentals. Some people have suggested that we reverse the decision to make mineral royalty tax non tax deductible. This results into an additional K3.2 billion in domestic revenue. Does this local solution solve the problem? No! It takes our domestic revenue to K102 billion, 77% of which still goes to debt service.
4. WHY THE IMF DEAL IS KEY
This dilemma explains why Hon. Felix Mutati, Hon. Margaret Mwanakatwe and Hon. Bwalya Ng’andu were all chasing the IMF deal. To understand the importance of this IMF deal, you have to look at the debt crisis at hand as analysed above. The only feasible way is by restructuring debt and addressing the weak kwacha. Zambia is largely dependent on imports for both consumption and production. If we want to step up local production as a key driver of economic recovery, our firms need to import capital equipment which is key in production. If we let kwacha depreciate to K30/dollar, very few local firms will manage to import good capital equipment, if they do manage to import at a high cost, it will push up their cost of production and makes their businesses less profitable and hard to compete with foreign goods and services.
5. HOW THE IMF DEAL WILL HELP STRENGTHEN THE KWACHA
What makes our kwacha weak? It is all about demand and supply of dollars. Producing and exporting more and attracting investments will bring dollars into the economy. Our foreign debt is paid in dollars, so if it debt service outlays keep going up, we lose more dollars and it weakens the kwacha. There are other factors that influence the strength of the kwacha but I will focus on the two major factors so that we understand how the IMF deal comes in.
The impact of the IMF deal on the kwacha can be analysed as follows: (i) Restructuring our debt will reduce the amount (dollars) we pay annually in debt service. This alone means less demand for dollars and strengthening of the kwacha. (ii) Attracting more foreign investers will bring dollars into the economy and aid strengthening of the kwacha as supply of dollars on the domestic market will go up (iii) The IMF deal comes with a $1.4 billion concessional loan. This also increases the supply of dollars in the economy. These three measures will strengthen the kwacha and in the years to come reduce it to below K15/dollar. If it stabilises below K15/ dollar, it will help lower the cost of imports and enable firms to import capital equipment. Note that while cheap imports do disadvantage local products, we are at a point where we need to import better capital equipment to enhance production hence at this stage, cheap imports of capital equipment would favour us more. We can use economic instruments to regualte import of consumables once quantity and quality of production starts improving.
6. WHY A STRONG KWACHA CAN CANCEL THE EFFFECT OF REMOVING ENERGY SUBSIDIES
While today we are worried about electricity and fuel prices pushing up the cost of production as well as cost of living, we should realise that if we don’t address the debt crisis which is at the core of our economic crisis, we risk seeing our kwacha depreciate to as high as K30/ dollar, and send the cost of production and cost of living skyrocketing. Our economic crisis has left us in a situation where all solutions have a painful initial effect but we have to go for the ones that represent better long term outcomes.
7. WHY IMF DEAL IS THE ONLY FEASIBLE SOLUTION UNDER THE CIRCUMSTANCES
How does the IMF deal come in? IMF deal does not only come with $1.4 billion, it is tied to debt restructuring. There are four key benefits that come with the IMF deal: (i) $1.4 billion (ii) Easy debt restructuring (iii) Increased foreign and local investments (iv) Increased access to concessional borrowing. As explained above, debt restructuring will free resources to help better support economic social sectors which is key to making local solutions work. It will further help strengthen the kwacha and lower the cost of production and cost of living as we are still import dependent.
8. WHAT WILL HAPPEN IF WE WALK AWAY FROM THE IMF DEAL?
Should we decide to walk away, all debt restructuring discussions will break down, kwacha will instantly depreciate, eurobonds will go ‘mad’, the cost of borrowing on the international market will be very high and some lenders will actually ask for our key assets as the risk of default will be very high. We risk a situation where domestic revenue is not even enough to pay debt. Government will have to borrow heavily on the domestic market pushing interest rates up. Government won’t even have the money to pay for the same subsidies we are worried about. The challenge is that as we discuss the IMF deal, we only focus on the pain we have to go through as we implement reforms but we don’t realise that things will be worse without the deal.
9. CAN TAXING THE MINES MORE REPLACE THE IMF DEAL?
Suppose we reverse the decision to make mineral royalties tax deductible and further increase tax rates, the mines will not only withhold planned investments but will also scale down production. Total revenue we get from the mines will instantly decline and our economic crisis will worsen. So whatever measures are taken, we have to fully understand our overdependence on the mining sector and how such actions can easily leave us in a big economic crisis. A survey conducted by the Bank of Zambia in 2019 indicated a 50% reduction in foreign investment. This was mainly driven by a reduction in investments in the mining sector arising from operational challenges and low profitability. Much as prices of copper have increased, we have to anslyse how operational challenges and costs have evolved on a case by case basis. Realising tangible benefits from the mining sector lies in stable and predictable policy environment and tax regime, other incentives to suppprt expansion and sealing leakages in revenue.
10. WHAT IF ZAMBIA BORROWS AND INVESTS DIRECTLY INTO MINING PROJECTS?
What if ZCCM IH goes it alone and embarks on new mining projects? Mining projects are usually phased and require huge capital investments and it takes time before you start making good profit. These projects too need a good economic environment and cannot be relied upon to instantly address our debt crisis. Infact if we borrow heavily from the international capital markets at commercial rates to invest in these projects, we risk a situation where when we start making profit from these projects, all earnings go to servicing debt. By then we would have defaulted on our current debt and we even risk finding it hard to sell our minerals on LME.
In conclusion, wr are not in a situation of ‘foreign only’ or ‘local only’ solutions, we need a mix and what some people have termed as local solutions would actually require an IMF bailout to work better. Lastly, while the process of restoring economic stability will be painful, its absence will even be more painful.