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Zambia and the IMF News Brief: IMF Completes Review Under Zambia's PRGF Arrangement and Approves US$64 Million Disbursement Country's Policy Intentions Documents |
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Zambia—Letter of
Intent
Mr. Horst Köhler Dear Mr. Köhler, 1. In this letter, we discuss progress in implementing the 2001 program supported by the PRGF arrangement, and describe the government's key economic and financial policies for the rest of 2001. The letter also requests completion of the third review of the PRGF arrangement and the disbursements related to the end-March and end-June performance criteria. As the performance criteria were not observed on domestic arrears for end-March and end-June, and on the net domestic assets of the Bank of Zambia (BoZ) for end-March (by less than K1 billion), the government is requesting waivers for their nonobservance. The government has agreed to implement a comprehensive framework to deal with domestic arrears. The attached Tables report on developments with regard to performance criteria and benchmarks through end-December 2001. |
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I. Recent Economic Developments 2. Zambia's economic performance during the first half of 2001 continued to improve. Although growth in agriculture is projected to decline moderately, the targeted real GDP growth of 5 percent for 2001 should be achieved on the basis of a strong performance by the mining, manufacturing, and services sectors. In addition, the 12-month inflation rate through August was markedly lower than the indicative target, largely on account of tight financial policies and a greater-than-expected appreciation of the kwacha, and it is expected that the end-December target of at most 17.5 percent will be met. 3. Following a substantial tightening of monetary policy in January 2001, broad money declined by 15.6 percent through end-March compared to the outstanding stock at end-December 2000. Over the same period, the kwacha appreciated by 27 percent in local currency terms. Towards end-March, the BoZ eased monetary policy by lowering the minimum reserve ratio from 15 percent to 10 percent. Mainly as a result of this relaxation of the monetary stance, the exchange rate depreciated by 22 percent between end-March and end-June, and largely in response to this rapid depreciation, the BoZ again raised the cash reserve ratio to 12.5 percent. Through end-June, broad money declined by about 5 percent compared to the targeted increase of about 1.5 percent. In line with monetary developments, the yield on 91-day treasury bills rose from 34 percent at end-December 2000 to 53 percent in March 2001. However, with the moderation in inflationary pressures and larger-than-expected public sector net deposits, the yield declined to 43 percent by end-June. Thus, real interest rates have remained very high, notwithstanding the deceleration of inflation. 4. Fiscal performance through end-June was generally favorable. In particular, revenue exceeded the program target by over 9 percent, despite the unexpected appreciation of the kwacha, mainly because of the strong performance of income tax and the VAT. Total government cash expenditures fell short of the program target by some 13 percent as overruns in domestic capital outlays and in RDCs were more than offset by lower-than-programmed expenditures on HIPC-related programs, elections, transfers to Zambia Consolidated Copper Mines (ZCCM), and contingency outlays. Consequently, net borrowing from the banking system was much lower than anticipated despite a significant shortfall in external program support. At the same time, domestic arrears at end-March and end-June were substantially higher than programmed. In addition, at end-June, cash releases for social sector outlays were below budgeted levels, and there was a delay of one quarter in commencing with HIPC Initiative financed expenditures. 5. Balance of payments developments during the first half of 2001 were mixed. Despite lower-than-expected copper and cobalt prices, exports receipts of these two products rose substantially on account of greater-than-expected volume increases from the newly privatized mines. However, growth of nontraditional exports was substantially lower-than-programmed largely because of the continuing civil strife in Zambia's key regional export markets. Nonfactor service receipts rose significantly, but external assistance fell short of the program target by US$56 million reflecting a substantial shortfall in disbursements from the World Bank and the European Union (EU). Nonetheless, the program's gross international reserves targets for end-March and end-June were met after taking account of the program adjustor for shortfalls in balance of payments support net of debt service and Fund disbursements. 6. Regarding structural reforms, the government issued instructions in March 2001 to the Zambia Privatization Agency (ZPA) to proceed with the sale of a majority controlling interest in ZNCB, consistent with Zambia's commitments under the PRGF and the HIPC documents. A full-scope inspection of the bank for the period ending December 2000 revealed that its financial position remains unsatisfactory. However, its position has been stabilized mainly as a result of repayments by RAMCOZ and by government on guarantees on loans to ZNOC. Going beyond ZNCB, the stability of the banking system has improved. Of the three problem banks, two have been put under liquidation and the third is now fully capitalized. Some members of the management of the fourth bank were found to be pursuing improper financial practices and this resulted in the bank being closed temporarily. The bank has since reopened under a new management team approved by the Bank of Zambia. 7. Actions to liberalize the oil sector have been delayed. However, we have been working closely with the World Bank and have taken the following measures: (i) issued a written notification that the private sector is free to import crude oil; (ii) amended the Energy Regulatory Board (ERB) license conditions to abolish the requirement for ex-ante price adjustment request; to monitor pump prices ex-post; to require display of pump prices; and to maintain a minimum stock of products; and (iii) began the process of forming a private consortium for importation of feedstock. Moreover, the Government has agreed that the import tariff on petroleum products will be lowered from 25 percent to 5 percent, by end-December 2001. II. Program Implementation 8. All quantitative performance criteria for end-March, and end-June 2001 were met1 except that the domestic arrears ceiling was breached on both dates,2 and the end-March ceiling on the net domestic assets of the BoZ of K 193 billion was missed by less than K 1 billion (Table 1). Given that the verified stock of domestic arrears at end-June is now much larger than programmed, the performance criterion for end-September is unrealistic. 9. The program's structural performance criterion on the abstention from new tax reductions was observed, as was the benchmark on the nonaccumulation of new tax arrears by ZESCO and ZNOC. The benchmark for end-June for the BoZ to improve the treasury bill market was also observed, albeit with some delay on the issuance of auction guidelines. III. The Program For The Remainder of 2001 A. Macroeconomic Policies 10. The key macroeconomic objectives for 2001 remain to achieve GDP growth of 5 percent and limit the 12-month rate of inflation to at most 17.5 percent by year-end, within a financial framework that targets a substantial increase in gross international reserves while reducing poverty. Achieving these objectives will require implementing appropriate fiscal and monetary policies, strengthening structural reforms, and re-orienting government expenditures towards the social sectors and poverty reduction. B. Fiscal Policies, External Resources, HIPC, and PRSP 11. Notwithstanding the more appreciated exchange rate, total revenue is projected to exceed the program target by 0.6 percent of GDP. The shortfall in domestic VAT will be largely offset by the VAT on imports as the impact of the Import VAT Deferment Scheme has been much smaller than expected, and as the delay in the operation of the Indeni refinery has required continued imports of refined petroleum. Income taxes are projected to perform strongly, reflecting increased activity in the mines. We will continue to abstain from new tax reductions, exemptions, rebates or any other preferential tax treatment, including for the mining sector, pending a thorough review of mining taxation policy in consultation with Fund staff. 12. Expenditure pressures during the rest of the year are likely to remain strong, particularly in view of the upcoming elections. The government recently concluded the lengthy process of reaching wage agreements with the civil service and public workers unions. The major agreement covers the period July 2001 to December 2002 with no retroactive increases for January-June 2001. The wage bill is now projected to reach 6.3 percent of GDP compared with the program estimate of 5.7 percent. There have also been overruns in recurrent departmental charges and in domestically financed capital expenditures. To offset these overruns, outlays for financial restructuring will be curtailed by agreeing on an appropriate repayment schedule with ZNCB for the remaining payments on the government guarantee on its loan to ZNOC. In any event these payments will need to be made in the context of concluding the privatization of the bank. No new financial commitments will be made on account of ZNOC by the government or BoZ other than those for which they are legally liable. Transfers to the former ZCCM's creditors will continue, but will be less than budgeted partly on account of an audit which has questioned the validity of some of these claims. Taking account of increased revenues, the domestic budget balance will be limited to 3.8 percent of GDP or 0.5 percentage points above the program target. 13. While maintaining control on overall expenditures, the government will re-orient expenditures toward the social sectors. Following the government's reestablishment of the "80 percent rule" in April, and the move to a "100 percent rule" in July for social sector ministries,3 the cumulative share of social sector spending in discretionary expenditures during January-July (38 percent) is now broadly in line with targets agreed with the World Bank. In addition, since setting up the mechanism for channeling HIPC Initiative debt relief toward pro-poor activities, HIPC-financed spending has increased substantially as noted below. 14. A significant problem for public finances that has emerged is the likelihood of a substantial shortfall in donor balance of payments support in 2001. The 2001 budget was based on disbursements of US$79 million grants from the EU. However, it appears likely that actual disbursements will amount to only US$10 million because of complex conditionality, and a recently instituted historical audit of the use of EU funds since the mid-1990s. The budget also envisages highly concessional loans of US$95 million from the World Bank comprising two tranches. We believe that the policies and actions underlying the first of these tranches have been implemented. The last tranche is related to the reform of the oil sector. Substantial progress has already been made as noted above and we envisage taking all necessary remaining actions by end-December 2001. The government will continue to cooperate closely with its development partners. 15. Total public sector debt service (including to the Fund) for 2001 is currently estimated at US$145 million, compared with the programmed US$160 million,4 mainly reflecting lower payments to Russia. Paris Club creditors are expected to agree to a flow rescheduling on Cologne terms shortly, and key multilateral institutions, including the Fund, World Bank, and the African Development Bank, are providing interim relief as envisaged. The government is also making best efforts to reach agreement with non-Paris Club bilateral and commercial creditors on terms comparable to those provided by Paris Club creditors. 16. HIPC Initiative financed expenditures have been delayed by uncertainties about the timing and level of relief and how to set up a mechanism to register the inflows. These issues have been resolved, and each month, estimated debt relief received (excluding from the Fund) will be credited to a HIPC account (account 49) from which disbursements will be made to the relevant projects.5 The government deposited US$42 million to the HIPC account in June and an additional US$12 million per month will be deposited for the period July-December 2001. The government will inform the Fund staff of the monthly payments into account 49 and the cash releases to ministries. Given the delay in starting HIPC-financed poverty-reducing programs, spending the full amount programmed for the year would involve inefficiencies. In collaboration with line ministries, a revised disbursement profile was agreed which is expected to bring total HIPC-financed expenditures for the year to K 280 billion. Thus 80 percent of the original programmed K 352 billion will be spent during July-December. The Accountant General has drawn up guidelines for tracking and reporting on the disbursement of funds from the HIPC account, and issued them to Controlling Officers. The first summary report on HIPC resources and expenditures, which covered the first and second quarters, has been published in the newspapers. The second report will be published by end-November. The World Bank, UK, and others are planning to fund a public expenditure tracking survey in the education sector, and we will cooperate with donors in this regard. 17. The system outlined above will enable the government to track the receipt and use of HIPC resources. At the same time, the current system of budget classification makes it difficult to judge whether overall spending has taken on a more "pro-poor" orientation. As such, government has set up a committee charged with establishing an agreed set of anti-poverty expenditure items in the budget and, in this manner, hopes to be able to define an expenditure baseline for 2000 against which to compare the outturns for 2001 and beyond. Government intends to request technical assistance from the Fund in this regard. 18. Regarding the PRSP, considerable progress has been made and a draft final document has been prepared, which has benefited from a country-wide participatory process involving local government officials, civil society groups, and local communities. The government will hold a National Summit in mid-October involving all stakeholders, in order to reach a broad consensus on the PRSP. C. Monetary Policies 19. Monetary policy during the second half of 2001 will aim to achieve the program's targets on growth, inflation and international reserves. In line with these objectives, growth of broad money will be targeted at about 13 percent during 2001 compared with 16.5 percent in the program. The BoZ has made substantial progress in improving the operations of the treasury bill market, including the issuance of the new auction guidelines, and the modification of the book entry system to enable the reintroduction of the multiple pricing format for treasury bills and the prorating of the marginal bids. The BoZ will adhere strictly to the new auction guidelines so that interest rates will reflect the prevailing market conditions. The recent introduction of repurchase agreements will enhance the BoZ's capacity to implement monetary policy. The government recognizes the need to recapitalize the BoZ in order to strengthen monetary policy implementation. D. External Sector and Exchange Rate Policies 20. Zambia's external current account deficit (excluding grants) is projected to be 18.5 percent of GDP in 2001, as a larger trade deficit is partially offset by a substantial improvement in the services account. Total exports receipts are projected to increase by 14 percent, compared with the programmed 24 percent, reflecting lower copper and cobalt prices and lower-than-expected nonmetal exports. Total imports are envisaged to rise by 18 percent linked to higher project financing, foreign direct investment, and maize imports. The better-than-expected performance in services largely reflects increased tourist receipts, partly on account of the OAU conference and the solar eclipse. Reflecting mainly the shortfall in balance of payments assistance from the EU, gross international reserves are projected to increase by US$74 million to 1.5 months of imports, compared with the programmed increase of US$135 million to 1.9 months of imports. 21. Since end-June 2001, the exchange rate has remained relatively stable. The exchange rate will continue to be market-determined, with central bank intervention limited to meeting the international reserves target and to smoothing short-term fluctuations. Zambia continues to maintain a liberal trade regime, and as noted earlier, the government has agreed that the import tariff on petroleum products will be lowered to 5 percent by end-December 2001. The government will lift the recently imposed ban on the export of maize as soon as conditions return to normal. E. Structural Reforms, Public Expenditure Management, and Governance Structural Reforms 22. Completing the privatization of ZNCB remains the government's top priority. The recent full scope inspection of the Bank confirmed weaknesses in its financial condition. To address some of these weaknesses, the BoZ has issued instructions for ZNCB to properly account for the unrealized trading losses/gains on its foreign exchange holdings, and to write off all unreconciled inter-branch items of more than 90 days. A targeted inspection to review compliance with the instructions will be completed by end-October 2001. 23. Following Cabinet approval of the proposal to privatize ZNCB, consultants began a due diligence study which is scheduled to be completed by October. The study will assess the bank's current financial situation and valuation, and prepare international tender documents. The consultant will also identify options for privatization, including hiving off the nonviable rural branches of ZNCB and possibly combining them with the National Savings and Credit Bank as part of developing a rural financial entity that will provide services in small towns and rural areas. In any event the rural branches will be fully separated from the sale of the bank as a commercial undertaking, and the final decision on those branches will not delay the offer for sale of the bank. It is expected that the ZPA board will approve the privatization proposal and tender document, and appoint a negotiating team, and we intend to issue the tender documents for sale of a majority controlling interest in the bank by end-November. In the interim, the government will strengthen oversight by appointing ZPA to the Board of ZNCB. 24. The BoZ has taken steps to strengthen the banking system and, in May 2001, it conducted a self assessment of Zambia's compliance with the Basel Core Principles. The assessment, however, focused more on laws and regulations as opposed to actual practice. In this context, the Financial Sector Assessment Program (FSAP) mission from the Fund and the World Bank planned for 2002 to conduct a comprehensive external assessment of the financial system will be useful. 25. The government is moving as rapidly as feasible to implement the remaining actions agreed with the World Bank on the oil sector. In this regard by end-December, government will (i) offer for sale its share in Indeni refinery in order to reduce its equity stake to below 50 percent; (ii) offer for sale or long-term concession the Ndola storage tank and TAZAMA pipeline to a private sector operator through a competitive bidding process; and (iii) restructure ZNOC to limit its role to that of maintenance of strategic stock of petroleum products. Public Expenditure Management 26. Public expenditure management requires further strengthening, as evidenced by the sharp increase in domestic payments arrears during the first half of the year. Recognizing the critical importance of improvements in this area, government has devised an action plan to deal with this problem. First, the Controller, Internal Audit has conducted an audit of arrears at end-June and the reasons for the large increase. Controlling officers will be required to sign off on these results, certifying that no other bills corresponding to this period will be unearthed at a later date. The line ministries should take the results of the internal audit as the base for reporting the monthly expenditure returns from September onwards. To verify the accuracy of the data for the Ministry of Works and Supplies, which accounts for 45 percent of total arrears, the Auditor General has commenced an independent audit of the ministry's arrears with its major contractors. The audit will be completed by end-November. At the same time we are taking urgent steps to strengthen the monthly reports from controlling officers that must form the basis of long-term improvement in financial management and control. In particular, we intend to modify the existing system of computerized monthly reporting to include information on commitment and arrears. Until then, the system of manual monthly reporting should continue and be strengthened. Once this system is more reliable, the quarterly reports of the Controller, Internal Audit could fulfill the normal function of quality control. In addition, we are taking a number of steps, as detailed in Annex I, to improve budget preparation and expenditure control. 27. With regard to the IFMIS, in September 2001 an EU-funded consultant, produced a "roadmap" of the development and implementation of the system, which has served as a useful input for the internal project management team in analyzing existing weaknesses and preparing user requirements for the IFMIS. The members of this team have recently been freed from their other duties in government to allow sufficient time for IFMIS. A World Bank-funded consultant is currently reviewing the work of the project management team. Government anticipates that the user requirements and timetable for implementation will be submitted to the IFMIS steering committee by end-October. The next steps will be clarified in the team's report, but it appears unlikely that a consultant for designing hardware and software requirements will be in place by December 2001, as initially envisaged. 28. The accounts of government at the Bank of Zambia are being streamlined to improve information availability for monitoring government finances. The government has requested technical assistance from the Fund to simplify the system of government accounts at the BoZ. In the meantime, the government plans to close all dormant accounts and will review the foreign exchange bridge loan account at the Bank of Zambia. Government is moving to a system in which the general revenue account receives all inflows, including the kwacha value of external support, and is used to pay all outflows, including debt service, in order to strengthen the management of public finances. Credit to government would be provided by treasury bills and by a single ways and means account on which government would pay an appropriate rate of interest. The government will issue rules governing the terms and conditions for commercial bank accounts of all government agencies. Governance 29. Given the importance for good governance and transparency of publishing the audited government accounts in a timely fashion, the Financial Report for 2000, prepared by the Accountant General and verified by the Auditor General, was tabled in Parliament in September, and the Auditor General's report on the overall outturn should be completed by December, all as required under Zambian law. This represents a substantial improvement over recent years, when Financial Reports have been delayed by up to four years. 30. In June 2001, the government completed the provision of all information and documents requested by the auditors as necessary to finalize the report on cobalt sales. However, the Metal Resource Group (MRG), the apparent beneficiary of the below-market-price sales, questioned the findings of the draft report and has initiated legal action for libel against the auditors and the government. This has delayed the auditor's completion of the report, but we expect it to be finalised shortly. The report will be referred to Cabinet for appropriate follow-up actions under the law, and if feasible the government will publish the document. IV. Technical Assistance and Data Issues 31. Zambia continues to require technical assistance in the areas of public expenditure management, monetary operations and liquidity management, and simplification of government accounts with the banking system. More critically, this year there has been a considerable delay in producing monetary statistics, particularly the monetary survey.6 BoZ is making concerted efforts to ensure that this problem is resolved as soon as possible. Regarding national accounts, methodological weaknesses relating to the use of outdated weights, long delays, and frequent revision in the estimates undermine government's ability to monitor economic developments and formulate policies. The BoZ will also seek to improve the tourism and foreign direct investment statistics in the balance of payments. To address these weaknesses, the government will request technical assistance from the Fund and other donors. V. Program Monitoring 32. For end-December 2001, the implementation of the program will be monitored on the basis of the quantitative and structural performance criteria and benchmarks indicated in Tables 1 and 2. Owing to difficulties in measuring and monitoring domestic arrears, the quantitative performance criterion on domestic arrears has been replaced by a structural performance criterion and benchmarks involving progress towards improving the monitoring and control of these arrears. The fourth review of the PRGF-supported program will be conducted based on performance through end-December 2001, and will include agreement on an appropriate macroeconomic and financial framework for 2002. Yours faithfully,
ANNEX I Improving Budget Preparation and Expenditure Control Government efforts to strengthen public expenditure management focus both on budget preparation and on expenditure control. Regarding the former, if ministries are expected to carry out a certain set of programs but given unrealistic budget appropriations, the accumulation of arrears is inevitable. As such, government intends to narrow the scope of expenditure so as to allow an increase in budget allocations for key priorities. In particular, circulars have been issued to curtail motor vehicle allowances for government servants and education and housing allowances for foreign diplomats: savings from these two initiatives will be redirected toward road works and other areas in which arrears have typically arisen as a result of low budget allocations. Government is also committed to ending the practice of entering projects and programs in the budget with only a token provision (usually one kwacha). This practice, intended to obtain parliamentary authority for items for which funding sources may emerge in the future, has often led to spending pressures from line ministries even in the absence of funding. Government will ensure that no item will be recorded in the Yellow Book without an adequate appropriation. In terms of expenditure control, the procedures of the Zambia National Tender Board will be tightened. Current regulations state that a contract can only be approved if the project appears in the Yellow Book and if there are adequate funds, but in practice, it is difficult for the Tender Board to assess whether funds are, indeed, available. As such, it is proposed that endorsement of the Minister of Finance should be required for any project above K 500 million. To eliminate any possible uncertainty regarding permissible virement, the 2002 Yellow Book will clarify budget regulations to state clearly that, without prior Treasury authority, a controlling officer may not apply funds released for a certain subhead toward expenditure under a different subhead. For instance, variations between grants and RDCs would be forbidden, as would variations between drugs and allowances within RDCs. To reinforce financial discipline, permanent secretaries shall be made contractual employees. Terms of their contracts would include compliance with all financial regulations (including those governing virement and aggregate commitments), and any malfeasance would be regarded as grounds for sanctions, up to and including dismissal. Finally, as a further boost to expenditure control, the personal responsibility of heads of accounting units shall be enhanced. Although it is recognized that the controlling officer bears ultimate financial responsibility for an expenditure head, chief accountants will be subject to disciplinary action by the Accountant General should they fail to report on all instances in which they have been requested to process transactions inconsistent with the Financial Regulations. Similarly, the responsibility of internal audit will be reiterated in a treasury circular. 1 After applying the adjustor for the shortfall in balance of payments assistance net of debt service payments (US$42.6 million), the delay in Fund disbursements (SDR 24.94 million) related to the end-March performance criteria, and the reduction in the cash reserve ratio to 10 percent in March and the subsequent increase to 12.5 percent in June. 2 The increase since December reflected the verification of old arrears on previously contracted road works, the impact of the exchange rate on dollar denominated arrears, and a build-up of penalties on outstanding arrears. It also reflected the accumulation of new arrears, which we estimate to amount to about K 40 billion. By comparison, over the same period, net credit to government was K 218 billion less than programmed. 3 These rules require the Budget office to make cash releases to line ministries consistent with their budget appropriations. 4 Pending agreement with the Paris Club on interim relief, Zambia has stopped paying to Paris Club creditors debt service that was expected to be subjected to interim relief under the HIPC initiative, to allow the resources freed by relief to be directed towards poverty-reducing expenditures rather than towards debt service. Once the Paris Club agreement is finalized, we hope to recoup the overpayments made to Paris Club creditors during January-August 2001. 5 Each month, the kwacha bridge loan will be debited for the kwacha equivalent of US$12 million and funds will flow first to account 99 and then to account 49. At the time of disbursement, funds will flow back through account 99 briefly so as to utilize current government cash release procedures. As for the amount of debt service remaining due after debt relief, the foreign exchange bridge loan will be debited for this amount, as payments fall due, and funds will be transferred to account 99 and then to account 63 before being paid. 6 The BoZ has been having problems introducing a new accounting software package and has temporarily reverted to its previous software for generating monetary data. |
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