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Sunday, 25 February 2007

A cause for optimism.....

"From Stability to Improved Service Delivery", was the theme of Magande’s latest budget. It does not take long to go through the budget to see that the Government seems to have found a new level of confidence in the area of macroeconomic management. From the positive announcement of the new Chinese economic zone to the praise of the continuing mining recovery, the budget oozes with confidence. Two key areas particularly magnify this new found inner belief – the "7% GDP growth rate” projection for 2007, and the "5% inflation” target for 2007"

There's no doubt that Magande's has achieved broadbased macroeconomic stability as result of the fiscal reform that him and LPM continue to take forward, and not least aided by the debt relief and the overwelming advantage of the recent trends in commodity prices.
Not only that, we know mining is expected to grow even more, while the Government continues to push for more diversification of the economy. But are those targets really achievable in 2007? A key question economists have been asking is, "how will the country cope with the appreciation of the Kwacha, driven by a flood of yield seeking portfolio flows in late 2006?"

A closer inspection of the sectoral breakdown of the GDP provides more questions than it answers. While growth last year was high at 5.8%, the sectoral performance showed significant variability across the piece. Agriculture in particular only posited a 2.4% growth in 2006 despite a bumper harvest of 1.4m metric tonnes in 2005/6 season, probably held back by the fall in external competitiveness due to the dramatic appreciation of the Kwacha towards the last quarter of 2006.
But we must also remember that inflation digits fell to a 30 year low, a great achievement. The cost of imported oil key to our growth at this stage of development has also been kept lower than would otherwise have been the case. Given that a gradual depreciation in the Kwacha has begun the ‘damage’ appears not
to have been lasting. Its fair to say that the economy does appear to be primed for growth. So it is indeed possible that 7% can be achieved, all things being equal.
The inflation target set out in the Budget may be more challenging to achieve. With yields on Government securities significantly lower than they were when the portfolio flows flooded in, inflation in 2007 will not benefit from a repeat performance of the currency's gains. In 2006, inflation also benefited from the impact on food prices of the bumper harvest. This will now contribute to a lower base, making y/y inflation difficult to control. The real test though, is likely to be the extent that inflation expectations have really changed, given events of recent years. Wage negotiations - which are traditionally around 20% - will thus provide a key test. There's however some positive signs on that front, with the Government this past week reaching a settlement with civil servants of about 4%. How other unions react will be crucial.

The stock of domestic debt also increased 24.2% in 2006, to stand at 20.2% of GDP (from 19% previously). This largely reflected the securitisation of domestic arrears, including the debt owed to the Bank of Zambia. Similar growth is not expected in 2007, potentially removing a key source of support to yields. Much will also depend on the FX risks. Despite the receipt of large portfolio inflows (estimated at $149m in 2006), we do not appear significantly vulnerable to a sudden outflow of these funds. Last year, the we received $338m in FDI, and donor grants of $293m. Although these numbers could certainly decline, they still appear more than adequate to cover any potential portfolio outflows.

Following Multilateral Debt Relief, our external debt has fallen dramatically, from $4.5bn at the end of 2005, to only $635mn by the end of last year. Debt service payments in 2007 will fall tenfold relative to pre- HIPC levels, to only $33.9mn. So, even with around two months of import cover, we are not hugely vulnerable. With a strong trade surplus still, most analysts agree that the balance of risks suggest only gradual depreciation of the Kwacha deprecation in 2007.

Finally, Magande also announced that Government will be taking steps in the direction of boosting revenue from the mining sector. Proposals have been put forward to increase corporate tax in the mining sector from 25 to 30%. The standard 15% rate of withholding tax on dividends and interest is also likely to be reintroduced with respect to the mining sector. Finally, negotiations are underway to increase mineral royalties from 0.6% for base metals, and 2% for precious metals, to 3% overall. Although the Budget did not include much detail on when these measures are likely to take effect, given the continued favourable outlook for the sector, these are steps that we can afford to take. The long term implications regarding fiscal sustainability are therefore sound. A few uncertainities in 2007, but we have a cause for optimism on the macroeconomic front in the long term.

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