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Tuesday, 30 September 2008

IMF on Zambia's Economic Outlook

The IMF have concluded their mission to Zambia, with predictions of slow growth and some rebuke of the government's recent fuel policy, something this blog has highlighted already :

Statement at the Conclusion of an IMF Staff Mission to Zambia, Press Release No. 08/227, September 30, 2008

An International Monetary Fund (IMF) mission visited Zambia during September 17-26, 2008 to conduct the first review of the Poverty Reduction and Growth Facility (PRGF) arrangement that was approved in June 2008. The mission met with Acting President Rupiah Banda, Minister of Finance and National Planning Ng'andu Magande, Bank of Zambia Governor Caleb Fundanga, and other senior officials, as well as with representatives of political parties, the business community, civil society, and Zambia's cooperating partners. Birgir Arnason, IMF Resident Representative to Zambia, issued the following statement at the conclusion of the mission:

"The Zambian economy continues to perform strongly despite several adverse shocks. Growth may slow somewhat this year due to the relatively poor harvest and extensive load shedding while inflation has accelerated on account of increases in world fuel and food prices. Beyond 2008, prospects for strong growth and declining inflation remain broadly favorable. The main risks to the outlook stem from a significantly slower rate of global growth and a sharper decline in copper prices than currently anticipated.

"Implementation of fiscal policy has been weaker than planned. Large amounts of supplementary expenditures have been undertaken and the lowering of fuel taxes will result in sizable revenue losses. The persistent difficulties with implementing capital projects highlight the urgent need to strengthen budget execution, including cash management through the establishment of a Treasury Single Account and Treasury Department at the Ministry of Finance and National Planning. Fiscal discipline in the period ahead requires that decisions that would further undermine the attainment of the 2008 fiscal targets be avoided.

"Zambia's economic resurgence in recent years owes much to improved economic management. Continued adherence to prudent macroeconomic policies is essential for sustaining this achievement. For 2009, the use of revenue flows from the new fiscal regime for mining should take into account constraints in the absorptive capacity and uncertainty about the implementation of the new regime needs to be resolved. Monetary policy needs to ensure that only the immediate impact of the surge in food and fuel prices is accommodated, and in the face of strong wage pressures that an upward spiral of wages and prices be prevented.

"The ongoing electricity crisis threatens to stifle economic growth. Current electricity tariffs are too low to meet the cost of supplying electricity and to support investment in new generating capacity. However, improved services and greater efficiency by ZESCO, the state-owned electric utility, are also necessary to contain the cost of electricity.

"The mission will continue its work in Washington, D.C., in close collaboration with the Zambian authorities, and anticipates returning to Lusaka as soon as possible after the presidential elections to finalize discussions on an economic program for 2009 that could be supported by the PRGF arrangement."

14 comments:

  1. I agree with IMF on the electricity tariffs being too low, it reduces the attractiveness of the sector to investors.

    http://www.entrepreneur.com/tradejournals/article/177721558.html

    A limited electricity subsidy to poor consumers is okay.

    I disagree with IMF on fuel prices, they were too high and affecting business growth. Increased business growth will increase income tax collections and help offset fuel tax reduction.

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  2. Utility companies if properly run could also be viewed as stable investments, investment rate of return may not be high, but cash flow is stable because the economy needs the utility companies products. So pension funds could invest in utility companies stocks and bonds helping them raise capital provided they are allowed to set profitable tariffs.

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  3. Kafue,

    ”I agree with IMF on the electricity tariffs being too low, it reduces the attractiveness of the sector to investors. “

    This has always been the IMF line – a report they issued earlier this year said the same thing.

    http://zambian-economist.blogspot.com/2008/05/obstacles-to-growth.html

    The Cost of Service Study also said the same thing. Zambia has one of the lowest tariffs. But I don’t think that is the only problem, and even the IMF acknowledges this in the reference report. The other problem is that ZESCO is also owed huge amount of debt and therefore suffers from the usual “parastatal madness” problem.

    http://zambian-economist.blogspot.com/2008/06/parastatal-madness-3rd-edition.html

    Also Bob Sichinga made a good point recently, the structure of the industry does not easily lend itself to competition and investment.

    http://zambian-economist.blogspot.com/2008/07/quote-of-week-bob-sichinga.html

    That said, I remain cautious on whether breaking up ZESCO is necessary the answer, since similar initiatives in RSA have not exactly brought forward significant investments. I think better models need to be developed.

    ”I disagree with IMF on fuel prices, they were too high and affecting business growth. Increased business growth will increase income tax collections and help offset fuel tax reduction.”

    I just don’t follow you. Let us take the case of small businesses who rely on buses to get from A to B. I don’t see how this measure helps them. The buses have not reduced prices, in fact they have just captured the rent created by the reduction. I read a Times Editorial which was calling them immoral etc for not passing on the reduction, clearly missing the point that is just how markets operate. Incidentally, the reduction has simply realigned the incentives in favour of car drivers (OMC companies MUST reduce prices, so drivers benefit directly) putting more pressure on our roads…so not only does fiscal revenue go down, but road mantainance costs must rise as well….

    Let us not forget that when prices do rise, the tax reduction impact would have little effect…..

    I think what Zambia needs probably is a fuel escalator, which responds to price shocks…with the tax being lower at higher oil prices and higher at lower ones. In that sense keeping the prices fairly stable. But that is very much a second best world.
    Also your arguments that this helps businesses has no empirical basis. The problem in Zambia is not that entrepreneurial activities are too expensive to undertake but that the “cost of doing” business is generally high.

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  4. Cho,
    "I just don’t follow you. Let us take the case of small businesses who rely on buses to get from A to B. I don’t see how this measure helps them. The buses have not reduced prices, in fact they have just captured the rent created by the reduction."

    There could be a time lag between fuel tax reduction and bus fare reduction. Or bus operators may still be charging higher prices to recoup revenue lost while fuel prices were increasing and bus fares were not. I think in the long term competitive forces will bring about price reduction unless other factors intervene (such as bus maintenance or labor costs increase).

    A more obvious example of a benefit would be a trucking company which was not able to buy more trucks to expand their business because higher fuel costs were reducing profits. Now they can buy more trucks producing more income for them and thus more income taxes for the government.

    The purpose of a fuel tax should be for road maintenance and not for funding other government operations. Thus the car owners you mention benefiting would increase traffic but also increase tax revenue through the higher volume of fuel sold.

    Cho,
    "The other problem is that ZESCO is also owed huge amount of debt and therefore suffers from the usual “parastatal madness” problem."

    That definitely is a problem. That is why I don't believe in long term cross subsidies, it distorts the functioning of the economic system. The only solution is for the government to pay up.

    Cho,
    "That said, I remain cautious on whether breaking up ZESCO is necessary the answer, since similar initiatives in RSA have not exactly brought forward significant investments. I think better models need to be developed."

    I agree. I prefer the model in western countries before deregulation, where public utility commissions determined a rate that would give a small but fair profit to the utility. As I said before, in those days utilities were regarded as "widows and orphans" stocks, because of low risk and stable though small return on investment to those investors.

    Cho,
    "I think what Zambia needs probably is a fuel escalator"

    I think what you mean is a stabilization fund, purpose being to have stable prices rather than raise revenue for the government. I agree, especially for poor countries. Besides that, the only other fuel tax should be for road maintenance.

    Cho,
    "The problem in Zambia is not that entrepreneurial activities are too expensive to undertake but that the “cost of doing” business is generally high."

    I don't understand your statement. Are you talking about red tape and corruption?

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  5. i have the kenyan report too, but I'm unsure of the relevance of the report or if our government [or any african country] cares about what it says anymore

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  6. ”There could be a time lag between fuel tax reduction and bus fare reduction. Or bus operators may still be charging higher prices to recoup revenue lost while fuel prices were increasing and bus fares were not. I think in the long term competitive forces will bring about price reduction unless other factors intervene (such as bus maintenance or labor costs increase).”

    Three problems with your assessment:

    First, you assume “competition”, and ignore the ineffectiveness of the Zambia Competition Commission to tackle collusive behaviour. But even without any hint of collusion, the bus industry is not as competitive as you assume. Also different models of competition predict different outcomes on price. Not to mention that in many rural parts of Zambia often these buses have niches, and therefore not operating in strictly contestable markets in the short to medium term.

    Second, what exactly is your “long term”. One year, two years etc. ?

    Thirdly, prices don’t usually REDUCE as you have assumed, they SLOW down i.e. rise at a lower rate. The saving that has been passed on may slow bus prices down, but they are unlikely to reduce them nominally unless competition is fierce.

    ”A more obvious example of a benefit would be a trucking company which was not able to buy more trucks to expand their business because higher fuel costs were reducing profits. Now they can buy more trucks producing more income for them and thus more income taxes for the government.”

    Fuel is a variable cost. Trucks are a fixed cost.

    Reducing the price of fuel reduces the fuel cost which in turn allows them to do more trips, all things being equal. But the profit margin ultimately determines whether they invest in more trucks. In other words, we don’t know how the revenue side looks.

    ”The purpose of a fuel tax should be for road maintenance and not for funding other government operations.”

    Ideally yes, but that is not the case. The truth is that as you reduce the fuel tax the fiscal position of government worsens. The IMF (and myself) are not confident that government can plug this gap. May be the money will come from mineral royalties, but even that is bad because that money should be used as part of a long term stabilisation fund or as part of investment in infrastructure. Giving it away as tax rebate is just bad management, especially when the price of oil can go up any time. Anyway as it turns out the government wont get that much from mining taxes anyway given recent reduction in copper prices and the willing to accept that mines wont budge.

    ”I don't understand your statement. Are you talking about red tape and corruption?”

    I am saying that fuel is not the binding constraint. The constraint is red tape and lack of market discovery.

    Put it this way, the issue of fuel taxes is not about businesses really, its about consumers. It’s a distribution issue not an efficiency one. Businesses will always get the difference between revenue and cost. The only way businesses benefit is if they retain the rent, which allows them to expand production. Like the bus companies are doing, assuming oil prices do not rise. What the government wants to see is the rent passed on to consumers.

    So I come back to where I started….government meant the tax as a freebie to consumers….in practice it will just worsen the fiscal position and pass the rent onto producers….yes in the long term they may get the tax back….but its not obvious…ultimately the question is whether the billions of Kwachas being rebated would have been better spent on other infrastructural related activities…

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  7. Cho,
    "First, you assume “competition”, and ignore the ineffectiveness of the Zambia Competition Commission to tackle collusive behaviour. But even without any hint of collusion, the bus industry is not as competitive as you assume."

    Yes, I assume competition (possible along busy routes such as Great East Road and Great North Road). If there is no competition, then you are correct.

    Cho,
    "Second, what exactly is your “long term”. One year, two years etc. ?"

    More than 12 months.

    Cho,
    "Thirdly, prices don’t usually REDUCE as you have assumed, they SLOW down i.e. rise at a lower rate."

    Even price slow down is better than no slow down. It means more money in the pockets of people or businesses than if there is no slow down. More money in pockets means more money available to spend in other areas stimulating the economy, creating jobs and increasing income tax collection.

    Cho,
    "Fuel is a variable cost. Trucks are a fixed cost.
    Reducing the price of fuel reduces the fuel cost which in turn allows them to do more trips, all things being equal. But the profit margin ultimately determines whether they invest in more trucks. In other words, we don’t know how the revenue side looks."

    You are correct. A better example would be a farmer or manufacturer exporting his products to neighbouring countries. Lower fuel costs mean lower transport costs and thus more income available for expansion (assuming export revenues remaining the same) creating more jobs and more income tax revenue for the government.

    Cho,
    "The truth is that as you reduce the fuel tax the fiscal position of government worsens."

    Not if income tax revenue increases as indicated in the previous example from the beneficial effect of fuel price reduction.

    Cho,
    "Giving it away as tax rebate is just bad management, especially when the price of oil can go up any time."

    I object to the tax portion of the fuel price used to fund non-transport and non-stabilization government activities, not the base price. The base price can increase if the price of oil increases - a stabilization tax portion can help even out the increases and decreases

    Cho,
    "I am saying that fuel is not the binding constraint. The constraint is red tape and lack of market discovery. "

    That too, but fuel prices are a major factor, especially for investors wanting to come to Zambia and manufacture products for export in this era of globalization.

    Cho,
    "Businesses will always get the difference between revenue and cost. "

    Not really - especially not for exporters who are subject to global prices for their products which they can not influence.

    Cho,
    "ultimately the question is whether the billions of Kwachas being rebated would have been better spent on other infrastructural related activities…"

    Infrastructural activities should be funded by user tolls or fees where possible.

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  8. Kafue001,

    The point I made in a separate blog actually stands.

    If the government wanted to encourage exports and so forth you need to realign the fuel policy within a broader transport policy.

    So while I agree with you that reducing fuel exports may reduce transport costs in the short term...ALL THINGS BEING EQUAL...its quite obvious government has not got that in mind....

    Because if it did..it would have reduced the cost of jet fuel...

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  9. This article says something about the suppliers negotiating jet fuel prices with the industry - maybe jet fuel prices under negotiation?

    http://allafrica.com/stories/200809240358.html

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  10. The narrative of that article is no different than what was in the ERB statement. See A new fuel policy..

    What he is basically saying is that it is up to airlines to discuss with suppliers what they should pay and when. In other words it will be determined by market forces.

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  11. If SADC/COMESA is to become a reality, then this implies specialization within member countries, i.e. Angola specializes in oil products, Lesotho on wool products, in other words countries focus on producing what they are good at because they have comparative advantage in producing these products. So in this context, they become export oriented economies and fuel costs become important in developing these exports.

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  12. Cho,
    "Put it this way, the issue of fuel taxes is not about businesses really, its about consumers. It’s a distribution issue not an efficiency one. Businesses will always get the difference between revenue and cost."

    Not in the case of Zambian Airways!

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  13. Cho,
    " Let us take the case of small businesses who rely on buses to get from A to B. I don’t see how this measure helps them. The buses have not reduced prices, in fact they have just captured the rent created by the reduction."

    Article showing reduction in bus fares. As I said before, there is a time delay when changes in fuel prices affect fares:

    http://www.daily-mail.co.zm/sundaymail/press/news/viewnews.cgi?category=2&id=1212315406

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  14. Kafue,

    I think I made it clear that the first tranche of government policies excluded changes on Jet Fuel, something that would have helped Zambian aviation businesses directly. The argument based on "businesses" was therefore flawed.

    Of course now government has reduced Jet Fuel prices...see Ms Siliya's statement to Parliament.

    With respect to bus operators. Its interesting that they had to collude to reduce prices. The ZCC appears to have allowed direct collusion. Under the normal operation of competition policies its unlikely this reduction would have taken place. But more importantly, my point was aimed at rural consumers, who still have not benefited from fuel reduction.

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