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Tuesday, 4 December 2012

Zambia's Lost Gemstones

By Chola Mukanga

Gemstones are among the most lucrative minerals in the world. They are also stones that Zambia has in abundance. It has the second largest deposits of emeralds in the world and accounts for about 20% of global supplies. The quality of these emerald stones is very good for colour and specific gravity. Zambia also possesses Africa's largest deposits of amethyst and aquamarine, with the quality of the former considered to be amongst the very best in the world. These deposits can be found in Copperbelt, Eastern and Southern provinces, with more discoveries being made in other parts of Zambia as exploration intensifies. 

Unfortunately, like much of Zambia's mining story, the country has failed to benefit from these vast gemstones riches. Our completely liberalised gemstones sector has not delivered any tangible benefits to ordinary Zambians. There’s minimal employment creation. Most of the mines are not owned by Zambians and the tax revenue is non-existent. As former Mines Minister Wilbur Simuusa, put it, “the gemstone sector can contribute about US$700 million annually if properly managed”. That dwarfs any amount being collected currently from copper mining. Properly managed is the key. If properly managed, the production of gemstones has the potential to earn the country significant tax revenues and aid the much diversification away from copper. A fully fledged gemstone sector may also be a catalyst in fighting unemployment, especially if it is dominated by indigenous firms and is able to create employment for many jobless youths. 

A number of explanations have been offered on why Zambia continues to fail to reap the benefits this critical sector. The Banda administration attributed it to the laziness of ordinary Zambians which has manifested itself in a lack of entrepreneurial zeal. Former Mines Minister Maxell Mwale argued that Zambians have failed to develop emerald mines despite government doing all it can to help. According to Mr Mwale, rather than using the credit facilities GRZ had apparently put in place, many Zambians increasingly resort to selling their gemstone licenses to foreign buyers. It is apparently common practice for Zambians to obtain mining licences and giving them to foreigners to undertake operations at a fee.Interestingly though Mr Mwale does not believe that poor licensing regime is the issue. Instead it all has to do with people's laziness. 

That conclusion is of course misguided. It is true that reselling of licenses happens all the time but it is merely a symptom not the disease.  Providing licences to Zambians will continue to lose government revenues because the structural incentives for individual Zambians to develop gemstone mines are fairly weak. It is clearly cheaper and more immediately rewarding for many Zambians to allow foreign production (by charging the "fee") rather than develop the mine themselves. To successfully develop these mines it requires access to finance and established supply chains. Foreign investors usually have all these things in abundance and crucially they are able to harness the economies of scale that are associated with pooling licences together. Its therefore no surprise that they increasingly buy out locals!

Of course increased foreign led production is not bad in of itself. Indeed, at one level perhaps it probably does not matter whether foreign investors dominate the sector. The problem in Zambia is that foreign investors keep their revenues abroad! With zero profit retention restrictions, foreign originating gemstone companies are earning significant revenues without directly benefiting the economy as a whole. The other problem is that the whole sector is corrupted with rampant illegal smuggling. Indeed, even the more legitimate players have been accused of complex transfer pricing mechanisms. The gemstones sector in many ways is bedevilled with the same problems facing the mining sectors as a whole.

A major problem which has been flagged up by the Government’s Gemstones Processing and Lapidary Training Centre (GPLTC) is the dual issue of illegal mining and export of unprocessed stones. There are many mines in the country which operate without a license and smuggle stones abroad. These stones are nearly always unprocessed and therefore do not fetch good price on the international market, as compared to legally exported, cut and polished products. The uncontrolled sale of gemstones and lack of accountability are just few of the challenges being faced in the development of the gemstones industry. Sadly, even legitimate exporters also shun processing which explains why India is the top destination of Zambia's gemstones. It is estimated that less than 10% of the gemstones exported from Zambia are cut or refined in any way, meaning that the bulk of value-added to these stones is earned abroad by international trading houses, jewellery factories, and others.

The question of course is how best to solve these problems. At the fundamental level the strategic choice would appear to be whether the development of the industry should be state led or private sector led.

A state-led model would essentially mean more active involvement of Government in the production process. The argument is that revenues may be maximised if a larger proportion of licenses belonged to Government and it developed the gemstone mines on behalf of the people. Stronger government role has the advantage of minimising the fundamental problems associated with licensing and coming up with adequate taxation mechanism. The downside to state led capitalism is the extent to which it would be inefficient and difficult to maintain. The main contention against greater state involvement boils down to competence. Can GRZ run a national firm that is seeking to develop precious stones? This idea of state led production naturally evokes historical nightmares of failed projects of the past. The failure to run these companies in the past presents a psychological barrier for many Zambians who now believe Government is incapable of running profitable companies.

However, greater state involvement should not be easily dismissed. Government already is directly involved in the industry through its 25% per cent shareholding in Kagem mines. Gemfields acquired a 75 per cent shareholding in the mine in 2007. The Gemfield-GRZ partnership demonstrates that public private partnerships may deliver better results than a purely market led gemstone industry. Indeed, the PPP model is the basis for most of the successful mining development initiatives across Africa. Botswana’s Debswana initiative, and recently Angola’s Endiama serve as prime examples. Typically, in Angola the developer is expected to fund 100% of the capital expenditure although owning only around 40% of the mine. The rest of the equity is held by the Angolan government through Endiama and by nominated private Angolan investors all of whom are entitled to a “free carry.” Once completed, the developer has priority over revenues until the capex outlay is recovered but may still get only about 80% of the initial revenues because of profit share agreements with the Angolans. Such a model if implemented in Zambia may guarantee stronger revenues in this sector than at present.

An alternative model is to continue relying on private sectorbut with renewed Government focus on addressing key areas where it may add value. Three areas are particularly critical.

First, government could identify areas which need more coordinated action. A key example is investment in processing equipment that would enable the gemstone miners to produce finished products. Small firms may be unable to invest in such and therefore would need direct Government involvement to pull these together. Government may also be better placed to invest in geological mapping with the potential for auctioning of licenses to highest bidders for surveyed areas. Another area is providing expertise and training, as currently undertaken through GPLTC. The sector is currently too dependent on foreign professionals and a high proportion of the senior management is foreign. In the largest gemstone mining companies the geologists and gemologists are predominantly foreign. More training may help reverse this trend and increase employment opportunities for ordinary Zambians.

Secondly, there would be need for more stringent laws and regulations target reducing illegal exports and reduction of undeclared revenues. The proposed Extractive Industries Transparency Initiative (EITI) Act which is designed to compel all mining firms operating in Zambia to disclose their production figures and all material payments they make would be a step in the right direction. It will encompass copper and gemstone small scale miners who will be required to disclose their production proceeds and payments being made to the Government annually. The challenge is to ensure that such new legislation is properly enforced.

To ensure that revenue is maximised, it would be necessary that processing is undertaken in Zambia. At present nearly all exported stones are processed in India. The reason for that is that India has implemented very stringent laws and regulations that encourage the importation of rough gemstones and export of finished gemstones, and discourage export of rough gemstones. Zambia would need to review is taxation framework to make it more punitive to export rough stones. However, in doing that care may be needed to minimize the potential for diverting the trade further underground. A key part of that effort is to encourage the formation of a gemstone association to provide a central focus for Government consultation.

In general, both the State and private sector models offer interesting possibilities to improve on the status quo. Both approaches have inherent risks. On the balance, the the state led model through stronger PPP arrangements offers the more certain way to capture revenues. Whatever is done, it is important that sanity is restored to this sector. Illegal mining and trading actives needs to be curbed. Adequate infrastructure is needed in terms of training and value addition. There’s an urgent need to improve technologies, increase training and management skills; and developing reputable, enduring market linkages. The sector holds vast potential for Zambia. The question is : are we bold and visionary enough to drastically bring about the change we need to ensure that the poorest benefit? Or are we simply content to leave to foreign companies to continue the exploitation of this sector?

Chola Mukanga is an economist and founder of the Zambian Economist which provides independent economic perspectives on Zambia's progress towards meaningful development for her people

Copyright: Zambian Economist, 2013
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2 comments:

  1. Hey do you have any information about supply chains in the Zambian gemstone industry and issues of external intervention in the industry in form of foreign entities exploiting Small scale miners through exploitative loan financing?

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