Parliament yesterday voted to increase the threshold of domestic borrowing payable over a period of ten years from K200m (US$35m) to K13 billion (US$2.3bn). Domestic threshold for loans repayable over one year has risen from K10m(US$5.8m) to K20bn (US$3.8bn). Finance Minister Alexander Chikwanda says the increase in the domestic borrowing threshold is meant to help the Patriotic Front (PF) government implement various economic projects given the burgeoning budget deficit and limited room for external borrowing.
Chikwanda's 2014 Budget has a huge hole that needs to be filled. The PF were looking to do that through a Eurobond before Christmas but the tapering of US credit has made it a little bit more costly for Zambia and other African economies to borrow. This has meant that PF has had to invent a Plan B. Though it is still possible that Eurobond may be revisited down the line if the situation improves.
The decision to increase domestic borrowing will inevitably crowd out private sector borrowing and make it difficult to bring down the cost of borrowing for ordinary Zambians. This is at a time when there’s already a legally binding maximum lending rate imposed by the PF. One suspects that the Budget 2014 will need to have more tax breaks for the Banks as a quid pro quo of some sort - as we saw last time.
That of course is the least of PF’s worries. The Kwacha this week broke the K5.80 per $1 barrier as it continues its free fall. For their part the Bank of Zambia continue to insist that the currency is simply on a "random walk"! And Mr Chikwanda insists “it's nothing to worry about”. They both know better than that, but what do we honestly expect them to say?
The Kwacha has been falling for the last three years, but over the last four months it has lost substantial value (last month shown above) . It is currently the worst performing currency in Africa and there is every sign that this will continue. The Kwacha is losing against all major currencies. At the basic level this is expected because of the tapering of US credit. But there’s more happening.
The country faces significant structural, political and policy risks. Zambia public deficit continues to grow and it is very likely that this year it will miss the deficit target again. The 2014 Budget projected a 6.5% fiscal deficit target but this was predicted on high domestic revenues and measures to rein government spending, including wage freezes and limited FRA activities.
Based on spending policies alone the target was already not worth the paper it was written on. The IMF estimates that the fiscal deficit would come in at 7.4% at best. When the risk of non-tax revenues are priced in a fiscal deficit of around 8% plus seems very likely. That is before accounting for some of the already reversed hiring and wage freezes. In addition there non-budgeted spending commitments being made already (e.g. INDECO, new stadiums) which are all pointing to an even larger deficit.
On top of all this there’s the strong likelihood that government copper revenues are increasingly looking less favourable than assumed. Copper prices are headed for the longest slump in 20 years, on signs of weakening demand after manufacturing slowed in China and the U.S., the world’s top metals consumers. Copper in London has slumped over 15 percent in the past 12 months, partly as economic growth eased in China.
There's a huge risk that if the copper prices decline further Zambia's fiscal deficit will worsen because mining taxation revenues will be lower than forecast. Indeed, some believe this is part of the reason why Government has urgently moved to remove the debt limit for domestic borrowing. The problem is that with all these risks there’s a strong possibility of future credit downgrades. Indeed it seems some are already voting with their feet.
The sharply depreciation of the Kwacha now risks generating a spiral effect. Going forward we can expect Government debt repayments to become dearer. This may lead to further credit downgrades leading to much higher cost of future repayments. In general the cost of doing government business will become more expensive. On the production side the cost of imports are rising sharply, especially for mining companies where oil is a critical input for mining production costs.
On top of all this the Kwacha’s volatility brings its own challnges. With reserves currently low the central bank has little room to manage downward volatility . This further makes the Kwacha a riskier alternative for investors because it becomes inherently unpredictable. It is also a a problem for domestic businesses who may struggle with planning future decisions. There's also the important point that low reserves reduces confidence in Zambia's ability to service foreign loans. This is why dwindling foreign currency reserves are always associated with a deterioration in a country’s credit worthiness.
All these problems are largely due to incompetence. We continue to see policy chaos at the heart of government. Unfortunately when you have a toxic cocktail of a politically captured central bank and incompetent fiscal managers one cannot ignore the politics that has created it. Economics does not exist in a vacuum.
Chola Mukanga | Economist
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