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Monday, 8 June 2015

Zambia's growing public debt

Editor's note : an interesting recent article from Kundhavi Kadiresan (World Bank - Zambia) focuses on Zambia's growing debt. There are a couple technical nuances missed (e.g. link to tax revenue base, trade deficit, international comparators, importance of CBA). But it is a helpful contribution to the debate. 
An intense debate is going on in the country on Zambia’s debt and how it is affecting the economy. The debate is taking place because debt owed by the government to domestic and foreign creditors has increased sharply during the past few years, evoking images of the not too distant past when Zambia was categorised as a highly indebted poor country and received a huge debt relief.

At the end of 2011, Zambia’s total public debt was K22.1 billion, which grew to K48.9 billion at the end of 2014. About 57 percent of the total public debt in 2014 was owed to external creditors and the rest to domestic.

In terms of debt compared to the size of the economy – which is a more meaningful way to look at the stock of debt across time – the debt-to-GDP ratio increased from 19 percent at the end of 2011 to 30 percent at the end of 2014. At its peak, before Zambia received debt relief, this ratio was well over 100 percent.

Why has debt grown so fast? Debt grows when a government borrows to finance its fiscal deficit, which is expenditure in excess of government resources from tax and non-tax revenues and grants. In Zambia, the average fiscal deficit during 2012-14 was 4.8 percent of GDP compared to 1.1 percent in the previous three years.

Government expenditure itself grew fast because of new road construction projects, much bigger maize subsidies, large fuel subsidies and the large increase in salaries of public servants. Therefore, indirectly, these are the main reasons behind the fast increase in Zambia’s debt.

So what does it mean for the economy? Raising debt allowed the government to scale up its roads construction programme. Where projects are implemented efficiently and the new roads connect people to markets, this additional government spending helps the economy grow faster and the government raises more revenues in the future.

Thus, borrowing for the construction of roads could pay for itself in the long run. But the same cannot be said of borrowing to raise salaries of public servants or expand maize subsidies. Nor can this be said of a public investment programme if projects are poorly managed or selected only for reasons not related to development. These expenditures do nothing to increase the economy’s productive capacity and government revenues in the long run.

The implications of larger debt for Zambia as a country are similar to those of personal debt for a Zambian. Economists assess a country’s capacity to carry debt over the long term in an exercise called ‘debt sustainability analysis’. The results of such an analysis were reported in the December 2014 issue of World Bank’s Zambia Economic Brief.

What should the Government do? It is clear that the government cannot suddenly stop borrowing. The objective, instead, should be to borrow while staying on a sustainable course, and at minimum cost and risk. In the current situation, borrowing sustainably means borrowing less, and also cutting down on the use of borrowed funds for government consumption.

Since government’s borrowed funds and own resources can mostly be used in a fungible manner, this essentially boils down to reducing the share of subsidies, and public service salaries in government expenditure.

The years 2015 and 2016 are particularly important when the government needs to manage its budget carefully and reduce expenditure on these items. Currently it seems that the Government will end up with a much higher fiscal deficit than planned in the 2015 budget. Loans from the World Bank’s concessional arm feature a 38-year maturity, six-year grace period, zero interest, and a 0.75 percent service charge. Therefore, these should stay as the first source of choice.

Borrowing from other governments could also entail low risk as long as costs are transparent.
Borrowing from global capital markets through Eurobond appears relatively cheap, but may turn out to be expensive in Kwacha terms because of depreciation of Kwacha. Eurobonds also need to be paid off in one instalment when they mature (compared to loans that are amortised) and that requires more careful budgetary planning.

A carefully planned debt management strategy is essential. The government can analyse cost and risk trade-offs carefully in the process of developing a debt management strategy. Such a strategy can allow the government to make informed choices about financing deficits rather than making ad hoc mid-year decisions.

Some certainty about government’s borrowing plans is particularly important for domestic markets. Unexpected change in government’s domestic borrowing plans can make liquidity management difficult for the Bank of Zambia, resulting in sharp movement in short-term interest rates and disruption of inflow of credit to the private sector. This is what happened in 2014.

(Source : Daily Mail)


Is Zambia's current debt level a real problem or has it been exaggerated? 

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