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An important characteristic of the DSF is that, unlike the HIPC initiative, it is not used as a basis to calculate debt relief. The policy consequence of lower debt thresholds under the HIPC initiative was to flag the need for greater debt relief. Instead, the policy consequence of a lower debt threshold under the DSF is decreased access to lending in non-concessional terms and the need to finance remaining development and poverty 4 reduction goals via grants, with the option of debt relief being ruled out.
Again unlike HIPC, the DSF does not rely on pre-set numerical indicators but rather on country-specific debt thresholds. The establishment of thresholds is arrived at through a method based on three pillars. The definition of debt thresholds is dependent on the quality of policy of the indebted country, assessment of actual and projected debt burden indicators based both on baseline and stress test scenarios, and a comparison of the country’s debt burden against these indicators, leading to an overall assessment of the country’s risk of debt distress. It is on this final conclusion that subsequent financing decisions are meant to be based. Country-specific debt thresholds are generated on the basis of the quality of their policy and institutional environments, measured using the Country Policy and Institutional Assessment (CPIA) methodology.
The CPIA system compares a country’s institutional and policy framework against a set of pre-established criteria, receiving a score based on a particular view (defined by the World Bank) of what is considered a good performance. It can be commended for the practice of rating implemented rather than intended policy actions. Depending on their CPIA ratings, countries are placed into three categories (poor, medium and strong), and for each of the five fiscal measures used, are assigned a threshold debt level range.
The DSF makes important efforts to assess the future capacity of countries to carry debt without compromising human development. Though it is a considerable improvement over the backward-looking assessment system in the HIPC initiative, some important criticisms have been launched against the DSF. To begin with, greater clarity is needed on how the assessments are incorporated into the actual macroeconomic programs of the IMF such as the PRGF. The view is that the DSF is only weakly integrated into the financing programs of the IMF. In this sense, it is debatable whether human development is actually incorporated into debt sustainability considerations or for that matter, macroeconomic programs.
Secondly, many stakeholders, particularly at the national level in LICs have raised concern that the new DSF seems somewhat discriminatory and unfair, applying only to LICs and not to middle income countries. The framework has therefore not been fully
54 Zambia: Debt Strategies to Meet the Millennium Development Goals
accepted in LICs as a tool for development. Moreover, the CPIA methodology, which is a key element for determining the country-specific debt thresholds, is said to not be transparent because its formulation or application has not been publicly available.
Many commentators feel that the CPIA system is applied unevenly in practice, and are reluctant to accept this as the approach for determining the “goodness” of a countries policies and institutional environment. Moreover, the fact the CPIA process is a fairly closed one limited the appreciation of World Bank’s discourse policy on the Assessment28. Greater transparency on the part of the World Bank in including stakeholders in the CPIA process, and sharing information about the CPIA methodology and results is called for if the DSF is to be widely accepted as a framework for establishing debt thresholds. In the absence of such transparency, considerable pressure to revise the DSF 4 can be expected from many circles, some of whom will have simply misunderstood the DSF and the CPIA system.
4.3 Domestic Debt in Zambia As is the case in many sub-Saharan African countries, domestic debt is not a recent phenomenon of the Zambian economy. The country’s history of borrowing domestically is perhaps as long as its post-independence economic history. However, due partly to the enormity of the external debt component until recently and for a long time, domestic debt issues were ignored in Zambia. In addition to this lackluster attention to domestic debt issues, the country did not have a formal domestic debt statement until 2003 because domestic debt was (and continues to be) managed and reported by different government institutions and departments within the government system.
Domestic debt information is not centralized and the aggregates are not well known.
The various components of the debt are kept in different institutions such as Treasury Bills at the Bank of Zambia, expenditure arrears at the Accountant-General’s Office, government guarantees and parastatal debts at the Department of Investment and Debt Management, MOFNP.
From a historical perspective, before January 1993, the Bank of Zambia used government securities to solve liquidity problems in the commercial banking system at a controlled interest rate. In the near hyperinflation situation, which started in 1992, the authorities undertook to fight inflation primarily to avert the impending hyperinflation.
A cash budget system and opening of tender for government securities at market-determined interest rates were therefore conceived as the two policies for monetary and fiscal policy to control government spending and liquidity in the market.
Starting in May 1993, there was reportedly a systemic failure to meet the financing 28 On September 7, 2004, the Board approved the disclosure of the CPIA ratings for IDA-eligible countries. Beginning with the results of the 2005 exercise, for all IDA eligible countries the numerical scores for all the CPIA criteria, as well as the overall score, are disclosed as the IDA Resource Allocation Index (IRAI). This disclosure policy does not affect the IBRD countries.
55 Zambia: Debt Strategies to Meet the Millennium Development Goals
of maturing debt and interest due on government securities. This in turn provoked the high cost of rolling over the maturities and interest. By December of the same year the cash budget had completely broken loose due to shortfalls on anticipated donor inflows.
The government therefore resorted to borrowing from the Bank of Zambia in order to meet service obligations on domestic and external debt through bridge loans.
Considering that external debt levels have ultimately been drastically reduced, issues of domestic debt and its consequences are now coming to the fore in national and international debate. The authorities have had to face up to the problems created from years of rolling over domestic debt maturities and interest, and from maintaining, over a prolonged period, the cash budget which was originally intended as a very temporary solution. A major concern is that the service costs of domestic borrowing were historically much higher than the costs of servicing external debt. With the stock of Zambia’s domestic debt projected to overtake the size of external debt (see Figure 4.4), issues of domestic debt and its costs must be paid close attention to.
The average ratio of domestic debt in the region has increased only marginally to 26 percent of GDP during 2000-2005 from 25 percent in the 1980s29. Although Zambia’s total domestic debt has remained fairly stable over time, its domestic indebtedness is rather high by regional standards30. Zambia has relied extensively on domestic debt, making considerable used of its government securities market and as a result, experiencing a sizable domestic debt burden.
29 The outlook of domestic debt in the 1990s in terms of the average debt-to-GDP ratio is not very clear due to data inconsistencies that were observed during the comparability and consistency checks (through data triangulations/data cross-matching exercises) in this study 30 The average debt-to-GDP ratio in the COMESA region for instance was about 15 percent during 2001-2003 (COMESA, 2004).
56 Zambia: Debt Strategies to Meet the Millennium Development Goals
In connection with the development of the domestic debt market, Christensen (2004) observed that generally the domestic debt burden in [then] HIPC countries such as Zambia was significantly lower than in non-HIPC countries. He argues that this was indicative that HIPCs, which almost by definition, had relied heavily on foreign financing, had not developed their domestic debt markets to the same degree as non-HIPCs.
Interestingly, in Zambia, extensive use has been made of the domestic debt market.
Mainly the impetus for domestic borrowing has been the financing of fiscal deficits, the financing of monetary policy and the payment of interest charges on public works and statutory contributions. Occasionally, domestic borrowing was also resorted to for financing external debt servicing when external pressures mounted.
The recent upward trend from 2004 (see Figure 4.4) is a source of some concern because, given its ambitious developmental and poverty reduction programs, the country could easily became more heavily domestically indebted as it attempts to finance much needed expenditures out of domestic sources.
A closer look at selected debt indicators however reveals that domestic debt has been on a downward trend in nominal GDP and fiscal spending terms (see Figure 4.5). The increase in the domestic debt-to-total debt ratio is mainly on account of the drastic reduction in external debt. Although these outturns are largely encouraging, they are still considerably below the expectations of the International Financial Institutions. The IMF indicates that, in line with the MTEF, government domestic borrowing needs would be reduced to about 0.5 percent of GDP by 2007, to show spending discipline.
Considering the governments borrowing outturn, which increased the total domestic debt stock by 18.4 percent in 2005 implies a total stock of 19 percent of GDP that year, the country still has a long way to go to satisfy the IMF domestic borrowing requirements.
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Domestic Debt Composition
The composition of domestic debt in Zambia is in terms of:
• Government securities (i.e., Treasury bills (TBs) and government bonds);
• Borrowing from the banking system (including BOZ);
• Outstanding debt to suppliers of goods and services;
• Called up guarantees and parastatal debt, and;
• Outstanding statutory payments (i.e., pension contributions and litigation against GRZ).
According to the Ministry of Finance and National Planning, the residency of the 4 creditor defines domestic debt in Zambia. Therefore, even if debt is denominated in foreign currency and the creditor is domiciled in the domestic market, the debt is understood as domestic debt. The structure of Zambia’s domestic debt is highlighted in Table 4.1. Government securities (Treasury bills, GRZ Bonds and Central Bank Loan and Advances) are historically the largest part of domestic debt – accounting for 57 percent of the debt in 2005 – followed by consolidated bond and then domestic areas.
The main holders of overall official domestic debt in the Zambian debt market are the non-banks institutions, holding about 47 percent of all outstanding domestic debt in
2005. Obviously, the government has relied more on deferring payments falling due to pensioners and goods and services suppliers, and settlements of awards, compensations and contingent liabilities than on borrowing from commercial banks and the Bank of Zambia. The latter institutions accounted for 37 and 17 percent, respectively, of total domestic debt in 2005.
Specifically in terms of government securities, commercial banks are the largest holders of this debt category with 59 percent of government securities. The Bank of Zambia holds 27 percent of securities largely due to restructuring of part of the government’s debt to the Bank into bonds while the non-bank public holds 14 percent.
While the commercial banks enjoy a relatively high income from government securities, their large holdings of these securities also reflects some fundamental shortcomings in their commercial banking operations (Christensen, 2004) as well as shortcoming in the broad financial policy environment. These shortcomings include institutional weaknesses that undermine lending to the private sector given ineffective screening and monitoring capabilities of loans, a small amount of reliable information on creditworthy 4 borrowers, and weak legal systems (such as the absence of commercial courts to settle payments disputes). These weaknesses combined with high interest rates on government securities in the past made commercial bank lending to the private sector considerably less attractive than holding financial assets in securities. In that sense, private investment was considerably crowded out, ultimately compromising prospects for growth. The core reasons have yet to be established for commercial banks’ continued holding of large amounts of government securities even after real interest rates have declined considerably (e.g., from 14.3 percent in 1995 to 0.6 percent in 2005).
When one considers the Zambian company tax rate structure, it is even more surprising that commercial bank subscriptions to government securities remain so high. Langmead et al (ed) (2006) highlights that commercial banks are subjected to the highest company tax rates among enterprises operating in Zambia. Commercial banking income is taxed at the standard company tax rate of 35 percent for banks earning incomes of less than or equal to K250 million and an increased rate of 45 percent for banks above K250 million. Against observations of high economic rent associated with large interest rate spreads (i.e., high base lending rate and low base deposit (or savings) rates), the authorities’ rationale for imposing a higher tax rate on high income earning banks was that this would “cream-off” some of the economic rent. Apparently this has not worked as well as the authorities had anticipated since the environment is presumably still conducive enough for banks to buy into government securities instead of lending to the private sector and remain in business.