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«2015 Bilateral debt Multilateral 8000 7000 poverty 6000 goals 5000 sustainability 4000 3000 macroeconomic millennium 2000 1000 0 1995 1996 1997 1998 ...»

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Whether the above is a realistic stance or not is debatable. Parastatals such as ZESCO and ZAMTEL have highly ambitious investment plans. During 2006-2008, it is expected that the operations of utilities in the energy and telecommunications sectors (i.e.,

66 Zambia: Debt Strategies to Meet the Millennium Development Goals

ZESCO and ZAMTEL) will be improved through commercialization. Furthermore, ZESCO’s Power Rehabilitation Project entails major developments and investments in the energy sector such as the development of the Kafue Gorge Lower power station (at an estimated cost of US$600 million) and the Kariba North Bank (at a cost of US$300 million). Other large capital investments include the rail infrastructure projects that are planned in the Infrastructure chapter of the FNDP.

The core FNDP cost estimates exclude the above-mentioned very large capital programs, which are expected to be financed through private public partnerships or wholly private capital. Thus, while the IMF and the authorities have made room within the borrowing plans to provide ZESCO some breathing space to build a track record of credit worthiness, the new borrowing on concessional terms (mainly from the World Bank) guaranteed by the government is permitted only up to US$40 million and this was only until the end of 2005 (IMF 2005). Looking ahead, the prospects of attracting 5 private capital to fill the investment gaps are very unclear. Should private capital not be forthcoming, pressure for recourse to non-concessional borrowing to meet the investment requirements may become significant.

This raises the possibility that some amount of non-concessional (i.e., on market terms) borrowing will be undertaken. According to Harding (2006), the issue of free-riding by some non-concessional creditors on the HIPC and MDRI debt relief is coming to the fore. This can be seen to some extent by the interest of commercial/investment banks in Zambia’s short-term securities markets. Several financial institutions are also looking to offer longer term non-concessional lending to the government or quasi-government institutions (e.g. parastatals such as ZESCO), who have highly ambitious investment plans. The temptation to take up these offers of financial support will be difficult to resist for a government that wishes to meet public expectations of rapid improvements in the provision of public goods and services, including infrastructure.

The concern here is that the debt may again build up to be an unsustainable future liability. It therefore becomes essential to understand, in respect of the human development imperative, if additional loans will be entered into what should constitute a ‘sustainable’ level of debt? This question raises sufficient room for us to argue that the concept of debt sustainability should not be limited to financial viability of debt repayment, but should be re-looked at, within the context of meeting the MDGs.

5.2 Aid Trends to Zambia – Donor Views on Prospects It is widely understood that the IMF influences greatly the prospects for aid in any given country given the signals it sends on macroeconomic stability. The role of the IMF in providing signals to the rest of the international donor community about the consistency and coherence of a recipient government’s macroeconomic program is well established.

In most LDCs that are following a PRGF program, this is principally operationalized in the form of the regular PRGF review missions and associated IMF Board papers. These

67 Zambia: Debt Strategies to Meet the Millennium Development Goals

are, as the IMF recognizes and intends, extensively scrutinized by donors for evidence of continued government commitment to “sensible” macroeconomics and agreed reforms and hence some assurance that donor resources disbursed to a multitude of programs, but mainly projects, will contribute positively to developmental objectives and outcomes (Harding, 2006).

It is therefore clear that the IMF’s signaling role – through its assumptions and projections about policy and macroeconomic commitment as well as specific assumptions about required aid outturns – is critical for donor decisions about whether or not to scale up aid flows to Zambia. Naturally, it is therefore important to see how the IMF has set the aid assumptions within its macroeconomic programs.

Goldsbrough and Cheelo (2007) find that the initial IMF programs were based on conservative assumptions about future aid, once account is taken of the unusually low starting position following the 2003 slump in aid (see Table 5.2). This reflects earlier 5 experience when performance-related disruptions to aid complicated macroeconomic policy.

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Note: p implies projections based on AfDB/OECD (2005) calculations Source: IMF documents, AfDB/OECD* and **FNDP Subsequent programs incorporated the rebound in aid that occurred in 2005 (helped by the finalization of HIPC debt relief), but still included rather conservative baseline assumptions about aid prospects for the medium term, projecting that aid would remain 5 flat in dollar terms. In effect, these later programs assumed the level of aid would plateau at its existing level or would decline slightly.

Thus though higher levels of non-debt ODA would be welcome, the IMF is conservative in its program assumptions, anticipating stagnation and declines in external aid over time. This is in sharp contrast with fundamental commitments made in the HIPC initiative that debt relief would not replace ODA and further commitments in the Gleneagles Summit that donor aid to Africa would be doubled.

The inherent risk in the IMF’s conservative position is that other donors may start to raise concern about whether Zambia can manage to absorb increased aid flows and use them effectively. Indeed, with an understanding by some donors that the role of the IMF is to highlight the risks and the potential benefits of increased aid in Zambia, these donors already feel that should the risks of aid scale-up outweigh the benefits then they should withhold additional aid flows. This withholding of aid should be maintained until the conditions for the effective use of such resources are put in place. Furthermore, similar concerns of particular relevance to Zambia have been raised by David Bevan of the Centre for Study of African Economies (CSAE), University of Oxford (cited in

Harding, 2006; p.2):

• “If donors are prepared to raise aid to a country very substantially, is there a level at which it would be wise to turn some of this aid away/be selective about which aid to accept?” • “Whatever the new level of aid is to be, how fast can aid prudently be increased from current levels?” The real risk it that without a clear signal from the IMF to donors on the speed at which aid levels can be scaled up without compromising macroeconomic stability and without resulting in a further decrease in the efficiency and effectiveness of aid, the conservative

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aid assumptions in IMF programs can easily be misconstrued as a signal to withhold aid or reduce commitments on grounds that the country does not possess the right environment for taking up more aid. Clearer and sharper signals from the IMF are required both within and outside its programs.

5.3 Role and Limitations of Private Finance Table 5.1 above shows that the private sector is starting to play an increasingly more substantial role in the overall economy. Gross private sector capital formation is projected to have overtaken public sector formation, accounting for about 67 percent of total gross capital formation. Private investments have been mainly in mining, commercial agriculture, tourism and urban construction. The buoyant performance in agriculture and mining also supported manufacturing performance.

Despite the positive outturns in private sector participation in the economy, many 5 sectors remain constrained by a series of bottlenecks, including the high cost of credit, the high cost base (mainly due to Zambia’s landlocked status), administrative barriers and unfavourable duties on inputs compared to the rest of the region, which reduce competitiveness vis-à-vis neighbouring countries. Entrepreneurs and business associations have also complained about the lack of an overall vision and of a long-term development strategy, which translates into an inadequate/outdated regulatory framework.

This includes protracted delays in the approval of the new Investment Act. Various domestic and external efforts are being attempted to redress the bottlenecks and in many respects significant progress in being made. Observers expect that these initiatives together with spillover effects from continued investment in mining and agriculture will benefit private-sector activity in the medium term.

Finally, while overall outturns on private capital formation have become increasingly more favorable during 2002-2006, outturns in foreign direct investment (FDI) have improved only marginally from 2.3 percent of GDP in 2002 to 3 percent in 2005.

This suggests that the contribution of FDI to the dramatic increases in private capital formation has been marginal. Like many sub-Saharan African countries, Zambia has just not been attractive as a destination for FDI.

5.4 The Loan Contraction Process In the mid 2000s, the authorities in Zambia initiated a process to develop a new loan contraction strategy on external borrowing. The impetus for this effort came largely in the form of pressure from civil society, which pushed the government to realize that it is has the responsibility towards its citizens to establish the necessity and desirability of all loans. It is government’s responsibility to negotiate beneficial and sustainable terms of repayment, to account for the success of loan performance, and to ensure that loan repayments do not curtail the country’s ability to achieve the MDGs. To fulfill these responsibilities, the government needed a transparent, inclusive and accountable

70 Zambia: Debt Strategies to Meet the Millennium Development Goals

mechanism of loan contraction and debt management; hence, the idea of formulating a Debt Management Strategy (DMS) was conceived.

Such strategies are important for protecting the country and its citizens from bearing the brunt of unscrupulous loans and deals. Zambia has had a number of bad experiences with the so-called Vulture Funds, which it could have been protected from had there been a debt management framework in place (see, Annex 4 cases for illustrations). These funds deprive the country of much needed resources.

While the DMS is widely recognized as an important element for loan contraction, particularly given Zambian past debt experience, recent inquires of the authorities revealed that little progress to date has been made in actually formulating a plan. No explanation could be obtained to highlight the sources of the delay.

This raises many questions about transparency and accountability in Zambia’s loan contraction process. With the lack of transparency about debt contraction, the national 5 authorities can enter into loan agreements without ever being held accountable for the funds once these are received or even for the performance of the loans. Similarly, creditors are able to grant loans even when they have little or insufficient evidence that the ventures they are supporting will be productive or support sustainable human development. The main problem in this overly closed arrangement is that the risks and losses associated with bad debts and debt repayment difficulties are passed on to the (sometime desperate) recipient country and its population.

Looking forward, it will be prudent for the national debt management authorities to take serious steps towards finalizing the DMS, as the DMS would be an effective mechanism through which transparent loan contraction processes are achieved. The formulation of the strategy should therefore equally follow a fully inclusive consultative process to foster greater transparency, accountability and national acceptance. Furthermore, the final DMS should ensure that all salient (legal, social and economic) features for effective and efficient debt management are contained in the strategy. A sound DMS will be important for preventing the accumulation of unproductive, unnecessary and costly external debts, and will also help to prevent corruption, bribery, fiduciary risks and leakages in loan contraction.

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6 Conclusions and Recommendations Towards understanding what makes for sound financing and debt strategies that are not only financially viable, but are also consistent with achievement of human development imperatives such as the MDGs, this paper has made several important observations.

We offer these insights along with key recommendations as inputs to the debate on a renewed overall understanding of MDG consistent debt sustainability. In summary, the

following are the main insights and conclusions:

Firstly, Zambia is clearly no longer in an external debt trap. Several illustrations have been given to show that the external debt has been brought down to financially sustainable levels (according to the conventional definition of “debt sustainability”). Related to this, the country’s growth and stability performance in recent times has been largely favourable; the country seems poised for even better performance in the future.

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