The U.S Fiscal Cliff analysed by Kampamba Shula

The U.S.A Fiscal Cliff

Much has been debated recently in International media as well as in the U.S.A over the fiscal cliff. Democrats and Republicans are at longer heads to get to some amicable deal while the market limbos in uncertainty and businesses hold back on recruitment and capital expenditure.

“Fiscal cliff” is the popular shorthand term used to describe the conundrum that the U.S. government will face at the end of 2012, when the terms of the Budget Control Act of 2011 are scheduled to go into effect. Planned tax rises and government spending cuts will create a ‘fiscal cliff’ in the US in 2013 equivalent to 4.7% of national income.

Several fiscal stimulus measures are due to expire at the start of 2013 at the same time as additional tax rises and spending cuts come into force. Should this happen the expected tightening during 2013 would be $655bn, or 4.7% of national income. This is the ‘fiscal cliff’. It dwarfs the planned consolidation in the UK over the same period of 1.3% of GDP. Indeed it is much larger, and more sudden, than planned in bailed out Eurozone countries such as Greece (2.8%) and Ireland (2.6%). Such a sharp and aggressive adjustment in fiscal policy will significantly damage US growth and employment.

• This would lead to a pronounced recession next year. National income would fall by 1.0% and unemployment would rise to over 10%.

• Even partial implementation of these tax and spending changes would severely hamper growth and employment.

• It is imperative that policymakers prevent this outcome. Yet the poisoned political environment makes it difficult to generate the consensus needed to revoke these plans. Looser monetary policy wouldn’t fully offset this fiscal headwind.

• Even if crisis is averted, the long term outlook for the US public finances is a growing concern. Policymakers will have to make tough decisions in order to prevent debt reaching unsustainable levels. This will again require the sort of political consensus that has been sorely lacking over recent years.

Why is the Fiscal Cliff a Big Problem?

The important question to ask is why the fiscal cliff is such a big problem and should the rest of world really be concerned about its implications. Then answer lies twofold, firstly the fiscal cliff is a big problem because it means that the U.S, the world’s largest economy is unable to pay back its debt and secondly when it hits the debt ceiling in February 2013 it will have to default and will not be able to borrow any more, a devastating turn of events.

Why should the world be concerned?

The question that remains unanswered now is what does this have to do with the rest of the world and should they even be bothered. The answer for this question is also twofold; countries like Switzerland, Japan and China would be worried since they own U.S debt while the rest of the world could suffer from a crisis of confidence, and yes we mean crisis. If Stock market indexes in Asia and Europe rally on better housing market data from the U.S what could possibly be the effect of a default on U.S sovereign debt, definitive, the correlation between international markets has deepened due to globalization.

The Real Focus

During an interview with Bloomberg’s Charlie Rose on the Fiscal cliff Warren Buffet said “The world may think we are idiotic, but we are not suicidal.”According to Warren, there is not much to read into the fiscal cliff because he believes a solution will be found that will avert market fears. I tend to agree with Warren but only to certain extent as I do believe there is also a substantial confidence risk that the fiscal cliff poses in the short term.

The real focus of the fiscal cliff discussion is around the tax increases and budget cuts. This seems to be the pin point where Democrats and Republicans seem to be differing in congress. President Obama has proposed a tax increase on high net worth individuals (top 2 %) while rates remain unchanged for the rest of the population. Many say this is a step in the right direction but some CEOs believe it will not be enough; I tend to agree with this view in part.

There is a sacrifice that has to be made. With U.S growing at about 1.5%, for every $1 trillion of budget cuts about half a percentage point will be shaved off GDP, a $4 trillion budget cut is needed.

 Key issues

The incentives to prevent the fiscal cliff from putting the US back into recession are very strong. Even during periods of robust growth such a large and sudden change in fiscal policy would be unwise, but with the US still struggling to recover from the financial crisis it would be a baffling decision. The poisoned political environment, however, makes progress on new legislation difficult. Both the main parties agree that current policies are unsustainable and that deficits need to be reduced. They disagree on how to achieve these objectives. Neither of the competing presidential candidates has offered much by way of specifics, but at a broad level the Republican party continues to advocate spending cuts and reject tax rises while the Democats prefer tax increases and fewer spending cuts. 

To get to the core of this issue it would be appropriate to establish the actual cause of the fiscal cliff, and by this I don’t mean who is to blame between Republicans and Democrats but what policies have led to the U.S incurring such a large sovereign debt. Part of the reason lies in welfare, Medicare and military spending. The problem is neither the republicans nor the democrats are willing to tackle issues of welfare, though the republicans are eager to attack Obama’s healthcare package.

Unfortunately, the fiscal cliff isn't the only problem facing the United States right now. At some point in the first quarter, the country will again hit the "debt ceiling" - the same issue that roiled the markets in the summer of 2011 and prompted the automatic spending cuts that make up a portion of the fiscal cliff.

What do the markets want?

The markets are looking for about a $4 trillion budget cut to ease their fears. The problem is that they probably won’t get that much.

What will the markets get?

In my personal view the markets will probably get some deal from congress which will be something small, maybe in the range of $1.3 trillion (not including the expired Bush tax cuts) and a promise of something bigger later on.

Solutions

 

 

Republicans want to cut spending and avoid raising taxes, while Democrats are looking for a combination of spending cuts and tax increases. Although both parties want to avoid the fiscal cliff, compromise is seen as being difficult to achieve. There's a strong possibility that Congress won't act until the eleventh hour. 

Avoiding the fiscal cliff would be positive in the short term, but the US still needs to take decisive action to put its public finances back on a sustainable track. The CBO estimates that the fiscal restraint embodied in current law will reduce the budget deficit markedly to an average of 1.4% of GDP over the 2013-2022 period. Debt as a share of GDP would peak at 76% in 2014 before falling to 61% by 2022. Alternatively, if some but not all of the current tax and spending policies are extended the budget deficit would average 5.3% and public debt as a share of GDP would keep on rising, reaching 93% by 2022 – the US public finances would remain unsustainable. Given this, US authorities need to at some point agree on how to make this medium term fiscal adjustment. The ideal outcome of this issue would be for policymakers to avoid the shock of a fiscal cliff, but commit to long term deficit

Technically, there is a December 31 deadline for Obama and Congress to find a way to avoid hundreds of billions of dollars in tax increases and spending cuts that experts say would give Americans a hangover far worse than what any drunken New Year's Eve celebration could deliver.

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Rebasing the Zambian Kwacha analysed by Kampamba Shula

Rebasing the Zambian Kwacha

On 23 January 2012, GRZ gave approval to BOZ’s recommendation to rebase the Zambian Kwacha. The change over date has been set for 1 January 2013.

 •The rebasing will involve dividing the existing currency by one thousand (1,000). To illustrate, the current K50,000 note will become K50 following the rebasing exercise.
••The BOZ have indicated that the key drivers for implementing the rebasement are as follows:
1. To facilitate easier business transactions: use of smaller units simplifies accounting and reduces the risk of errors arising from data input and time spent reviewing such financial data.
2. To increase confidence levels in the Zambian currency: People tend to have less confidence in currencies with numerous zeros.
3. To reduce the costs associated with adapting standard accounting packages: Most accounting packages are developed in countries where currencies have significantly few zero’s compared to Zambia. Accordingly, Zambian entities purchasing these accounting packages, are required to customize them by increasing the field size to accommodate multiple zeros, at a cost.
4. To encourage an efficient payment system: the adoption of a rebased currency will enable easier use of vending machines, car park meters and other related technologies. In addition it will avoid the need to carry large sums of money for transactions.
5. To facilitate the introduction of coins: the rebasing of the currency will enable the BOZ re-introduce the use of coins, which are significantly more durable compared to notes.

In 2012 the Zambian Government began discussing plans to re-base the Kwacha. The reason for this was to reduce accounting errors by eliminating three zeros from the currency.

There has been wide media coverage to sensitize the Zambian public on the implications of the new re-based Kwacha. This has created a need for an economic analysis of the new re-based Kwacha.

Key Points

Amounts converted from old to new currency will be rounded off to two decimal places. When the third decimal of an amount converted is equal to or higher than 5, the second decimal is raised by 1. If the third amount is less than 5, the second decimal remains the same. E.g. K38,255 becomes KR38.26 and K38,351 becomes KR38.35. The exception is Wages and salaries, pensions, retirement funds and other social benefits of workers, which should be rounded upwards.
The exchange of old notes over the counter will be limited to K25 million (K25,000 rebased currency) per individual transaction.

Anti- Dollarization

 The anti-dollarization policy eliminated artificial demand of the US dollar, which was created by certain individuals and firms who quoted their services in US dollars. This was a timely move to bring stability to the exchange rate which suffered severe volatility in the earlier part of this year. Let me elaborate, given the rebasing of the Kwacha there is an incentive for individuals and businesses to hold their money in US dollars to keep value. This is understandable, but given that US dollar is not legal tender it will still be changed back to Kwacha. The benefit here is at least artificial demand has been eliminated and market forces of supply and demand can dictate the exchange rate.

Money Supply to Interest rate Policy

Money supply is the amount of total money circulating in the economy. This refers to the summation of notes, bank deposits and coins. The economic abbreviation of this is called M3.The Bank of Zambia was initially using a money supply mechanism to control monetary policy. This proved rather counterproductive as the interest rates remained high at micro-financing institutions though it slightly lowered in Banks. Bank of Zambia now uses an interest rate policy with a rate that stands at 9%.

Now Given the Rebasing it is estimated that the Interest will have rise somewhat to about 10% to cushion upward inflationary pressures.Let me explain further, certain individuals (you may know some or be the one) prefer to keep their money under a mattress or in a ditch on some farm (no pun intended).This money will have to come into circulation in the next 6 months for which the old kwacha will still be legal tender.
BOZ has placed a K25mil (old kwacha) transaction limit to changing the old currency to the new one.This makes an incentive for people with too much money to change at once to use it to purchase goods and services.This will effectively increase money supply and in turn raise the Inflation rate.

Inflation

Zambia has recorded a significantly lower inflation rate in the recent past years which created a solid fundamental ground on which the rebasing of the Kwacha would be sustainably effective. There is however, a high probability that there will be short term upward inflationary pressures as both the new and old Kwacha circulate in the economy simultaneously. This will increase the money supply temporarily as the old Kwacha will still be legal tender for at least 6 months.

The re-basing of the Kwacha has one notable change to the currency which is a hedge against inflation, Coins. The introduction of Coins as legal tender back into the Zambian economy will help keep inflation low in the long run, effectively. It may take some time for society to come to terms with the new coins which many may perceive as an inconvenience, which indeed they are, but a necessary one as I will explain.

By virtue of their nature coins are rather cumbersome to move around with. This inconvenience is surprisingly a component of a hedge against inflation. The velocity of money is higher at the lower ends of currency strength, meaning money changes hands faster at lower notes e.g. K10, K2, K1. Given the introduction of Coins this velocity is reduced which in turn reduces the growth in money supply and effectively inflation in the long run. Once most people have collected enough coins they will usually go to the Bank and change them, the Bank will in turn give its customers coins back from deposits thereby maintaining a stable money supply.

The most effective hedge against inflation that coins provide is in the overall circulation of bank notes. Unlike Zambia’s previous currency regime, coins allow for limitation of the notes in circulation by accounting for a decent portion of the total money supply in the economy.

Last but not least is what many would call a disadvantage of coins, they easily get lost. Surprisingly though this is also a hedge against in inflation as it marginally diminishes the money supply, thereby keeping inflation low.

Round off Inflation

Amounts converted from old to new currency will be rounded off to two decimal places. When the third decimal of an amount converted is equal to or higher than 5, the second decimal is raised by 1. If the third amount is less than 5, the second decimal remains the same. E.g. K38,255 becomes KR38.26 and K38,351 becomes KR38.35. The exception is Wages and salaries, pensions, retirement funds and other social benefits of workers, which should be rounded upwards.
"Round off Inflation" is a term that I have coined myself to describe the slight inflation or general increase in prices due to rounding off from the old to the new currency.This could affect essential commodities and luxury goods.For example for Shop owners who have been given a Government mandate to quote both the old and new price this will not be a problem.However for deals done on the "street" this will be a big opportunity for sellers to slightly increase their prices without consumers noticing the difference.This will cause round off inflation.

Advantages of Rebasing	Disadvantages of Rebasing
Reducing Accounting Errors	Adjustment phase may be frustrating
More accurate estimation of Money supply	Short term inflationary pressures
Creates Global confidence in Kwacha
More Effective Monetary policy

It must be emphasized that the downside to re-basing the Kwacha is the inevitable upward inflationary pressure. Part of this will stem from the dual circulation of both the new and old Kwacha but this will be rectified once the old Kwacha is no longer legal tender. The other part of this inflationary pressure will arise from the food and commodity prices. This will be because some wholesalers and retailers will have an incentive to slightly over quote their prices during this transition phase. This could have us see a visibly higher food and commodity inflation rate unless the Zambian Government steps into to regulate this transition. It can be foreseen that the Consumer could suffer unless corrective action is taken to ensure this does not happen.

Exchange rate
The Kwacha has been trading at about K5200 to the US dollar with a lower level of K5000 and an upper level of K5400.Check the graph below

  

 The graph above was prepared by myself with data that was made available to me for the period.
With Rebasing coming to effect I estimate that the Dollar will gain against the Kwacha.This is because a short term incentive for investors and BIG players will exist to short the Kwacha.In other words they will sell their Old Kwacha and trade it into Dollars until they feel the exchange rate has stabilised.This will drive up the Kwacha to about K5.5 with an upper limit of K6 to the Dollar.
These are only estimations and I will not be held responsible for trades and transactions made on this information.
 

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The Zambian Mining Industry Reviewed by Kampamba Shula

The Zambian Mining Industry

Zambia plays an important role in the global copper mining industry. The country contains the largest known reserves of copper in Africa, holding 6 percent of known copper reserves in the world. The history of Zambia’s copper mining industry is one of decline followed by revival. From around 700,000 tonnes in the 1970s, copper production fell to just 255,000 tonnes in 1998 as nationalization of the mines proved counter-productive. However, since the mines were privatized in the 2000s, investment and output have revived, and Zambia is regaining its world market share. In addition, the industry is expanding geographically from its traditional base in the Copperbelt to other parts of the country, where geological surveys suggest significant deposits of copper.
Copper plays a critical role in Zambia’s economy. Historically, the performance of the Zambian economy has followed the fortunes of copper mining closely. Although the economy is diversifying, copper mining continues to account for a sizeable part of GDP and is one of the lead industries for economic growth. However, Zambia—as a country—could benefit more from the mining industry. All countries that depend on natural resources face the shared challenge of taxation: determining tax levels and administering tax revenues in an effective manner that balances the needs of Government and investors. Mining depletes a valuable natural asset and taxing the mining companies is a way of generating savings that can be redeployed to increase the productive capacity of the rest of the economy, and thereby help sustain the country over the long-term. Despite the revival of the industry post-privatization, the mining industry’s contribution to government revenues in Zambia has remained low. The industry accounts for 15-18 percent of GDP and exports over US$3 billion worth of copper per year, but contributes just 8 percent of total tax revenue.

The reason for the low tax-take lies in the Development Agreements that were signed by Government and the mines at the time of privatization and that gave away generous tax concessions. By early 2007, concerns about ‘resource robbery’ caused by the low tax-take were creating a public outcry, which led the Government to impose, in 2008, a new tax regime consisting of higher royalties and taxes, including a windfall tax. Many aspects of the new regime, including the windfall tax, were ultimately reversed in response to the fall in copper prices during the global financial crisis. In 2009, the Government instituted another new tax regime with an effective tax rate (47 percent) within the international range (40-50 percent). This regime was designed to increase the level of government revenues, as mines that were rehabilitated after privatization began to generate strong, positive cash flows. The new tax regime, however, was challenged by the mining industry, which argued that the invariability clauses in the original Development Agreements precluded such changes. It is worth noting that a country’s legal/regulatory environment is a key determinant for investors when they compare the attributes of different destination countries. Exploration and mining companies seek a stable, predictable and transparent regulatory environment in which the rules of the game are clearly set out and administered on an equitable basis. These characteristics are particularly important in the case of the mining industry, given the high upfront capital investment and long payback periods involved. In late-2010 the Government reached an agreement with a number of mines, and these mines have already started paying in accordance with the new regime. Negotiations continue with a few remaining mines in order to bring them into the fold of the new regime. Due to its significant footprint and the debate over its tax contributions to the country, the mining industry has remained the focus of economic and political attention in Zambia.

Industry Structure

Many of the firms involved in Zambia’s copper mining are the subsidiaries of small- to medium-sized firms (by international standards of mining companies). However, there are notable exceptions (such as Vedanta, Glencore, and the China Non-Ferrous Metal Mining Group) that are major global players. Reports suggest that these are also likely to be joined by BHP Billiton, the world’s largest mining house. Though Zambian copper mining essentially is a private industry, the Government has retained a sizeable holding of the shares of the privatized mines.

The global copper mining industry operates with a long-term perspective, and production costs and risk are critical issues. The nature of the industry requires high upfront investment, high risk and long payback periods, and this has a number of implications (see below). Production costs can differ significantly between mines, depending on the type of mine and nature of the deposit. In the mining and refining industries, with prices determined by international markets, the key determinants of competitiveness are the costs of production and transporting product to market. A mine’s cost of production is a function of the nature of the resource (the quality of the ore, its depth, etc.) and the extent to which the most accessible resources have been exploited. The depletion of resources at the older mines means that they now need to mine at considerable depth and distance from the mine head, leading to high costs. Younger mines can save on operating costs, but they have to bear the upfront investment in capital and equipment, which can be significant. In addition, the cost and productivity of inputs influence the cost of production at all mines, irrespective of the nature of the resource. If prices are reasonably attractive, the cost of inputs low and the productivity of inputs high, even older mines can earn profits. For transport costs, location relative to processing and refining facilities is the key driver of costs. The overall business environment in which the mine operates also affects costs.

Potential for Zambia

Zambia is recognized internationally as having good mineral potential. The Fraser Institute’s highly respected survey of mining and exploration companies ranks Zambia 26th out of 79 jurisdictions worldwide for mineral potential. In Africa, only the Democratic Republic of the Congo and Burkina Faso have an appreciably higher score for mineral potential. The resources available to existing mines in Zambia are estimated at 2.8 billion tonnes of ore ranging between 0.6 percent and 4 percent copper. This, together with recent successful exploration, should be sufficient to sustain even an expanded industry well into the middle of the twenty-first century. Global demand for copper is expected to remain strong. Long-term forecasts are by nature uncertain, but global demand for copper is expected to grow at around 3 percent annually, reaching 25 million tonnes by 2020. Much of the increase in demand will be driven by economic growth and urbanization in emerging economies, especially China and India. Limited global supply should support high (but volatile) prices and continued investment. Global supply of copper from known sources is expected to peak at 20 million tonnes by 2013/14 and decline thereafter, resulting in a shortfall in supply. As a result, copper prices are expected to remain high in real terms, though they will be subject to cyclical fluctuations and periodic, short-term volatility. To meet the shortfall in supply and to take advantage of high prices, the global mining industry is looking to increase investment in copper mining and refining. Good mineral potential, combined with strong demand in the global market, provide an excellent opportunity for growth in Zambia’s copper mining industry. Assuming other conditions are right (e.g. Zambia’s mines are competitive in terms of costs and productivity levels), Zambia can capitalize on its mineral potential as well as the strong demand for copper in the global market.

Cost Structure

Production costs are high, driven by high (and rising) input costs and low productivity. The Zambian mining industry has a high cost base. Nearly all operations in Zambia are in the top half of the international cost curve (see Figure below). Many of the older mines, which account for the majority of output, are in the upper quartile of the cost curve. The newer mines have lower costs but are still in the middle of the curve. The major input cost of concern is labor, which has risen dramatically in recent years and the productivity of which is well below international standards. The cost of other inputs, such as equipment, spares, fuel and other consumables is also high.

Poor infrastructure is a major constraint on competitiveness. Electric power shortages limit output and existing generating capacity is insufficient to keep pace with any significant expansion in the mining industry. The rail system is costly and unreliable. Clearing borders is slow and costly, and this compounds unnecessarily high transport costs. Zambia’s policy environment is not considered favorable. The Fraser Institute’s 2010/11 survey ranked Zambia 57th out of 79 jurisdictions in terms of policy environment. This is confirmed by the influential mining consultant Behre Dolbear which, in its 2011 report, ranked Zambia 19th out of 25 countries in terms of attractiveness to mining investment. Given the significant upfront capital investments and the long payback period inherent in the industry, the stability of the regulatory environment—in relation to taxation in particular—is crucial, and Zambia scored only 3 out of 10 on the tax regime component of the Behre Dolbear Index.

Exploration

Better availability and quality of geological survey information could facilitate new mining investment. With as much as 40 percent of the country remaining to be surveyed, it is impossible to state with precision the size and economic potential of additional copper reserves in Zambia. Without high quality and detailed survey data upon which to base exploration decisions, potential investors face greater uncertainty and must proceed on a speculative basis. Investor uncertainty is ultimately reflected in the price they are willing to pay for a license, compromising Zambia’s ability to get appropriate value for money from exploration licenses. While some data are available, the quality and level of specificity is often not sufficient to support exploration. In addition, information is often not easy to access from abroad. Higher quality and more easily available survey data are likely to attract more investment and lead to development agreements that deliver better outcomes for the Government, the mines, and the Zambian people.

The cost of electric power from the public grid in Zambia (US$0.04-0.06 per kWh) is among the lowest in the world. Periodic outages, however, are a concern for power-intensive industries like mining and refining due to the sometimes lengthy disruptions to production. Should the country again suffer frequent electric power outages as it did in 2008, mines would have to rely on a combination of grid power and costly standby diesel generation (US$0.32-0.40 per kWh), making the cost of electric power uncompetitive compared to countries with reliable supply from the grid. Even more important is the capacity of the grid to accommodate planned growth in production. Without a 40 percent or more increase in supply, availability of electricity may be the binding constraint on whether and when the industry reaches the 1 million tonne target. Assuming a constant intensity of electric power demand, the target of 1 million tonnes is likely to be achievable only when the Kafue Gorge Lower project comes on-stream in 2016. In addition, as the industry expands to new parts of the country, there is a need to extend the grid.

Greater labor productivity could improve cost competitiveness. Low labor productivity is driven, on the one hand, by increasing labor costs and, on the other, by low output per worker. For example, at Mopani, labor costs increased almost fourfold between 2003 and 2008, and now comprise just over 40 percent of costs, compared with 22 percent at Indonesia’s Grasberg mine. This is despite the fact that mining is not a labor-intensive industry. Adversarial wage bargaining and Government and social pressure has encouraged large wage increases for “insiders” (trade union members) at the expense of restricting employment opportunities for the large number of unemployed Zambians (“outsiders”).

Labor productivity is a larger concern, and in this regard Zambia lags well behind international standards. In Chile, annual production of copper per worker is almost seven times greater than in Zambia, and a difference of this magnitude cannot be explained solely by variables like scale, nature of resources and better equipment. Low productivity is in large part driven by gaps in workers’ skills that are rooted in weak technical and vocational training from industry and training institutions.

More competitive, locally-produced goods and services could reduce mines’ supply costs. Manufactured goods, equipment and consumables are expensive and/or difficult to obtain in Zambia; hence mines rely heavily on imports from South Africa and elsewhere. Due to the logistics costs, trade facilitation fees and markups associated with imports, equipment and spare parts in Zambia can cost more than twice what they would in other countries. Motivated by profit, mines are keen to source from the least-cost providers that can meet their standards of quality, quantity and reliability. The greater use of local manufacturers could theoretically reduce the import and logistics-related costs that mines currently incur. Local manufacturers, however, lack the capacity to deliver the more complex, high value- added products that account for the majority of mines’ spending at a sufficient quality to meet the needs of the mines. International mine suppliers, who can produce the required quality, have thus far not located in Zambia due to its lack of attractiveness for manufacturing and, until recently, insufficient demand from mines. As a result, the industry buys only low-value items (such as food, clothing, and non-critical services) locally, often from traders rather than local manufacturers. Developing a high-quality, high-value-added manufacturing base in Zambia that is capable of supplying reliably a number of key products to the mines, will take time and will likely not be feasible for all types of mine supplies. Nevertheless, a more efficient local manufacturing industry could ultimately reduce input costs for the mines, improve industry competitiveness over the longer term, raise the incomes of local producers, and, potentially, help create markets for the copper fabrication industry.

Transport

Almost all of Zambia’s copper is ultimately exported, exiting Zambia along the routes of the North-South Corridor which connects the Copperbelt province with the major ports of Durban in South Africa (2,600 km) and Dar es Salaam in Tanzania (1,800 km). Due to the weight and volume of copper and, in many cases, long transport distances to port, rail—which tends to be lower cost than road transport—is the preferred mode of transport in the copper industry worldwide. In Zambia, however, the railway that links the Copperbelt to Dar es Salaam and Durban commands a very limited market share. Privatization has not brought the investment and skills needed to revive a rail system that fell into disrepair under public ownership, and the system has not been extended to new mining areas. In contrast, the trucking companies that, in the absence of an effective rail system, carry the vast majority of Zambian copper to market, are relatively price competitive despite significant inefficiencies along the corridor. Trucking companies interviewed during the course of this study charge around 4.2 cents/tkm for southbound traffic from the Copperbelt to Durban and 6.7 cents/tkm for northbound traffic. The southbound price compares favorably with many other African transport corridors and countries such as China and France (5.0 cents/tkm). However, the trucking of copper does face a number of challenges that unnecessarily increase costs and transit times. Aside from inefficiencies related to border crossings (described below) the main inefficiencies in the logistics environment are related to high fuel prices, poor conditions on some road stretches, and the risk of theft of cargo.

Regulatory Environment

A new regulatory and tax regime that balanced the interests of the industry and the country could create a ‘win-win’ situation. At the root of the disagreements over the tax regime is the inability of the Government and industry to find an equitable balance between, on the one hand, the commercial interests of the industry and, on the other, the industry’s contribution to national prosperity. Such a regime needs to cover, in a clear and transparent fashion, taxation, as well as Government’s obligations to provide the macro stability, governance, infrastructure and social services that the industry needs to prosper. In exchange, the Government and public at large need assurances that the mines are in fact contributing sufficient tax revenues to support the communities within which they operate and at levels consistent with profits they receive from extracting Zambia’s natural resources. Unless such a regime is agreed upon, the industry will continue to dispute at least some aspects of the new tax regime and the growth of government revenues will be constrained. Moreover, the regime will remain unstable, thereby undermining investor confidence. A more predictable regulatory environment could increase stability and reduce risks for investors. Given the large upfront investments, long-term commitments and long investment payback horizons inherent in the mining industry, stable and predictable policies are essential in evaluating a mining project’s perceived risks and economic viability. Frequent legal and regulatory changes create an air of uncertainty for investors. Zambia’s recent history of regulatory changes (such as has been seen in relation to taxation, as discussed earlier) is a severe constraint on both new investment as well as the continued operation of established mines. Responsibility for the delivery of social services could be transferred to the Government and supported by appropriate tax contributions from mines. In Zambia, expectations for the social contribution of mines extend well beyond those typically borne by private industry. Zambian mining companies incur costs and responsibilities associated with operating schools, hospitals and clinics, and maintaining local road infrastructure. Mines serve these roles partly due to gaps in government provision but in large part due to legacy expectations of mines that developed prior to privatization. While in financial terms these costs are relatively minor, uncertainty and lack of clarity under the current arrangement is cited as a key deterrent to greater investment in the sector. Hence, there may be a need for a more explicit agreement with the Government and the public at large on an appropriate allocation of social provision responsibilities, with the Government taking greater responsibility for supplying the services and a shared understanding that the industry contributes its part through the tax revenues it provides to the Government. Such an understanding would have to be supported by mechanisms to ensure appropriate tax compliance and payment by industry.

References

F. McMahon and M. Cervantes for The Fraser Institute. April 2010. Survey of Mining Companies 2009/10.

Michael Engman. May 2010. The Role of Trade and Transport Issues in the Competitiveness of Zambia’s Copper Industry (draft)).

 

 

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Zambian 2013 Budget Reviewed by Kampamba Shula

Zambia Budget Review

On 12 October 2012, the Minister of Finance, Hon. Alexander Bwalya Chikwanda, MP, announced the 2013 National Budget. Budget highlights and taxation and other changes as contained in the Budget speech and the Zambia Revenue Authority (“ZRA”) publication.

The Government plans to spend K32.2 trillion to be financed by:

·         K24.7 trillion (77 percent) from domestic revenues;

·          K5.9 billion (18 percent) from domestic and foreign borrowings; and

·          K1.5 billion (5 percent) grants from cooperating partners.

Macroeconomic targets for 2013 are to:

·         Achieve real GDP growth of above 7 percent;

·         Attain end-year inflation of no more than 6 percent;

·         Achieve domestic revenue of at least 20 percent of GDP;

·         Limit overall fiscal deficit to 4.3 percent of GDP, of which domestic borrowing will be 1.3 percent;

·         Maintain gross international reserves of at least 4 months of import cover; and

 

Utilization of US$750 million Eurobond Proceeds

The Minister has proposed to apply:

·         US$430 million, 57.3 percent of the Eurobond proceeds, towards road and rail transport projects;

·         US$255 million (34 percent) on energy generation and transmission projections; and of

·         The balance of US$65m going to fund central hospitals, SMEs and transaction and funding costs.

Tax Incentives and Loopholes in Customs and excise duty

·         Remove customs duty on importation of :

(a) Engines of all types;

(b) Cranes of all types;

(c) Conveyor belts;

(d) Machines for cutting, grinding, polishing, drilling and welding;

(e) Vacuum and liquid pumps; and

(f) Sprayers of all types.

·         Remove customs duty on importation of the following:

(a) Automatic data processing machines;

(b) Magnetic or optical readers; and

(c) Machines for transcribing and processing data.

·         Remove the 15 percent customs duty on importation of ambulances in a move aimed at increasing access to health care services.

·         Remove the 15 percent customs duty on importation of motor cycles. Motor cycles play an important role in supporting access by rural health and agriculture extension workers to areas not accessible by other means of transport.

·         Increase customs duty from zero percent to 15 percent on flat rolled products of iron or non-alloy steel excluding those coated with tin and lead used in the manufacture of roofing sheets.

·         Remove excise duty on carbonated drinks and packed water in a measure intended to stimulate growth of the beverage sector.

·         Remove customs duty on locomotives, carriages and rail traffic control equipment for railways to encourage investment in the railways sector.

·         Suspend duty on articles and equipment for sports, games and general physical exercise for a period of 3 years to 31 December 2016.

·         Suspend customs duty on the following goods up to 31 December, 2013 effect from midnight on 12 October, 2012:

(a) New motor vehicles for tourism enterprises that offer transport services;

(b) New articles and equipment for furnishing and refurbishment of accommodation and catering

facilities for businesses licensed as tourism enterprises.

·         Remove customs duty on new and re-treaded pneumatic tyres intended to reduce the cost of doing business

Sectors

Agriculture

 

The agriculture sector is expected to contribute one half of the new employment opportunities over the next five years, making it one of the priority sectors. The Country has continued to record bumper harvests in crop production. However, this has mostly been concentrated in maize production, which has been the focus of the Farmer Input Support Programme (FISP). In order to boost and diversify crop production, Government intends to:

·         Include other crops in the FISP such as soya, cotton, sunflower and rice;

·         Streamline the electronic voucher system from 2013 in order to strengthen the private sector’s role in supplying agriculture inputs;

·         Scale up investment in extension services, irrigation, training institutions and research and development in order to improve crop yields.

Key initiatives in 2013 will include:

·          Promotion of increased local production of key inputs such as fertilizer and seeds;

·          Incentives to encourage local value

·          Restriction of the operations of the Food Reserve Agency to management of strategic food reserves only.

·         The Government has increased the budget allocation to this sector from K1,698 billion in 2012 to K1,865.4 billion.K1.1 trillion for the core agriculture programmes, including those aimed at promoting the sector’s diversification and cater for livestock, fisheries, crops and irrigation development;

·         an amount of K500 billion (2012: K500 billion) for the reformed FISP; and

·         K300 billion (2012: K300 billion) for the purchase of strategic food reserves.

Mining

The sector performance has been weaker than expected against a backdrop of a lethargic global economy leading to depressed copper prices and reduced copper export volumes during the year. To improve monitoring and mining systems the Government will aim to:

·         Building capacity at the Ministry of Mines, Energy and Water Development to facilitate the monitoring of both quality and quantity of mineral production and exports; and

·         Strengthening the regulatory and penal system with regard to false reporting of production and export volumes.

Tourism

The Sector has been identified as key in diversification of the economy. Accordingly, the Government intends to promote and expand tourism products and develop key infrastructure with the planned move to make Choma the provincial capital for Southern Province, it is expected that resources in Livingstone will be devoted to enhancing its status as the tourist capital. A total of K21.1 billion has been allocated

to the Tourism Sector compared to K12.8 billion in 2010 towards marketing activities. In order to leverage the maximum benefit from hosting the 2013 United Nations World Tourism Organisation Conference, Government proposes to suspend duty up to 31 December 2013 on the following goods:

·         New motor vehicles for tourism enterprises that offer transport services; and

·         New articles and equipment needed to furnish or refurbish accommodation and catering facilities for businesses licensed as tourism enterprises.

 Government aims to facilitate creation of 300,000 jobs in the tourism sector over the next 5 years.

Manufacturing

The Government’s primary strategic objective is to enhance the competitiveness of locally manufactured products, in both the local and export market by:

·         Promoting value addition to locally available raw materials; and

·         Implementing targeted investment incentives for entrepreneurs involved in value addition ventures.

The Government proposes to eliminate the following duties:

·         Customs duty on engines and cranes of all types, conveyor belts, machines for cutting, grinding, polishing, drilling and welding, vacuum and liquid pumps and sprayers of all types;

·          Excise duty on carbonated drinks and packed water; and

·         Customs duty on locomotives, carriages and rail traffic control equipment to reduce transportation costs for bulky products.

The Government has made a specific K255 billion budgetary allocation for the rehabilitation of the Nitrogen Chemicals of Zambia. The Government anticipates that some 90,000 jobs will be generated over the next five years as a result of these interventions.

Energy

The sector faces a number of challenges including frequent disruptions of power supply.

In collaboration with the private sector, the Government intends to:

·         Increase installed generation capacity;

·         Improve the transmission and distribution infrastructure; and

·         Expand rural access to electricity.

To this end, the Government is working with the private sector with regard to the:

·         Development of the Itezhi – Tezhi and Kafue Gorge lower power stations; and

·         Completion of the extension of the Kariba North Bank Power Station, amongst others. The petroleum sub-sector continues to be of key focus with the Government pledging to:

·         Continue with the construction of fuel depots across the country; coupled with the

·         Promotion of the use of renewable energy and alternative sources of energy such as solar, bio-mass, geo-thermal and wind.

In support of the above initiatives as the Government proposes to allocate:

·         K984.3 billion for electricity generation, transmission and distribution infrastructure; and

·         K336.3 billion for the rural electrification programme.

The Government expects approximately 90,000 jobs to be created on account of these interventions.

Transport and Communication

The Government has reaffirmed its commitment to reduce the cost of doing business through, among others, transport infrastructure improvement. Government’s objective is to ensure that all provincial capitals and rural areas have accessibility to markets.

The following key initiatives have been undertaken by the Government:

·         Link Zambia 8,000 project to result in over 8,000km of a road network over a five year period K billion has been allocated over three phases

·         2,000 km of township roads to be paved using labour- initiative and environmental friendly technology

·         Termination of concession agreement of the Railway Systems of Zambia and Government proposes to allocate K642.6 billion to revamp the sector.

·         US$430 million of the Eurobond proceeds have been allocated to road and rail transport

Monetary and Financial

Despite unfavorable global economic conditions Government believes performance of the domestic economy has been satisfactory. Government monetary policy targets to stay this course and:

·         Achieve real GDP growth of above 7 percent;

·         Achieve year end inflation of no more than 6 percent;

·         Achieve domestic revenue of at least 20 percent of GDP;

·         Limit the overall fiscal deficit to 4.3 percent of GDP, of which domestic borrowing will be 1.5 percent;

·         Maintain gross international reserves of at least four months of import cover; and

·         Maintain a flexible foreign exchange climate that espouses limited Bank of Zambia interventions to curb volatility. Other notable decisions undertaken in 2012 to facilitate Government macroeconomic policy implementation in 2013 are as follows:

·         Rebase the Zambian Kwacha from January 2013 for the purpose of simplifying financial transactions;

·         Increase commercial bank’s minimum aggregate capital from the current ZK12 billion to ZK104 billion for locally owned banks and to ZK520 billion for foreign owned banks. This is intended to enhance commercial banks’ capacity and promote the financial services sector;

·          Introduction of a policy rate to signal the Bank of Zambia’s monetary policy stance and to provide financial markets with a credible and stable anchor for setting of interest rates;

·         Removal of tax on interest earned by individuals from savings and deposit accounts;

·          Removal of medical levy currently charged on interest earned on savings and deposit accounts, treasury bills, government bonds and other similar financial instruments;

·          Statutory requirement for all local transactions to be effected in Zambian Kwacha; and

·          Statutory guidelines to address large disparities between buying and selling foreign exchange rates levied by authorized foreign exchange dealers.

Health

A total of K3.6 trillion representing 11.3% of the total budget has been allocated towards the health sector. This is 40.% over the 2012 allocation. The focus in the health sector has been highlighted as follows:

·         Improving service delivery especially in rural areas;

·         Scaling up of the provision of essential drugs and medical equipment and other supplies; and

·         Upgrading all hospitals commencing with the three referral hospitals.

Empowerment Funds

K103.9 billion has been allocated for the purpose of empowerment of entrepreneurs, with women and the youth the primary focus. This compares with K40 billion allocated in 2012

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