Food Prices: Why are prices high despite production surpluses? by Kampamba Shula

1.1. Background
Government has challenged food security researchers to provide comprehensive answers for the continued high food prices despite having food surplus in the country.
Agriculture and Livestock Permanent Secretary Julius Shawa observed that the issue of food prices is complex and requires the involvement of all stakeholders.
During a policy dialogue meeting on food security and nutrition in Zambia organised by the Indaba Agricultural Policy Research Institute (IAPRI) and the International Food Policy Research Institute (IFPRI) in Lusaka, Mr Shawa noted food security had become more complicated with many issues that were cross-border and needed to understand the complexities in order to make strategic decisions.
“Our policy makers are asking why food prices continue to accelerate despite the surpluses the country has been recording lately,” Mr Shawa said. “Researchers and us as policy advisers need to look at that and provide answers.”
He noted that there were various issues that keep coming up regarding high food prices such high cost of production, marketing and that sometimes the blame goes to the middle men. Mr Shawa observed that researchers were key in provide the true findings because good decision making depended on solid evidence and rigorous information.
This paper is an answer to this call for comprehensive answers on the high food prices in Zambia.
1.2. Introduction
For all intents and purposes this article will mainly focus on the price of maize, even though prices of other food commodities have been rising. The reason for this is due to the apparent contradiction that a surplus in maize production coupled with higher prices has perplexed some of the policy makers. This paper will aim to shed light in this regard.
 
1.3. Review
Since 2009/2010 production season, maize harvests have been above 2.5 million metric tons each year
• Projected maize surplus between 2010 & 2012 was 4.4 million MT of which FRA purchased 83%
• Despite maize surpluses, there were widespread maize meal shortages & skyrocketing m/meal prices
The question that seems to perplex stakeholders is how could Zambia face maize shortages and high prices despite three consecutive bumper harvests, large subsidies to mills, and significant maize held by the FRA?
As its initial mandate, FRA was established to maintain national strategic food reserves
• After amendment of Food Reserve Act in 2005,
• FRA has become a major player in the maize market
FRA purchased nearly all surplus maize between 2010 & 2012
Because FRA bought more maize than what they could handle, there were greater levels of FRA maize spoilage estimated at 32% (2013 ministerial statement by MAL Minister). This loss translates to K2.5 billion - loss equals 60% Euro bond. Private sector loss is only about 5%
• Retail maize markets became thinly traded as many traders were forced out of business
• Informal sector squeezed out of market
FRA’s procuring nearly all surplus maize and selling it at subsidized rates to a few selected commercial mills squeezed out informal milling sector
Selected subsidies to large millers provided un-levelled playing field.
• Not all large millers received heavily subsidized grain
• Others lost market share and exited the market
• Concentration of the milling sector
Undermined competition as such mealie meal prices did not come down.
Because FRA purchased majority of the maize, commercial mills’ access to maize directly from the market became limited and this resulted into:
• increased risk of bottlenecks in maize supply chain
Exit of commercial farming sector from maize production
• Because large millers started waiting for cheap FRA maize, it led to loss of forward contracts with commercial farmers
 
1.3.1. Summary
Less competition within large-scale milling sector which resulted into concentration of the sector
• Shortage of maize and mealie meal on the market
• Informal traders and retailers squeezed out of the market
• Overall surplus diminished by spoilage/wastage
• Commercial farmers’ maize production declined
• Major cost to national treasury & big opportunity cost to investments in R&D, extension, irrigation & infrastructure
Total estimated loss to national treasury through FRA maize marketing from 2010 – 2012
Total estimated operating LOSS: total grain sold x average loss/MT = (2.5 x 1,680)
• 4.2 billion kwacha rebased
• Loss more than Euro bond
1.4. Who sets the price for Maize?
Determining an FRA purchase price is a complex matter as it affects a multiplicity of factors that influence the performance of Zambia’s agricultural sector. The sustainability of a maize farmer, however, depends on that farmer’s price competitiveness, both locally and on the regional export market. Issues of adoption of new agricultural technologies and public goods investments that will reduce costs – such as feeder roads, improved agronomic practices, more productive seed varieties, meaningful extension messages, and ensuring the availability of fertilizer at the appropriate time -- are critical for the future competitiveness and viability of Zambia’s farm sector.
The FRA purchase price has normally been below the Lusaka wholesale price. The FRA must incur transport, handling and storage losses associated with moving grain from the outlying production areas to urban areas. As long as the FRA selling price to millers reflects these marketing costs, its selling price will be higher than its buying price. Hence it is unsurprising that the FRA purchase price should be set below the price in urban markets (otherwise its selling price to millers and other buyers would be uncompetitive compared to grain sourced by private traders). Therein lies the problem and effectively, the loss.
A major topical issue that can be informed with accurate production cost estimates is the price offered to farmers by the Zambian Food Reserve Agency (FRA) each year. The FRA sets its maize buying price each year to compensate farmers for the costs incurred during production and provide a reasonable return to their own land, labour, mechanical, and animal inputs. However, the setting of FRA’s producer price has never benefitted from national farm survey evidence on production costs. Rather, illustrative figures are provided by various stakeholder groups to lobby and influence the setting of FRA purchase price levels (Burke, Hichaambwa, Banda, & Jayne, 2011).
A key observation by a report done by (Burke, Hichaambwa, Banda, & Jayne, 2011) is that the FRA pan-territorial pricing policy does not reflect the wide geographic differences in costs and even among farmers in the same village. Geographic variation in production costs follow differences in agro-ecological suitability for maize production and input costs. The average production cost per bag in 2010 varied from as low as ZMK 34 in the Eastern and Northern Provinces (representing 35% of national production) up to ZMK 53 in the Copperbelt and Western Provinces (10% of national production). Within-village production cost differences arise due to differences in farmer ability and knowledge and the various management decisions they make.
These sources of variation result in a wide range of production costs in Zambia, which leads to the conclusion that there is no single “cost of maize production”. There is only a distribution of production costs across the millions of maize farmers in Zambia. This analysis reports the range of production costs for all maize farmers surveyed in the 2010 Crop Forecast Survey. The most productive 20% of farmers in the 2010 CFS produced maize at a mean of ZMK 15.567 per bag.
The next most productive 20% of farmers produced maize at ZMK 29.078 per bag. Mean production costs for the third and fourth quintiles of production costs were ZMK 42.776 and ZMK 64.341 per bag, respectively. The least productive maize farmers’ production costs were well over ZMK 100 per bag, which in many cases likely reflected unexpected events leading to partial or near total crop losses. In such cases, production expenses are extremely high when.
The wide variations in production costs per bag are due to variations in farmers’ production costs per unit of land planted, but especially due to variations in farmers’ yields.
The second key observation from the analysis of 2010 production costs is that 86% (2.06 million MT) of Zambia’s total maize output was produced at a total cost lower than the ZMK 65 FRA buying price. The mean cost of production per bag was ZMK 40.739. Cash expenditure on inputs per bag was ZMK 18.630 on average.
Thirdly, the majority of Zambian maize could be sold at a profit competitively in regional markets. At the beginning of the 2010 harvest season, the export parity price (the landed cost of maize in Lubumbashi, Democratic Republic of Congo (DRC), minus transfer costs from Kabwe to Lubumbashi) was roughly ZMK 59. Meanwhile, 1.8 million metric tons of Zambian maize was produced at costs lower than 50 ZMK/bag. It was found that smallholder households selling or expecting to sell maize produced maize at somewhat lower costs than the average (roughly 38 ZMK/bag). Among this group, 76-82% of the maize produced could have been competitive in regional export markets.
Fourth, there is a strong correlation between higher yields and lower costs of production. This is not surprising. Clearly, a key factor in increasing Zambian maize producers’ comparative advantage in the region will be the promotion of productivity enhancing technologies and agronomic practices.
Rural smallholder production remains highly labour-intensive. On average, family labour accounts for 62% of the total cost of maize production in Zambia’s small- and medium-scale farm sector. Promoting the identification and adoption of practices and technologies that save labour and /or identifying labour-productivity-enhancing technologies through research and development will therefore help to make Zambian maize more competitive and allow farmers to maintain profitability even at lower producer prices.
 

1.4.1. High Maize Price
Truth be told, Zambia’s agriculture sector revolves around maize, never mind the growing of other crops and livestock. The bulk of the maize is grown by peasant farmers who are faced with regular droughts during the rainy season, an unreliable and expensive supply of fertilizer, and difficulties transporting the commodity to markets.
In 1986, Zambians in the Copperbelt and Lusaka regions rioted because the price of maize increased several fold when incomes were stagnant. Four years later, unrest over price increases even sparked a coup attempt.
High maize prices disadvantage many poor rural households Research results indicate that, unfortunately, the majority of households in Zambia, both rural and urban, are not sellers but buyers of maize.
Moreover, the rural poor in Zambia tend to be buyers of maize. Hence, a rise in the maize price surface to ZK 85 per bag would have adverse income distributional effects by transferring income from the majority of the population in Zambia who are relatively poor net maize buyers to large commercial farmers and to about 25% of the nation’s smallholder households who sell relatively small amounts of maize.
In perfectly competitive markets, prices in the domestic country are fully determined by international conditions. Therefore, price setting does not involve any local factors, such as cost or market structures (Dreger & Kholodilin, 2007). From the perspective of consumers an equal amount of money could buy the same bundle of goods and services at home and abroad.
1.5. Imports and Exports
The importance of import prices it is also expected that the FRA purchase price should be lower than the cost of importing grain from South Africa. This has indeed been the case for each year that the FRA has set a purchase price since 2005. As long as the Government of Zambia tries to keep maize prices in the country below import parity levels, the FRA’s buying price will be below the landed cost of imports.
The surplus crop of maize achieved in recent years presents an opportunity to export value added products to the region, thereby increasing demand for the local produce, which will in turn raise the maize prices for the farmers (Cottan, 2006).
DRC has the largest export potential, but lack of signed bilateral trade agreements between Zambia and DRC is restricting the formal flow of exports. The estimated population for the Katanga province including Lubumbashi is 9.5 million.
However, there is very stiff competition mostly, mainly from South Africa and Tanzania for both Maize Meal and Wheat flour. The Zambian millers should therefore find ways and means to minimise the cost of production in order to remain competitive on the export markets.
 

1.6. “Price Floor”
A “price floor” is a government- or group-imposed price control or limit on how low a price can be charged for a product (McGraw-Hill, 1994). A price floor must be higher than the equilibrium price in order to be effective.
A “price floor” set above the market equilibrium price has several side-effects. Consumers find they must now pay a higher price for the same product. As a result, they reduce their purchases or drop out of the market entirely. Meanwhile, suppliers find they are guaranteed a new, higher price than they were charging before. As a result, they increase production.
Taken together, these effects mean there is now an excess supply (known as a "surplus") of the product in the market to maintain the price floor over the long term.
1.7. The Dilemma
The government has finally announced the maize “floor price” of K70 per 50 Kg bag of maize. Maize, Zambia’s staple food is grown by over 2.7 million agricultural households. The crop is not only used as source of food but is a source of income for many of the rural households. The income obtained from maize sales enables the families meet other basic necessities for livelihood and provides the resource needed to purchase inputs for the upcoming agricultural season.
According to (Nguleka, 2014) it is important to consider the economic conditions that farmers face especially in view of the fact that the floor price was last revised in 2009  (6 years ago). Taking inflation as the starting point, the prices of most goods and services in Zambia have continued to rise, with the magnitude of the increment varying from month to month and year to year. As mentioned earlier, the maize floor price has been static from 2009 at ZMK65/50Kg bag which means that while the prices of commodities that farmers face just like any other consumer has been rising the incomes of farmers remained unchanged. Looking at the inflation statistics below, the floor price was eroded by 36.6% from May 2010 to May 2014.  Had this taken into consideration, the maize price would have ranged from K70.79 in 2010 to K92.26 in 2014
Furthermore the costs of major inputs such as fertilizer and seed have been increasing. Fertilizer prices have risen by about 25 percent from ZMK160/50Kg bag during the 2009/10 agricultural season to about ZMK200/50Kg bag in the 2013/14 agricultural season in Lusaka. In other parts of the country, further from Lusaka, the prices of fertilizer are even higher.  The price of seed has also risen from about ZMK120/50 kg bag in 2011 to ZMK310/25 kg bag in 2013.
Other cost centres that should have been considered are;
The cost of fuel was adjusted upwards in April this year by 7.22% on petrol, 8.75% on diesel and 9.54% for kerosene. Increase in the price of fuel immediately raises the cost of transportation for the maize from farm gate to the market and the cost of transporting inputs onto the farmsteads.
The depreciation of the Kwacha drives upwards the cost of all imported farm requirements such as packaging bags, insecticides, fuel, etc.
Interest rates have gone up. The emergent and small scale farmers who have pushed up maize production get seasonal loans through a group lending scheme, the Lima Credit Scheme by depositing 50% of the value of the inputs as collateral to get double the value of inputs. Since last year the policy rate has been adjusted several times upwards and since April it is at 12% hence the cost of money has gone up hence commercial banks’ lending rates have gone up signalling a rise in seasonal finance costs in future.
Maize production is labour-intensive and wage related costs have gone up from ZMK12.200 to ZMK19.03 per man-day.
The general cost of doing business has gone up, the most recent is the increase in electricity tariffs which went up by 5.11% on large power MD3 /MD4 customers to 24.63% the highest on residential consumers. Small power MD1/ MD2 customers and Commercial consumers face an increase of 19.49% and 15.38% respectively while consumers falling in the social services bracket will face a 15.38%. Now since farming has different sizes of farmers falling in different electricity consumption groups what is not in dispute is that most farmers are faced with a double digit increase of 15.38% to 24.63% in the cost of electricity.
 Besides all the factors listed above, it is important to recognize that during the year, new fees/charges were introduced by some local council including toll fees on some main roads meaning that transporters will be adding all these costs to the cost of inputs. And for now since maize marketing is taking place, these costs will reduce the price paid to the farmer making farmers poorer and discontented. Therefore, the FRA floor price has an important bearing on the price that other traders pay the farmer.
At farm level, the rising costs of inputs means that a farmer producing maize at a yield of 2.26 Tons/ha which is the national average yield in 2014 requires a price of at least ZMK83/50Kg bag of maize grain just to break even without considering the fixed cost of production.  A price of ZMK108/50Kg bag of maize grain would make economic sense if the fixed costs were considered as well.  Some districts recorded yields as low as 1.5 tons per hectare, implying that farmers in such districts would need a price of at least ZMK159/50Kg bag to break even.
The inadequate return on the maize affects the productivity of small-scale farmers as they are forced to use less and less of the recommended inputs which reduces the yields even further.  This year, a national average yield of 2.26tons/ha of maize for small and medium scale falls way below the yield potential of hybrid maize varieties currently available on the local market.
Therefore, the maize floor price of ZMK70/ 50 kg bag announced is a source of misery because to a farmer in Kaputa with a yield of just 2tons/ha for a maize crop which cost over ZMK4, 700 per hectare to grow and whose breakeven price is K118.70 for a 50 Kg bag is a total disincentive especially that a fellow farmer in Zimbabwe is getting a price equivalent to ZMK119/50Kg bag (US$390/ton).  This will discourage farmers to continue growing maize because the price does not allow a farmer to cover the variable cost of production. It should therefore not come as a surprise that the yields will continue to remain low while farmers remain poor.

The farmers of Zambia have remained committed to producing the much needed food for the entire Zambian population and this has been demonstrated by the continued positive food balance sheet the country has enjoyed over last six years.  It is rather disappointing and difficult to comprehend that farmers should to get an upward adjustment of only one ngwee/kilogram as a reward after working so hard to produce a bumper harvest and more so after waiting for so long since 2009 when the price was last adjusted.

1.8. Analysis
Let us first understand that price floors are only an issue when they are set above the equilibrium price, since they have no effect if they are set below market clearing price.
Now here is the issue. FRA sets a “floor price” of K70 per 50kg bag. Then the FRA buys ALL the maize from farmers at that price. FRA then sells this maize to millers who in turn place their mark up and sell to end consumers.
It must be noted that the control that FRA places on the maize price is a PRICE CEILING and not a price floor. These two terms cannot be used interchangeably because they mean two different things. So as long as the Zambian government regards the price ceiling as a price floor, then policy direction on this issue will be misguided.
Now one might ask why it should be called a price ceiling instead of a price floor. The reason lies in what exactly is the effect of the actions of the FRA. Let us break it down, FRA “recommends” a price at which farmers should (I use this term loosely) sell their maize to FRA. Now the farmer has two options, he can either sell his maize lower than the price at which FRA sets to other “briefcase” dealers or he can endeavour to sell it at a price higher than what the FRA sets. Selling maize lower than the FRA price is possible but selling higher is impossible because any other dealer would not pay for maize at a price higher than what the FRA is paying. This is the reason this is a price ceiling and not a price floor because it prevents farmers from selling at a higher price but allows them to sell lower at a disincentive of course.
A price floor can only be effective if it is above the equilibrium price level. Factoring in inflation and other costs of production which have increased since the last time the “price floor” was set in 2009, the equilibrium price is actually higher than the price FRA sets. This means FRA is actually setting a price ceiling rather than a price floor. Which means whilst they might believe they are helping the farmers in an effort to keep prices low and protect consumers they are actually hurting farmers.
Now what does this mean effectively? The logic for having a price floor and a price ceiling by government are very different. The main reasons why a lot of government will try to fix the prices of a commodity below a certain limit is that they want to protect consumers from exploitation by suppliers. However the effects of prices control can hurt the economy if it is carried out for long periods without adjustments. If the government continues to impose the price ceiling the supply will continue to reduce hence negatively affecting that sector (This is seen by the increase in disincentive of some farmers to farm maize). The government should therefore not impose policies to protect consumers from exploitation when the real problem is undersupply not exploitation.

Apart from having a price ceiling, the maize market in Zambia is dominated by millers who purchase maize from FRA and resell to consumers. These millers have not always passed on price cuts to consumers (as was evidenced by the unsuccessful subsidies on grain programme).
With the presence of FRA in the maize market there are effectively three mini markets which make up the whole maize market.
The first market is a closed market with occasion intruders between Farmers and FRA. This market is occasionally intruded by briefcase dealers looking to buy from farmers at a low price and sell to FRA at a higher price. This is the market in which FRA sets a price ceiling which it unfortunately mistakes for a price floor.
The second market is the market between FRA and Millers. This was the market in which the subsidies where introduced. FRA would sell subsidized maize to millers in this market but millers never passed on the cost saving to consumers.
The final market is the one between Millers and Consumers. This is the market in which the ordinary person buys the mealie meal which the take home and consume.
If the market was liberalised this would be a two way market, one between farmers and millers and one between millers and consumers. But this is not the case. What is happening is that government is actually setting a price ceiling in the Farmer-FRA market and a price floor in the Miller- Consumer market. What government intends to do is actually set a price floor in the Farmer-FRA market and a price ceiling in the Miller-Consumer market.
This is distortion of policy is what is creating the illusion that higher surpluses will translate to lower prices while the market dynamics between the three mini markets do not support such an assertion.
There is always a trade-off. Government will have to decide an appropriate way to address the welfare of consumers as well as households who make their income from maize. But to do this Government will need to see the maize market for what it really is, a three tier market with little homogeneity formed into one. Under these market dynamics production surpluses will not translate into price decreases due to the inherent difficulty in such a market structure.

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Bibliography
Burke, W. J., Hichaambwa, M., Banda, D., & Jayne, T. S. (2011). FOOD SECURITY RESEARCH PROJECT: The Cost of Maize Production by Smallholder . Lusaka: FOOD SECURITY RESEARCH PROJECT .
Cottan, P. (2006). PROSPECTS FOR REGIONAL . Lusaka: Millers Association of Zambia (MAZ).
Dreger, C., & Kholodilin, K. (2007). Price convergence in the enlarged internal market. European Commission.
McGraw-Hill. (1994). Economics.
Nguleka, E. (2014, June 24). Zambia National Farmers’ Union- Press Statement On Maize Floor Price. Retrieved September 15, 2014, from http://www.znfu.org.zm/: http://www.znfu.org.zm/article/zambia-national-farmers%E2%80%99-union-press-statement-maize-floor-price

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Zambia 2014 First Half Economic Review: H1 2014 by Kampamba Shula

Zambia 2014 First Half Economic Review: H1 2014
This is the first ever edition in the series which highlights the performance of the Zambian Economy in the first half of 2014.

Growth

Industrial Performance: Whole sale and retail grew by 31% while real estate and construction grew by 9.5% and 9.1% respectively
• The Whole sale and retail was the best performing sector in the first quarter growing by 31%.
• The real estate sector was the second best performing sector growing by 9.5%
• Construction was the third best performer growing at 9.1%
• Other sector performance
• Financial services growth of 2%
• Transport sector growth of 2%
• Energy sector was the worst performer contracting by 23%
• Manufacturing contraction by 14%
• Mining contraction by 2%

Agriculture

In terms of the National Food Balance Sheet for the 2014/2015 agricultural marketing season, the country has a significant maize surplus above the national maize requirement. Other crops expected to register an increase include rice, tobacco, millet, and groundnuts.
• The stock of maize held by the Food Reserve Agency (FRA) declined to 349,120.3 mt as at end-May 2014 from 644,682.4 mt at end-December 2013.
• Similarly, the stock of rice held fell to 1,560.0 mt from 1,948.5 mt during the same period. The decline in stocks is typical during the lean period, which runs from October to May. However, with the crop marketing season commencing soon, the stock of maize is likely to increase significantly.
• According to the Crop Forecast Survey results for 2013/2014 the country is expected to produce 3,350,671 mt of maize, 32.3% higher than 2,532,800 mt produced during the 2012/2013 agricultural season.
Construction

The Zambia Government propped up construction expenditure on the Link 8000 and Pave 2000. K245 Million was released to the National Road Fund Agency.The Zambia Development Agency (ZDA) has disclosed that the country recorded US$3.3 billion in foreign direct investment (FDI) pledges in the first quarter ended 31st March, 2014.
The pledge of US$3.3 billion is mainly in the construction sector which accounted for US$3 billion
Construction was the third best performer growing at 9.1%

Mining

China has began to revaluate its use of copper as collateral for loans. This coupled with lower manufacturing sentiment has contracted demand for commodities like copper.
• Mining sector contracted by 2% in Q1 but rebounded slightly in the second quarter
• Copper prices fell by 7% in Q1
• Weaker demand constrained supply of the usual foreign exchange reserves from the Mining sector
MOPANI Copper Mines in Mufulira has increased copper production by 2,500 tonnes in the first quarter of 2014 highlighting a growth rate of 10 per cent
First Quantum Minerals (FQM), the owner of Kansanshi copper mine in Solwezi, recorded a 43 per cent rise in copper production during the first quarter ended March 31 2014.
The increase is due to sound management of the factors under the mines control and benefits from the investments in process improvements.
Copper prices have trended down since reaching an all-time high in early 2011 and fell by more than 10% during the first quarter of 2014 (mainly in March), owing to market concerns about the Chinese economy, and linked to this the ability of Chinese firms to continue to use copper as collateral in trade financing which has supported higher global prices
Copper output rose to 473,249 mt during the period January to May 2014, compared to 399,515 mt produced during the same period last year. However, cobalt production was lower at 1,951 mt when compared with 2,709 mt produced during the corresponding period in 2013.
Energy
Fuel prices rose in Q1 by 7.22% for petrol, 8.75% for diesel and 9.54% for kerosene on the back of foreign exchange rate losses on the oil import bill.

In the energy sector, total electricity generation during the period January 2014 to May 2014, increased to 5,731,907 Mwh from 5,467,181 Mwh during the corresponding period in 2013. This reflects the investments made in power generation in order to raise power supply required to meet the high demand arising from increased economic activity in the country.
Inflation
Inflation has been on an upward trend since the beginning of the year with annual inflation rising to 7.9% in June from 7.1% in December 2013

Factors contributing to these inflationary pressures include
• The seasonal supply factor (lean pre-harvest period October-May), removal of Government subsidy on maize,
• Pass-through effects of the depreciation in the exchange rate, higher fuel prices
• Increase in excise duty on cigarettes and alcoholic beverages
Foreign Exchange Market

The exchange rate of the Kwacha against the US dollar has exhibited a depreciation trend since the beginning of the year. As at 11th June 2014, the Kwacha had depreciated by 14.9% against the US dollar to trade at K6.3348/US$ compared to K5.5126 per US dollar at the close of December 2013. This was mainly due to intra-day mismatches between supply and demand for foreign exchange in the domestic market on account of the following:
• A reduction in the supply of dollars to the market, particularly from the mining sector which accounts for the bulk of foreign exchange supply.
• The decline in copper price by 9.1% to US$ 6,691.00 per tonne as at 11th June 2014 from US$7,360.00 per tonne at the end of December 2013, which impacted on market sentiment.
• Deterioration in the current account balance to a deficit of US $260.7 million during the first quarter of 2014, from a surplus of US $28.7 million in the fourth quarter of 2013, mainly on account of stronger imports relative to exports and higher service payments.
•  A significant build-up of liquidity over the fourth quarter of 2013 into the first quarter of 2014 (after civil service wage increase) and expanding informal trade sector which supported demand for foreign exchange.
•  The strengthening of the dollar on the international financial markets has also impacted on the Kwacha, leading to a corresponding weakness in then Kwacha through financial flows.
Government and Private Investments

During the first quarter of 2014, the Treasury released K1 Billion for Investments and Special Projects
• K245 Million was released to the National Road Fund Agency
• K140 Million was targeted at remodelling works at the Kenneth Kaunda International Airport
• K35 Million for ZESCO rehabilitation works
Other Investments included
• K15 Million for recapitalization of the Government Printing Department
• K6.8 Million as GRZ support to the Millennium Challenge Account Compact.
• K6.4 Million was released for the Youth Skills Development Programme
Government Spending

Ministry of Finance released K168 Million grants to various institutions of government to facilitate their operations and efficient programme implementation in Q1
The Treasury has also released K84 Million for road maintenance, rehabilitation, and construction. K20.7 Million was released to the Ministry of Local Government and Housing for water and sanitation programs.
A further K166 Million was released for salaries for civil servants in various government institutions, compensation and awards, and for emoluments for personnel in Zambia’s Missions Abroad.
Foreign Direct Investments 

Zambia recorded US$3.3 billion in foreign direct investment (FDI) pledges in the first quarter ended 31st March, 2014.
China recently emerged as Zambia's biggest source for FDI with inflows estimated at about US $1 billion, mostly into mining, manufacturing and construction sectors.
• Pledges reflect an increase in foreign direct investment in 2014 as compared to 2013 during the same period which recorded pledges of US$2.3 billion
• US$3.3 billion is mainly in the construction sector which accounted for US$3 billion, with the manufacturing sector accounting for US$132 million while other sectors contributed the rest of the FDI.
• The increase in FDI in the first quarter of 2014 as compared to the same period in 2013 further explains that regardless of how the economy is performing, increase in FDI is dependent on what the investor is looking for in terms of resources, market and the expected returns.
• Projection for the second quarter, the month of April has already recorded US$98 million in FDI pledges with pledged employment of one thousand forty five jobs from 25 projects.
Monetary and Fiscal Policy

During the period January to May 2014 monetary policy remained focused on achieving the end-year inflation target of 6.5%. In line with this objective, the Bank of Zambia (BoZ) tightened monetary policy by raising the policy rate from 9.75% in January 2014 to 10.25% in March, and then 12.0% in April 2014. The statutory reserve requirement was also increased by 600 basis points to 14% with effect from 10th March 2014. Following persistent volatility in the exchange rate, the Bank of Zambia took further measures to tighten liquidity in the banking system by extending the application of statutory reserves to government deposits and vostro accounts, as well as tightening the maintenance regime for statutory reserves.
Money market liquidity, as measured by commercial banks current account position, decreased by 46.8% to K593.6 million at end-March 20145 from K1,115.7 million at end-December 2013.
This was mainly on account of
• Net statutory reserve withdrawals
• Net Government securities sales
• Net sales of foreign exchange
Weighted lending rates

Commercial banks’ nominal interest rates recorded a mixed performance during the review period. The average lending rate rose to 18.1% in May 2014 from 16.4% in December 2013, following the rise in the BoZ policy rate. However, the 30-day deposit rate for amounts exceeding K20,000.00 and the average savings rate for amounts above K100.00 was little changed at 5.4% and 3.5% from 5.3% and 3.6%, respectively in December 2013.
Yield rates on Government securities have however trended upwards, largely reflecting higher Government domestic borrowing. The weighted average composite yield rate for Treasury bills closed 410 basis points higher at 19.4% in June 2014 from 15.3% in December 2013, while the weighted average bond yield rate gained 180 basis points to close at 18.1% from 16.3%.
In terms of the outstanding stock of Government securities, Government Treasury bill marginally declined to K9,881.2 million in June from K9,942.9 million in December 2013, while the stock of Government bonds rose to K10,576.8 million from K9,429.1 million in December 2013. Commercial banks remained the largest investors in Treasury bills with holdings of K6,160.9 million at face value, representing 62.4% of the total bills in circulation as at end June. The non-bank public accounted for 26.9% while the Bank of Zambia holdings stood at 10.8%. In the Bond market, the non-bank public were the largest holders at 53.0% (K5,601.7 million), while commercial banks accounted for holdings of 30.0% or K3,167.4 million. The Bank of Zambia held 17.1% or K1,807.6 million.

Fiscal Policy: Debt Management

As at end of April, 2014, external debt stood at US $4.2 Billion or 22 % of GDP whilst domestic debt stood at K20 Billion or approximately 16.4 % of GDP. In this regard, both external and domestic debt levels remain below the international thresholds of 40% and 25%, respectively.
For the period from January, 2014, total external debt service (principal plus interest payments) now stands at USD 52.2 Million of which USD 2.6 Million is a payment made in April, 2014. According to Ministry of Finance projections, the total external debt falling due over the next 12 months stands at USD 249 Million or 1.3% of GDP.
For the period from January, 2014, total domestic debt service related to Government securities (principal plus interest payments) now stands at K3.2 Billion of which K544.6 Million is a payment made in April, 2014. In the same month, Government issued K458 Million Treasury Bills in the domestic market. According to Ministry of Finance projections, the total domestic debt falling due over the next 12 months stands at K9.8 Billion or 8% of GDP.

External Sector Developments

Preliminary data shows that Zambia’s international trade performance during the first five months of 2014 was unfavourable. The merchandise trade surplus narrowed by 16.1% to US $271.1 million from US $323.7 million recorded over the corresponding period in 2013. This was largely attributed to a higher decline in merchandise export earnings relative to the merchandise imports bill.

Merchandise export earnings declined by 5.0% to US $4,264.3 million from US $4,488.9 million realized the same period in 2013, explained by a decline in non-traditional exports and cobalt earnings.
During the first five months of 2014, Non-traditional export earnings, at US $1,009.5 million were 30.0% lower than US $1,441.9 million registered during the corresponding period last year. This was largely on account of lower earnings from the export of copper wire, burley tobacco, cotton lint, fresh flowers, fresh fruits and vegetables, gemstones, cement and lime, and maize.
Similarly, cobalt export earnings declined by 23.2% to US $45.7 million from US $59.5 million recorded during the corresponding period in 2013, largely on account of a 37.0% decline in export volumes to 1,725.6 mt from 2,740.1 mt registered the previous year. The realized monthly average price of cobalt, however, increased by 22.0% to US $26,491.91 per ton from US $21,709.42 per ton registered during the same period in 2013.
However, copper export earnings grew by 7.4% to US $3,209.1 million during the first five months of the year from US $2,987.5 million recorded over the same period last year, driven by higher export volumes. Copper export volumes, at 477.485.3 metric tons (mt), were 19.4% higher than 399,919.8 mt recorded during the corresponding period in 2013. The average realized price of copper, however, declined by 10.0% to US $6,720.86 per ton from US $7,471.77 registered during the same period last year.
Meanwhile, the year-to-date (May 2014) merchandise imports bill declined by 4.1% to US $3,992.6 million from US $4,165.2 million registered in 2013. This was due to lower import bills of commodity groups such as industrial boilers and equipment, motor vehicles, chemicals, plastic and rubber products, and paper and paper products.
There was a decrease in the total value of metal exports from K 3,631 Million in January to K 3,458 Million in March 2014.
The overall contribution of metals and their products to the total export earnings averaged 75 percent.
The share of Non Traditional Exports recorded an average of 25 percent in revenue earnings between February and January 2014.
Gross International Reserves
Gross International Reserves (GIR) rose to US $3,387.13 million as at end-May 2014 from US $2,683.8 million at end-December 2013, largely due to the receipt of the second Euro bond proceeds. The level of reserves in May 2014 represents about 3.5 months of import cover as opposed to 3.0 months of import cover in December 2013.
Banking Sector
The banking sector financial performance and condition continued to be satisfactory and stable. As at 31 May 2014, the banking sector was adequately capitalized, with the aggregate capital adequacy ratios at 21.7% and 23.8%, which were well above the minimum requirements of 5.0% and 10.0% for the primary and total regulatory capital, respectively. In addition, the sector continued to post strong earnings

Projections for Third quarter 2014 and Rest of the year
Inflation is expected to edge downwards by the end of the third quarter of 2014. This projection is premised on expected improvement in the supply of various food stuffs as well as the lagged effects of the kwacha strengthening following monetary policy tightening in recent months. However, upside risks include cost push factors emanating from the recent increase in fuel prices and electricity tariffs.

The Bank of Zambia projects an annual growth rate of 6.5% of rebased GDP. We estimate a growth rate slightly higher at 6.8% of rebased GDP on the premise of a rebound in the third quarter driven by the mining sector, construction (especially railways and roads),energy, Agriculture and tourism driven by the 50th Jubilee independence celebrations.

Disclaimer: All speculation given in this article is plausibly deniable.

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Zambia Investment Profile: Overview Invest in Zambia by Kampamba Shula

Zambia Investment Profile
Economic Review
The country's economy has historically been based on the Copper Mining Industry. However, the Zambian Gvernment is undertaking economic diversification to reduce the country's reliance on the Copper Industry and exploit other components of Zambia's rich resource base by promoting Agriculture, Tourism, Gemstone Mining and Hydro Power generation.
Gross Domestic Product (GDP)
In 2013 real GDP was K125.9 billion compared to K106 billion in 2012. GDP growth in 2013 was 6.5%, with average real growth over the past three years (2011 – 2013) of 6.9%
Key contributors to real GDP growth in 2013 were: transport, storage and communications (27.1%); construction (24%); community, social and personal services (17.4%); financial institutions and insurance (13.7%); manufacturing (8.2%); and mining (5%).
The growth sectors that the Government is presently promoting include; Mining, Agriculture, Energy, Manufacturing and Tourism. These sectors have experienced exponetial growth in recent years, and are expected to continue to grow due to the numerous investments opportunities that are available in the country.

Zambia is consistently undertaking vcarious measures to improve its business environment. The Private sector reform development programme (PSRDP) is bent on streamlining business licensing processes and improving other administrative processes related to business establishment.

ZDA

The Zambia Development Agency (ZDA) was established in 2006 under Act No. 11 of 2006.
The ZDA is responsible for fostering economic growth and development in Zambia through promoting trade and investment and an efficient, effective and coordinated private sector led economic development strategy.The agency also has the challenge to develop an internationally competitive Zambian economy through innovations that promote high skills, productive investment and increased trade.
The ZDA principally furthers the economic development by promoting efficiency, investment and competitiveness in businesses, as well as promoting exports. It also addresses the high cost of doing business in the country by simplifying the processing of various business formalities, such as licensing.It builds and enhances the country’s investment profile for increased capital inflows, capital formation and employment creation. It also promotes the growth of the SME sector by providing incentives that can propel long-term sustainable domestic growth.

Investment Incentives
A corporate tax rate of 0% for 5 years from commencement of operations
Taxation on only 50 % of profits in year 6 through year 8 from commencement of operations and only 75% for years 9 and 10
5-year exemption on dividend taxes following the first year of declaration
5-year customs duties exemption on imported machinery and equipment
Improvement allowance of 100% Capital Expenditure on improvements or upgrading of infrastructure.

There are no limits on the amount of investment required to be made, however, there are some minimum investment thresholds to qualify for certain benefits, specifically: No less than US$250,000 in order to qualify for an Investors Permit ; and, No less than US$500,000 in order to qualify for special tax incentives for Priority Sectors or products (a list of such sectors and products can be found under Annex 2).
Once received, the CoR is valid for ten (10) years from the date of issue and you may apply for its renewal prior to the date of expiry.

Non-Fiscal Incentives
Once you hold a CoR you will be entitled to the following non fiscal incentives: Investment guarantees and protection against state nationalization; Free facilitation in applying for immigration permits, secondary licenses, land acquisitions and utilities; and The ability to own land under the company’s name.
Fiscal Incentives
If you invest $500,000 or more in a priority sector, you will be able to receive: A corporate tax rate of 0% for an initial period of 5 years from the first year profits are made by your company. For years 6 to 8 thereafter your corporate tax rate will only be applied to 50% of your profits and then 75% of the profits in year 9 to 10; Dividends shall be exempted from tax for 5 years from the year of first declaration; and Improvement allowance of 100% Capital Expenditure on improvement or for the upgrading of infrastructure Suspended Customs Duty to zero for 5 years on machinery and equipment.
Other Incentives Applicable to CoR Holders
As a CoR holder, you will also be entitled to the incentives of: Exemption from taxes on dividends declared by a company listed on the Lusaka Stock Exchange; Exemption from taxes on dividends declared by a company in the assembly of motor vehicles, motor cycles and bicycles industries for a period of five years from the date of first declaration; Duties on computer parts being reduced from 15% to zero percent;

Agriculture

Zambia is endowed with a large land resource base of 42 million hectares of which only 1.5 million hectares is cultivated every year. There are abundant water resources for irrigation and the country has 40 percent of the water in Central and Southern Africa.
Agricultural output in Zambia increased from 18 percent of the Gross Domestic Product (GDP) in 2008 to about 20 percent of GDP in 2009. This was as a result of increased area planted, good rainfall patterns in the whole country, as well as favorable agriculture policies by the government.
The agricultural sector continues to be the backbone of the Zambian economy as it contributes to the growth of the economy and also to exports. Primary agriculture contribute about 35 percent to the country’s total non traditional exports (all the country’s exports other than copper and cobalt) and about 10 percent of the total export earnings for the country.
Agro-processing
Agriculture in Zambia remains a major contributor to Zambia’s economy contributing about 13% to the country’s Gross Domestic Product (GDP). Agriculture is also a major employer in Zambia and currently employs about half the total workforce in Zambia. However agriculture alone not enough to bring about meaningful development to the Zambia people, there is need for Zambia to diversify from primary agriculture into agro processing. Alternative or additional income generating opportunities are needed to support the millions of poor families who can no longer support their livelihoods from the land alone.
Agro processing - turning primary agricultural products into other commodities for market - has the potential to provide those opportunities.
Currently the agro processing industry and the manufacturing industry contributes about 11% to Zambia’s Gross Domestic product with increase investment it is hoped that the sector can contribute more to Zambia economic well being and bring about tangible benefits to the Zambian people such as employment creation and poverty alleviation.
Agro processing aims to increase income and access to food for the poor, by establishing smallscale, appropriate and sustainable processing businesses that are flexible, require little capital investment and can be carried out without the need for sophisticated or expensive equipment.

Tourism

Zambia’s tourism sector is currently one of the country’s growth potential areas. It has been given the non-traditional export status and is receiving a lot of support from the Government by way of infrastructure development, promotion of increased private sector participation, as well as attractive tax incentives for all investments in the sector.

Zambia’s tourism potential draws from its natural environment, from which abound a variety of tourism attractions. The main tourism attractions in the country include; the Victoria Falls (which is one of the most renowned beautiful transcendental Seven Natural Wonders of the World), and the wealth of wildlife spread out in the country’s 19 national parks and 34 game management areas with a total area of 65,000 km2. Furthermore the country boasts of vast water falls, lakes and rivers, one of the largest concentrations of bird species in the world, a rich cultural heritage and several monuments spread across the country.

Infrastructure

Infrastructure development, is one of the Government of Zambia’s priority areas, and is upheld in both the country’s Fifth National Development Plan, and the Sixth National Development Plan, as well as in the National Vision 2030.
Infrastructure is an essential driver of competitiveness which is critical for ensuring the effective functioning of any economy and the country has basic reliable infrastructure in terms of; airports, road networks, railway lines, energy generation and transmission installations and telecommunication infrastructure.

Energy

Zambia’s energy sources include; electricity, petroleum, coal, biomass, and renewable energy. It is only petroleum which is wholly imported in the country, while the country is basically self-sufficient in all the other energy resources, as it has substantial unexploited reserves of these forms of energy. The country’s economy has been growing at an average of 5 percent per annum over the past 10 years and demand for energy has also been rising.
The demand for the most important energy source in the country - electricity has been growing at an average of about 3 percent per annum mainly due to the increased economic activity in the country especially in the agriculture, manufacturing and mining sectors, as well as increased activity in the region. Furthermore the country’s growing economy has also lead to an increase in the demand for the other forms of energy such as petroleum and coal, as these are key factors of production and operations in most economic sectors. The demand for renewable energies has also seen significant growth in the recent years as the market explores alternative sources of energy, with renewable energies proving to be a viable alternative.

Mining

Zambia is Africa’s largest producer of Copper and Cobalt. Although copper production was affected by low copper prices in the late 1990s, Copper production has been increased since 2000.  It increased to 572,793 tonnes in 2007 from a low of 256,884 tonnes in 2000, representing an increase of over 100%.  The rise in copper production over the years is attributed to investment in rehabilitation of infrastructure and technological innovations in existing mines, the coming on board of new mines and the increase in existing mines, the coming on board of new mines and the increase in small-scale copper mining activities.  Copper production has been increasing over the recent past from 575,000 metric tonnes in 2008 to 665,000 metric tonnes in 2009 and to about 700,000 metric tonnes in 2010.  This has been due to increased capacity utilisation facilitated by the continued increase in metal prices on the international markets.

The Zambia Development Agency Act provides for incentives for companies investing substantial amounts in the mining sector in the country. The Act provides for the investment thresholds that investors have to meet in order to qualify for fiscal and non-fiscal incentives. Currently the threshold is; investments of US$ 500,000 and above qualify for the incentives.
The general investment incentives applicable to the mining sector are;
Guaranteed input tax claim for five years on pre-production expenditure for exploration companies in the mining sector.
Any mining company holding a large-scale mining license carrying on the mining of base metals is taxed at 30%. Other mining companies are taxed at 35%
Dividend paid by a mining company holding a large-scale mining license and carrying on the mining of base metals is taxed at 0%
Income earned by companies in the first year of listing on the Lusaka stock exchange qualifies for a 2% discount on the applicable company tax rate, however companies with more than 1/3 of their shareholding in the hands of Zambians qualify for a 7% discount
Duty free importation of most capital equipment for the mining sectors.
100% mining deduction on capital expenditure on buildings, railway lines, equipment, shaft sinking or any similar works.
The debt to equity ratio reduced from 2:1 to 3:1 to encourage further investment in the sector.

Manufacturing Sector Overview

The manufacturing sector in Zambia accounts for about 11 percent of the country’s Gross Domestic Product (GDP) and has been growing at an average annual growth rate of three (3) percent in the last five years. Growth in the sector is largely driven by the agro processing (food and beverages), textiles and leather subsectors. Secondary processing of metals in another main activity in the sector, including the smelting and refining of copper, and this has led to the manufacturing of metal products. Fertilizers, chemicals, explosives and construction materials such as cement are also produced in the sector. Other activities include wood products and paper products.
The manufacturing activities in the country are undertaken by the private sector with government playing a proactive role. The sector is of vital importance in relation to the country’ macroeconomic strategy for encouraging broad based economic growth. In this regard, the Government has put in place measures to support manufacturing activities, such as the establishment of Multi-Facility Economic Zones (MFEZs) and Industrial Parks (these are industrial areas for both export orientated and domestic orientated industries, with the necessary support infrastructure installed), and provision of sector-specific investment incentives. Government also promotes small and medium enterprises in rural and urban areas so as to enhance labour intensive light manufacturing activities in these areas.

The sector has attracted significant investment in recent years (foreign direct investment stocks in the sector totalled about US$ 1,200 million as of 2009), and other than producing many different products, manufacturing also absorbs much of the output from other sectors such as agriculture, and also supplies inputs into the other sectors such as mining and construction.

Public Private Partnership (PPP) Projects
A PPP is a contractual arrangement whereby the private sector performs government functions of service delivery or infrastructure development, or uses state property, and assumes associated risks for the property, on behalf of Government, for a defined and agreed period of time. The private sector in return receives financial remuneration in form of concession fees, user fees, or any other form of repayment that maybe agreed upon with the Government. In this process, the Government retains a significant role in the partnership as the main purchaser of services or the main enabler of the project.

Health

An Ultra-modern Center of Excellency Hospital in Lusaka
Three diagnostic health facilities in Lusaka, Livingstone and on the Copperbel
Transport

E-Governance programme
Chingola-Solwezi-Lumwana-Jimbe railway line
Kazungula-Livingstone railway spur
Kafue Lions den
Njanji commuter
Nseluka-Mpulungu railway spur
Solwezi via Kasempa-Kaoma-Mongu to Katima Mulilo
TAZARA line to Chipata
Operation of train services between Chipata and Mchinji
Agriculture

Development of Kalumwanga Farming block
Development of Luena Farming blocks
Energy

Development of Kabompo mini-hydro
Development of Kalungwishi mini-hydro
Development of Mombututu mini-hydro

Multi-Facility Economic Zone (MFEZ)
The Multi- Facility Economic Zone (MFEZ) is a Government programme.Introduced to Zambia in 2005 by the Japanese Government through Japan International Corporation Agency (JICA).
The aim is to create a platform for Zambia to achieve economic development by attracting significant domestic and foreign direct investment (FDI) through a strengthened policy and legislative environment. The initiative emphasises on political will and integrity, private sector dynamism and integrity and civil service efficiency and integrity as key forces that enable the economy to attain accelerated economic development.
The implementation of MFEZs in Zambia is designed to make Zambia competitive through increased activity in the trade and manufacturing sectors, which have numerous positive spillover effects in other sectors such as utilities, transport, agriculture and services.
The MFEZs are, special industrial zones for both export-oriented and domestic-oriented industries. The zones will have the well appointed infrastructure in place in order to attract and facilitate establishment of world-class enterprises in the zone (s).
The MFEZs blend the best features of the free trade zones (FTZs), export processing zones (EPZs) and the industrial parks/zones concept and create the administrative infrastructure, rules, regulations etc that benchmark among the best dynamic economies. The blending of physical infrastructure with an efficient and effective administrative infrastructure will create the ideal investment environment for attracting major world class investors.
The legislation governing the MFEZs, is mainstreamed in the Zambia Development Agency (ZDA) Act No. 11 of 2006 under section 18.
In addition, the regulations and guidelines governing the declaration and establishment of MFEZs were put in place through a Statutory Instrument No. 65 of 2007.
Section 5 (p) of the ZDA Act no. 11 of 2006 mandates ZDA to administer, control and regulate MFEZs in Zambia.
The MFEZ incentives are non discriminatory and applies fairly to all eligible investors be it from Zambia or outside Zambia.

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Why Wind Fall Tax is not the Solution: The Golden Goose Example By Kampamba Shula

Windfall tax
First off before we delve into this subject we must define what Windfall tax actually is.
Windfall tax is a tax levied by governments against certain industries when economic conditions allow those industries to experience above-average profits. Windfall taxes are primarily levied on the companies in the targeted industry that have benefited the most from the economic windfall, most often commodity-based businesses (Collins, 2013).

The Problem
A combination of an excessively investor-friendly copper-mining tax regime, persistent and even tolerated tax  evasion among very high income earners, a low corporate tax take generally, and the  suspected purposeful neglect of taxing the gemstone sector have diminished state tax-revenue mobilization.
Firstly, Zambia does not benefit extensively from mining operations the way it should. 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.
Earlier this year Finance Minister Alexander Chikwanda signaled that Government was considering introducing new "tax measures" in mining to boost revenues:
"We will introduce measures and relook at the tax system in the mining sector. Our mining sector has not contributed much compared to the rest of the region. So we want to engage local experts and ensure we have the statistics on mineral production and exports, and then we will find modalities to effect new tax measures to increase revenue collection..." (Times of Zambia, 2013)
Windfall Tax
A windfall tax will be introduced to be triggered at different price levels for different base metals. For copper, the windfall tax shall be 25 percent at the copper price of US $2.50 per pound but below US $3.00 per pound, 50 percent at price for the next 50 cents increase in price and 75 percent for price above US $3.50 per pound;
Back in 2009 when the Windfall tax was still applicable the Government removed the upper 2 bands before it eventually scrapped windfall tax altogether.
Windfall is effectively a “revenue-based tax”, meaning that it is applied on the basis of gross revenue, without taking account of costs.
In addition, the windfall tax and the variable profits tax appear to duplicate each other – both being aimed at capturing that part of gross profits which is attributable to price windfalls.  From an economic viewpoint, the variable profits tax is preferable, because it takes account of costs and more closely approximates value-added.  However, there are concerns about the mining companies’ cost data, due to possible transfer pricing.  In addition, the mines apparently reported costs for tax purposes prior to 2008 that are lower than those they claim to be incurring now.  While this may well be true, it gives rise to a need to verify cost information.
Solution
ZRA’s capacity to review and verify cost information is in the process of being built up.  While this is being done, there is a case for a windfall tax based on revenues.  In addition, there is a strong case for independent verification of mining company cost information, and for open public scrutiny.
In 2008 the Economics association of Zambia suggested that “Government should seek to replace it as soon as possible by either the variable profits tax which would consider the cost structures of companies or structure the revenue based tax regime in such a way that the windfall tax will only apply from a price level which takes into consideration the cost structures of companies. The windfall tax should also be a flat rate. Thus the government should in the meantime re-examine the issues of tax deductibility, as well as the price thresholds and tax bands in the current legislation.”
I personally support the intentions of the  general public but windfall tax as it was initially introduced in 2008 does not yet provide the stability and predictability needed to sustain investment in the mining sector.
Much of the difficulty and, indeed, suspicion surrounding mining company representations reflects concerns that they are exaggerating their costs and thereby reducing the potential tax take if taxes are based largely on profits. We know that ZRA is in the process of building up its capacity to review mining company tax returns critically, and would strongly encourage that this continue and be accelerated.
The EITI, as an internationally supported mechanism, appears to have started to help such countries as Nigeria address issues of transfer pricing in their extractive industries.  The initiative is at an early stage in Zambia, and should be pursued with vigor.
The Example
A Farmer has some golden geese which lay golden eggs on his farm, he also has other geese which lay normal eggs. He keeps all the geese in the barnyard with other geese. The golden geese are very stubborn and require sensitive treatment and care; otherwise they refuse to lay as many eggs.
The farmer runs into some debt and needs to borrow money to keep his farm running. An animal care doctor comes to his aid and gives him a loan on condition that he treats the golden geese with even more care and preferential treatment than the other geese. He treats the golden geese well but to his dismay the geese (which are very smart) lays their eggs in cracks in the barnyard in which the farmer cannot reach. The geese then communicate to other geese that take those hidden eggs and go trade them for other assorted items to the Birds.
When the farmer occasionally does get some eggs, the farmer can’t price these eggs any way he would like but sells them at the market price for every ounce of gold eggs he brings. The farmer begins to get frustrated that he is not benefiting and has two options. Firstly he considers whipping and strangling the golden geese to force them to lay more eggs for him and secondly he considers covering the cracks in the barnyard to prevent the geese from sneaking out golden eggs.
He attempts to whip and strangle one of the golden geese and it dies, it lays two eggs then dies.
He tries the second option and he closes the entire cracks in the barnyard such that the geese are forced to lay the eggs out in the open where the farmer can easily pick them up and go sell them. The geese lay the Eggs and the farmer lives happily ever after.
In this story the farmer is the Zambian government, the golden goose are the mining companies. The animal care doctor is the IMF and World Bank who had the Zambian government sign very investor friendly concession in exchange for debt cancellation.
The first option of strangling the golden goose is Windfall tax.
The second option is covering tax loopholes that exist in Zambia’s current Tax laws and empowering ZRA with greater capacity to audit and tax mines properly.
It’s not rocket science to see which one is the better option.

Kampamba Shula | Economist

Economeka Capital

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Zambia Debt Analysis by Kampamba Shula

Zambia Debt Analysis
Recently the Minister of Finance presented the 2014 Budget and estimated the budget deficit to be around 8.5% of GDP. Standard & Poor recently changed their outlook to negative while Fitch Downgraded Zambia’s debt. This and many other recent events called for a fresh review of Zambia’s debt.
Intro
In April 2005, Zambia reached the completion point of the enhanced initiative of Highly Indebted Poor Countries (HIPC Initiative). This resulted in more than 80% of Zambia’s external debt being forgiven (2000 – US$6.5billion, 2004 – US$7.1 billion, 2006 US$0.7 billion). Further, given the prevailing conducive macro-economic environment, domestic borrowing has been on the rise hence threatening the sustainability of domestic debt. (Masengo, 2011)
Fitch Ratings 
On October 28 Fitch Ratings downgraded Zambia's Long-term foreign and local currency Issuer Default Ratings (IDRs) to 'B' from 'B+'. Its foreign currency senior unsecured bond ratings have also been downgraded to 'B' from 'B+'. The Outlook is Stable. Simultaneously, the Short-term IDR has been affirmed at 'B' and the Country Ceiling downgraded to 'B+' from 'BB-'.
The authorities expect a deficit of 8.5% of GDP in 2013, against an expected deficit at the time of the budget of 4.5% and an average of 2%-3% between 2006 and 2011. The overshoot largely reflects overspending on subsidies, which will total 4% of GDP, against 0.7% in the budget. This reflects perennial under-budgeting for subsidies, delays in scrapping the fuel subsidy as well as arrears payments and taking on contingent liabilities of the Food Reserve Agency. Lower-than-expected revenue also contributed towards the deterioration. (Reuters, 2013).
Domestic Financing and Crowding Out
In addition, though it is healthy to borrow domestically, excessive borrowing is distortionary. If the government becomes heavily indebted domestically and inflation and interest rates rise, the government will have to pay high interest to service this domestic debt. Further, in most cases domestic debt cannot be defaulted or rescheduled unlike external debt. This is because domestic debt is mostly held by the banking sector and default may trigger a banking crisis. Domestic borrowing has distortionary effects in the economy when excessively done. It can affect interest rates – heavy borrowing can lead to increased interest rates. It can also lead to “crowding out effect” – where the private sector’s access to finance for investment is shadowed by heavy government borrowing (Masengo, 2011).
It can also result in the ponzi game effect – where there is accumulation of borrowing to service already existing domestic debt (borrowing to pay off maturing debt and interest thereof).

Debt: The Bigger picture 
Reports by (Masengo, 2011) suggest that Zambia’s domestic debt has become sustainable, owing to the past decades positive developments– external debt cancellation, price and financial system stability. These results have been similar for both revenues with and without grants. The first reason explaining this result is the attainment of the HIPC completion point which led to (and has continued to result in) cancellations of most of the external debt stock. This has freed resources from external debt service towards domestic deficit and project financing. This has also reduced the size of the Government’s total expenditure as it includes external debt service.
Notably, Zambia has embarked on and succeeded in bringing and keeping inflation in single digit levels since sometime in 2006. GDP growth rate has also been consistently above 5% since 2003. Exchange rate stability has been achieved and maintained for relatively long periods. Project financing has been directed towards intended sectors like infrastructure development, citizen’s empowerment and poverty reduction. This, if properly done will enhance economic development and poverty reduction and help break the syndrome of repeated borrowing for the same expenditure.
However, it is important that Zambia continues with its economic diversification efforts so as to reduce dependency on exports of raw copper. There is need to enhance the manufacturing and processing sectors to begin exporting value products in both mining and agriculture. Further the Government needs to widen the tax base to incorporate the informal sector. This will reduce the tax rates and reduce incidents of tax avoidance and tax evasion. Therefore, it is evident that Zambia has continued to make progress in fiscal management and economic development, and indeed performing an analysis of domestic debt sustainability, for quarterly data for the recent period of say 2000 to 2010 would yield more precise and convincing results. However, this study recommends that for Zambia to achieve and maintain a strong form of sustainability for both domestic and indeed external debt, a debt sustainability monitoring office needs to be permanently set up. This office should regularly carry out thorough analysis for sustainability of both domestic and external debt (Masengo, 2011).
Economics Association of Zambia Insight
We are aware that the MoFNP has been conducting Debt Sustainability Analysis to guide the levels of additional loans that the Government contracts. The Ministry has indicated to the EAZ that the DSA conducted in 2007 and confirmed by the Word Bank and IMF in 2008 showed that the country’s debt is sustainable over the period 2007 to 2023. The analysis further indicates that the country can still sustain additional non-concession borrowing of US$1.0 Billion and concessional borrowing of the same amount. According to the Ministry, this analysis was confirmed in the subsequent DSA conducted in 2009 and 2010 (Economics Association of Zambia , 2012).

In line with the recommendations of the JCTR Report in 2007, the EAZ believes that it is in the interest of the country to develop a comprehensive debt strategy and policy that will stipulate when to borrow, at what terms and for what purpose. This should also be reinforced by a policy that debt should not finance recurrent expenditure but only capital expenditure.   Adequate guidelines should also be set regarding the contraction of domestic debt. The Government’s strategy of rolling – over could be defective and a careless way of using public resources (Economics Association of Zambia , 2012).
There is also need to move towards reorganization of the debt offices particularly to centralize borrowing powers, strengthen the monitoring capacity of the debt stock and strengthening of the debt strategy and policy.  In line with this, there is need to improve debt data management systems. As observed by the JCTR report, Zambia does not have a centralized comprehensive domestic debt database. The data is usually inconsistent and has moving figures in certain particular years. This has resulted in the lack of control and monitoring of the debt (Economics Association of Zambia , 2012).
The Economics Association of Zambia is also aware that there are intentions to review the legislation to address issues relating to the weakness in the debt management practices. Among these issues is the inclusion of a provision requiring the Minister to obtain approval and authorization of National Assembly and also to report on:
 The source of the loan
 The extent of the total indebtedness by way of principal and accumulated interest
 Provision made for servicing or repayment of the loan
 All borrowings by any state institution or authority annually
 Provision requiring debt managers’ strict adherence
 Provision for the establishment of a central depository of   original loan agreements
 Setting limits to the indicators such as Public debt/Gross Domestic Product (PD/GDP)
It is the Economics Association view that these proposals be supported by the members of the parliament as they are meant to enhance the debt management system in Zambia

EuroBond
Zambia, which 13 months ago issued its first international debt, is considering the sale of a record $1 billion Eurobond to plug a budget deficit that contributed to a credit downgrade.
Africa’s biggest copper producer will try to contain some spending to reduce the fiscal shortfall to below the forecast of 8.5 percent of gross domestic product for this year, Treasury Secretary Fredson Yamba said in a phone interview from Lusaka, the capital, today. The government this month raised its estimate for the gap from 4.3 percent and is finalizing as much as $250 million in syndicated loans as funding needs are pushed higher by government spending on wages and subsidies.
Yields on Zambia’s $750 million of bonds have climbed 161 basis points since being issued in September 2012 compared with an average 123 basis-point increase for dollar-denominated African debt tracked by JPMorgan Chase & Co. Fitch Ratings yesterday lowered Zambia one step to B, five levels below investment grade. Standard & Poor’s downgraded its outlook to negative on Oct. 25, while retaining its B+ rating.
The sale of a second Eurobond “is one of the avenues available,” Yamba said. “We are looking at various options. We have to go out there and see which is the cheapest source.”
While the southern African country would be able to sell a $1 billion Eurobond, it will be more expensive than its debut securities, Chris Becker, a market strategist at Johannesburg-based ETM Analytics, said by phone. A sale would follow record issuances by African nations, including debut bonds from Rwanda and sales by Ghana, South Africa and Nigeria, with plans by Tanzania, Kenya and Senegal to tap international markets.
Conclusion
Some might say that Zambia should not borrow externally and even as sincere as they may be they are wrong. When the Government borrows locally “Crowing out” happens. This raises the cost of borrowing for private companies. As this research indicates there is room for concessional and non-concessional borrowing.But prudent fiscal and debt management should not be overlooked.

Sincerely
Kampamba Shula
Member of Economics Association of Zambia
Economic Advisory at Economeka Capital



References
Economics Association of Zambia . (2012). THE STATUS OF ZAMBIA’S DOMESTIC AND EXTERNAL DEBT. Lusaka: EAZ.

Masengo, P. C. (2011). DOMESTIC DEBT SUSTAINABILITYANALYSIS. Lusaka: UNZA.

Reuters. (2013, October 28). Fitch Downgrades Zambia to 'B'; Stable Outlook. Retrieved October 30, 2013, from Reuters: http://www.reuters.com/article/2013/10/28/fitch-downgrades-zambia-to-b-stable-outl-idUSFit67460520131028

http://www.bloomberg.com/news/2013-10-29/zambia-considering-1-billion-eurobond-after-rating-cut.html

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