A Primer on the Genesis of Debt Unsustainability in Zambia: Pre-HIPC
1.0 Introduction
Zambia has been one country that was primed for economic prosperity, with some of the early scholars and technocrats from the 60s and 70s anticipating that the country would attain high levels of development due to its rich natural resource endowment and the exploitation thereof.?
Unfortunately, this wasn’t the case. Rather, Zambia has over the past 5 decades been in a mixed developmental state where its economy has heavily relied on foreign earnings from mining, its experienced minimal industrial development, and the majority of its population has been living in poverty for the most part of the country’s latter history.
A famous example of Zambia’s woes is usually pointed out through the difference in per capita growth trajectories between Zambia and South Korea, a country that was in a similar economic state to Zambia at the time of its independence. South Korea has since seen its gross domestic product (GDP) per capita value grow 30 times over since 1964 while Zambia has seen its GDP per capita barely increase over the same period.??
There are a number of reasons that could be attributed to this development outcome but most of these attributes remain a topic of discussion for another day. One attribute that will be explored in more detail in this paper is the concept of (sovereign) #debt. To gain a better understanding of debt and its resultant implications on the Zambian economy in its early years, a few key debt concepts are reviewed below.???
1.1 What is & Why - Debt??
As countries strive for economic growth, they most often overrun their budgets and run budget deficits where their expenditure exceeds their income. In most cases, governments rarely opt to cut their spending to manage their deficits. Instead, they seek alternative sources of income to finance their budget deficits with the hope that the investments they make produce a high enough return in the future to offset the accrued deficit financing.??
How do governments finance budget deficits? There are several options for budget deficit financing:
Due to small domestic savings and the lack of well-developed domestic debt markets in developing countries, history has shown that developing countries have leaned towards external funding (i.e. both grants and loans) as a means of deficit financing. Thus, the paper pays a heavy focus on external debt.
By definition, the IMF Debt Guide defines government gross debt as all liabilities (i.e. financial claims) that require payment(s) of interest and/or principal by the debtor to the creditor at a date, or dates in the future.
The effects of debt are ultimately very hard to determine. Empirical evidence has produced mixed results. In principle, there exist two schools of thought around the issue.
The first school believes that debt causes growth. Government debt is argued to foster growth by enhancing the supply of liquid assets or collateral. This is the liquidity channel through which government debt facilitates investment. The second school believes that debt leaves a country worse off in the long term. Higher private borrowing costs are seen to have the potential to trigger sovereign default risk.?
However, an important detail that comes out from a majority of studies has been that the effectiveness of debt is highly dependent on the ultimate use of the funds. Borrowed funds financing efficient productive capital should be able to generate enough return to repay the debt and ensure external solvency. The opposite is true if borrowed funds are used to support unproductive capital.?
1.2 Debt Management/Sustainability
The World Bank defines public #debtmanagement as the process of establishing and executing a strategy for managing the government’s debt in order to raise the required amount of funding at the lowest possible cost over the medium to long run, consistent with a prudent degree of risk. Thus, it is best practice for a country to adopt a debt management strategy to guide debt management.?
The debt management strategy is always unique to the country's context. It is a rolling, medium-term plan and must have objectives, cost and risk implications, governance framework, accountability structures, promote financial development, and should be aligned with macroeconomic policies.?
Good debt management is important because government debt can have a substantial impact on the country’s budget and financial standing. Therefore, a good understanding of the government’s revenues and expenditures, as well as its assets and liabilities, is essential for sound debt management.
#Debtsustainability is one of the key definitions underlying the situation of whether a country can meet its current and future debt service obligations in full, without recourse to debt relief, rescheduling, or accumulation of arrears. Debt is deemed to be ‘affordable’ if it is compatible with the stabilization of the debt to GDP ratio and it allows for an improvement in the standard of living of the people. In general, this means that part of GDP, or of the value of exports, has to be set aside for poverty reduction expenditures, prior to debt service.
The two main approaches to quantitatively assess debt sustainability are (i) the Debt Sustainability Analyses (DSAs) undertaken by the IMF and the World Bank, which compare baseline five-year forecasts with thresholds combined with stress testing for adverse shocks; and (ii) the debt-stabilizing primary balance approach. The latter looks at the current debt to GDP ratio and computes the primary balance that would permanently keep this ratio unchanged.
However, debt unsustainability issues materialize when liabilities are not well administered in terms of implementing investment projects, and the government fails to generate sufficient revenues to repay loans. Realistically, debt management constraints will exist, to avoid debt unsustainability, debt management decisions must positively impact the government's overall fiscal position.
1.3 Characteristics of Good Debt Management
Good debt management is characterized by sound debt structures. These help governments reduce their exposure to interest rates, currency, refinancing, and other risks. It is standard practice by many governments to establish targets and ranges for key risk indicators.
In some instances, where feasible, governments also target portfolios related to their desired currency composition, duration, and maturity structure of the debt to guide borrowing activities and other debt transactions.
Sound debt structures are important due to the material effects of sovereign risk. Also, debt itself represents a burden in the classic public finance sense (i.e. distortive taxation is needed to service it, thereby undercutting the foundation of future economic growth).
Good debt management is characterized by the maintenance of key debt thresholds. This is done through regular stress tests in order to assess the risk of the debt portfolio on the basis of the economic and financial shocks to which the country is potentially exposed.
Debt management should be anchored in sound macroeconomic and financial sector policies to ensure that the level and rate of growth in public debt are sustainable given the interconnections and interdependencies between their respective policy instruments. In principle, there should be a separation of debt management policy and macroeconomic policy objectives and accountabilities.?
Other characteristics include setting communication strategies; setting communication targets, periodic dissemination of debt data, and developing stakeholder relations with key players in the debt triangle. Communication also ensures there’s accountability between the debt managers, creditors, and the general public.
A good debt management framework should advocate for relevant and appropriately qualified and trained debt management staff to handle all the affairs relating to debt. This point is very important in that it is a risk mitigation measure that prevents haphazard decision-making by government officials and ensures all protocols and best practice techniques are adopted in managing the sovereign debt. Thereby reducing the risk of default.
2.0 The Case of Debt Management in Zambia
2.1 Pre-Independence Period
Northern Rhodesia was primarily designed to be a British colony centered overwhelmingly on the export of copper. This extractive model meant that very little investment was made toward traditional sectors. This ensured a cheap and plentiful supply of labor for mining the mainstay of the economy.??
British policy towards Northern Rhodesia was not the creation of a viable, self-sufficient state, but the integration of the country into the British colonial plan. Northern Rhodesia’s manufacturing, social, and farming sectors were neglected at the expense of other British colonies in Southern Africa that were developed to fill these gaps (e.g. Cape Colony & Southern Rhodesia).
The underlying economic structure of the colony was basically unsound. Copper revenues were never used effectively to diversify Northern Rhodesia's export base (i.e. to develop manufacturing industries or support agriculture) laying the foundation for external dependence.
2.2 Post-Independence Period?
In 1964, Zambia gained its independence. The country inherited the dualistic economy from the colonial period that was greatly dependent on the mining sector for employment, foreign exchange earnings, and government revenue. The heavy focus was placed on mining with little attention paid to other traditional sectors; Zambia was particularly vulnerable to external shocks.
In order to address the dependency on mining, the political leadership of the United National Independence Party (UNIP) developed a political economy anchored around state-ownership (ref. Mulungushi Reforms of 1968). The government adopted an import substitution strategy that was supplemented by the change from a private enterprise-oriented strategy to state-ownership.
The period of import substitution saw remarkable growth in the manufacturing sector and targeted areas such as processed foods/drinks, meat processing, dairy products, and textiles. The state ownership strategy saw the subsequent nationalization of the mines and other foreign-owned firms active in manufacturing, transport, retail and wholesale distribution, and newspaper publishing.
Thanks to a host of factors Zambia became one of the richest countries in Africa. The first decade of Zambia’s independence became known as the ‘golden age’ and was characterized by high growth rates, high copper prices, high mineral production, and a relatively advanced manufacturing base that was developed under the import-substitution model.
领英推荐
2.3 Global Economic Crises 1970s & 1980s
The mid-1970s marked the sharp discontinuity in the development of Zambia. Regardless of the shift in development policy by the UNIP government, there was no reduction in the large capital outflows and Zambia’s economy was still mainly dependent on copper export earnings.?
The growth in the manufacturing sector was not export-oriented. It is estimated that during 1965-1972 around 55 percent of the growth was due to import substitution, while 44 percent was due to increases in domestic demand and only one percent was due to increases in exports. Therefore, the country was prone to global shocks as the main facets that economically drove the country were affected by external economic shocks.
Following the oil crisis of the 1970s, growth rates fell. The effects of the penultimate global recession on Zambia were severely aggravated by falling copper prices and rising fuel costs. The decision of the state to nationalize the mines, over time, led to rising costs and the government struggled to maintain operating systems and disinvestment. Copper earnings and production fell, and so did the government’s revenue base.?
2.4 Zambia’s First Debt Crisis + SAPs?
Like many developing countries Zambia ran down foreign reserves and began to borrow in the late 1970s from bilateral and multilateral sources in order to provide support to its ailing economy. Much of the debt went to sustain the economic structures and socialist policies that were built up by the government in the affluent 1960s.
The financing of the fiscal deficit, by increased borrowing, together with the rise in import prices, increased the rate of inflation among other things. To combat the inflationary spiral, the government increased its regulation of consumer prices and expanded its subsidies on basic commodities. The control of prices for basic commodities also implied that many state-owned companies could not make profits, their losses being covered via the budget. Altogether, consumer subsidies and net lending to parastatals claimed 80 percent of government revenues in 1980 alone.
The economic decline continued and Zambia’s debt became unsustainable. In order to address the #debtcrisis, Zambia signed on to a series of IMF programs. These programs regularly broke down due to politics and the government’s failure to adhere to the agreed conditions. In addition, the extreme debt burden overshadowed remedies administered through government policy.
The structural adjustment programs (SAPs) prescribed by the World Bank and IMF were aimed at increasing investment levels and investment allocation. They failed to yield fruit due to the risks associated with African investments at the time and low investor confidence.?
What followed was a dramatic fall in the value of the Zambian currency, negative economic growth, inflation, and gradual deindustrialization. Thus, explaining the volatility in economic growth observed in the 1970s and 1980s. Zambia officially transitioned from one of the richest countries in Africa to one of the poorest in less than two decades.
Foreign interest payments increased during this period and by 1984, Zambia was paying out over US$610 million in debt service (approx. 60 percent of foreign exchange earnings at the time). The country underwent a few economic recovery programs (New Economic Recovery Program - NERP/ New Economic Program - NEP) but these failed to restore economic sustainability to the economy.
Following the continued heavy borrowing, slower growth due to lower copper prices, and high subsidies for government-run companies, Zambia’s debt in 1990 was a staggering 244% of GDP. Important to note that at this stage most of the debt was concessional debt.
2.5 Debt Management under MMD + The Role of AID?
Economic hardships brought about by the global recession and bad economic management by the government influenced the separation of the people from the UNIP.? The party that had ruled the country since independence.?
In 1991 through a democratic election, there was a change of government in the Movement for Multi-Party Democracy (MMD). The MMD pushed an economic liberalization agenda and opened up the economy to foreign investment with the aim of driving up economic growth. For a short while, Zambia observed some economic gains but these were short-lived.????
Zambia was in a period of debt overhang. Debt overhang occurs when there is an adverse effect of a high debt stock on investment incentives owing to medium-term (& sometimes long-term) uncertainty.
Zambia’s overall economic performance in the 1990s was disappointing. In 1990 and 1991, the country saw declines in GDP driven by substantial declines in the mining sector. In 1993, 1994, and 1995, further declines in mining and manufacturing output led to negative GDP growth in each of those years; with the largest decline being experienced in 1994.?
Foreign aid played a significant role in supplementing budget deficits. In 1995, total aid flows to Zambia reached a high of 50% of GDP. This was the first time the country experienced such levels of development assistance and the explanation behind the sudden rise in development assistance was attributed to the release of Structural Adjustment Facility (SAF) and Enhanced Structural Adjustment Facility (ESAF) funds which amounted to over $1 billion at the time. Foreign aid continued to be a major financial inflow for investments in social-economic infrastructure for the remainder of the 1990s.?
2.6 HIPC/MDRI Initiatives + Debt Relief Outcome
Attempts by bilateral and commercial creditors to solve the debt problems of many low-income countries (LICs) had proven insufficient. By the mid-1990s it had become clear that creditors, including multilateral institutions, needed to deliver much more comprehensive and concerted debt cancellation to overcome the insolvency of their debtors.
The Heavily Indebted Poor Countries (#HIPC) initiative was initiated in 1996 by the international community following a proposal by the G7 countries to guarantee a permanent exit from debt rescheduling in favor of LICs. In 1999, following a thorough review of the initiative, HIPC was enhanced to further increase debt relief and enhance the link with poverty reduction.
In order to be eligible for debt relief, the country had to carry out structural and social reforms, implement its Poverty Reduction Strategy (#PRS) for at least one year, improve on its debt burden indicators, and maintain a track record of macroeconomic stability. In the year 2000, Zambia reached its decision point and from then onwards began to receive interim debt relief annually.?
At the turn of the millennium, it can be observed that economic growth became more stable depicting an uptrend for a 10-year period due to the commodity boom. Moreover, following a change of leadership within the ruling party through general elections in 2001, the country observed increased fiscal discipline in the years to come.
In 2005, the HIPC initiative was supplemented by the Multilateral Debt Relief Initiative (#MDRI) to help accelerate progress toward the Millennium Development Goals (MDGs). Under the MDRI, the International Development Association (IDA), the IMF, the African Development Fund (ADF), and the Inter-American Development Bank (IADB) provided 100% debt relief on eligible debts.
These #debtrelief initiatives ensured that the majority of the country’s debt stock was either reduced to manageable thresholds or was completely canceled upfront. By the end of 2005, Zambia attained its completion point and qualified for debt relief under the HIPC and MDRI initiatives.?
A total stock of debt relief amounting to US$ 6.6 billion was committed to Zambia. Debt declined to 25% of GDP in 2006 from 130% in 2004. Thus, Zambia gained extra resources through debt service savings that could now be used to increase its expenditure towards developmental purposes in sectors such as health, education, and as well as in other social services.
3.0 Conclusion
From 2005 to 2010 debt build-up was cautious and slow, budget deficits during this time averaged 1.6% of GDP per year. The debt-to-GDP ratio reached a low of 18.9% in 2010. Growth increased from 7.9% in 2006 to a peak of 10.3% in 2010.?
Based on the debt history of Zambia that has been reviewed, the country’s debt sustainability challenges can be traced and attributed to the following key structural issues:
2. Poor Policy Management:
3. Poor Debt Management:
In dire situations of debt distress, debt relief does play a vital role in cushioning economic hardships, influencing government fiscal policy decisions, increasing social-economic expenditure, and spurring economic growth. On the other hand, debt relief is not a substitute for good debt management and does not guarantee current or future debt sustainability.