Policy Review Quarter 1

American Chamber of Commerce in Zambia

Policy Review

January - March 2023 | Issue 9

IN THIS ISSUE:

Is the Public Debt Management Act progressive or a replica of the previous one? Does it have the potential to change Zambia's trajectory in debt management?

Implications of Delayed Debt Restructuring on the Livelihoods of Zambians

Causes & Challenges in Curbing Illicit Financial Flows in Zambia and Possible Recommendations

What are the pros and cons of the proposed upward adjustment of tariffs by Zesco in a quest to dismantle its debt?

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Dear Members,

Foreword

At the Chamber, the first quarter of 2023 was marked with exciting achievements and occasions. The Chamber had its first ever hospitality sector meeting where various challenges and opportunities were re discussed. These were later presented to the Minister of Tourism and Arts, Honorable Rodney Sikumba. The Chamber also signed a memorandum of understanding with Zambia Institute for Policy Analysis and Research (ZIPAR) which will enhance the advocacy role of AmCham

During this period, we as the Chamber hosted our virtual Economic Outlook discussion, where a perspective of the economy for the year was given. The Chamber would therefore wish to encourage the membership to leverage positive prospects from this discussion

We sincerely hope this policy review will be of importance to you, our members. Thank you once again for your continued support.

Chansa Mwila Chief Executive Officer American Chamber of Commerce in Zambia

By PMRC

Is the Public Debt Management Act progressive or a replica of the previous one? Does it have the potential to change Zambia's trajectory in debt management?

In the last few years, Zambia has faced a crisis of crippling debt During the last quarter of 2020, the country became the first nation in Africa to default on its debt during the Covid-19 pandemic when it failed to make a US $42.5 million Eurobond repayment. At the end of December 2022, the total stock of Central Government debt was US $27.13 billion, of which US $11.63 billion (K210 billion) was domestic debt while the external debt was US $15.5 billion 1 . To stem excessive public debt and to formalize decision-making responsibilities relating to the contraction of public debt, the Public Debt Management Act, No 15 of 2022 was enacted, to repeal and replace the Loans and Guarantees (Authorization) Act. The objectives of the Public Debt Management Act (PDMA) include, among others, curing recognized weaknesses of the repealed Loans and Guarantees (Authorization) Act.

The government’s debt management objectives in the medium to long term as stated in the PDMA are meant to meet Government’s financing needs promptly; minimise the borrowing costs following a prudent degree of risk; and promote the development of the domestic financial market. The purpose of this article is the demonstrate the progressive nature of the PDMA, with specific reference to the introduction of a debt management office, greater parliamentary oversight, the inclusion of a Debt-GDP ratio and debt reporting mechanisms.

The PDMA introduces a Public Debt Management Office under the Ministry of Finance and National Planning. Amongst others, the functions of the office are to: conduct the debt management operations of the government, formulate the medium-term debt strategy, conduct annual debt sustainability analyses, prepare an annual borrowing plan and monitor and evaluate all borrowing and debt-related transactions to ensure compliance with the medium-term debt strategy A concern regarding placing the Debt Management Office under the Ministry of Finance and National Planning is that casts a cloud over its autonomy to make decisions relating to approvals of debt contraction. The necessary boundaries will have to be stipulated. Furthermore, in addition to the staff of the proposed Debt Management Office, it would be prudent for a board to be included to oversee the decision-making function These points withstanding, the introduction of a specific office for the management of debt is commendable

One important failing of the repealed Act was the disconnect with the Constitution (Amendment) Act No.2 of 2016 on the final authorization function on debt contraction. Previously, the law provided that the final authority for debt was Cabinet while the Constitution states that debt should be approved by the National Assembly before contraction According to practice, “Cabinet” is the President and one Minister The magnitude of debt incurred without vetting by the legislature, which represents the interests of citizens, has been a heated source of debate in the nation. To cure some of these shortcomings, the PDMA has strengthened the legislature’s role in the oversight and approval of debt. Under the PDMA, the Minister of Finance and National Planning must present an annual borrowing plan to the National Assembly not later than 90 days before the commencement of the next financial year Approval from the National Assembly then constitutes approval of loans contained in the plan for that financial year.

The Act sets out that annual borrowing must be set within the ceiling of a Debt to GDP ratio that shall not exceed 65%. The lack of a debt ceiling in the repealed LGGA partially contributed to unsustainable debt levels in the country According to the National Assembly Research 2 Department, Zambia’s debt-to-GDP ratio was calculated at approximately 124% in 2021, demonstrating an unsustainable trajectory in its borrowing. Therefore, the introduction of a debt ceiling in the Act is a progressive step that ensures Zambia’s future borrowing will be aligned with economic growth and the ability to pay back those debts. Additionally, the Act stipulates that debt servicing will not exceed 20% of government revenue in any given year. This will go a long way in ensuring that debt is not serviced from resources that should otherwise be spent on public service provision.

The Public Debt Management Act requires the Minister of Finance and National Planning to publish three debt reports annually These are a debt sustainability analysis report, a debt statistical bulletin and an annual public debt, guarantees and grants execution report In this respect, the PDMA will enhance transparency in a way not previously seen under the LGAA. Given the foregoing, it can be argued that the Public Debt Management Act has the potential to change Zambia’s trajectory in debt management. It is a progressive Act that will improve the management of Zambia’s debt through the establishment of a debt management office; it has strengthened parliamentary oversight in the management of debt; it has introduced debt ceilings and; it has taken steps to improve transparency concerning debt reporting The Government should take caution to ensure the PDMA does not fall prey to poor implementation that characterizes most legislative reforms. Moreover, the strengthening of other legislative reforms including the Public Financial Management Act, the Public Procurement Act and the Public-Private Partnership (PPP) Act is critical to further putting a lid on unbridled debt accumulation

By JCTR

IMPLICATIONS OF DELAYED DEBT RESTRUCTURING ON THE LIVELIHOODS OF ZAMBIANS

Zambia is still battling with a debt distress which has denied the country the opportunity to grow at its full potential. This has worsened the poverty levels as the past few years have seen a rechanneling of resources from key sectors of the economy such as: social security protection; education; health; water and sanitation among others to debt serving. The coming in of Covid-19 further worsened the living conditions in Zambia through disruptions of livelihood as productivity was lost and government’s responsibility to meet health needs of its people increased. Zambia therefore needs to grow to its full potential to improve livelihoods of its people and eradicate poverty It is for this reason that the country desperately needs a debt restructure to unlock investment and improve fiscal space.

Zambia was among the first countries to apply for debt restructure under the G20 Common Framework for debt treatment in early 2021. Progress has been made in this regard as the next step is for the Official Creditor Committee for Zambia to agree with the authorities the specific modalities of how official creditors intend to deliver debt relief consistent with the Fund-program parameters in the form of a Memorandum of Understanding (MoU). The authorities aimed to complete discussions on the MoU by the end of 2022, however, this is yet to be accomplished as the process has lagged The Zambian government has remained committed to fiscal sustainability. The country has also received support

from the International Monetary Fund (IMF) through the US$1 3 billion extended credit facility and a total of US$740 million concessional loan from the World Bank (WB). This has helped Zambia return to positive economic growth levels. However, debt restructuring is needed if Zambia is to achieve sustained economic growth The Zambian government has implemented a medium term strategy to run for the period between 2023 and 2025. This is intended to improve livelihoods of its people through reduced cost of living; improved and sustained economic growth averaging 4 2 percent; increased domestic revenue and improved reserves in the treasury. For all these to be actualized, Zambia needs investment inflow. The delayed restructuring in Zambia’s debt is blocking investment inflow into the country as investors may not perceive Zambia to be credible This is making it difficult for the government to meet the needs of its people to the required extent due to limitations of resources. It is very important to understand that no nation can grow in isolation as global partnership and trade is very important. Foreign direct investment boosts the countries reserves, increases the country’s revenue generation capacity and creates jobs.

The delayed debt restructuring is also contributing to the instability of the Zambian currency. As earlier highlighted, Zambia’s huge debt overhang is eroding market and investor confidence. Reduced direct foreign investment reduces the country’s forex earnings. For a country that is a net importer like Zambia, high demand for forex to import commodities adds pressure to the country’s reserves and leads to the devaluation of the local currency. his has been evident as the Zambian kwacha has been depreciating against major currencies. The depreciation of the kwacha means more of the Zambian currency is needed to import commodities for consumption This is likely to lead to increased inflation rate, which if not accompanied by increased nominal income (salaries) reduces household’s real income implying that household’s income can no longer purchase the same quantity of basic needs (food, shelter, clothing, medicine among others) that it previously could Therefore, the delayed debt restructuring is likely to contribute to the rising cost of living for an average Zambian as monitored by the

study by JCTR on the basic needs and nutrition basket. The rising cost of living is causing households to cut down on the number or quantity of meals per day as well as compromise on nutritional content of these meals It is also compromising the capacity of households to access decent housing due to reduced real income and therefore worsening the poverty levels in Zambia. With the aim of speeding up the debt restructure process, the Zambian government needs to step up bilateral engagement with China (Zambia’s

largest creditor) to help expedite the restructuring process under the G20 Common Framework. The perceived foreign policy shift must not be allowed to jeopardize the debt restructuring negotiations The interest of the Zambian people must take precedence over the geo-political and economic dynamics between the West and China. Ultimately it is the Zambian people who are bearing the brunt of delayed debt restructuring and who will bear consequences in the event that the debt restructuring deal collapses.

CAUSES & CHALLENGES OF CURBING ILLICIT FINANCIAL FLOWS IN ZAMBIA AND POSSIBLE RECOMMENDATIONS

Illicit Financial Flows (IFF) are defined as illegal movements of money, wealth or capital from one country to another This movement has been defined as an illicit flow when funds are illegally earned, transferred, or utilized across an international border

CAUSES OF ILLICIT FINANCIAL FLOWS IN ZAMBIA

IFF’s are a challenge that continue to plague the development of many countries on the African continent including Zambia

The main sources of illicit financial flows in Zambia include: Abusive transfer pricing which occurs through employing multiple and complex structures to shift profits from normal tax jurisdictions to low or no tax jurisdictions. This is a major source of IFF’s in Zambia. According to the United Nations Commission on Africa, Zambia loses 10% of its gross domestic product annually, due to corporate tax avoidance practices

Secondly, mis-invoicing is another source of IFF’s this is often found in intra-group transactions for goods and services and involves the deliberate fabrication of the value of such goods or services. Additionally, unequal contracts which present themselves as opaque contracts relating to resource extraction have been known to be another source of IFF’s

Furthermore, the economic structure Just like many other developing nations, makes Zambia prone to capital flights. This includes natural resource abundance combined with trade openness, in this regard, a relaxed approach to enforce regulation According to research, resource-exporting countries are more prone to exporting large amounts of illicit financial flows due to several factors.

Another additional factor includes high and variable inflation in contrast which raises investment risk, this in turn encourages IFFs. High fiscal deficits and high tax rates which also discourage domestic investment and could stimulate capital flight

Political and governance factors are also known to be major causes of Illicit financial flaws. This means that the political and governance environment of a country has influence on capital flight. Poor governance is key to facilitate theft, embezzlement of national resources, trade mis-invoicing, and smuggling of goods and capital across borders, all of which induce illicit financial flows

CHALLENGES IN CURBING ILLICIT FINANCIAL FLOWS

Combatting illicit financial flows (IFFs) is an integral part of the 2030 Agenda for Sustainable Development. The COVID-19 pandemic, the war in Ukraine and the increasing costs of climate change and environmental challenges have had a devastating impact on developing economies highlighting the critical need for addressing the financing gap.

The ability to achieve the sustainable development goals (SDGs) remains fragile when IFFs continue to drain resources that would be needed to pursue sustainable development and fulfill human rights Domestic resource mobilization, asset recovery and curbing IFFs are more critical than ever Governments’ capacity to raise resources, including through combatting crime and recovering the proceeds of crime, and the return of stolen assets are now fundamental to achieve SDGs. IFFs are a global problem, and it will require strong international commitment and cooperation to combat them.

Corruption and abuse of entrusted power are other contributing factors to the key challenges faced in curbing IFFs as they are crosscutting and an integral part because of their facilitating role. Corruption in the form of abuse of entrusted power for private benefit in both the public and private sectors remains an issue of continuing concern.

Additionally, dependence on natural resources extraction has also proved to be a challenge in curbing IFFs. Zambia’s dependency to a large extent on the extraction of natural resources for her exports and tax revenues has been seen as one of the major contributors to IFFs. However, this sector is very prone to the generation of illicit financial flows by such means as transfer mispricing, secret and poorly negotiated contracts, overly generous tax incentives and under invoicing

RECOMMENDATIONS

Combating and curbing IFFs would not be successful if it focuses only on its financial dimension, such as financial flows related to tax evasion, trafficking or smuggling. Ability to significantly curb IFFs can only happen if the whole value chain of transaction is considered, from the production to the export, and to the retail Steps should be taken for comprehensive accounting of IFFs by type, channel, source and destination, building on a comprehensive analysis of the activities generating IFFs.

Secondly, the Zambia Revenue Authority (ZRA) needs to engage the private sector where possible, to obtain new transaction level data to break down macro gaps Additionally, the Government needs to invest in data collection infrastructure by building capacity of personnel at port, customs and tax authorities to better collect and analyze trade data. The Government should also formulate a deliberate policy that requires or expedites progress on tax reporting.

Furthermore, the Government needs to strengthen domestic regulatory frameworks by weighing the costs and benefits of investing in the expertise and facilities to detect, investigate and prosecute perpetrators of reported illicit financial flows. The Government also needs to intensify the fight against corruption and moneylaundering by devoting more resources to the recovery of stolen assets.

Lastly, there is a need for regional cooperation and international actions, the cross-border nature of IFFs necessitates strengthening collaboration among countries. In this sense, African countries need to strengthen engagement in international taxation reform, make tax competition consistent with protocols of the AfCFTA, and aim for more taxing rights.

What are the pros and cons of the proposed upward adjustment of tariffs by Zesco in a quest to dismantle its debt?

By PMRC

The Eighth National Development Plan recognizes Energy as a key enabler for Zambia's economic transformation and job creation. Studies have shown that there exists a positive correlation between energy use and economic growth Notwithstanding the positive relationship, the energy sector, particularly the electricity subsector, has been faced with numerous challenges which include overdependency of hydro- power and non costreflective electricity tariffs which have contributed to low private sector involvement.

Usually, most public power producers in Africa, such as ZESCO, charge tariff th t h l th th actual cost of gene

electricity purchased from Independent Power Producers (IPPs), which averages US$11 cents, and the price at which the end users buy the power from ZESCO Limited which averages US$ 7 cents. This price differential has resulted in the accumulation of debt to IPPs, rise in the corporation’s debt servicing obligations and reduced revenue for investment and operations.

According to the 2021 Cost of Service study, Zambia's current tariff setting scenario is that the Energy Regulation Board (ERB) does not fully follow a Cost Plus approach. It scrutinizes ZESCO costs but does not reflect the total exploitation costs in the electricity tariffs it approves, and consequently, ZESCO has not achieved financial sustainability ERB received an application from ZESCO for an upward adjustment of electricity tariffs for various

customer categories with the exception of those supplied through a power supply/purchase agreement. The proposed adjustments will be effected with a weighted average of 37% in 2023, 9% in 2024, 15% in 2025, 10% in 2026 and 14% in 2027

As of December 2022, ZESCO had a debt burden of $3.5 Billion which has hindered the corporation from functioning optimally. An upward adjustment of tariffs will increase ZESCO’s liquidity which it can use to dismantle its arrears to IPPs Other benefits that will be accrued to ZESCO should the proposed tariffs be adjusted include the completion of the As of December 2022, ZESCO had a debt burden of

$3.5 Billion which has hindered the corporation from functioning optimally. An upward adjustment of tariffs will increase ZESCO’s liquidity which it can use to dismantle its arrears to IPPs Other benefits that will be accrued to ZESCO should the proposed tariffs be adjusted include the completion of the t is important to note that the upward adjustment of tariffs will come with some disadvantages that consumers will face Some of these include decreased economic activities, as it will affect different consumer categories differently. The increase in tariffs through the implementation of cost-reflective tariffs may reduce electricity use which may lead to decreased

economic activities as electricity is one of the key inputs of production in most businesses Small enterprises will be the most affected as they usually have limited capacity to invest in alternative energy sources. In the event that businesses maintain their electricity use, they will incur an increase in the cost of production which will increase the prices of goods and services as well as the cost of living for residential consumers. Zambia has a goal of achieving 100% access to electricity by 2030. However, only 5% of the population in rural areas has access to electricity Cost-reflective tariffs, therefore, pose a risk towards achieving this goal. In conclusion, cost-reflective tariffs are needed if

the electricity subsector is to flourish. Zambia’s geographic position provides the opportunity to be a regional power hub, which will enhance the country's resource base. In order to achieve this, there is need for more private sector participation, which can only be improved by having cost-reflective tariffs. However, it is important to note that with costreflective tariffs comes an increase in the cost of doing business as well as in the cost of living. Therefore, it will be imperative that Incentives are put in place to enable small and medium enterprises afford alternative energy sources, which will lessen the shocks to the economy should the proposed tariffs be implemented.

References

Bringing Zambia’s debt to sustainable levels: the role of parliamentarians (2022)

Brookings.edu

Debt Statistical Bulletin End of Quarter 4 (2022)

https://www.erb.org.zm/wp-content/uploads/files/Tariffs/ZescoApplication2022/ZESCOTARIFF-APPLICATION-2022.pdf

https://www.zesco.co.zm/storage/media_releases/1676012538.pdf

Policy Monitoring Research Centre

American Chamber of Commerce in Zambia

Policy Review

Prepared By: Mirriam Lungu (Policy Research & Advocacy Associate), with the support of Osward Nzimah (Communications & Administration Associate), Tumelo Chitindi Bwalya (Business Development Manager) and Chansa Mwila (Chief Executive Officer)