Parley Approves 2015 National Budget

PARLIAMENT on Wednesday 17th December 2014 unanimously passed the K46.7 billion 2015 national budget. The 2015 budget is boring. As far as I can tell, there is only one controversial issue and that is the new mining tax regime. I will come to that, but the rest is, frankly, boring.

Which is as it should be.

Budgets should be boring. They should ideally contain no surprises, but should represent the outcome of solid planning, policy analysis, wide consultation, fine tuning of well-established policies and the next step along a well-worn path towards better delivery of public services and development of needed infrastructure. It's true that new revenue measures are usually kept quiet before the budget, so that potential losers from the measures can't take steps to avoid the tax. So, far from being a complaint, this is a compliment. Good job, Hon. Chikwanda.

From the macroeconomic point of view - i.e. from the point of view of the impact of the budget on the Zambian economy (and leaving aside mining tax) - the most important piece of news is that the budget deficit is decreasing to 5.5% of GDP from 6.5% last year, and that the minister is targeting it to fall further to 4.6% next year, with domestic borrowing at 2% of GDP for 2015. It is the budget deficit and the way it is financed that has the greatest short term endogenous (i.e. excluding outside shocks like fuel and food prices) impact on inflation, interest rates and indirectly the exchange rate. Domestic borrowing through Treasury bills and bonds has drained bank liquidity in the early part of the year. With the 6-month TB rate at 17%, it is not surprising that bank lending rates have remained high, though it is not the only factor. Therefore reducing domestic borrowing from the banking system is, and should remain, a high priority. Likewise, inflation, now at 8%, is slightly above target, and so the statements and the commitment to control it better are welcome.

One issue not addressed directly in the budget speech, and which is relevant here, is arrears. Much has been said about the $600 million VAT refunds which are claimed by some mining companies, an issue which is in dispute, and about which the minister, on this occasion, only hopes for a quick solution. However, one hears reports about arrears to contractors and suppliers, an indication that the Ministry of Finance is trying to run a tight ship and contain its recourse to the banking system. If arrears are large and rising, it will make fiscal and monetary management more difficult, since the achievement of deficit reduction objectives will then require adjustments in revenue or - more likely - expenditure.

External financing of the deficit for 2015 is targeted at 2.8% of GDP. As far as I am aware, the DSA referred to in the minister's speech is not yet in the public domain, but the minister is correct in saying that Zambia's external public debt is still within acceptable limits. Indeed, one might be surprised that, within 8 years of Zambia's debt being written off by HIPC and MDRI, we would even be raising that question. But there are concerns. First, the rate at which external debt has been increasing (i.e. the size of the deficit) suggested at one point that it was getting out of control. The large exchange rate depreciation earlier this year was, one suspects, partly a reaction to that fear. Then there are the terms on which external finance is available, notably the latest Eurobond. External debt service on the 2 Eurobonds is now, I believe, running at $120 million per year, not a small sum.

As Marcelo Giugale of the World Bank puts it in a recent article: "Whether poor borrowers [like Zambia] can avoid a financial squeeze [when repayment is due] will depend on several factors. One is whether they will be able to issue more bonds to pay off those coming due. Another is whether they invest the money prudently, thereby enabling repayment. And it will also depend on whether countries with volatile incomes, especially those reliant on natural resources, put money aside when earnings are high.”

Thus the quality of the expenditure financed by the external borrowing is crucial. And it's important to note that it's not the projects directly financed by the Eurobond that are to be considered here, it's the marginal expenditure which is made possible by the extra financing.

The minister mentions in his speech that he now plans to set up a Sovereign Wealth Fund under the IDC, funded by dividends from State-owned enterprises. It's important to point out that this is not a mechanism for setting aside funds when earnings are high, to meet debt obligations, or simply to smooth fluctuating revenues, such as countries like Botswana and Chile have done. Such a mechanism is still needed.

The target for domestic revenue is K35.1 billion, or 18.5% of GDP. It is set to increase further during the R-SNDP period. A large part of the increase is from mining, and we are told that this is because of the change in the mining tax regime, notably the increase in mineral royalties. There is no doubt that revenue from mining needed to increase, but there are some questions:
1. Will mining tax receipts actually increase? Not if mines close (as now looks likely in the case of Lumwana), and not if the mines adjust their production to avoid the high royalties on open cast mining. (For open cast mines, the royalty rate goes up more than threefold). Were we not going to see an increase anyway from CIT as the capital allowances and loss carry-overs were fading out?
2. There has been widespread frustration with the CIT because of transfer pricing and other forms of tax evasion by some mining companies. But is this not throwing the baby out with the bathwater? And won't the two-tier royalty tax be equally difficult to administer? ZRA and other branches of government, and their international partners, can't give up on ensuring compliance, which means verifying results through tax audits and investigations. Sooner or later, a profit-based tax system will be needed. All countries exporting minerals use a mixed system.
3. What effect will the new regime have on new mine investment, especially since capital costs presumably cannot be carried forward any longer? And what effect will it have on exploration? Perhaps government has decided that it doesn't want or need new mine investment, but does this really make sense?

Little is said in the budget speech about tax administration, yet we know that tax evasion is rampant. A recent study by ZIPAR concludes potentially uncollected PAYE could be as high as 6.7% of GDP and 40.3% of total tax revenue. Similar calculations could be made for VAT and CIT. Our impression is that ZRA is trying to improve its performance and address these issues. But there is a long way to go, and it is surprising that the issue is not being flagged by the minister, and that, as noted above, there is even a sense that, on CIT for the mines, he has given up.

Last, the expenditure side. Much will be said about the wage freeze. Whether this is the right answer or not, public sector wages and salaries currently absorb more than 50% of the budget, probably more than 10% of GDP. This cannot be sustained, so something needs to happen. At the same time, government is surely right to increase the number of extension workers, teachers and community health workers, since these are the crucial frontline services that can directly address poverty. So it is hard to see how a wage freeze can be avoided. Likewise, the small allocation to the cash transfer program, which has been shown to be effective in reducing poverty in many countries, is entirely welcome, and could indeed be larger.

Nearly K1 billion has been allocated to FRA for the strategic food reserve. But is this realistic given current policies in the maize sector? The bumper harvests of recent years, welcome though they are, have resulted in FRA being pressed to procure much more maize than 500,000 tons, the strategic reserve. This is a difficult and complex issue. Suffice it to note for this discussion that, based on past experience, there is a high probability that more resources will be needed.

Which brings me to the thorny issue of expenditure management. Parliament will now spend several weeks debating the yellow book (or whatever replaces it under the proposed reforms) vote by vote and line by line. But we know that, as for FRA, actual spending will probably diverge significantly from the approved estimates, for all sorts of reasons, some good some not so good. On some accounts, the expenditure system has all but broken down, with the MoF effectively operating a cash budget system.

Against this background, the minister tells us that the PFM reform was launched; that IFMIS is being rolled out to more sites; that the new planning and budgeting policy has been published and that OBB will be introduced. Nothing could be more laudable than making expenditure more results-oriented, but will it address the fundamental problem of the apparently broken expenditure system, with negligible predictability and hence little if any accountability? Where has it worked and where is it working? Is it true - as I have been informed - that even highly developed and sophisticated countries are struggling with it? Will it become yet another wellintentioned innovation that ends up complicating things while not addressing the basic problems with the system?

My plea would be to introduce, as part of the planning and budgeting cycle, an annual public expenditure review, that systematically scores the successes and failures, studies the causes and ensures that, year by year, there is learning from mistakes and from successes. Other countries, like South Africa, Tanzania and Uganda have used such a system, and I don't see why it wouldn't work in Zambia.