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close this bookThe Courier N 138 - March - April 1993 Dossier: Africa's New Democracies - Country Reports : Jamaica - Zambia (EC Courier, 1993, 96 p.)
close this folderCountry reports
close this folderZambia
View the documentThe score so far: Democracy 2, Economic Recovery 1
View the documentAn interview with President Frederick Chiluba
View the documentAn interview with Rodger Chongwe, Minister of Legal Affairs
View the documentBiting the bullet: the challenge of beating inflation
View the documentPoverty for many, wealth for some
View the documentSmall farmers: planting the seeds of prosperity
View the documentAIDS-a shadow hanging over Zambia's future
View the documentProfile
View the documentEC - Zambia cooperation

Biting the bullet: the challenge of beating inflation

One of the unwanted legacies of the Second Republic which the new Chiluba Government is having to cope with as it struggles to carry through its economic recovery programme is severe inflation. Over the 27 years of UNIP rule, inflation became deeply embedded in the Zambian economy. At independence it stood at between 7 and 8%, then in the mid-1970s it started to accelerate and for the last five years has been going at a rate described as very high by economists or even as hyperinflation in some of the economic and political circles where it bites hardest. A paper on inflation produced by the Ministry of Information at the end of 1992 says that from 1964 to 1991 the inflation rate as measured by the consumer price index for the low-income group increased by an average of 27% a year. The rate now is something like 200%.

The Ministry of Information paper puts the blame fairly and squarely on excessive government spending. 'Except for the 1960s and early 1970s' it says, 'the government has all along spent more on goods and services than its revenues allow.' The chronic budget deficits this created have averaged 12% of GNP since 1975. Furthermore, for the last several years-and even now under the IMF-backed structural adjustment programme-the deficit has been calculated without including debt interest payments as current expenditure or grants as current revenue; since payments exceed grants, the deficit is actually worse than it looks on paper.

In his first budget speech after the handover of power, the Minister of Finance, Emmanuel Kasonde, pledged that the government would from now on aim to balance its budget without borrowing from the banking system. The practice of not including the interest payments, however, already unbalanced the budget, on top of which there were other payments 'below the line', such as large wage increases wrested from the State by the civil service, the military and the staff of the state-owned Zambia Airways. Last year, too, parts of Zambia suffered severe crop losses from the drought which hit southern Africa, a national emergency was declared and the IMF created a separate drought budget, which was to be financed by the proceeds of selling the maize sent in as food aid by foreign donors. But in a context of high inflation, drought relief bills had to be paid before any revenue came in, and that simply added to the inflationary pressure.

Overspending

The budget consequently unravelled. At the start of 1992 the projected expenditure was 90 billion kwacha, consisting of roughly 80 billion in revenue plus grants to make up the remaining 10 billion, so that there would be no need to borrow from the banking system. This arrangement, however, made no provision for covering the large payments which had to be made on existing government borrowing from the public in the form of treasury bills; and the extra drought-related expenditure was not covered by any revenue either. By October, the Government had to enter a supplementary appropriation of 60 billion kwacha to finance overspending. In the event, at the end of the year spending stood at about 120 to 130 billion kwacha. How was this paid for? In effect, the Bank of Zambia was asked to write a cheque.

Part of the blame for this sorry state of affairs has been laid at the door of a government whose members had no experience of the realities of running a country, and which consequently took a number of ill-advised spending decisions. But revenue collection is a problem too. Consultants have been called in to computerise the tax administration system and the Minister of Finance has appointed a task force to make the system perform properly. One consultant who formerly worked for the US revenue service estimates that by making the system more efficient and improving compliance it should be possible to increase tax revenue by up to 50%. The very large parastatal system, for instance, only reluctantly pays tax, as many of the industries concerned run at a loss (and of course their heavy borrowing from banks to cover those losses also steps up the inflationary pressure).

Exchange and interest rates have also played their part. The developments outlined above took place against the background of a plunging exchange rate: in January 1992 there were about 90 kwacha to the US dollar-by December the rate was 360 to the dollar, and this of course pushed up the cost of imports which had to be paid for in foreign exchange. As the currency has depreciated against the dollar, there has been no incentive for anyone to hold on to the kwacha or kwacha-denominated assets. The resulting flight into foreign exchange itself adds to inflation.

Negative interest

Bank interest rates in Zambia have been negative, in other words lower than the rate of inflation. This obviously discourages investment in the country, since money can be invested at positive rates elsewhere, especially when there are no exchange controls. The exchange controls in place for years have not worked properly since the early 1980s. This has skewed income distribution, leaving the few who could export their money much richer in kwacha terms, while most people became much poorer. International financial statistics show that people giving Zambia as their place of residence hold something like US $450 million outside the economy, which at current exchange rates is more than the entire local money supply. With declining or stagnant real incomes, there has been massive excess kwacha demand for all kinds of resources, including foreign exchange: 'too much money chasing too few goods', in the classic phrase.

Some commentators put further blame for inflation on excessive wage demands by workers in the State monopolies. However, the trade unions, although they form the main power base of the governing Movement for Multi-party Democracy, and despite large pay rises in the parastatals last year, have not managed to maintain their members' real purchasing power. And although the much-needed cuts in the. civil service payroll have been delayed for political reasons, real wages for those still on the payroll have fallen too. If they cannot even cushion their own earnings against
the effects of inflation, it is difficult to see where or how the alleged pressure from the monopolies is being applied.

Nor can imported inflation be blamed for the present situation. In the 1970s the oil price shock was transmitted directly into higher domestic consumer prices in Zambia, but for some time now, relative to Zambia, the rest of the world has been deflating-so where would Zambia be importing inflation from? There is, however, some argument for saying that disruptions to Zambia's import and export routes through neighbouring countries have raised the corresponding costs and thus fuelled inflation.

Drought

As far as the role of the drought is concerned, droughts are known to occur in Africa from time to time, so plans can be laid for dealing with their results. But Zambia when last year's drought struck had no foreign exchange reserves to buy food, there was no real carryover of maize from previous seasons and there was no dynamism left in the agricultural sector, as farmers had for years been taxed through exchange rate pressures on purchases of inputs and discouraged from efficient production by the system whereby the State buying agency paid the same price for maize in every part of the country and whatever the season. An indication of the seriousness of the situation came from President Chiluba in December, when he told a meeting of Zambia's donors in Lusaka that his Government expected the economy to show a decline of 10% in 1992 as a result of the problems faced by agriculture in the drought year.

So what are the consequences of inflation ? In January this year the Government organised a conference to discuss this very issue and possible ways forward. It was attended by Ministers, opposition politicians, bankers, employers, trade unionists, academics, diplomats and guest speakers from the World Bank and the IMF. The Minister of Finance, Mr Kasonde, singled out the impact inflation had on investment in the economy as its most damaging effect. As businesses could only guess what exchange rates, wages and prices would be in six months or a year, they could not engage in medium- or long-term planning, so investment became too risky. Uncertainty about government policy also destroyed investment incentives. Secondly, negative real interest rates made unproductive investment in physical inventory (buildings, land, equipment and supplies) more profitable than saving money, so there was a shortage of funds available for investment. High nominal interest rates, even if negative in real terms, could cause serious cash flow problems for companies which did want to invest and could get loans.

A tax on capital

All these points were echoed by the Chairman of the Zambia Association of Chambers of Commerce and Industry, David Frost, who pointed out in an interview for The Courier that it was manufacturers rather than traders who were suffering. In practical terms, because of the high cost of replacing inputs industrialists were struggling to produce their goods with old, inefficient machinery, kwacha loans were available only on short, overdraft terms and in an inflationary situation it was too risky to borrow in foreign exchange; the resulting costs of inflation had to be passed on to consumers-and they were increasingly unable to buy as their own purchasing power dwindled. Mr Frost called inflation a tax on capital, and said that if it were not brought down to below 10% Zambia's manufacturers would simply turn into traders servicing local needs and would be replaced by manufacturers from the country's competitors, particularly South Africa.

Minister Kasonde also warned that the increasing tendency to conduct transactions in foreign exchange rather than in the local currency, whether legally or not, merely aggravated inflation, since it left even more spare kwacha in the system chasing too few goods and services, resulting in even higher prices-and, indeed, immunising those parts of the economy operating in foreign exchange against any Bank of Zambia monetary policies.

On this subject, The Courier was told by a specialist on a macroeconomic technical assistance project being run for the Zambian Government by Harvard University that, at least from the point of view of industry, dollarisation is not necessarily a bad solution. When Brazil, for example, was in a similar situation some years ago, price stability was achieved by turning the whole economy over to dollar transactions, so that inflation in the local currency, although it remained a nuisance, did not affect the activities of manufacturing industry. The Brazilian economy, however, was and is more outwardly oriented than that of Zambia. And in Zambia most of the population cannot acquire dollars (or pounds or rend) in the first place.

The hardest hit are, indeed, the genuinely poor. Each increase in price directly and immediately reduces their purchasing power. As the President has put it, 'There is nothing that will help the most vulnerable groups more than the bringing down of the rate of inflation.' How, is the question.

Budget pledges

The basic cure is acknowledged to be making sure that the Government does not spend more than its revenues allow. This entails either increasing revenue or reducing spending, or both. There is no proposal to increase taxation, but the Government has given several undertakings on expenditure in the 1993 budget.

Firstly, it says that all expenditure will be financed by domestic revenues. Second, there will be no new borrowing, even on a temporary basis, from the Bank of Zambia; the Bank will not process any Government transaction unless the revenue to pay for it has already been deposited. Treasury bills, too, have been floated, so money financing is over. The intention is apparently to borrow shortterm from the non-bank public, for example Zambia Consolidated Copper Mines, which has large foreign exchange inflows available for deployment, through Government borrowing, elsewhere in the economy. Third, any supplementary spending in 1993 will have to be paid for-in advance-by increased revenues or lower spending elsewhere. And perhaps the hardest promise to keep will be the fourth one, an undertaking, if revenues rise owing to inflation, not to adjust spending upwards as well.

Low money growth is also promised. Here there is certainly room for improved performance, as last year the targeted reduction from 130% to 25% was not achieved. According to the Bank of Zambia, this was because increased copper production during the year had led to greater export earnings than expected. The Finance Minister also told the inflation conference that positive real interest rates (as a stimulus to saving and productive investment) would be brought about, ideally by a seduction in inflation but, if necessary, by an increase in nominal rates.

This constitutes a very dry recipe for economic stabilisation, yet the Harvard project goes even further and advocates actually running a sharp budget surplus, so as to free resources for paying off Zambia's huge external debt. Even balancing the books, let alone producing a surplus from a cash budget while inflation runs at 200%, is a tall order, since by the end of the year the initial appropriations are likely to have fallen to between a third and a quarter of their value, but the macroeconomists say it has been done in other countries in Bolivia, for example, in 1985, inflation of 20 000% was reduced virtually to nothing in a year by a government which simply did not spend money it did not have.

Social costs

As to the social costs of this course of action, observers agree they can hardly be worse than the social costs of continuing with the ruinous economic policies of the last 20 years. The Finance Minister said he recognised that many workers faced serious difficulties and that promises of future improvements in real wages might seem hollow today. There would therefore be measures to increase workers' take-home pay, to be financed through spending restraint throughout the budget, not by borrowing as before, and the Government called on workers to show wage restraint in return. To offset this sacrifice by the labour force, the Government also called for voluntary price restraint in the markets, urging producers who faced no effective competition not to exploit their market power.

So the priorities for this year's budget, which was presented to Parliament on 29 January, are to attack inflation and stimulate new local and foreign private investment. Dramatic cuts were made in taxes and duties, and government departments were warned that they would not be bailed out if they overspent their allocations. President Chiluba made a personal commitment to fighting inflation by voluntarily taking a cut of 100 000 kwacha (about US $270) in his monthly salary of 300 000 kwacha, and calling on all Zambians to enlist in the battle. It seems unlikely that many workers, particularly those at risk of redundancy from cost-cutting and privatisation, will be able to follow his lead in surrendering income, but he reminded his countrymen that the medicine applied during the past year, although it had already yielded results, was still inadequate. 'Painful as the therapy is, 'the President said' 'we have taken too much pain to give up now.' It is too early to say how successful the cure will ultimately be, but one encouraging sign is that although inflation stands at 200% now, when the MMD took power at the end of 1991 it was at a peak of 400%. Movement may be slow, but it is in the right direction.

R.R.