In Tandem with Africa and Asia
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Triple deficits and Economic Crises in Zambia
Kwacha on the run….
I concluded my last blog suggesting that this week I’d be exploring the role of China in Africa using Zambia as a case study. However, my conversations since stepping off the MV Liemba, whether with roadside tomato sellers, farmers, mining executives or indeed Chinese businessmen, haven’t strayed far from the currency. The Kwacha value against the dollar has halved in the last 2 years, with the majority of the depreciation coming in the last 6 months (chart below). And when an economist with more than 40 years experience in Zambia tells you that the underlying economic crisis, caused by a perfect storm of three deficits, is shaping up to be the worst he can remember, the Chinese blog can wait…
Deficits, (as Claire reminds me, derived from from the Latin deficio meaning to fail or let down) are situations generally to be avoided. In economics, the most common deficits relate to international trade or government finances. When an economy suffers both, as many emerging markets have learnt, a potential crisis is often not far away1. Add a 3rd deficit, in this case a ‘power deficit’, and alarm bells start ringing. Bob Liebenthal, former World Bank expert and currently senior advisor to the IGC, is one calling for the need for a rapid IMF bail-out to avoid a more serious crisis and is particularly worried about the power deficit.
The fall in the Currency has been dramatic and de-stabilising; Bob Liebenthal, one of Zambia's most experienced economic advisors
‘There is no quick fix’, he laments as we catch up over a coffee in the capital city Lusaka. ‘With the economy so heavily dependent on mining (in turn requiring significant energy), the impact on output and employment is direct and significant’. Coming down from Tanzania to Lusaka saw us stop in the Copperbelt, the country's mining hub, for 10 days and the impact was clear, with regular power shortages and a request to visit Mopani Mine (MCM) unsurprisingly rejected as Glencore management deal with the unenviable task of laying off 80% of the workforce. As we left, we were forced off the road by the presidential motorcade coming in the opposite direction as Mr Lungu travelled into town to try and resolve the situation. A week before, he called for a national day of prayer and fasting for the economy. A desperate situation hoping for divine intervention (main picture above).
Mines such as MCM have been laying off workers as Copper prices have fallen sharply over the last 2 years
Sadly, many of Zambia’s wounds are ‘self-inflicted’ Bob reflects as we dig deeper into the causes of the crisis. A lack of planning (the world bank warned 10 years ago that a power crisis would hit Zambia in 2015) and populist government spending (we heard of free beer being handed out at a government rally in the Copperbelt whilst we were there) have contributed to the power and fiscal deficit respectively.
A lack of power is causing rationing, boosting sales of charcoal on the side of the road with obvious negative externalities
The fiscal deficit (where government spending exceeds tax revenue) is estimated to be as high as 10% of GDP today, according to a DFID economist I met, compared to the governments forecast in 2014 of 4%. ‘Major fiction going on there’, Bob offers a wry smile worn by a man who has observed governments in sub-saharan Africa for too long. Meanwhile, government debt to GDP is c.40% having been effectively zero fewer than 10 years ago as debt was written off by donors as part of the IMF HIPC (Heavily Indebted Poor Countries) initiative2. The deterioration has been particularly pronounced since the PF (Patriotic Front) government has been in power since 2011. With a presidential election approaching next year (the 4th in 5 years) hopes of a long-term sustainable approach to government finances are likely to be on hold for another year at least.
‘Powering the nation’: Hydro electricity is the main source of power in Zambia but it has proved unreliable.
Higher energy prices makes it cheaper to cycle or walk…
Of course, there are factors out of the government control. Poor rains in recent years have left water levels in dams unseasonably low. For a country reliant on Hydro for more than 90% of its energy, this is very serious. Moreover, the Chinese slowdown and corresponding collapse in commodity prices have worsened both the fiscal and trade deficit. Copper, Zambia’s biggest export, has seen its price fall some 50% from its peak of $10,000 per tonne in 2011 (see chart above). With export demand and prices falling simultaneously, the effect of the trade balance has also been significant, with the recent surplus over the last 5 years quickly turning negative in 2015.
The trade balance has moved into deficit territory in 2015
This automatically reduces demand for the Kwacha, causing a depreciation which has been compounded by a fall in foreign direct investment (FDI) appetite into Zambia as economic prospects and credibility have been damaged by the government mis-management.
Why should this affect the lady who sold me tomatoes in the Northern province nearly a month ago when I arrived in Zambia. Her largely subsistence lifestyle doesn’t require many imports (which have rocketed in price due the depreciation) and the input costs of her tomatoes are largely local too.
Inflation accelerated sharply in October as the recent depreciation takes effect; Even tomatoes have been going up.
‘Ahh, prices will be rising’ she told me with the confidence of a city economist! In contrast to many city economists, she was of course right. Last weeks’ inflation data showed prices of a typical shopping basket were up to 14.3% YoY in October from 7.7% in September, prompting the central bank to hike interest rates. The month on month figure of 6% (annualised = c 100%) suggests inflation will accelerate from here. Whilst locally grown tomatoes shouldn’t be rising as fast, traders tends to raise their prices in any case to keep up with the rising cost of living. Whilst the dreaded hyperinflation experienced by Zambia’s neighbour Zimbabwe should easily be avoided, a period of ‘stagflation’ (falling output and rising prices) is a real threat to the Zambian Economy. The central bank's move to hike interest rates this week is the standard monetary policy response to such a crisis but it won't make it easier in the short run. Lets hope Policymakers can take the long-term view needed to get this country near to acheiving its potential.
1 Some economists think the UK is currently at risk of a twin deficit crisis. see http://citywire.co.uk/wealth-manager/news/how-serious-is-the-uk-s-twin-deficit-problem/a811905
2 See theIMF website for more on this.