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Zambia | Copper output cuts threaten weak economy

Zambia | Copper output cuts threaten weak economy

With poor fiscal management and the government's reluctance to engage with the IMF to make approporariate reforms, there is little prospect for an improvement in Zambia's wider economic situation.

The outlook for Zambia’s economy is poor, with several domestic and external factors threatening to destabilise it. Particular risks are a collapse of the currency (kwacha), the implementation of foreign exchange controls, rising inflation, and an unsustainably large government deficit. The government appears to be unwilling to take appropriate steps to avert such scenarios, and has expressed opposition to seeking support from the IMF. Although we do not expect that this will lead to a substantive change in the security environment, it could create severe restrictions on the ease of doing business in Zambia.

Two major international copper producers announced two weeks ago that they are reducing operations at their mines in Zambia. This is likely to hit the economy and government finances hard. The copper price has dropped by around 25% since mid-2014, in large part because of a drop in demand from China. Approximately a quarter of government revenue comes from the copper industry, which reportedly also accounts for around 70% of the country’s foreign exchange income.

The severe slowdown in the country’s main export industry will exacerbate other economic and political risks. The most pressing of these is probably the falling value of the kwacha. It has fallen by over 35% against the US dollar since the start of the year, making it the world’s second worst performer. The authorities do not have sufficient foreign reserves to support the currency. Because of this, they are faced with three options: allow the currency to fall further, seek support for an institution such as the IMF, or impose exchange controls.

On current indications, a further drop in the kwacha’s value, followed by the imposition of exchange controls appears to be the most probable scenario. However, a deferral of a US interest rate rise from September to November or December will reduce some of the pressure on the kwacha. Given this, we assess that a likely timeframe for exchange controls coming into effect is later this year.

A fall in the kwacha’s value plays into other economic problems. The inflation rate is currently at 7.3% according to Zambia’s central statistics office. We expect that this will increase steadily in the coming months, as the impact of lower fuel prices wears out, and as the depreciating kwacha pushes up import prices. It will also make it harder for the government to service foreign denominated debt and increase the costs of obtaining new financing.

The longer-term implications of a squeeze on government financing are concerning. The country’s energy generation infrastructure is in need of expansion, and a large amount of public funding is required for this. There has been rationing of power supplies since June, in an attempt to ensure the mining industry can continue to operate. However, the shortfall in generation has meant that mining companies were reportedly asked in early September to cut their usage by 30%.

Another issue that we expect will undermine attempts to obtain financing, improve energy infrastructure, and attract foreign investment, is the government’s poor record on fiscal management. A financial management expert working for a European embassy in Lusaka told us that budgeting ‘is volatile with short-term ad hoc solutions being found to immediate problems’.

Several other well-placed sources expressed similar concerns about the political motivations for government decisions on spending. Examples of this from last month alone are decisions to increase maize purchase prices by around 7% and civil service salaries from 2016. A general election is due next year, and the government appears to be seeking to boost support in key constituencies.

With this trend of poor fiscal management set to continue, and the government reluctant to engage with the IMF and make appropriate reforms, we see little prospect for an improvement in the wider economic situation anytime soon. Instead, we expect the operating environment for foreign companies will become increasingly difficult, and government policy more erratic, over the coming year.

Image: Creative Commons - "ZM-Nkana-headgear-Kitwe" by Per Arne Wilson

Published: 21st September 2015
Categories: Company News