Zambia Zambia at a Glance: 2006-07

Country Report

Zambia Zambia at a glance: 2006-07

OVERVIEW Political tensions in Zambia will increase as the presidential and legislative elections, which are expected in October 2006, approach. The Economist Intelligence Unit expects the president, Levy Mwanawasa, and the ruling Movement for Multiparty Democracy (MMD) to be re-elected, given the benefits of incumbency and the strong support of rural voters. The prospect of greater opposition unity represents a threat to the president and government, but it is uncertain whether the opposition parties will be able to put aside their differences for long enough to work together and secure power. Even if the MMD manages to win the elections, the party is likely to remain divided over Mr Mwanawasa!s leadership style. Compliance with the economic reforms agreed under the country!s poverty reduction and growth facility (PRGF) may slip in the run-up to the 2006 polls, which would strain, but not break, relations with the IMF and other donors. The government is expected to get largely back on track with its agreed economic reforms in 2007 and relations with donors should improve. Real GDP growth is forecast to rise to 6.2% in 2006 as copper production increases, before declining investments in the copper sector as prices drop cause the rate of growth to fall slightly in 2007, to 5.8%. However, fuel shortages and industrial action in 2005 have highlighted the vulnerability of many sectors of the economy to supply disruptions, and economic growth could be below expectations. Even assuming normal weather conditions, a wider fiscal deficit and high fuel prices will keep inflation in double digits, at a forecast 16.5% in 2006. Falling oil prices should allow average inflation to fall to 13% in 2007.

Key changes from last month Political outlook • There have been no major changes to our political outlook. Economic policy outlook • There have been no major changes to our economic policy outlook. Economic forecast • The availability of new official data combined with an adjustment in our expectations for mining-sector profit remittances have caused a widening of our forecast for the current-account deficit. The deficit is now forecast at 5.3% of GDP in 2006 (up from 4% of GDP), widening to 6.2% of GDP in 2007 (up from 5.8% of GDP) as copper prices fall. March 2006

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Zambia 1

Contents

Zambia

3 Summary

4 Political structure

5 Economic structure 5 Annual indicators 6 Quarterly indicators

7 Outlook for 2006-07 7 Political outlook 8 Economic policy outlook 9 Economic forecast

13 The political scene

19 Economic policy

25 The domestic economy 25 Economic trends 27 Agriculture 27 Mining 28 To u r i s m 28 Construction 29 Manufacturing 29 Financial markets 29 Infrastructure

30 Foreign trade and payments

List of tables 9 International assumptions summary 12 Forecast summary 15 Composition of parliament 21 2006 budget: expenditure 21 2006 budget: expenditure by function of government 23 2006 budget: revenue and financing 25 Real GDP growth by activity 26 Exchange rate, 2005 31 Debt owed to the IMF 31 Current account

List of figures

12 Gross domestic product 12 Consumer price inflation

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Zambia 3

Zambia March 2006 Summary

Outlook for 2006-07 Political activity in Zambia during 2006 will remain focused on the presidential and legislative elections, which are due by the end of the year. Both the president, Levy Mwanawasa, and the Movement for Multiparty Democracy (MMD) are expected to be re-elected, owing to their strong rural support and the advantages of incumbency. However, owing to divisions in the party, some members of parliament may defect to the opposition in 2007. The main thrust of economic policy will be to maintain progress in fiscal consolidation and to remain broadly on track with donor-led reforms, although these could slip in the run-up to the 2006 polls, which may provoke tensions with the IMF and other donors. Strong copper production is expected to be the main factor behind robust economic growth, and real GDP growth is forecast at 6.2% in 2006 and 5.8% in 2007. Despite improving agricultural production, high oil prices and a growing fiscal deficit will ensure that inflation remains in double digits during the forecast period.

The political scene Mr Mwanawasa has backed down from his stance over the implementation of the new constitution, although he appears to have succeeded in delaying key constitutional changes until after the 2006 elections. The three largest opposition parties have declared their intention to field a single presidential candidate. All of the main political parties have begun their election campaigns.

Economic policy The 2006 budget, announced on February 3rd, contained pre-election expenditure increases, some tax incentives and a reduction in donor reliance. The IMF has released another broadly positive review of Zambia’s economic reform programme, but it did note some areas where improvement is needed.

The domestic economy Economic growth is estimated to have slowed in 2005, owing mainly to disruptions in the mining sector. Growth in tourism and construction was buoyant in 2005, but manufacturing growth was below potential. Inflation has continued to fall in 2006, while the kwacha has remained strong. Supported by better rains, early indications are that agricultural production will be significantly higher than the drought-hit levels seen in 2005.

Foreign trade and payments The IMF has granted Zambia debt relief worth almost US$600m, but it is unclear how this will affect new aid levels. The current-account deficit is estimated to have widened in 2005 as import growth outpaced export growth and profit remittances by mining companies increased.

Editors: Philip Walker (editor); Pratibha Thaker (consulting editor) Editorial closing date: March 8th 2006 All queries: Tel: (44.20) 7576 8000 E-mail: [email protected] Next report: Full schedule on www.eiu.com/schedule

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Political structure

Official name Republic of Zambia

Form of state Unitary republic

Legal system Based on the 1996 constitution

National legislature National Assembly; 150 members elected by universal suffrage, serving a five-year term. The president can appoint eight further members

National elections Presidential and legislative elections due in late 2006 (last presidential and legislative elections December 2001)

Head of state President, elected by universal suffrage for a term of five years

National government The president and his appointed cabinet; the last major reshuffle was in May 2003

Main political parties The Movement for Multiparty Democracy (MMD) is the ruling party and holds a slim parliamentary majority; the United Party for National Development (UPND), formed in late 1998, is the largest opposition party in parliament, followed by the former sole party, the United National Independence Party (UNIP), and the recently formed Forum for Democracy and Development (FDD); other parties represented in parliament are the Heritage Party, the Zambia Republican Party (ZRP) and the Patriotic Front

President & minister of defence Levy Mwanawasa Vice-president Lupando Mwape

Key ministers Agriculture & co-operatives Mundia Sikatana Commerce, trade & industry Dipak Patel Communications & transport Abel Chambeshi Defence Wamundila Muliokela Education Brian Chituwo Energy & water development Felix Mutati Finance & national planning Ng’andu Magande Foreign affairs Ronnie Shikapwasha Health Sylvia Masebo Home affairs Bates Namuyamba Information & broadcasting Vernon Mwaanga Labour & social security Bates Namuyamba Lands Gladys Nyirongo Legal affairs George Kunda Local government & housing Andrew Mulenga Mines & minerals development Kalombo Mwansa Science, technology & vocational training Judith Kangoma-Kapijimpanga Tourism, environment & natural resources Kabinga Pande Works & energy development Marina Nsingo

Central bank governor Caleb Fundanga

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Economic structure

Annual indicators 2001a 2002a 2003 a 2004 a 2005b GDP at market prices (ZK bn) 13.1 16.3 20.5 25.3 b 31.1 GDP (US$ bn) 3.6 3.8 4.3 5.3 b 7.0 Real GDP growth (%) 4.9 3.3 5.1 5.4 b 5.1 Consumer price inflation (av; %) 21.4 22.2 21.4 18.0 18.3a Population (m) 10.9 11.1 11.3 11.5 11.7 Exports of goods fob (US$ m) 912.0 945.0 1,081.0 1,810.0 2,127.1 Imports of goods fob (US$ m) 1,253.0 1,204.0 1,393.0 1,727.0 2,068.0 Current-account balance (US$ m) -507.0 -346.0 -416.0 -286.0 -419.9 Foreign-exchange reserves excl gold (US$ m) 183.4 535.1 247.7 337.1 559.8 Total external debt (US$ bn) 5.7 6.0 6.4 6.4 b 4.6 Debt-service ratio, paid (%) 27.5 40.2 43.6 b 27.2 b 21.0 Exchange rate (av) ZK:US$ 3,610.9 4,307.0 4,733.3 4,778.9 4,463.5a a Actual. b Economist Intelligence Unit estimates.

Origins of gross domestic product 2004 % of total Components of gross domestic product 2004 % of total Agriculture 22.6 Private consumption 64.9 Industry 28.3 Government consumption 14.5 Manufacturing 3.2 Gross fixed capital formation 26.1 Construction 9.4 Change in stocks 1.3 Mining 12.0 Exports of goods & services 21.6 Services 49.1 Imports of goods & services -28.3

Principal exports 2004 US$ m Principal imports 2004 US$ m Metals 1322 Metals 286 Non-metals 457 Others 1,441

Main destinations of exports 2004a % of total Main origins of imports 2004a % of total Tanzania 14.5 South Africa 47.4 South Africa 12.8 Zimbabwe 15.4 China 8.9 United Arab Emirates 5.3 Japan 7.7 UK 3.4 a Based on partners’ trade returns; subject to a wide margin of error.

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Quarterly indicators 2004 2005 1 Qtr 2 Qtr 3 Qtr 4 Qtr 1 Qtr 2 Qtr 3 Qtr 4 Qtr Prices Consumer prices (1994=100) 971.5 994.8 1,018.8 1,075.3 1,147.3 1,183.7 1,214.1 1,259.4 Consumer prices (% change, year on year) 17.3 17.9 18.7 17.9 18.1 19.0 19.2 17.1 Copper, LME (US$/tonne) 2,724.5 2,781.5 2,854.7 3,093.2 3,264.7 3,387.2 3,750.4 4,303.8 Financial indicators Exchange rate ZK:US$ (av) 4,751 4,774 4,809 4,782 4,751 4,684 4,489 3,930 Exchange rate ZK:US$ (end-period) 4,722 4,789 4,906 4,771 4,678 4,676 4,503 3,509 Deposit rate (av; %) 14.80 10.44 10.10 10.70 11.03 11.10 11.50 11.17 Weighted lending base rate (av; %) 33.27 30.0 29.90 29.77 27.83 28.70 28.12 29.23 Treasury bill, 91-day rate (av; %) 13.63 7.15 12.48 17.15 18.06 15.29 15.57 16.35 M1 (end-period; ZK bn) 1,499.3 1,767.9 1,849.1 1,860.4 1,829.0 2,141.1 2,173.0 2,167.1 M1 (% change, year on year) 44.6 42.8 41.3 22.9 22.0 21.1 17.5 16.5 M2 (end-period; ZK bn) 4,459.1 5,040.0 5,235.4 5,639.4 5,323.7 5,824.7 5,937.0 5,783.6 M2 (% change, year on year) 28.7 35.4 33.0 32.1 19.4 15.6 13.4 2.6 Sectoral trends Copper in concentrates, production (‘000 tonnes 98.6 102.8 104.7 103.4 92.2 111.1 113.3 127.5 Copper in concentrates, exports (‘000 tonnes) 92.1 100.5 102.0 98.6 82.6 105.8 113.8 118.9 Cobalt production (tonnes) 1,424 1,478 1,566 1,613 1,516 1,362 1,389 1,270 Cobalt exports (tonnes) 1,506 1,497 1,573 1,527 1,406 1,358 1,419 1,251 Foreign trade (US$ m)a Exports fob 338.3 362.9 389.5 366.4 424.5 450.6 476.2 n/a Imports fob -474.5 -483.7 -523.1 -534.5 -495.2 -509.4 -557.8 n/a Trade balance -136.2 -120.8 -133.7 -168.1 -70.7 -58.9 -81.6 n/a Foreign reserves (US$ m) Reserves excl gold (end-period) 228.4 260.3 304.1 337.1 332.6 469.9 496.5 559.8 a DOTS estimates. Sources: Bank of Zambia, Statistics Fortnightly; IMF, International Financial Statistics; Direction of Trade Statistics.

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Outlook for 2006-07

Political outlook

Domestic politics Political tensions are expected to escalate as the presidential and legislative elections, which are expected in October 2006, approach. The president, Levy Mwanawasa, will stand for re-election but will have to work hard to combat dissension in the ranks of the ruling Movement for Multiparty Democracy (MMD). There are deep divisions within the MMD, as many of its members are unhappy with Mr Mwanawasa!s style of leadership and his decision to prosecute his predecessor, Frederick Chiluba, on corruption charges. Although there is likely to be some show of unity as the elections approach in order to present a united front to the electorate, such is the depth of the divisions that they will be difficult to heal even after the polls. The bleak political prospects for those outside the MMD have been one factor preventing significant numbers of its members from leaving to date. However, if the opposition parties perform well at the polls, more MMD members are likely to be prepared to leave the party in 2007.

Election watch Despite the divisions within the ruling party, the Economist Intelligence Unit still expects both Mr Mwanawasa and the MMD to be re-elected in the 2006 elections. Their strong rural support will be crucial in this, and has been boosted by the government directing greater resources to the agricultural sector. In addition, the powers of incumbency are a significant asset, especially in a large country with poor transport infrastructure where mounting a nationwide campaign is a significant logistical exercise. Support for the president and the MMD in urban areas has been undermined by party in-fighting and corruption allegations, coupled with the government!s refusal to implement a new constitution before the elections. The current constitution is deeply unpopular with much of the urban middle class, and the opposition and civil society groups are pushing hard for a new one to be adopted. The president and the government are extremely reluctant to agree to this prior to the elections, ostensibly on grounds of cost, but more probably because a new, fairer, constitution would make their re-election more difficult. The MMD will also benefit from the ongoing disunity within the opposition. At least five opposition presidential candidates would be capable of securing a reasonable level of support in the polls because of the backing of various ethnic groups. However, the prospects for greater opposition co-operation have recently been boosted by an announcement from the three largest opposition parties that they intend to field a single presidential candidate at the election. Such a candidate would be in a stronger position to pose a real challenge to Mr Mwanawasa. However, owing to the powers that it confers to the holder, the presidency is an enormously attractive position and it is doubtful that many opposition party leaders will be prepared to give up their chance of securing it. Therefore, the chances of the coalition lasting to the elections are not good. The opposition!s best hope of achieving victory in the presidential election has been dashed by the government!s continuing refusal to change the voting system to

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one where the victor has to secure 50% plus one of the ballots cast, potentially over more than one round of voting. This would have allowed the opposition to unify around one candidate in a second-round run-off.

International relations Zambia is not expected to face any external threats during the forecast period. The government will remain focused on building relations with key donors. Although adherence to donor requirements has been good during the last 18 months, donors will remain vigilant over governance issues. As long as relatively free and fair elections are conducted in 2006, however, donor support is expected to remain broadly on track.

Economic policy outlook

Policy trends The main goal of Zambia!s three-year poverty reduction and growth facility (PRGF) with the IMF, which is due to run to June 2007, is to improve fiscal discipline and management. A reduced fiscal deficit would limit the need for the government to borrow domestically, curbing inflationary pressure and ultimately allowing cuts in interest rates, with the aim of boosting private-sector borrowing. Other priorities under the PRGF are to improve governance, develop the business environment for the private sector and complete the privatisation programme. So far the government has remained on track: the last review of the PRGF was completed in January 2006 and was broadly positive. Indeed, the government has done enough to reach completion point under the IMF-World Bank!s heavily indebted poor countries (HIPC) initiative, which should eventually lead to debt relief of more than US$3.9bn. There will, however, be obstacles to continued progress under the PRGF. The government is developing a number of projects aimed at improving the lives of ordinary Zambians. Much of the financing for these projects is expected to come from the funds saved through debt relief, but these are unlikely to cover the spiralling number of schemes. If this is the case, the government will be faced with the dilemma of whether or not to cut back on the projects. With elections approaching and many Zambians unhappy about the government!s lack of visible progress on improving living standards, the government is likely to push on with many of the projects and cover any financing shortfall with greater borrowing. This would strain relations with the IMF and other donors, although the government is unlikely to overspend to an extent that would create the risk of a significant suspension of donor support. In terms of the government!s attempts to increase private-sector borrowing, the problem is that even if the government were able to reduce its domestic debt stock (which is currently estimated to be over 20% of GDP), commercial banks are risk averse. Because of this, as well as the huge structural constraints to lending, growth of credit to the private sector will not pick up significantly over the forecast period.

Fiscal policy Government spending is likely to increase fairly rapidly in 2006 as the elections approach. Strong growth in domestic revenue is also expected as the government seeks to widen the tax base, and because strong economic growth will bring higher tax revenue. To some extent, this will act to offset the

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expenditure increases, but the fiscal deficit is still projected to increase to 3.2% of GDP in 2006, from 2.5% of GDP in 2005. In 2007 the government is likely to come under pressure from the IMF to show renewed fiscal discipline. With the elections out of the way, this should be possible, and growth in expenditure is expected to slow. However, as copper prices are forecast to fall significantly in 2007, growth in company income tax and mineral royalties will be sluggish. At the same time, donor support is expected to decline slightly as some adopt a "wait and see" policy regarding the early performance of the new government. As a result, revenue is likely to fall, and the fiscal deficit is forecast to increase slightly, to 3.5% of GDP. The deficits expected over the forecast period will be financed through a mixture of domestic and external borrowing. Domestic debt is forecast to rise modestly, from 20.6% of GDP at the end of 2005 to 22% of GDP in 2007.

Monetary policy The government has set the Bank of Zambia (BoZ, the central bank) an inflation target of 10% by the end of 2006, down from the current rate of around 20%. However, a significant tightening of fiscal policy and lower domestic debt issuance would be required for inflation to hit this level. Given that this is unlikely in 2006, we do not expect this target to be achieved. A 5% target has been set for the end of 2007, which, again, we think the BoZ will struggle to achieve. In addition to trying to contain inflation, the main focus of the BoZ will be to try to increase commercial bank lending to the private sector. However, as a consequence of the structural constraints to lending experienced by the banks, lending rates are expected to remain high. More fundamental structural reforms, such as revisions to the bankruptcy laws, may be necessary to give a real boost to lending. Moreover, even if the spread between lending and deposit rates is lowered substantially, there are many other bank charges that borrowers face that will keep the cost of borrowing high.

Economic forecast

International assumptions International assumptions summary (% unless otherwise indicated) 2004 2005 2006 2007 Real GDP growth World 5.1 4.5 4.2 4.0 OECD 3.2 2.6 2.5 2.3 EU25 2.4 1.7 2.1 2.2 Exchange rates ¥:US$ 108.1 110.1 112.5 104.5 US$:€ 1.244 1.245 1.253 1.338 SDR:US$ 0.675 0.677 0.679 0.653 Financial indicators € 3-month interbank rate 2.13 2.15 2.64 3.33 US$ 3-month Libor 1.62 3.57 5.21 4.77 Commodity prices Oil (Brent; US$/barrel) 38.5 54.7 60.0 55.3 Gold (US$/troy oz) 409.5 445.0 525.0 493.8 Copper (US cents/lb) 129.5 166.8 150.0 95.8 Industrial raw materials (% change in US$ terms) 21.0 10.4 -1.3 -10.7 Note. Regional GDP growth rates weighted using purchasing power parity exchange rates.

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Although growth in the global economy is forecast to decelerate over the outlook period, to a forecast 4.2% in 2006 and 4% in 2007, it will still compare favourably to the rates achieved for much of the 1990s. Mainly in response to the need to rebuild stocks, growth in global demand for copper"Zambia!s largest export"is expected to increase in 2006. In 2007 a weaker outlook for the US, subdued demand in the EU and slowing demand growth in China will combine to lower global demand. The higher prices seen throughout 2005 will encourage producers to increase supply in 2006, which is expected to lead to oversupply in 2007. Owing to increased production combined with softening demand, average copper prices are expected to decline moderately in 2006, to 150 US cents/lb, before sharper falls are recorded in 2007, with the price averaging 95.8 US cents/lb. Continued industrial growth in India and China will keep oil demand high over the forecast period. On the supply side, there are growing concerns that there is a lack of spare capacity among OPEC producers. As a consequence, we expect the price of benchmark dated Brent Blend to remain high, at an average of US$60/barrel (/b) in 2006, before easing to US$55.3/b in 2007 as stocks and spare capacity increase.

Economic growth Continued strong expansion of copper production"reflecting the high levels of investment that have been made in the sector over the past five years"will provide a boost to real GDP growth during the forecast period. However, the sector will remain vulnerable to temporary production disruptions, such as fuel shortages and industrial unrest, which reduced production in 2005. On a slightly more negative note, investment is expected to slow as many of the mining projects that are currently in the development stage reach completion and because few new projects will be started owing to the worsening outlook for copper prices. As a result of these trends, real GDP growth in 2006 is forecast at 6.2%. In 2007 additional production increases are expected to come on stream, but a further decline in prices will restrict investment. In addition, growth in government consumption is likely to fall after the elections. Thus, real GDP growth is forecast at 5.8% in 2007. After copper, agriculture is probably the most important sector of the economy, given that it is the country!s main source of employment. Maize output has been hit hard by drought in 2005, and food security problems are, therefore, likely to affect a large proportion of the population into the forecast period. Coupled with the effects of HIV/AIDS, this will reduce the productivity of those affected and, in turn, their earnings and consumption. However, assuming normal weather conditions in 2006-07, a modest pick-up in agricultural growth is expected. In terms of its contribution to total GDP, services represents the largest sector of the economy. There is expected to be reasonable services growth, in line with increasing economic activity, greater demand from the mining sector as copper production increases and strong tourism growth. Although manufacturing performance is heavily influenced by food processing, the sector is expected to perform relatively well over the forecast period, owing to strong growth in the tobacco, beverages and chemicals sub-sectors. However, continuing electricity shortages will hold back more significant levels of manufacturing growth. The building of new hydroelectric power stations,

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combined with donor-funded work on infrastructure improvements, will ensure continued strong growth in construction.

Inflation Although the fiscal deficit will not be large enough to push up overall inflation, it will still limit the likelihood of inflation coming down quickly in 2006-07. In addition, trends in food and oil prices will continue to be important determinants of inflation during the forecast period. Early indications are that food production will increase substantially in 2006 and, assuming that normal weather conditions continue during the remainder of the forecast period, food prices should come down. However, in 2006 only a small fall in inflation is expected, to 16.5%, owing to high oil prices coupled with election-related expenditure. In 2007, given lower oil prices, inflation should fall further, although the persistent fiscal deficit as tax revenue stagnates will prevent a significant fall, and inflation is therefore forecast to average 13%.

Exchange rates Owing to a combination of strong copper exports, a weak US dollar, donor support and growing investor confidence following the attainment of HIPC completion point, the kwacha appreciated strongly during 2005. The currency ended the year at ZK3,416:US$1 and averaged ZK4,464:US$1 for 2005 as a whole, representing an annual appreciation of 26.6%. Further appreciation is expected in early 2006, before falling copper prices, high inflation and election-related uncertainty affect confidence in the currency. Therefore, the kwacha is expected to depreciate during the second half of 2006 and into 2007. However, an overall appreciation is expected in 2006, owing mainly to the strong performance in the early part of the year, and the kwacha is forecast to average ZK3,400:US$1. The average exchange rate is then forecast to depreciate to ZK4,276:US$1 in 2007. Historically the kwacha has been vulnerable to sharp bouts of depreciation, and these could recur in the forecast period. Predicting the timing of these is difficult, but possible triggers could be a deterioration in relations with the IMF, a stronger collapse in copper prices than anticipated or a deterioration in the political scene during the elections. Although intervention by the central bank might smooth out short-term fluctuations, this would postpone rather than avert a sharp depreciation.

External sector Although copper production is expected to increase over the forecast period, international prices are likely to fall. In 2006 the production increase will out- weigh the price fall, and total exports are therefore expected to increase, to US$2.4bn, from US$2.1bn in 2005. However, a steeper price fall is expected in 2007 and exports are forecast to decline to US$2.1bn. On a more encouraging note, non-metal exports, such as tobacco and horticultural products, are forecast to perform strongly during 2006-07, although their rate of growth is expected to fall back in 2006 as the strong kwacha affects competitiveness. Imports are projected to increase from US$2.1bn in 2005 to US$2.3bn in 2006, driven largely by high oil prices and higher government spending as elections approach. In 2007 imports are expected to fall back marginally as global oil prices decline and investment in the Zambian mining sector slows. An increase in trade- related costs in 2006, associated with the rise in imports and election-related spending, will more than offset higher tourism revenue, causing the services

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deficit to widen. In 2007 trade-related costs for exports of copper will remain high, but those related to import demand for copper investment products and the elections will fall, resulting in a narrowing of the services deficit. Increased profit remittances by mining companies will cause the income deficit to widen in 2006, but lower copper prices will see a fall in profit remittances and a decline in the income deficit in 2007. Current transfers are expected to remain high as donors continue to support the country. However, compared with recent years, donor assistance is not expected to increase substantially, since relations are likely to be strained as the elections approach and government spending increases. Overall, the current-account deficit is forecast to narrow to 5.3% of GDP in 2006, before widening to 6.2% of GDP in 2007.

Forecast summary (% unless otherwise indicated) 2004 a 2005 b 2006c 2007c Real GDP growth 5.4 b 5.1 6.2 5.8 Gross industrial growth 10.4 b 7.9 10.2 8.8 Gross agricultural production growth 4.3 b 2.8 4.5 3.5 Consumer price inflation (av) 18.0 18.3 a 16.5 13.0 Consumer price inflation (year-end) 17.5 15.9 a 16.2 10.4 Short-term interbank rate 30.7 28.5 a 28.0 26.0 Government balance (% of GDP) -1.6 b -2.5 -3.2 -3.5 Exports of goods fob (US$ m) 1,810.0 2,127.1 2,443.4 2,100.2 Imports of goods fob (US$ m) 1,727.0 2,068.0 2,316.2 2,258.3 Current-account balance (US$ m) -286.0 -419.9 -577.7 -634.2 Current-account balance (% of GDP) -5.4 b -6.0 -5.3 -6.2 External debt (year-end; US$ bn) 6.4 b 4.6 4.2 4.5 Exchange rate ZK:US$ (av) 4,778.9 4,463.5 a 3,399.9 4,275.8 Exchange rate ZK:¥100 (av) 4,419.8 4,055.0 a 3,022.1 4,091.7 Exchange rate ZK:€ (av) 5,943.7 5,555.9 a 4,258.3 5,718.9 Exchange rate ZK:SDR (av) 7,078.3 6,597.0 a 5,007.3 6,552.0 a Actual. b Economist Intelligence Unit estimates. c Economist Intelligence Unit forecasts.

Gross domestic product Consumer price inflation (% change, year on year) (av; %)

Zambia Sub-Saharan Africa Zambia Sub-Saharan Africa 7.0 25

6.0 20 5.0

4.0 15 3.0

2.0 10 1.0

0.0 5 02 03 04 05 06 07 02 03 04 05 06 07 2001 2001

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The political scene

Mr Mwanawasa agrees to a Civil society groups and the opposition political parties secured a significant constituent assembly coup in February 2006 when the president, Levy Mwanawasa, backed down from a long-standing debate and agreed to adopt the new constitution through a constituent assembly representing a cross section of Zambians. The debate over a new constitution has been raging ever since the contentious and flawed 1996 constitution was implemented, and a well-attended protest on the issue was held in November 2005 (December 2005, The political scene). A constituent assembly is popular with civil society and the opposition as they have little faith that a constitution approved via a parliament that is dominated by the ruling Movement for Multiparty Democracy (MMD) would serve the people rather than the governing politicians. Mr Mwanawasa and the MMD had long held out against the calls for a constituent assembly; they had cited the cost implications, but an ulterior motive appears to have been Mr Mwanawasa!s fears that he might not win a second term should a popular new clause on the election of the president be implemented. Many educated Zambians want the next president to be elected through a 50%-plus-one voting system instead of the current first-past-the post or simple-majority system. Under the current system, the various tribal and ethnic divisions within Zambia, combined with the attractiveness of the power that comes with being president, ensure that the vote at presidential elections is split between a wide number of candidates. Mr Mwanawasa came to power in 2001 with less than 30% of the overall vote and with such a weak mandate from the voters, he has not been a popular president.

The president has probably As well as representing a triumph for the opposition and civil society groups,

made a shrewd move Mr Mwanawasa!s climbdown could actually be a very shrewd move on the part of the president. His move will appeal to voters who will credit him listening to their requests, but it will also buy him some time to delay the constitution!s implementation until after the presidential and legislative elections due in the second half of 2006. Mr Mwanawasa said that the government would facilitate the creation of a constituent assembly through amendments to the current constitution, but warned that there would be no shortcuts taken. In addition, a referendum will have to be conducted to ask Zambians formally how they want a new constitution to be adopted, and this will be a relatively lengthy process. Mr Mwanawasa!s determination to follow correct procedure in adopting the new constitution should go some way towards avoiding the controversy that has surrounded previous constitutions, and therefore the opposition and civil society will find it difficult to argue against his thorough approach. However, it also means that a new constitution is highly unlikely to be in place in time for the next elections, thus vastly improving Mr Mwanawasa!s chances of securing a second and final term in office under the existing voting system.

Splits in the MMD are still Although Mr Mwanawasa was quick to emphasise that he had wanted to listen

prevalent to the "will of the people" as regards the constituent assembly, it was probably the "will of his party" that swayed him. Mr Mwanawasa!s pronouncement

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came after legislators from the MMD voted overwhelmingly to adopt the constitution by a constituent assembly. The matter had been put to a secret ballot during consultations in the ruling party; among those that attended the meeting, 42 legislators voted in favour of a constituent assembly, while only two voted that parliament should adopt the constitution. Although the MPs would have been mindful of the wishes of their constituents in deciding on which way to vote, the secret ballot also presented Mr Mwanawasa!s opponents in the party with an opportunity to indicate their displeasure with him without facing the wrath of the president!s allies or the risk of losing their positions as deputies or cabinet ministers. Mr Mwanawasa has had to work hard since his election victory in 2001 to maintain his grip on power within the party and, although he appeared to be winning the battle at the MMD!s 2005 convention (September 2005, The political scene), it is clear that wide divisions are still prevalent in the party.

The MMD wins three more The MMD increased its parliamentary majority further when it won three seats

by-elections in by-elections held in January. The Chama South seat in Eastern province fell vacant owing to the death of Forum for Democracy and Development (FDD) legislator, Chile Ng’uni. Elsewhere in the same province, the Milanzi seat opened up after Rosemary Banda resigned from the United National Independence Party (UNIP) to join the MMD, which immediately adopted her as its candidate in the by-election. In addition, the Roan constituency in the Copperbelt town of Luanshya fell vacant after Cameron Pwele of UNIP died. The opposition again split its vote by fielding numerous candidates for each constituency. A failure amongst the opposition to agree upon which parties should contest which seats has played into the hands of the MMD during by- elections time and again (June 20005, The political scene). Nine parties fielded candidates in the Roan constituency where Joseph Chilambwe of the MMD emerged victorious. Five parties contested the Chama South seat, where the MMD!s candidate, Boniface Nkhata, won comfortably. Meanwhile, four parties took part in the Milanzi by-election and Ms Banda retained her seat, this time under the MMD. The results serve as another lesson to the opposition that if they want to win the presidential and general elections later in 2006, some form of coalition will be necessary. Aside from the splits in the vote caused by squabbling amongst the opposition parties, the losses in Eastern province signified the end of UNIP’s dominance in the region. UNIP had dominated in the province since the reintroduction of multiparty politics in 1991, but divisions in the former ruling party have made it ineffective and reduced its capacity to mobilise support even in a province where it had many strong supporters. The MMD was keen to capitalise on UNIP!s weakness, and transported in some of its supporters from the capital, Lusaka, to step up its campaigning. This caused tensions in Milanzi to rise and provoked some claims that the MMD!s supporters had intimidated villagers and damaged a vehicle owned by a civic group which had gone to Milanzi to persuade voters not to re-elect Ms Banda.

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Composition of parliament (no. of MPs, end-Jan 2005) Elected MPs Nominated MPs Total Movement for Multiparty Democracy (MMD) 80 8 88 United Party for National Development (UPND) 41 - 42 United National Independence Party (UNIP) 11 - 11 Forum for Democracy and Development (FDD) 11 - 11 Heritage Party 2 - 2 Patriotic Front (PF) 2 - 2 Zambia Republican Party (ZRP) 1 - 1 Independent 1 - 1 Total seats in parliament n/a n/a 158 Note. The president can appoint up to eight MPs. Mr Mwanawasa has appointed all of these from the MMD. Sources: Electoral Commission of Zambia; Economist Intelligence Unit.

The prospects for opposition Having apparently learned from their poor showing in the 2001 elections and unity improve recent by-elections, Zambia!s three main opposition parties agreed on March 1st to field a single presidential candidate, in what represents the most potent threat to Mr Mwanawasa!s re-election. The United Party for National Development (UPND), the Forum for Democracy and Development (FDD) and the United National Independence Party (UNIP) will come together under the banner of the United Democratic Alliance (UDA) and intend to pick their presidential candidate at a joint congress later this year. The three parties currently supply the bulk of Zambia!s opposition legislators in parliament and control one-third of the country!s nine provinces, including Lusaka. Such a coalition represents the best chance for the opposition to defeat Mr Mwanawasa at the presidential election"the 50%-plus-one voting system is unlikely to be implemented in time for the election"as it would give the fractured opposition the opportunity to vote together as a block. Opposition alliances have featured before in Zambian politics, but no major coalition has ever survived long enough to contest elections. The problem remains that few, if any, opposition leaders are willing to stand down in order to support another opposition candidate, owing to the personalities involved and the widespread ambition to ascend to the powerful position of president. For these reasons, the Economist Intelligence Unit remains sceptical that the UDA will last long enough to field a single presidential candidate at the election.

Mr Mwanawasa bans use of Although his re-election campaign has been unofficially under way for some public funds in poll campaigns time (December 2005, The political scene), Mr Mwanawasa only officially launched his campaign in February. He said on February 18th that an election date would be announced soon, and hinted that it was likely to be in October. He went on to urge MMD supporters to start serious campaigning. Later in February Mr Mwanawasa reaffirmed his determination that no public funds will be used for his campaign and those of the MMD!s parliamentary candidates. Mr Mwanawasa said that he, together with his ministers, would only use government facilities that are their entitlement and that the MMD would raise its own finances.

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Already under Zambian law it is illegal to use public funds in an election campaign, so Mr Mwanawasa was only stating his commitment to abide by the law. However, after the controversy that surrounded the 2001 elections, when opposition parties petitioned the Supreme Court claiming that the MMD had abused state finances, Mr Mwanawasa!s statement was presumably intended to reassure the public that the elections would be better conducted this time around. Even though the Supreme Court dismissed the opposition petition owing to a lack of nationwide evidence, there was sufficient evidence of misdemeanours by the MMD to discredit the president and his party in the eyes of many Zambians.

An expelled legislator is On February 26th the MMD announced that it had re-admitted an expelled

re-admitted to the MMD legislator, Austin Chewe. Mr Chewe was suspended from the MMD in July 2005 shortly before he was due to contest the vice-presidency of the party at its convention (September 2005, The political scene). His expulsion came amid claims of corruption, although it is widely thought that the allegations were a cover story aimed at discrediting a rising star in the party who posed a threat to Mr Mwanawasa!s leadership. However, Mr Chewe, a powerful businessman, has remained extremely popular both within the MMD and among the electorate despite his expulsion, and this will not have gone unnoticed in an election year. It is likely that the MMD leadership feared that he would harm their election campaign if he joined an opposition party. In addition, the MMD also stands to benefit from his wealth as he is likely to provide a significant share of the financing for Mr Mwanawasa’s campaign.

The MMD nullifies elections On February 23rd the MMD nullified the results of primary elections held in

for parliamentary candidates constituencies countrywide to select its parliamentary candidates. The MMD!s national secretary, Katele Kalumba, said that the poll results had been cancelled to enable other party members to submit their nomination papers, in view of overwhelming interest from MMD members who wanted to be adopted as official candidates for the 2006 elections. However, rather than giving more time to additional MMD members to contest the primaries, it seems that the ruling party wants to create room for the legislators that are currently serving in the government but belong to opposition parties. These candidates cannot defect now without creating unnecessary by-elections, but will almost certainly leave their respective parties to join the MMD when parliament is dissolved. This is because they are highly unlikely to be allowed by their parties to re- contest their seats as they are considered as rebels for having accepted posts as cabinet and deputy ministers in Mr Mwanawasa’s government.

The UPND holds provincial The UPND has been holding its provincial conferences over the last quarter in

elections readiness for a national congress. Unless developments within the UDA dictate otherwise, at the congress Anderson Mazoka is expected to be formally adopted as the party’s presidential candidate. In each of the seven provinces where the UPND has so far held party congresses, Mr Mazoka has been backed as the party’s candidate. The two remaining provinces are also expected to support his candidature. Sakwiba Sikota and Patrick Chisanga look set to be adopted as the two vice-presidents for the party. Although the UPND remains strong in Southern province, it has done little to marshal support in other parts of the

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country. Its chances of forming a government are therefore slim, unless it either significantly improves its campaigning between now and the polls, or teams up with other, more significant, opposition parties.

Reform Party starts door-to- The Reform Party (RP) has yet to make a mark since it was formed in November

door campaigning 2005. The party is led by former vice-president, Nevers Mumba, who was sacked by Mr Mwanawasa in 2003, ostensibly for sparking a diplomatic row with the Democratic Republic of Congo, but probably also because Mr Mumba was becoming too much of a threat. In an attempt to raise the RP!s profile, Mr Mumba launched a door-to-door campaign on February 18th, which aims to target 5m households. It is an ambitious target for a small party which lacks a national presence, and needs to be a spectacular success if the party is to make any impact in the 2006 elections.

The FDD is struggling to make After accumulating debts running into billions of kwacha in the 2001 elections,

an impact the FDD has so far struggled to get any significant election campaigning under way. The campaign of the FDD!s president, Edith Nawakwi"the first woman to lead a political party in Zambia"ran into problems in December when a powerful women!s group, the Non-Governmental Organisation Co-ordinating Committee (NGOCC) unexpectedly declined to rally behind her. If the NGOCC had declared its support for Ms Nawakwi in the elections, she would have been a much stronger force. Now she will have to rely on the support that the FDD enjoys, which has diminished following the loss of some of its key members to Mr Mwanawasa’s government"the FDD subsequently tried to expel the defectors from the party. The legislators in question, namely Dipak Patel, Geoffrey Samukonga, and Patricia Nawa, have hung on to their FDD membership owing to an ongoing and damaging court case after they challenged their expulsion. The FDD remains popular in the capital, Lusaka, and should perform well there, but its performance elsewhere in the country is likely to be disappointing.

Patriotic Front draws up a new The president of the Patriotic Front (PF), Michael Sata"Mr Mwanawasa’s

manifesto bitterest rival owing to great personal animosity between the two"said in February that the PF was in the process of drawing up a new election manifesto. The PF does not appear to be organising any party conferences and Mr Sata is likely to enter the presidential race without having to win any election within his party. The PF had initially appeared set to win most seats in Copperbelt province where it enjoys some support. However, that support now appears to have waned owing to the party’s inability to organise support at the grassroots.

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Potential 2006 presidential candidates

Since it appears unlikely that the opposition will unite behind a common candidate, the 2006 presidential election will probably be contested by numerous candidates, although only a few can hope for much success. Levy Mwanawasa The advantages incurred by incumbency, primarily the logistical ability of the ruling Movement for Multiparty Democracy (MMD) to campaign nationally, makes Mr Mwanawasa a firm favourite. Mr Mwanawasa has also performed relatively well on the economic front; his government has reduced poverty to 65% from 73% two years ago, lowered inflation to 15.9% from the high 20s, and achieved average growth of 4.5% in the last four years. Anderson Mazoka Mr Mazoka will benefit from representing the most viable opposition party, the United Party for National Development (UPND), and has what many Zambians consider the best manifesto. However, poor health may restrict Mr Mazoka!s campaigning and the MMD has stolen some of his thunder by implementing suspiciously similar policies to those espoused by the UPND. Michael Sata Mr Sata has played populist politics and has touched on key issues such as reducing taxes, which play well on people’s minds. Mr Sata’s track record as a hardworking minister in all the ministries he has served in ensures that he will be rated highly by many, although most intellectuals see his humble education as a problem for anyone seeking to run for the office of president. Mr Sata is, however, popular with many ordinary Zambians. Edith Nawakwi Ms Nawakwi, the leader of the Forum for Democracy and Development (FDD), is a vibrant woman who is more than capable of operating effectively in a male- dominated political system. She has much experience in the upper echelons of government service, where she has served as finance minister and later as energy minister. If she can marshal the support of female voters whilst keeping the FDD!s traditional supporters appeased, then she could perform well. Nevers Mumba Mr Mumba’s support base will mainly be from his native Northern province and the Christian community. Mr Mumba needs to redeem himself from the stigma of being a perceived sell-out, after he abandoned his colleagues in the opposition to work with Mr Mwanawasa in 2003. He is a good orator and is seen by many as a politician with a clean track record.

The government resists media The government has continued to resist media reforms, when the information

reforms and broadcasting minister, Vernon Mwaanga, ignored a court order to name in parliament the people selected to serve on the Independent Broadcasting Association (IBA). The IBA is supposed to be an independent board that will supervise the operations of the state broadcaster, the Zambia National Broadcasting Corporation (ZNBC), in order to make it independent of the government’s influence. The court case was brought by the Press Association of

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Zambia, the Media Institute of Southern Africa, the Zambia Union of Journalists, the Zambia Media Women!s Association (Zamwa) and the Society for Senior Journalists. The High Court instructed Mr Mwaanga to present the names to parliament on December 23rd, but he refused to do so. A lawyer representing the media bodies that brought the case to court, Sakwiba Sikota, said on February 17th that contempt of court proceedings had been filed against Mr Mwaanga, a charge that carries with it the threat of imprisonment. Mr Mwaanga stated in February that the delay in presenting the names was due to the fact that the government is still making consultations on the matter. This is seen by the independent media and opposition as a delaying tactic. Given that elections are due later in the year, the fear is that the government intends to maintain a firm grip on the IBA in order to manipulate the state broadcaster and ensure that it receives more air time than the other parties during its campaigning.

Economic policy

The 2006 budget aims to build The minister of finance and national planning, Ng’andu Magande, presented upon previous successes the 2006 budget on February 3rd. Under the theme, From sacrifice to equitable wealth creation, Mr Magande explained how the 2006 budget was designed to consolidate on the gains made in 2005 and further strengthen the economy by directing resources towards priority programmes. Such programmes focus on road infrastructure, water supply and sanitation, agriculture, education and health. This represents a sensible policy orientation as the government seeks to move the economy away from its dependence on copper mining and a history of economic fluctuation caused by the vagaries of the commodities markets. The budget was set within the context of the government!s macroeconomic targets for 2006, which are to: • achieve real GDP growth of 6%; • bring year-end inflation down to 10%; • reduce domestic government borrowing to 1.6% of GDP (this is the definition of the budget deficit used by the Zambian government); and • maintain official gross international reserves equivalent to at least 1.5 months of import cover. All of these targets are achievable, but some are more likely to be achieved than others. Real GDP growth should improve in 2006 on the back of rising copper production as well as improvements in agriculture, manufacturing and the services sector. Although the government and the Bank of Zambia (BoZ, the central bank) have succeeded in establishing a monetary environment of declining inflation, inflation targets have often been missed in previous years. The early indications for inflation in 2006 are good (see The domestic economy), but election-related expenditure, drought, import growth and a depreciating kwacha later in the year could halt the progress that has been made in bringing inflation down. Owing to a sustained period of sensible budget making, the fiscal deficit is expected to be well below the levels seen in the early 2000s, of 6-8% of GDP. However, the target of a deficit of 1.6% of GDP

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may prove to be overly ambitious. A similar level was recorded in 2004, but this was achieved when the government was attempting to qualify for a new poverty reduction and growth facility (PRGF) with the IMF. To reach that level the government had to implement a public-sector wage freeze, amongst other austerity measures, something that it will be very unwilling to do in an election year. Therefore, although domestic revenue is expected to increase in line with the strong economy, the budget deficit is unlikely to meet the government!s target. Finally, buoyant exports and significant donor inflows have dramatically improved Zambia!s foreign reserves position over the last two years, and the government!s official import coverage target of 1.5 months"which is low by international standards"should be easily achievable.

A large increase in current Overall budget expenditure is expected to increase by under 5% in nominal

expenditure is planned terms when compared with the 2005 budget (March 2005, Economic policy). This translates as a reduction of budget expenditure as a percentage of GDP, from 31% in 2005 to 27% in 2006. However, a large increase of 34% in nominal terms is planned for current expenditure. Much of this is accounted for by a large increase in personal emoluments, which will be directed towards recruiting additional teachers, doctors and nurses. Mr Magande stated that the Treasury intended to recruit 4,578 teachers and 800 nurses and doctors during 2006 to plug a shortage caused by an exodus of trained staff to Europe and the US in search of better paying jobs. Treasury data indicate that Zambia has only 800 doctors, out of the estimated 1,400 that the country needs, while more than 2,500 nurses currently work abroad. Zambia currently has only about 43,000 primary and high school teachers, with a teacher to pupil ratio of around 1:60 instead of the recommended 1:30. The need for additional school and health workers is obvious, but it is questionable whether enough staff can be attracted and then trained to fill the gap. The 2005 budget also highlighted the need for many more teachers, and although the government was successful in boosting recruitment, teachers continued to leave the country and the skills gap has persisted. Elsewhere in current expenditure, the government has budgeted Zk239.6bn (US$72.9m) for the 2006 presidential and legislative elections. Donors subsequently announced that they would be contributing US$10m, but even so, in such a large country with poor infrastructure, this may not be enough. Current expenditure!s share of total expenditure increases to 67% in 2006, from 52% in the 2005 budget. This has left less room for capital expenditure, which accounts for 22% of total expenditure, down from 29% in 2005. This could impact upon certain key programmes, such as road infrastructure and water supply and sanitation, but it also reflects the government!s desire to lessen its dependence on donor assistance"foreign-financed capital programmes are expected to decline by almost 40% compared with the 2005 budget. The government proposes spending the remaining 12% of total expenditure on constitutional and statutory expenditure, a major component of which is debt service. This should be significantly lower than in 2005, owing to the various debt-relief agreements that Zambia has become eligible for.

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2006 budget: expenditure Allocation (ZK bn) % of total budget Current expenditure 6,853.5 67.0 Personal emoluments 3,022.8 29.5 Other personal emoluments 113.2 1.1 Recurrent departmental charges 1,851.6 18.1 Tri-partite elections 239.6 2.3 Arrears to suppliers of good & services 100.0 1.0 Fertiliser support programme 198.7 1.9 Strategic food reserve 50.0 0.5 Financial restructuring 92.3 0.9 Contingency 6.9 0.1 Grants & other payments 1,518.0 14.8 Public service pensions fund 254.0 2.5 Zambia Revenue Authority 127.0 1.2 Capital expenditure 2,203.7 21.5 Domestically financed 828.9 8.1 Foreign financed 1,374.8 13.4 Constitutional & statutory expenses 1,179.4 11.5 Domestic debt 777.6 7.6 Foreign debt 378.0 3.7 Constitutional posts 23.7 0.2 Total 10,236.6 100.0

Source: Ministry of Finance and National Planning, Budget address.

The machinery of government In terms of its spending plans by function, the government can be commended continues to suck up resources for its determination to increase the share spent on education and health. However, these improvements fail to mask the fact that "general public services" continues to be by far the largest destination for expenditure, with a share of over 40%. This includes financing for the bloated civil service, a few remaining loss-making parastatals and an insolvent public pensions system. Tackling these issues remains a difficult challenge for the government.

2006 budget: expenditure by function of government Allocation (ZK bn) % of total budget General public services 4,188.9 40.9 Defence 654.9 6.4 Public safety & others 391.7 3.8 Economic affairs 1,844.8 18.0 Roads 904.5 8.8 Agriculture & fisheries 580.0 5.7 Environmental protection 43.3 0.4 Housing, community development & amenities 292.0 2.9 Health 1,098.4 10.7 Recreation, culture & religion 29.7 0.3 Education 1,647.4 16.1 Social protection 45.7 0.4 Total 10,236.6 100

Source: Ministry of Finance and National Planning, Budget address.

Attempts to widen the tax base The Treasury introduced a range of new taxes and also raised some existing

receive an early blow ones, in line with advice from the IMF. This included some efforts to tackle the difficult task of bringing more of the informal-sector operators into the tax system. To this end, Mr Magande announced the introduction of a 45% withholding tax on payments to suppliers of goods and services who do not possess tax clearance certificates. The tax, however, received major criticism from the Zambia National Farmers! Union (ZNFU), who felt it would hurt small- scale farmers who would struggle to cope with the additional bureaucracy. Another government tax initiative that attracted fierce criticism was the decision to apply value added tax (VAT) to all agricultural products, including fertilizers and pesticides but excluding baby cereals and the maize and flour produced from them. Mr Magande argued that end prices for agricultural products would not necessarily have to rise in line with the VAT rate of 17.5% as the producers would now be able to claim back the VAT paid for their inputs. However, this sparked further outrage from the ZNFU, which was quick to point out that many of Zambia!s small-scale farmers are not VAT registered and would therefore be unable to reclaim the taxes paid on their inputs. Confusion reigned in the days after the budget, with some farmers charging VAT and others not. Protests by farmers and subsequent increases in the prices of some farm products forced the government to reconsider its decision, and on February 21st Mr Magande announced that the VAT on agricultural inputs was being scrapped. He added that the measure would lead to a Zk33.2bn (US$10m) loss in government revenue, which would affect the government’s plans to reconstruct roads in key farming areas.

Tax incentives aim to boost the In an attempt to revitalise the moribund textile industry in Zambia"which domestic textile industry cannot compete with cheap textile products from China and the Far East Asian nations"Mr Magande announced plans to suspend customs duty on textile raw materials for a period of five years. In addition, the customs duty on finished polyester and cotton fabrics was raised to 25% from 15%. Protecting the local textile industry is seen as a way of safeguarding employment and making the industry competitive. However, after several years of decline and closure by some of the textile firms, such measures are unlikely to bring immediate relief to the sector. Also, such efforts at protectionism tend to be frowned upon by the Bretton Woods institutions.

2006 budget: revenue and financing (ZK bn) Tax revenue 6,672.2 Direct taxes 2,898.5 Company income tax 492.1 PAYE 2,030.0 Other income tax 325.7 Mineral royalty tax 44.1 Medical levy 6.6 Excise taxes 965.3 Fuel levy 204.9 Other excises 760.4 Domestic VATa 846.8 Trade taxes 1,961.6 Import tariffs 754.6 Import VAT 1,207.0 Non-tax revenue 139.8 User fees & fines 63.2 Vehicle licences & fees 53.5 Dividends, interest & other levies 23.1 Exceptional revenue 147.8 Fertilizer recoveries 115.0 Other 32.8 Domestic financingb 592.0 Total domestic revenue & financing 7,551.8 Foreign financing 2,684.8 Project financing 2,286.0 General budget support 398.8 Total revenue & financing 10,236.6 a Does not include reduction stemming from the government climbdown on agricultural VAT. b In effect, the budget deficit. Source: Ministry of Finance and National Planning, Budget address.

The IMF gives some sound Shortly prior to the budget, the IMF released its annual Article IV Consultation, advice to the government along with its third review of Zambia!s progress under its PRGF. The Zambian authorities were commended by the Fund for broadly achieving the PRGF!s objectives and successfully implementing sound economic policies during 2005. The Fund was pleased that Zambia’s good macroeconomic policy framework had enabled the economy to sustain robust growth in 2005, despite a number of adverse supply shocks. In addition, the IMF felt that the government!s sustained efforts to strengthen the public finances had contributed to improved macroeconomic stability and strong growth, along with the favourable performance of non-traditional exports and the rehabilitation of the mining sector following privatisation. It was not all praise for the Zambian government, however, as the IMF clearly did not want complacency to creep in and so provided some sound advice for future policy direction: • the government needs to guard against potential pressures on economic performance in an election year;

• Zambia must closely co-ordinate fiscal and monetary policies to help break expectations of high inflation; • strengthening the government!s public expenditure management and financial accountability (PEMFA) system is critical for increasing the efficiency and effectiveness of the public sector; • efforts should be made to get around the delays in the implantation of the integrated financial management and information system (IFMIS), which will enable the Treasury to centrally monitor the disbursement and use of public finances by government ministries and departments; • the expansion and deepening of financial intermediation is critical for private-sector-led growth; • it is essential that Zambia follow through with planned measures to resolve the problems of financially troubled non-bank financial institutions and finalise the privatisation of the Zambia National Commercial Bank (Zanaco); • poverty remains a big problem with 65% of the country’s 10m people living below the World Bank poverty threshold of US$1 per day; and • the appreciation of the kwacha, supported by the improvement in Zambia!s longer-term prospects, points to the importance of increasing productivity in order to maintain competitiveness and shore up growth.

Some IMF recommendations Controlling election-related expenditure may prove difficult for the government.

are unlikely to be met The amount allocated in the budget for running the elections appears quite low, and the government has already been forced to abandon some of its new revenue-raising measures in the face of popular discontent. Inflation has been on a downward trend for a sustained period, in line with the implementation of tighter fiscal and monetary policy. However, the prime factor behind the high levels of inflation still evident is food prices; the government has struggled to tackle these and they depend ultimately on the prevailing weather conditions. Some expansion in bank credit to the private sector has taken place, facilitated by reduced government borrowing. But for real progress to be made, the government needs to enhance its financial-sector supervision in order to boost confidence in the system. The debt relief awarded to Zambia over the past year provides a significant opportunity for directing greater resources to increasing economic growth and reducing poverty. To this end, the government has revised the Zambian National Development Plan to map out how it intends to progress towards meeting the Millennium Development Goals, and this should help to reduce poverty. Caution still needs to be applied, however, as the government is at risk of making more fiscal promises on poverty reduction than the debt relief it actually receives will be able to facilitate. The rapid appreciation of the kwacha over the past year represents a threat to Zambia!s external competitiveness. The fact that non-traditional exports have continued to post strong growth is encouraging in this respect, but if the kwacha continues on its upward path during 2006, then such exports could be at risk.

The domestic economy

Economic trends

The budget details the During his budget speech, the minister of finance and national planning,

achievements made in 2005 Ng!andu Magande, provided an overview of the economic achievements made in Zambia during 2005. Real GDP growth in 2005 was estimated at 5.1% compared with 5.4% the previous year. The government had forecast that real GDP growth would reach 6.0% in 2005, but a fuel crisis in September and October made this target impossible to reach (December 2005, The domestic economy: Energy). The fuel shortage affected production at the copper mines, which play such an important part in the Zambian economy (see Mining). As a result, the mining sector grew by just 2.8% in 2005, a decline from the 13.9% growth posted in 2004. The fuel shortages also affected other sectors, such as manufacturing and transport, where growth was below potential. Another factor which caused GDP growth to slow down was reduced agricultural production owing to drought, which forced Zambia to import the staple, white maize. Annual inflation had declined to 15.9% by the end of 2005, from 17.5% at the end of 2004. This was above the government!s target of 15%, as food prices remained high, but represented the lowest rate of inflation in Zambia for over ten years. The budget deficit was estimated to have expanded to 1.9% of GDP compared with 1.6% of GDP in 2004. Again, this was above the government!s target (which was 1.6% of GDP), mainly because of the settlement of arrears with road contractors. Honouring its local debts remains a problem for the government (June 2005, Foreign trade and payments).

Real GDP growth by activity (% increase, year on year) 2001 2002 2003 2004 2005a Agriculture, forestry & fishing -2.6 -1.7 5.0 4.3 2.8 Mining & quarrying 14.0 16.4 3.4 13.9 2.8 Manufacturing 4.2 5.7 7.6 4.7 3.7 Electricity & water 12.6 -5.2 0.4 -1.7 5.4 Construction 11.5 17.4 21.6 20.5 19.9 Wholesale & retail trade 5.4 5.0 6.1 5.0 6.1 Restaurants, bars & hotels 24.4 4.9 6.9 6.4 12.1 Transport, storage & communications 2.8 1.8 4.8 6.4 8.5 Financial institutions & insurance 0.1 3.5 3.5 3.5 3.5 Real estate & business services 3.5 4.4 4.0 4.0 4.0 Community, social & personal services 5.8 1.6 1.6 0.6 3.6 Total gross value added 4.6 4.6 6.0 6.2 6.0 Taxes on products 7.0 -6.8 -2.8 -3.1 -4.1 Real GDP growth 4.9 3.3 5.1 5.4 5.1 a Estimates. Source: Central Statistical Office, The Monthly.

February inflation declines Having fallen to 15.9% in December 2005, annual inflation has continued to

to 10.3% decline in 2006, averaging 12.2% in January and 10.3% in February, according to the Central Statistical Office (CSO). The decline was largely due to a fall in food prices, aided by price falls for household energy, furniture and household appliances. Annual food inflation was recorded at 10.2% in February, down from 12.8% in January 2006, while annual non-food inflation fell to 10.1% in February from 11.5% the previous month. Although this is encouraging news for the government and Bank of Zambia (BoZ, the central bank) as they work towards bringing inflation down into single digits over the next two years, the prospect for a further decline in inflation during the remainder of 2006 is questionable. There is a significant prospect of another drought, which would push up food prices, and government spending, import growth and currency depreciation could all be higher than expected. A combination of such factors is likely to restrict further falls in inflation and the Economist Intelligence Unit thus forecasts average annual inflation of 16.5% in 2006.

The kwacha strengthens After having remained fairly stable in real terms during 2000-04, the kwacha

against major currencies appreciated strongly against the US dollar in 2005. Over the year the kwacha appreciated by 27% in nominal terms, reaching ZK3,416:US$1 in December and averaging ZK4,464:US$1 for the year. This appreciation was driven by a marked strengthening of market sentiment towards the kwacha, owing to strong exports on the back of record high world prices for copper, a perceived commitment on the government!s part to prudent fiscal and monetary policies, a substantial improvement in Zambia!s debt-sustainability outlook following a number of debt-relief agreements, and a weak US dollar. However, a similar performance is not expected in 2006. Although some appreciation is forecast in the early part of the year, international confidence in the kwacha is likely to wane as 2006 progresses. Copper prices are expected to fall back from the peak reached in 2005 and this will impact on the growth of Zambian exports of the metal, which is a key foreign-exchange earner. Fiscal and monetary policy may suffer around election time, and any election-related instability will also affect confidence in the currency. In addition, were the government to significantly depart from the fiscal discipline espoused by the IMF, another prime source of foreign exchange, donor funds, would be at risk. Finally, although Zambia stands to benefit from a number of debt-relief agreements during the year, particularly from the African Development Bank, the World Bank and the IMF, there could be delays and, in any event, the net benefit of the deals may be significantly lower than expected by the government (December 2005, Foreign trade and payments). Overall, we expect the kwacha to average ZK3,400:US$1 in 2006.

Exchange rate, 2005 (ZK:US$1) Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec 4,785.1 4,758.5 4,710.6 4,675.2 4,691.8 4,685.8 4,624.5 4,401.9 4,439.7 4,346.1 4,026.7 3,416.3

Source: Bank of Zambia.

Agriculture

The president bans white After the poor maize harvest of crop year 2004/05 (May-April), when output of maize exports the staple crop fell to 866,000 tonnes, early indications are that the 2005/06 harvest will be much improved. Farmers! representatives forecast that output will reach 1.2m tonnes. However, the president, Levy Mwanawasa, scoffed at suggestions by millers that they should be allowed to export ground maize meal to the Democratic Republic of Congo where prices are higher. Presumably mindful of the embarrassing u-turn forced upon the government in 2005, when widespread food shortages prompted it to cut import duties after it had denied that maize imports would be necessary (December 2005, The domestic economy: Agriculture), Mr Mwanawasa said that the government would be foolish to allow maize exports without first building up its strategic reserves.

Mining

Copper production was well Copper production was significantly below government forecasts in 2005. Data

below expectations in 2005 from the central bank showed that finished copper output reached 444,090 tonnes, compared with government forecasts at the start of the year that production would reach 550,000 tonnes. The copper mines were adversely affected by a shortage of diesel and heavy fuel oils during the final quarter of the year. The largest copper mining company in Zambia, Konkola Copper Mines (KCM), was forced to cut daily production by half, to 300 tonnes, at the peak of the fuel shortages. The second-largest mining company, Mopani Copper Mines (MCM), was forced to shut down one of its copper smelting plants. Apart from fuel shortages, KCM’s production was also reduced owing to strikes at its Konkola and Chingola copper mines during a pay dispute (September 2005, The domestic economy: Mining). However, it appears that the high levels of investment that have gone into Zambia!s copper sector during the last few years mitigated the problems faced during 2005. A refurbishment of pumps to avoid floods, repairs to shift and conveyor belts, and a greater availability of diesel loaders and locomotives at the major mines, all helped to improve production efficiency.

The future outlook is positive Given that the problems faced in 2005 have now largely been dealt with, production in 2006 is forecast to be buoyant. The Zambia Chamber of Mines (ZCM), a body of professionals which monitors development in the mining sector, projected that Zambia would reach 680,000 tonnes of finished copper production in 2006. Further production increases are expected in 2007, with output forecast at 750,000 tonnes, rising to 1m tonnes by 2010. The ZCM!s executive director, Frederick Bantubonse, said in January that copper production would rise because huge investments in the mining sector have allowed the greater use of modern technology, which has maximised output by the mines, and the opening of new mines. Although we also expect impressive increases in copper mining output, it seems likely that the ZCM has been overly optimistic. 2006 should see a strong rebound as some of the lost production from 2005 is made up, but it is unrealistic to expect no further supply

disruptions. Although 2005 appeared to be somewhat exceptional in terms of the variety and severity of the problems faced by the mining sector, 2006-07 is likely to bring with it its own challenges. Therefore, we expect copper production to reach 550,000 tonnes in 2006 and 630,000 tonnes in 2007.

Chinese firm is to build a new KCM!s head of corporate affairs, Augustine Seyuba, said on January 31st that the shaft at the Konkola mine firm had awarded the Chinese state-owned firm, the China Nonferrous Metal Company, a contract to sink mining shafts at its Konkola Deep Mine Project (KDMP). Mr Seyuba reported that the improvements were expected to boost total copper ore production at the Konkola complex to 6m tonnes/year (t/y), from the current 2m t/y. KDMP is expected to come fully on stream in 2007. On January 27th KCM had handed Finland!s Outokumpu Technology a contract to build a new smelter with a capacity of 300,000 t/y of finished copper. KCM!s biggest smelter is currently at Nkana and has a capacity of 219,000 t/y of copper, and thus the additional smelter will represent a significant widening of capacity. The new smelter is also expected to come on stream in 2007.

Tourism

A key sector records another The tourism sector continued to perform well during 2005; it is estimated to

year of strong growth have grown by 12.1%, compared with growth of 6.4% in 2004. Along with agriculture, the government views tourism as a key priority in terms of boosting economic growth and employment. For the fourth consecutive year the government provided ZK5bn (US$1.5m) for local entrepreneurs to access as development funds, under the Tourism Development Credit Facility. Advertising campaigns at home and abroad continued and there was a resultant increase in tourist arrivals. The political turmoil in Zimbabwe has seen tourists who would ordinarily have visited Zimbabwe now shun that country in preference of Zambia, with which it shares the mighty Victoria Falls. The celebrations to mark the 150 years of the sighting of the Victoria Falls by Scottish explorer, David Livingstone, attracted thousands of tourists to Zambia in 2005, which contributed greatly to the sector’s expansion. Aside from the Victoria Falls, Zambia is also now a popular destination for safaris. However, there have been reported problems with some of Zambia!s estimated 25,000 elephants vying for food and space with the country!s human residents.

Construction

Construction is buoyant The construction sector expanded by 19.9% in 2005, mainly because of the large number of houses built in Lusaka and other major cities. In addition, private investors built shopping complexes and the government’s programme to build more schools, clinics and other infrastructure also enhanced growth in the sector. The construction sector is likely to record impressive growth again in 2006; further residential complexes, as well as shopping centres and two massive power plants, are expected to be constructed during the year (September 2005, The domestic economy: Infrastructure).

Manufacturing

Manufacturing growth is Growth in manufacturing slowed to 3.7% in 2005, from 4.7% in 2004, owing

stunted mainly to the fuel shortages towards the end of the year, which forced industry to scale down production. The sector also continued to face stiff competition from imported goods owing to trade liberalisation policies and the strengthening of the kwacha against major foreign currencies, which made exports uncompetitive and imports cheaper. The government hopes that the introduction of incentives such as the zero-rating of equipment imported for manufacturing use in the newly introduced Multi-Facility Economic Zones (MFEZ)"special industrial zones for firms producing for domestic and export markets"will shore up the sector.

Financial markets

ZNCB is to be listed on the The chief executive of the Lusaka Stock Exchange (LuSE), Joseph Chikolwa, said LuSE in 2006 on January 25th that the long-delayed listing of the state-owned Zambia National Commercial Bank (ZNCB) would go ahead in 2006 in line with agreements reached with international lenders. The Treasury said last year that it would sell 25.8% of ZNCB shares to the public via the bourse and free a further 49% for a strategic equity partner. The Zambia Privatisation Agency (ZPA) is currently in talks with a Dutch co-operative bank, Rabobank, which is the preferred bidder for the strategic stake in ZNCB (December 2005, The domestic economy: Financial and other services). Mr Chikolwa also stated that the mooted linkage of his exchange and the bourse in neighbouring Zimbabwe to the Johannesburg Securities Exchange will probably take place at some point in 2006 if sufficient cash for the project can be raised. Although the LuSE experienced strong growth in 2005, with market capitalisation rising by 11% and the share index growing by over 60%, it remains tiny by international standards. The management of the LuSE therefore sees a Johannesburg tie-up as a way of raising the bourse!s profile and promoting foreign investment. The 14-member Southern African Development Community has a vision of a regional stock exchange by 2008, and has encouraged members to list across borders and experiment on linkages as a foretaste of how it will work.

Infrastructure

Zamtel is to be commercialised The government has announced its intention to commercialise the state-run

during 2006 Zambia Telecommunications Company (Zamtel), and has dropped its initial plans to sell a 20% shareholding through the LuSE. Mr Magande stated that the government would work out plans to grant autonomy to Zamtel and wean it off the government’s subsidy. Although the government intends to facilitate foreign investment in Zamtel so as to help run the firm on a commercial basis, it has shied away from selling a controlling stake, despite previous IMF and World Bank demands to privatise the telecoms firm. Mr Magande said that there was no need to privatise the company because there are already other

private investors in the industry. The government!s reluctance to fully privatise its remaining strategic assets is broadly in line with the general local sentiment, which views the Zambian privatisation policy as a failure that has led to job losses and money flowing out of the country. The ZPA argues that the plight of most of the privatised parastatals would have been much worse if they had remained in public hands, since they would have continued to disintegrate for want of investment. Although this is almost certainly true, neither the government nor the electorate believe this.

New investors take over the In February a consortium known as Zambia Energy Corporation (Zam-En) was

power distributor, CEC formed to take over the ownership of the Zambian power distributor, the Copperbelt Energy Company (CEC). CEC is Zambia’s sole power distributor to the country’s vast copper and cobalt mines and to its mining townships in the Copperbelt region. It purchases power from the state-owned power firm, ZESCO, and then supplies the mines. It also distributes power from the Democratic Republic of Congo!s state power utility, SNEL, to southern African countries using ZESCO!s transmission lines. The two previous major shareholders in CEC"each owned 38.5% of the company"Cinergy of the US and the UK!s National Grid, decided to sell their shares in order to concentrate on power projects in their respective countries. The vast majority of the remaining 23% of the company is owned by the government. Zam-En consists of Zambian investors, the Southern African Development Bank, a London- based private firm, Aldwych, and a Dutch development bank, FMO. CEC intends to sign a two-year technical services contract with National Grid to allow for a smooth transition, while its immediate expansion programmes include the construction of a second Zambia-Congo power interconnector in alliance with SNEL.

Foreign trade and payments

The IMF grants Zambia a large At the end of December the IMF announced that under its multilateral debt-

debt write-off relief initiative it was to grant Zambia 100% debt relief on all debt incurred to the Fund before January 1st 2005 that remained outstanding. The IMF estimated that this debt relief would be worth approximately US$577m, and it duly went through in February. A relief package from the World Bank, Zambia!s largest creditor, is also likely during the forecast period along with one from the African Development Bank. Although these announcements should lead to a substantial reduction in Zambia!s multilateral debt stock, details of the precise timeframes of the relief deals and how they will be implemented are likely to take some time to finalise, and agreement could be delayed until well into the forecast period. Moreover, under the terms of the write-offs, a major portion of any savings that Zambia gains from forgiven debt-service obligations can be netted out of future aid/lending flows to that country, and thus the net resource flow will remain broadly unchanged.

Debt owed to the IMF (US$ m) 2000 2001 2002 2003 2004 2005 2006a 2007a IMF debt stock 1,140 982 1,020 859 891 584 59 83 a Estimates. Sources: IMF; Economist Intelligence Unit calculations.

Another trade surplus, but the The minister for finance and economic planning, Ng!andu Magande, reported in

current-account deteriorates the budget speech that preliminary data indicated that exports improved by over 17% in 2005, reaching US$2.13bn. This figure is double that recorded for 2003 and came on the back of surging world copper prices and rising production (see Mining). In an encouraging development for the government!s efforts at diversification, non-metal exports increased by over 20%, to US$582m. However, it is worth noting that this figure includes metals that had been manufactured into products such as copper wire, and therefore does not reflect as great a diversification as Mr Magande alluded to. Import growth was also strong, rising by just under 20% to US$2.o7bn, owing to high world oil prices and investment in the mining sector, and a small trade surplus of US$59m was recorded. As in 2004, deficits on the services and income accounts wiped out the trade surplus. The services deficit deteriorated by 17% to US$252m, in line with import growth, while the income deficit grew by almost 43% to US$605m, in line with greater profit remittances from the mining sector. The overall current-account deficit widened to an estimated US$826m (11.9% of GDP) from US$583m in 2004 (10.7% of GDP). However, unlike the Economist Intelligence Unit, the Zambian authorities do not include grants in their current-account calculations. The current-account deficit including grants is estimated at around 6% of GDP.

Current account (US$ m) 2004 2005 Trade balance 83 59 Exports 1,810 2,127 Imports -1,727 -2,068 Services (net) -215 -252 Income (net) -424 -605 Current transfers (net)a -27 -28 Current-account balance -583 -826 (% of GDP) -10.7 -11.9 a Does not include grants. Sources: Ministry of Finance and National Planning, Budget address; Economist Intelligence Unit calculations.