Zambia - Recovery Program Project

Document of The World Bank FOR OFFIICLL USE ONLY Report No. P-4310-ZA REPORT AND RECOMMENDATION OF THE PRESIDENT OF THE INTERNATIONAL DEVELOPMENT ASSOCIATTON TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT OF SDR 42.6 MILLION TO THE REPUBLIC OF ZAMBIA FOR A RECOVERY PROGRAM May 27, 1986 This document has a restricted distribution and may be used by recipients only in the performance of their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  CURRENCY EQUIVALENTS Currency Unit Zambian Kwacha (K) US$1.00 = K 6.90 Kwacha 1.00 US$ 0.14 (The US Dollar/Zambian Kwacha exchange rate shown above is the rate that prevailed at the end of March 1986.) WEIGHTS AND MEASURES 1 meter (m) = 3.28 feet (ft) 1 kilometer (km) = 0.62 miles 1 sq kilometer (km2) = 0.386 sq miles I metric ton (tonne) = 1,000 kg = 2,204.6 pounds I liter = 1.057 US quarts = 0.22 Imp. gallon ABBREVIATIONS AFC = Agricultural Finance Corporation AfDB African Development Bank BOZ Bank of Zambia CIDA Canadian International Development Agency FRG = Federal Republic of Germany GNP Gross National Product INDECO = Industrial Development Corporation MAWD Ministry of Agriculture and Water Development MEMACO Metal Marketing Corporation of Zambia Limited MLTL = Medium and Long Term Loans NAMBOARD National Agricultural Marketing Board Tazara = Tanzania-Zambia Railway Authority ZADB = Zambia Agricultural Development Bank ZCCM Zambia Consolidated Copper Mines ZIMCO = Zambia Industrial and Mining Corporation, Limited FISCAL YEAR ZR: April 1 - March 31 GRZ: January 1 - December 31  FOR OMCIAL USE ONLY 7ZMBIA RECOVERY PROGRAM CREDIT AND PROJECT SUMMARY Borrower: Republic of Zambia Beneficiaries: Importers Amount: SDR 42.6 Million (US$50 million equivalent). Terms: Standard. Program Description: The objective of this credit is to help provide the minimum level of imports needed for Zambia's Recovery Program and thereby to help sustain the momentum of the policy and institutional reforms. This will allow the productive sectors of the economy to respond to the Incentives and favorable economic environment established by the reforms and provide the Increased supply of goods and services needed to support structural change in the economy. The Credit will finance: a) Imports of goods with an excepted ltst of defense and luxury consumer goods, and b) technical assistance and training to improve foreign exchange management by the Bank of Zambia, to audit implementation of Zambia Consolidated Copper Mines' 5-year Production and Investment Plan, -to improve debt management in the Ministry of Finance, and to devise a mechanism for limiting maize subsidies to low income famtlies. Terms to Beneficiaries: For the imports component (US$48.8 million equtvalent), the credit proceeds would be sold at the auctton-determined exchange rate. Funds allocated for technical assistance to the Bank of Zambia and Ministry of Agriculture and Water Development would be made available on a grant basis. The remainder of the technical assistance would be managed by the Ministry of Finance. The total allocation for technical assistance would be US$1.2 million equivalent. Benefits: By increasing domestic supplies of spare parts, raw materials, intermediate goods and other productive inputs, as well as basic consumption goods, the project would support the recovery of Zambia's economy. The policy and institutional reforms supported by the project would contribute to raising efficiency and help bring about the structural changes needed for stable long-term growth. The This docunent ha a estrted distibution nd may be used by rcipients only in the perfomnance o fthek orkieW duti Its contents may not otherwise be dbdosed without World Pink authoizato n.  rationalization of public expenditure would ensure a better focus to public sector recurrent and investment spending, thereby allowing such spending to make a more positive contribution to the recovery and diversification effort. Risks: The main risk facing the project is the delay, or possibly even a reversal, of the policy and institutional reforms supported by the project. This risk is limited by: a) the Government's strong commitment to the reform effort as evidenced by continuation of the reforms in recent months; b) the growing national consensus in Zambia concerning the severity of the crisis; and c) the expected benefits, in terms of increased output and exports, from the proposed credit. The credit would be tranched to ensure continuation of the reform program. Estimated Disbursements: US$ Million IDA FY87 50.0 Appraisal Report: None.  INTERNATIONAL DEVELOPMENT ASSOCIATION REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS ON A PROPOSED CREDIT TO THE REPUBLIC OF ZAMBIA FOR A RECOVERY PROGRAM 1. I submit the following report and recommendation on a proposed credit to the Republic of Zambia of SDR 42.6 million (approximately US$50 million equivalent) on standard terms to help finance a Recovery Program. PART I - THE ECONOMY Background 2. A Country Economic Memorandum on Zambia (Report No. 5000-ZA) was distributed to the Executive Directors on April 24, 1984. An economic mission visited Zambia in September/October 1985 to review the recent economic developments and medium-term prospects and its report is scheduled for distribution In June 1986. Also, a Public Expenditure Review mission visited Zambia In February 1986 and its report is due for distribution in August 1986. The findings of these missions are reflected in this report. Country Data sheets are attached as Annex 1. 3. Zambia is a large landlocked country with a land area of 752,614 km2, a population of 6.4 million (1984) and a population density of only 8.5 per km2. This makes Zambia very dependent on transport facilities both at home and in neighboring countries. Zambia's main resources are large mineral (mainly copper) reserves and relatively rich agricultural potential. Copper mining has made a significant contribution to economic development so far, but the reserves are likely to be substantially depleted in about two decades. Agricultural potential has been largely neglected even though the climate and land are favorable for the production of a wide range of crops, which can be exported or substituted for imports. 4. Zambia has a mineral-based duallstic economy that depends heavily on external trade and government activity. Mining provides over 90 percent of foreign exchange earnings and 15 percent of gross value added. Imports and exports range between 35 and 40 percent of GDP. Government expenditures varied between 35 and 45 percent of GDP during the early 1980s. The Government owns a majority sbare in mining and most manufacturing enterprises and dominates the nationwide marketing and distribution activities. Much economic activity is dependent on expatriate technical, managerial and administrative skills. 5. Zambia's current economic and financial problems were initiated by a sharp decline in the copper price in 1975. Zambia's terms of trade have deteriorated steadily since then, and by 1984, were 70 percent below the average for the early 1970s. Real GDP has has been in a general  - 2 - downward trend since 1975, declining on an average by about 1.5 percent per year through 1984. With population growing by 3.1 percent per annum, real GDP per capita in 1984 was 25 percent lower than in 1974. The balance of payments has been in chronic disequilibrium since 1975, with current account deficits climbing to an average of 19 percent of GDP in 1980-82. Nevertheless, the volume of imports declined steadily and is now 50 percent below its level in 1980 and 75 percent below its level in 1974. This has resulted in an economy-wide problem of severe underutilization of capacity and, especially in the mining sector, a large backlog of maintenance and rehabilitation expenditure. 6. The large current account deficits have also led directly to Zambia's high level of external indebtedness. At the end of 1985, Zambia's total external liabilities stood at US$5.0 billion, including drawings from the IMF (US$600 million), US$580 million in debt service arrears and about US$600 million in overdue commercial payments. By comparison, exports of goods and services amounted to about US$900 million, and scheduled debt service obligations amounted to over 70 percent of export earnings. 7. There is no doubt that Zambia's present economic difficulties have been caused in part by exogenous factors over which the Government has little or no control (e.g. low copper prices, rising cost of copper productlon as ore reserves are depleted; transport difficulties in neigbhboring countries, and recurrent severe droughts). Nevertheless, inappropriate policies and shortcomings in economic management have exacerbated the economic difficulties. Exchange rate and tariff policies encouraged the use of imported raw materials and other inputs and discouraged the use of local materials and the development of non-mineral exports. As a result, a highly capital and import-intensive productive structure was created. Tax incentives and low interest rates have also contributed to a pattern of capital-intensive investment. Pricing and subsidy policies favored the urban consumer at the expense of the agricultural producer, and controlled industrial prices led to low profitability in the manufacturing sector, limiting available resources for reinvestment. Recent Economic Development and Policy Reforms 8. Zambia's real GDP declined four successive years through 1985, with real GDP per capita dropping about 16 percent below that in 1981. Almost all the economic sectors have shared in the dismal performance of the economy except for the agricultural and the real estate and business services sectors. However, a major contributory factor to the overall decline has been the poor production performance of the mining sector, which has been particularly devastating when coupled with the declining copper prices. The effects of the ensuing foreign exchange shortage have been severe.  - 3 - 9. Mining. The copper industry worldwide has experienced a severe depression In recent years, which has led to mine closures and rationalization of operaticas in a number of countries. Copper prices, which averaged US