Zambia - Development Bank Project

CIRCULATtNG COPY 'I BE RETURNED TO REPORTS DESK Document of FILiL; COPYx - The World Bank International Finance Corporation FOR OFFICiAL USE ONLY ORCULATIN6 CoPY Report No. P-1688a-ZA reA RBE RN TO RErP0RTS DESY REPORT AND RECOMMENDATION OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS OF THE BANK AND TO THE BOARD OF DIRECTORS OF THE CORPORATION ON A PROPOSED LOAN BY THE BANK TO THE DEVELOPMENT BANK OF ZAMBIA WITH THE GUARANTEE OF THE REPUBLIC OF ZAMBIA AND AN INVESTMENT BY THE CORPORATION IN THE DEVELOPMENT BANK OF ZAMBIA January 29, 1976 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/IFC authorization.  CURRENCY EQUIVALENT Zambian Kwacha Kl = US$1.56 US$1 = KO.641 ABBREVIATIONS ADB African Development Bank AFC Agricultural Finance Corporation DEG Deutsche Entwicklungsgesellschaft EIB European Investment Bank INDECO Industrial Development Corporation KfW Kreditanstalt fur Wiederaufbau NCB National Commercial Bank SNDP Second National Development Plan FINDECO State Finance and Development Corporation ZAMDEV Zambia Development Loans Scheme ZIMCO Zambia Industrial and Mining Corporation FISCAL YEAR Government: January 1 - December 31 DBZ: April 1 - March 31  FOR OFFICIAL USFE 0NLY REPORT AND RECOMMENDAT::ON OF THE PRESIDENT TO THE EXECUTIVE DIRECTORS OF THE BANK AND TO THE BOARD OF DIRECTORS OF THE CORPORATION ON A PROPOSED LOAN BY THE BANK TO THE DEVELOPMENT BANK OF ZAMBIA WI H THE GUARANTEE OF THE REPUBLIC OF ZAMBIA AND AN INVESTMENT BY THE CORPORATION IN THIS DEVELOPMENT FINANCE COMPANY 1. I submit the following report: and recommendation on a proposed loan to the Development Bank of Zambia (DBZ7 with the guarantee of the Republic of Zambia for the equivalent of US$15 million to help finance the import com-- ponent of investments made by DBZ, and an IFC investment of K350,00o (approxi- mately $550,000 equivalent) in the share capital of DBZ. The interest on the loan would be 8.5 percent per annum. Amortization wouldl conform substantially to the aggregate of the amortization schedules applicable to the sub-loans financed out of the proceeds of the loan. PART I: THE ECONOMY 2. The last economic report on :ambia (Report No. 4a-ZA) was issued on December 26, 1972. An updating mission visited Zambia in October! November 1973. A basic economic mission visited the country in June/July 1975. Its report is scheduled to be issued in July of this year. The most recent economic data are summarized in Annex I. 3. With its large mineral reserves and wide area of land suitable for crops and livestock, Zambia has the potential for rapid and sustained develop- nment, but over the past decade real gross domestic product has grown at less than 4 percent per annum. The economy is characterized by a pronounced dualism between a large modern sector dominated by copper mining and a rural subsis- tence sector. The average per capita GNP of US$430 (1973) disguises a large differential in incomes between the urban and rural sectors which has led to rapid migration to towns. Today, more than a third of the country's population lives in urban areas and there is substantial urban unemployment. 4. The broad economic and social goals of Zambia's last two national development plans may be summarized as follows: (a) raising the general level of welfare; (b) diversifying the econonmy to make it less dependent on copper; Cc) raising the level of education and developing a wide range of technical and managerial skills; and (d) narrowing the gap between urban and rural incomes. 5. The modern sector of the economy continues to be dominated by copper mining which contributes about 60 percent of GDP and over 90 percent of the value of exports, shares which have not changed significantly during the past decade. Fluctuations in world copper prices thus have a large T|his document has a restricted distribution and may be used by recipients only in the performance olf their official duties. Its contents may not otherwise be disclosed without World Bank authorization.  impact on the balance of pavments as we]. as on the whole economy. Sinc 1969, when it obtained a majoritv interest in the ttwo major mining compaieos. the Government has attempted to promote the growth of copper production, chiefly through tax incentives. The Second National Development Plan 1972-76 (SNDP) projected that copper production would rise from 700,000 to 900,000 tons over the five year period. To date production has not increased due to (a) the failure of a major mine, flooded in 1Q70, to regain its former level of pro- duction; (b) the 1973 border closure with Rhodesia which caused a major re- routing of imports and hence delays in obtaining equipment and parts; and (c) the reluctance of the private mining companies to invest prior to the Govern- ment takeover, making substantial investment necessary merely I:o maintain production. However, the investment required to reach the projected target is now substantially in place and (assuming a 90 percent capacity utilization rate) copper output is expected to grow at about 3 percent per annum on average up to 1980. 6. The development of the manufacturing sector has contributed to the Government's goal of diversification. Since 1965, manufacturing output has expanded at a rate of 12 percent per annum and its share in GDP (13.2 percent in 1974) now exceeds that of agriculture (10.5 aercent). In 1966, on the grounds that Zambianization was too slow and investment insufficient, the Government directed the Industrial Development Corporation (lNDECO) to parti- cipate on its behalf in the industrial sector. Today, INDECO holds a majority interest in virtually all major manufacturing industries. In the meantime, the private sector has developed medium scale enterp-ises, ind in 1972, accounted for one half both of value added and of employment in manufacturing. The expansion of output in manufacturing has consisted mainly of import sub- stitution for consumer goods behind the protection of tcariffs and quota restrictions. Since the manufacturing sector is small and production tech- niques are relatively capital-intensive, even the rapid growth in output recorded has not provided sufficient employment opportunities for the growing urban labor force. 7. Zambia has made a major effort to develop its educational system. In 1964, there were only about 100 citizens with aniversity degrees and 1,000 with secondary school level certificates. Since then remarkable progress has been achieved in expanding education at all levels. The primary school en- rollment ratio was raised from 42 percent in 1960 to 85 percent in 1970. There are now over 800 Zambian university graduates and the annual output from secondary schools has risen to over 6,000. Despite the recent emphasis on vocational and technical training, skilled manpower remains an important constraint to development. 8. The objective of reducing the urban-rural income gap, however, has proven far less manageable. Despite the Government objectives to becone self-sufficient in foodstuffs and agricultural raw materials, increase economic diversification and expand the export base, and raise rural incomes, the performance of the agricultural sector has been d'sappointing. Output has grown at an average rate of only 1.7 percent per annum over the past ten  years. Imports of food and agricultural raw materials have been growing. In 1974, approximately 40 percent by value of Zambia's marketed food was imported; the major imported items (e.g. beef and dairy products, wheat, edible oils and cotton) were all products in which the country possesses a significant agricultural potential. In addition, the rapid rise in modern sector wages, especially during the five years following independence, widened the gap between the urban and rural sectors. The prices of agricul- tural goods, most of which are set by government marketing boards, were not allowed to rise as rapidly as the prices of manufactured goods. Recently, the Government has raised the prices of some agricultural commodities, but further increases are necessary to raise farm incomes and give farmers a greater incentive to increase production. 9. The Government has not as yet devised an agricultural development strategy which would stimulate production and increase the welfare of the rural poor by raising their productivity. A recent Bank Agricultural and Rural Sector Mission explored the possibility for formulating a long-run development strategy. The major elements that have been identified in this strategy are: (a) an increased allocation of Government infrastructure invest- ment and provision of supporting services to rural growth centers chosen on the basis of high land potential, access to transportation, and population density; (b) greater allocation of skilled manpower to the planning and execu- tion of rural development projects and a regional decentralization of these functions; (c) improved efficiency of government marketing organization; and (d) changes in the level and structure of agricultural producer prices to bring them more in line with the opportunities that Zambia faces in world trade and with regional comparative advantage. The Sector Mission's Report has stimulated wide discussions about agricultural policy at all levels of Government. The Government is considering a new agricultural development strategy and major policy changes. 10. Since 1970, Zambia's economic fortunes have been in sharp contrast with those of the previous period. Through 1969, increases in copper prices put Zambia in a strong financial position. The Government's budget and the balance of payments produced growing surpluses. National savings were more than adequate to finance capital formation while foreign reserves were accumulated. At the same time, the Government's current expenditures were allowed to grow rapidly to cover rising wages and public employment, sub- sidies of agricultural inputs and commodities (notably maize and milk), and defense expenditures without endangering the Government's development program. The stagnation of agricultural production did not create a financial problem because foreign exchange earnings were sufficient to pay for food imports. The two principal factors involved in the change in the economic climate since 1970 have been: (a) world inflation combined at times with a low copper price resulting in a deterioration in Zambia's terms of trade from the levels of the late sixties, and (b) the Mufulira mine disaster in September 1970 and the closure of the Rhodesian border in 1973 which brought about production losses and a further drain of financial resources.  1l.. .Government ;z.id?tar, mev,suzel. to mitigate tL- adverse developments of t:he pXSt: few years have ^ueen largpiy unsuccessful. because of its failure to curb the gv:wth in 1i racurrent budget. It has attempted to diversify its tax base away from, minet.al revenues by restructuring tha personal income tax, introducing eew salts ard excLse taxes, and raising most tax rates. However, increases I.-l r ir'r