Zambia - Public expenditure review (Vol. 2 of 2) : Main report

Document of - The World Bank FOR OFFICIAL USE ONLY Report No. 6438-ZA ZAMBIA PUBLIC EXPENDITUIRE REVIEW VOL. II: MAIN REPORT 2 October 6, 1987 / N_ Country Department VI Africa Region Tbh document has a resMted du_udes mad may be usd by 3ru0bn I in y-'l _ of their offidc dudes It contets may ao ohewtis be diWcsed odd lank a  CURRENCY EQUIVALENTS Currency Zambian Kwacha (K) US$1.00 K 8.00 (as of May 1, 1987) K 1.00 US$0.13 The following are average.annual exchange rates for recent years. 1970 K 1.00 - US$1.40 1975 K 1.00 = US$1.55 1980 X 1.00 m US$1.27 1981 K 1.00 8 US$1.15 1982 K 1.00 = US$1.08 1983 K 1.00 - US$0.80 1984 X 1.00 US$0.56 1985 K 1.00 - US$0.37 1986 X 1.00 US$0.13 WEIGHTS AND MEASURES 1 Metric T6n (Tonne) * 1000 Kg. or 2,205 Lbs ABBREVIATIONS CDE - Classified Daily Employee CEM a Country Economic Memor*'hdum GDP = Gross Domestic Product GFCF - Gross Fixed Capital Formation GNS a Gross National Savings INDECO = Industrial Development Company Limited MAWD = Ministry of Agriculture and 'Vater_Development MET M Mineral Export Tar- MOF = Ministry of Finance NAMBOARD - National Agricultural Marketing Board NCDP = National Commission for Development Planning Ps = Personal Emoluments RDC u Recurrent Departmental Charges ZCCM = Zambia Consolidates Copper Mines Limited ZIMCO = Zambia Industrial and Mining Corporation Limited FISCAL YEAR Government -- January 1-December 31 ZIMCO,<ZCCM -- April 1-March 31  FOR OMCIL USE ONLY Preface The mission would like to express its gratitude and appreciation to the large number of officials in the Government and ZIMCO who gave generously of their time and experience in diswussions with the mission members. In particular, the mission would liLe to acknowledge the following officers who provided liaison for the mission and were of great assistance in making appointments and other arrangements- Messrs. C. Chirva and L. Nkhata (Ministry of Finance), Hr. R. Vanniasinkam (ZIMCO), and the various officers in the Sectoral Planning Department in NCDP. In addition to the main report, a number of background papers were prepared by the mission and are avAilable an request: (i) "Sectoral Expenditure Programs- 1986-88"- fifteen sectoral chapters providing greater detail regarding the various expenditure programs described in the main report. (ii) *Improving Parastatal Performar-e in Zambia," by Ms. M. Shirley. (ili) "The Social impact of Expenditure Reform," by Ms. C. Allison This report is based on the findings of a public expenditure review mission which visited Zambia in February 1986. The mission leader and principal author of tha report was Mr. R. Westin. Otber members of the mission were Messrs. R. Hidver. S. Khan. Z. Drabek, IX Merelthi, B. Zegge, k. iitchell, M. Dick, M. Zymelman, A. Griffiths,. M. Murray, Ms. A. Vaughn, R. Kayani, Ms. S. Safeez, I. Lacroix and Ms. C. Allison. Major technical inputs into the report were provided by Messrs., R. Broadfield, J. Moose, K. Kleiner, D1. Rouag and J. Mullan. Thu docuement ha a stiddistbution and may be ud by ripints on in thepeHomance f teir offl duti Its contents may not odhrwbe be dbioed wihout Wod Bank autwhoton.  ZAMBIA PUBLIC EXPENDITURE REVIEW, 1986-88 Table of Contents Page I. THE NACROECONOMIC OUTLOOK FOR THE PUBLIC EXPENDITURE PROGRAM ...... *......... ...........-. 1 A. The Context for Publlc Expenditure Reform .............. I B. Investment and Savings Requirements .................... 3 Investment * .......................................... 4 Savings ........ *.... .... ............................. 8 C. Prospects for the Government Budget .................... 8 D. ?lanning for Uncertainty *............................ 17 II. SECTORAL PROGRAMS IN THE BUDGET ** * ... ........ ............. 19 As Overview .....i.9......................................... 19 B. Agricultural Expenditure Programs ..... ................. 25 Evaluation of Expendltulre Strategye................... 26 Proposals for Expenditure Reform ..................... 31 C. Health, Education, Roads and Development Administration. 36 Health ...................................... 36 Education *******.*...... ...................... 39 Roads .................... 44 Development Administration ............ .. ......... .... 45 D. Other Sectoral Programs . ............................ 51 Water Supply ...................................... 51 Housing .................... ................. 52 Tourism ...................................... 53 Information and Broadcasting ......................... 54 Regional Admlnistration ........ ...................... 55 Other Governuent Programs ............................ 57 III. REFORMING THE GOVERNMENT BUDGET ......*........... 58 As Overview ***..**...... ................*........ 58 B. The Core Government Expenditure Program, 1986-88 ...s.... 60 C. Inter-Sectoral Expenditure Issues ...... ................ 62 Wages and Employment Policy .......................... 62 Funding of Recurrent and Capital Expenditures ........ 66 Reduction of Government Services ...... ............... 68 Social Impact of Expenditure Reform .................. 69 Increase in Non-Tax Revenues ......................... 71 Maintenance of Government Assets ..................... 72 D. Planning and Budgeting ........... ...................... 73 The Previous Planning and Budgeting Cycle .....0....... 74 The Revised Planning and Budgeting Cycle ............. 75 Content of the Annual Plan and the Budget .....*....... 77 Role of MOF, NCDP and Operating Ministries ....... sees 77 Next Steps ....... ................................... 78  Table of Contents (cont'd) Page IV. TME PARASTATAL INVESTMENT PROGRAM ........ ........so......... 80 A. Parastatal Investment and Performance .................. 80 Savings and Investment ............ ............. 82 Fiscal Impact ....................... 85 B. 8ectoral Investment ?'rograme ........................... 88 Mining ......... ..0.... .....oco 88 Industry . 93 INDECO ..... 93 ITitrogen Chemicals of Zambia, Ltd. ................. 97 Development Bank of Zambia ......................... 99 Baerolu ............... ..*............ 99 Petroleum ................................. 100 coal***..*..*****h--**---** 102 Electricity ................................ 103 Woodfuel .c.....d.. co.g...c. c.oeooog..geo 104 Energy Sector Planning ............................. 104 Transport e......o................ ........ 105 Zambia Railways .. oc.og...o.o.e.ooeeo.. c. 106 Zambla Airways .ococo.c..ce.e...c...ocoo...occ 108 Contract Haulage, Ltd. .c.....o...oc.c....co..c..co.ce. 109 United Bus Company of Zambia .-o ..oceOce. 109 Transport Planning ......00........... 110 Telecommunications .. c.o............ 110 Postal Services ....0 0 ...... o c 113 C. The Core Parastatal Investwent Program, 1986-88 114 D. Improving Parastatal Investment Decisions ....oooooo.. 117 Investment Revlew ................00.0 eec 000 0e00 .00g. 118 Setting Objectives for Parastatals . 119 ANNEX A: GOVERNMENT REVENUE AND EXPENDITURES, 1975-1986 121 ANNEX B: SEC'TOR AND PROGRAM DEFINITIONS IN THE ANNUAL PLAN 126  I. THE MACROECONOMIC OUTLOOK FOR THE PUBLIC EXPENDITURE PROGRAM A. The Context for Public Expenditure Reform 1.01 The Government of Zambia has introduced major policy reforms to reverse the long economic recession that has been associated with the decline In Zambia's terms of trade. These difficult and far-reaching decisions, such as the introduction of the foreiRn exchange auction, liberalizatlon of the foreign trade regime, and virtual elimination of price controls, have fundamentally altered the prospects for sustained medium term economic growth. However,.while the policy reforms have created Incentives for a redirection of resources into productive activities, the resources will not flow at the required rate without further purposeful actions by the Government. Some of the most important measures which need to be taken involve the restructuring of the public expenditure program. To an unusual extent, the public sector exercises direct control over the allocation of resources in Zambia. The large size of the Government budget and the parastatal sector means that matters of Investment, pricing, and service delivery are heavily influenced by public sector decision maklng. Effective control of the public expenditure program implles more than limiting the budget deficit or restraining the growth of public borrowing, as lmportanc as these considerations clearly are. Decisions on the sectoral distribution of the Government budget and on cost recovery and parastatal prlcing and Investment will play a vital role 'n determining the character and responsiveness of the Zamblan economy. The problems of public expendlture reform constitute a difficult agenda for a Government that has already taken many decisions that have caused substantial disruption to the economy. Nevertheless, unless the rnvernment complements its actions on the macroeconomic policy front with equally forceful decisions concerning the allocation of public resources, the ;otential benefits of what has been accomplisned so far may be dissipated in lagging economic growth rates. 1.02 The extent of publlc sector control over resource allocation in the Zambian economy can be gauged by the indlca:.ors glven in Table 1.1. In 1982-83, the public sector accounted for approximately 63 perceint of value added, 72 percent of formal sector employment, and almoRt 80 percent of gross capital formation. These shares are unusually large in eomparison to other countrles. Moreover, In view of the high usage of inputs in comparison to value added, these data indicate that the publlc sector has contributed to the low aggregate levels of labor and capital productivity that have been identified in the Zamblan economy. As such, reform of the public expenditure program is a partlcularly Important policy Instrument In Zambia for improving both factor productlvity and the composition of final output. 1.03 Given the large size of the public expenditure program, this report has had to adopt certain restrictions In order to maintain adequate coverage of the major toples. The public expenditure review will focus on expenditures for 1986-88, with 1986 representlng a base year for the  -2- Table 1.1: Publlc Sector Shares in Value-Added, Captial Formatlon and Employment Value- Gross Flxed Employment Added Capital Formation (Formal Sector) Government 28 27 35 Parastatals 35 52 37 Total (Public Sector) 63 v79 72 Notes: Based on relatlve shares in 1982-83. Data for Government expenditures are from the Finaneial Reports of the Government. Data for parastatals are from ZIMCO Annual Reports and do not include the non-ZIMCO parastatals. analysis in the report. Wlthin the Government budget, the emphasis will be on expenditure programs for ministries which provide direct services to the population, particularly in agriculture, health, education, roads, and development administration, witb additional attention being glven to selected topies cutting across ministries (e.g., personnel policles, expenditure planning, vehicle maintenance) which are Important for developing a consistent program of budgetary reform. For the parastatal sector, the emphasis will be on the capital investment program. Recurrent expenditures by the parastatals will receive relatively less attention, except as they impinge on important lssues (e.g., pricing, cost efficiency) that affect the financial viability of the enterprises or limit the scale of the proposed investment program. 1.04 In the remainder of this chapter, we examine the economic outlook for the public expenditure program, particularly the macroeconomic cons- traints on public investment and savings and on the Government budget as a result of the economic reform program and Zambia's external resource situa- tion. While the Government has already taken substantial measures to stabilize Its external resource position, the internal resource balances (i.e., the investment-savings gap and the budget deficit) are still seriously out of allgnment. This means that the outlook for the public expenditure program Is intimately linked to such macroeconomic questions as the desired growth rates for public and private consumption, the antici- pated sectoral composition of final output, and the prospects for foreign debt-service payments and debt rescheduling. Section B of this chapter  -3- examines the Investment and savings requirements for the economy and the breakdown between publlc and private sources. Section C examines the Government's fiscal prospects and the composition of recurrent and capital expenditures in the budget. Section D considers what pollcies the Government should adopt to deal with uncertainty in the general economic outlook. B. Investment and Savings RequIremepts 1.05 One of the consequences of economic recession Ln Zambia has been a severe compresaion of capital investment. Gross fixed capital formatton (GFCF).fell from 18.2 percent of GDP in 1980 to 9.5 percent in 1985, representing an average annual rate of decline of 12 percent in real terms. Capital investment in a number of sectors has been below the requirements for replacement and rehabilitation, and there has been a significant deterioration of much of Zambias capital stock. This situation has a number of implications for the public lnveatment program. First of all, the major share of capital Investment over the next several years will have to go into reducing the large backlog of rehabilitation and replacement needs. Much of this investment will not contribute directly to economic growth, but rather is needed in order to avoid further declines in production or to prevent deterioration of the capital stock that could create bottlenecks to economic expansion. This is particularly true of the large investment requirements for projects such as rehabilitation of the major trunk roads, replacement of worn-out mining equipment for the copper Industry, repair of the oil pipeline from Dar-es-Salaam, and the ongoing rehabilitation programs for the railroads and the coal and fertiliter industries, all of which are discussed in the subsequent chapters. Much of the capital stock whlch requires rebabilitation Is held by parastatals, so the parastatal investment program will claim a large share of the total resources available for Investment. This will place a severe constraint on resources available for Government and private sector investment. Because so much of the capital investment will be tied-up in maintenance and rehabilitation projects, growth in production will have to depend on activities which do not have large capital requirements. In particular, emphasis must be given to stimulating growth through improvements in factor productivity, including greater utilization of existing capacity and reductions in unit costs. 1.06 Given Zambia's large requirements for capital investment, an Important objective of the economic recovery program should be to improve aggregate savings in order to provide the resources needed for investment. This effort will require a number of difficult decisions by the Government. Increasing private savings will require constraining the growth of consumption, which has fallen in per-capita terms throughout most  -4- of the past decade.1/ Zambia's ability to attract foreign savings will be limited, due to the large external debt burden. The Government will therefore need to place particular emphasis on improving public sector savings by reducing the budget deficit and Improving parastatal profitability, actions which should have high priority as part of the public expenditure program. 1.07 A possible medium term economic framework for Zambia has been proposed in the recent Country Iconomic Memorandum (CEM).2/ Briefly, this scenario envisions a slow improvement in economic growth over the next five years, sufficient to support a modest increase In GDP per capita. Policies to constrain the growth of public consumption would allow an increase in the level oi private consumption per capita, which is necessary to sustain support for the adjustment program. It would also release resources for an increase in investment to support the diversification of the economy into agriculture and economically efficient industrial p2roductiou,.as well as complete the rehabilitation of the mining industry. This would establish the basis for a return to stronger economic growth in the first half of the 1990s, which would complete the diversification of the economy in anticipa- tion of the expected decline In copper production in the latter half of the decade. Table 1.2 summarizes the major economic growth assumptions and resource projections for this scenario. The remaining discussion in this section provides additional detail as to the nature and composition of the savings and Investment projections underlying this scenario, particularly with respect to the public share of these quantities. 1.08 Investment. Table 1.3 presents a preliminary estimate of the composition of investment broken down between the Government, parastatals and other (mostly private) sources for the period 1980-84. Parastatals aucounted for the major share of gross fixed capital formation (GFCF), followed by direct Government investment and other (including private) sources. The level of GFCP by Government and the parastatals was generally stagnant in nominal terms throughout the period (and therefore declining significantly in real terms), with other (including private) sources showing a decline in GFCP in both nominal and real terms. As such, these data indicate that all sectors have shared in the decline of capital formation in Zambia. I/Between 1980 and 1985, gross domestic consumption increased at an average annual rate of less than one percent in real terms, signifl- cantly below the population growth rate of 3.4 percent. 2/Zambia: Economic Reforms and Development Prospects, World Bank Report No.6355-ZA, November 19, 1986.  -5- Table 1.2: Mocroes..nomic Growth Prospects and Domestic Resource Requirements, 1986-95 (in 1985 constant prices) Average Annual Growth (2) hare of CDP (2) 1986-90 1991-95 198S M0 1997 GDP at market prices 3.6 4.5 100.0 100.0 100.0 GDP at factor cost 3.1 4.5 87.6 85.5 85.5 Agrtculture 5.6 5.0 12.7 13.9 14.2 Mining 2.1 0.5 11.1 10.3 8*5 Industry, 4.2 7.0 23.5 24.5 27.1 Serviees 1.9 3.7 40.3 37*1 35.7 Exports 2.1 2.4 39.3 36.7 35.2 Imports 4.8 3.3 38.0 40.2 37.9 Go'nsumptton 3.9 4,3 86.8 87.7 87.3 Public 1 0.8 2.0 19.3 16.8 14.9 Private 4.6 4.8 67.5 70.9 72.4 Gross Investment 10.0 6.5 12.0 16.1 17.7 Gross Domestic Savings 2.8 8.2 13.2 12.6 15.0 GDP Per Capita 0.2 1.1 Consumption Per Capita 0.5 0.8 Source: Zambia: Country Economic Memorandum. 1.09 Table 1.4 outlines the tnvestment requirements of the medlum term recovery seenarto over both the near term (1986-88) and the next decade. Zambia will have to increase investment from 9.5 percent of GDP in 1985 to 14.5 percent in 1988 to sustain economic growth. This will support an increase In GFCF from K 600 mlllion in 1985 to K 1020 million in 1988 (1985 constant prices), representing an average rate of Increase of 10 percent per year. Total GFCP during the period 1986-88 would equal K 2800 milllon, of which parastatals would provide approximately K 2000 mdllion.3/ The Government and other (inc. ding private) sources would contribute approximately K 300 milllon of GFCF each. This would represent an Increase In the parastatal share of investment from 59 percent In the period 1980-84 3/In the discussion of the parastatal Investment program in Chapter IV, all costs have been estimated in January, 1986 prices at an exchange rate of K 6 - $1.00. Based on the assumption that approximately 70 percent of GPCF represents foreign exchange costs (an estimate based on experlence tn several sectors), parastatel investment during the 1986-88 pertiod ti expected to equal K 3800 million (US$635 mtllion) in 1986 prices.  -6- Table 1.3: Sources of Investment, 1980-85 If millton in current prices) 1980 1981 1982 1983 1984 1985 Gross Fixed Capital Formation 55 610 618 615 623 600 Government a/ 125 130 183 151 121 n.s. Parastatals_b/ ' 391 334 302 338 414 n.a. Other (including private)c/ 42 146 133 126 88 n.a. Percentages of GFCF Government 22 -21 29 25 19 n.a Parastatals 70 55 49 55 67 n.a, Other 8 24 22 20 14 n.a. Changes In Stocks 155 63 -15 -40 101 160 Gross Domestic Investment 713 6'3 603 575 724 760 Index of Real GFCF (1980-100) 100 102 90 72 61 52 n.a.= not available Notes 8/ GRZ, Financial Reports, various years. (Th e estimates have not been adiusted to exclude items ftnanced under foreign loans that may be more properly defined as recurrent expenditures under national income accounting conventions.) v b/ Estimated on the basis of net financial sources available to ZIMCO, defined as Internal generatlon of funds (after-tax profits plus depreciation) plus net external and Internal borrowings plus net transfers from the Government. For 1984, this estimate h-'--been adjusted downward (from K 629 mlllion to,K 414 milllon) to reconcile a major discrepancy with the national income accounts. The difference may be attributable to a DC-10 airplane which was purchased by Zambia Airways during 1984 and which may not show up in the national income accounts because of technicalitles in the financing plan for the aircraft. c, Residual category.  I'! Table 1.4: Investment Requirements, 1985-95 Rmllllon in constant 1985 prices) 1985 1986 1987 1988 1990 1995 Gross Fixed Capital Formation- 600 840 940 1020 1170 1610 of which: Government n.a. 120 130 150 180 240 Parastatals n.a. 600 680 720 760 970 Other (includlng n.a. 120 130 150 !30 400 private) Increases in Stocks 160 20 30 40 50 60 Gross Domestic Investment 760 860 970 1060 1220 1670 Memo Items: GFCF/GDP 9.5 13.0 14.0 14.5 15.5 17.0 GDI/GDP 12.0 13.3. 14.5 15.1 16.1 17.7 n.8. - not available. to 70 percent In 1986-88 in order to accommodate the large amount oi" rehabilitation investment required by the parestatals during this period. The share of Government capital expenditures would decline from 29 p*rcent in 1980-84 to 15 percent in 1986-88 in order to reduce the budget deficlt and release resources for parastatal investment. The share of GPCF for other (fncludlng private) sources woula be 15 percent, slightly above:the level achieved in 1984 but belew that of 1981-83. Given the unsettled environment for private investment and the high level of unutillzed capacity, this amount of private investment should not place a major constraint on increases in productioat, but greater provision must be rsade for private investment as the economy begins to recover. In the longer run, GFCF could Increase to about K 1220 million in 1990 and K 1670 mI1llion in 1995, representing 15.5 and 17.0 percent of GDP respectively in each year, and the share of private investment should increase to at least g0 peroent of total investment by 1990 and 25 vercent in 1995. 1.10 In order to make effectlve use of the limited amount of - investment resources provided in the recovery scenario, the Government will need to improve its investment planning and decision making. This work has already begun with the preparation of rehabilitation programs In several key sectors. Institutional reforms such as the .ecent formation of an economic evaluation unit for the inWustrial parastatal enterprises and tho lntroduction of Improved annual plinning procedures for the Government budget will help In screening investment proposals for, the public sector. Other Important actions, Including the maintenance of positive real, interest rates for commercial borrowing, full Implementation of the new  -8- Investment Act, and expansion of credtt facilities for agriculture and industry through appropriate financial institutions will be Important pollcy instruments for promottng increased Investment and lmproving efficiency in the use of investment resources. 1.11 Savings. Up until the end of 1982, Government policles strongly favored consumption over Investment. Strict price controls on most products, the weak financial performance of the copper Industry, and an expansionary budget situation reduced aggregate savings to minimal levels. Following the introduction of econowlc reforms beginning in 1983, national savtngs Improved but were still below the level needed to support gross domestic Investment. Table 1.3 provldes estimates of the composition of savings between the Government, parastatals and other (includlng private) oourtes for the period 1980-84. Overall, public savings (Government plus the parastatals) provided only a small share of gross national savings (GNS) between 1980-84, being negative in two years and not exceeding 35 percent of GNS In any of the remaining years. The Government has been a major contributor to the poor savings performance of the public sector, with revenues being less than recurrent expenditures in every year. The savings performance of the parastatal sector deteriorated sharply in 1981 and 1982 as a result of the deterlorating financial condition of the copper industry. With the suspension of price controls In 1982 and the reorganization of the copper industry, parastatel profitability and savings recovered steadily. The ratio of savings to investment for the psrastatal sector varied from 18 to 69.percent between 1980-849 wbile the savlngs effort of the private sector consistently exceeded private Investment and thus provided resources to support investment elsewhere In the economy (Table 1.6). In aggregate, however, Zambia relied on foreign savings to finance over half of its total Investment requlrements In four of the past ftve years. 1.12 In order to Increase public savings after several years of economic decllne, the Government will need to apply strict policies regarding taxation, Government employment and wages, expenditure control, and parastatal profltabllity. Private sector savings should continue to be an lmportant source of resources and can be enhanced through pollcies such as positlve real interest rates on deposit accourts and the development of greater lncentives for Increased savlngs behavior, for example through promotion of private sector housing development. Nevertheless, the major burden for increasing domestic savings In the short term must fall on the public sector. C. Prospects for the Government Budget 1.13 The economic reform pollcies which have been enacted In recent years have had a major Impact on the size and structure of the Government budget. Debt-servlce requlrements for both foreign and domestlc debt have increased as a result of devaluation and the Increase in domestic interest rates, so that they now constitute a major share of the Government's total expenditure obligations. Flscal policy has been marked by high levels of taxation and constraints on the Government's operational expenditures, but the budget deficit has contlnued to be Intractable, averagtng 13 percent of GDP between 1980 and 1985. In order to tmprove domestic savIngs, a major policy objectlve of tie Government should be to reduce this deficit to  -9- Table 1.5: savings, 1980-85 (K million in current prices) 1980 1981 1982 1983 1984 1985 Gross National Savings 223 25 32 277 472 661 Governmentaf -214 -300 -344 -82 -143 - Parastatelia/ 240 82 54 179 284 - Other (includiog prfvate)c/ 197 243 322 180 331 - Memo Items Publtc Savings (Government and 0.12 neg. oeg. 0.35 0.30 - parastatals)3ONS