Zim under severe stress

THE World Bank last week released a state of the economy report on Zimbabwe, which showed that it is under severe stress.

Below is a summary of the abridged version of the economic report.

Zimbabwe faces complex fiscal and macro-economic challenges, and well-designed policies will be vital to accelerate growth and poverty reduction.

Government debt to the banking sector increased dramatically since 2015 and contributed to a protracted financial crisis that severely limited credit to the economy, negatively affecting the private sector.

Meanwhile, the drought experienced during the 2015/16 agricultural season reduced agricultural output and exacerbated rural poverty.

However, favourable rains received in 2016/17 are projected to boost growth of the agricultural sector in 2017 and per capita output is projected to increase this year.

The GDP growth rate fell from 1,4% in 2015 to just 0,7% in 2016, continuing negative per capita income growth. Severe credit constraints have caused a significant contraction in private demand. Per capita consumption fell by some 5% and the investment-to-GDP ratio shrunk from a level that was already well below the average for Sub-Saharan Africa. A fiscal expansion and an increase in net exports partially offset the contraction in private demand.

While a drought caused a drop in agricultural production and hydroelectricity generation in 2016, mining grew strongly and output in the manufacturing, and services sectors increased modestly. Consequently, economic growth remained positive on balance.

Slowing growth has disproportionately affected poor households. Rural areas are home to 67% at least two-thirds of Zimbabwe’s population, including 79% of the poor and 92% of the extremely poor.

The agriculture sector remains the primary livelihood for many poor households, and a combination of poor weather and financial shocks in 2016 adversely impacted vulnerable households: the drought reduced the output of smallholder farms, while cash shortages delayed payments to agricultural workers.

By 2016 the number of people experiencing food insecurity had increased to an estimated 2,8 million, or 17,5% of the country’s total population. This is estimated to fall to 2,2 million or 13,8% of the total population as food security improves in 2017.

The central government shifted to an expansionary fiscal stance in 2016, resulting in the financial sector turmoil and crowding out credit to the private sector. Slowing growth reduced public revenue, while emergency food imports, the public distribution of agricultural inputs, payment of domestic arrears and a burgeoning public-sector wage bill increased expenditures.

The decision in 2016 to increase agriculture-related spending despite the decline in revenue and the continued growth of the wage bill substantially widened the fiscal deficit. The government’s fiscal position expanded by some 8% percentage points of GDP.

The banking sector bore the brunt of the government’s financing needs, which led to liquidity shortages in the economy.

Liquidity crunch

Fiscal expansion in 2016 triggered a liquidity crunch and prompted banks to limit cash withdrawals.

Prior to 2016, the Zimbabwean central government maintained a prudent fiscal-policy stance, but other public institutions developed large financial imbalances.

Zimbabwe’s public sector accounts for roughly 50% of GDP, yet the central government’s expenditures averaged about 25% of GDP during 2012-16. Statutory extra-budgetary funds, spending by local authorities (LAs), the operations of state-owned enterprises and parastatals (SEPs), user fees imposed by schools and medical facilities, and support from development partners account for over half of the Zimbabwean public sector and a quarter of the national economy.

The fragmentation of the public sector poses considerable fiscal challenges, which are exacerbated by the limited oversight of many public institutions and parastatals.

Oversight of extra-budgetary funds, LAs, and SEPs is largely limited to expenditure auditing. Delays in the publication of audited financial reports prevent timely fiscal assessments of the consolidated public sector.

Given the important role SEPs play in Zimbabwe’s economy, the government guarantees their debt, and the contingent liabilities generated by SEPs have increasingly strained the public finances.

According to audited reports of State-owned Enterprises, as of end 2015 SEP debt guarantees accounted for US$2,1 billion of Zimbabwe’s total public and publicly-guaranteed debt.

Zimbabwe’s growing public debt burden and large, fragmented public sector continue to threaten fiscal sustainability.

Zimbabwe’s total public debt stock has grown rapidly, reaching 70% of GDP in 2016. External debt, most of which is in arrears, accounts for two-thirds of the debt stock.

With limited access to international capital markets, Zimbabwe has increasingly turned to domestic debt financing, largely through the banking system.

The domestic financial sector covered most of the widening fiscal deficit in 2016, and as banks depleted their US dollar reserves, many were unable to accommodate withdrawals.

Cash shortages developed in early 2016, forcing banks to limit both cash withdrawals and import payments. Severe liquidity constraints also increased premiums for cash payments.

New bond notes introduced in November 2016 have eased liquidity shortages but are unable to address the underlying macroeconomic imbalances. The bond notes have increased the cash supply, boosting liquidity and attenuating deflationary pressures.

However, further issues of bond notes will need to be carefully monitored to contain inflationary pressures.

Fiscal policy

After nearly a decade of fiscal prudence, the central government’s shift to an expansionary fiscal stance in 2016 resulted in an economy-wide credit shortage and liquidity crisis.

Revenue and expenditure dynamics both contributed to the deterioration of the government’s fiscal position. As the economy weakened, public revenue fell by 6,3% — the first such drop since 2009.

Meanwhile, the public-sector wage bill continued to rise, and drought-response policies drove a dramatic increase in total spending of around US$870 million, or 5,3% of GDP.

In addition, the government started to issue Treasury Bills to honour outstanding domestic arrears accrued by the Reserve Bank of Zimbabwe (RBZ) and several SEPs.

The combined impact of falling revenues, rising expenditures and the repayment of arrears widened the fiscal deficit to around 10% of GDP in 2016. The government turned to the domestic banking sector to finance the widening fiscal deficit, resulting in an acute credit and liquidity shortage.

The public debt stock increased from US$9,4 billion (or 58% of GDP) in December 2015 to US$11,4 billion (or 70% of GDP) in 2016.

In addition to the fiscal deficit, purchase of non-performing loans (NPLs) through the Zimbabwe Asset Management Company (Zamco) and the assumption of pre-2008 arrears in the fiscal accounts contributed to the increase in the debt stock. Domestic debt rose from US$2,3 billion to US$3,9 billion. Eighty percent of Zimbabwe’s domestic debt is held by commercial banks. Most public debt is short-term weakening the debt profile.

The liquidity shortage has also highlighted the medium-term fiscal-policy challenges stemming from Zimbabwe’s large and complex public sector. Zimbabwe’s sizeable public-sector workforce and generous wages and benefits relative to the private sector have generated substantial personnel costs that crowd out priority spending on operations, maintenance, and poverty-reduction programmes. The central government wage bill accounted for about 90% of public revenue and 66% of public spending in 2016.

Rising personnel costs have also constrained the finances of LAs and SEPs, reducing their ability to deliver public goods and services. As their expanding wage bills have reduced the fiscal space for other current and capital spending, LAs have increasingly turned to user fees and other forms of extra-budgetary own-source revenue, further expanding the size and complexity of the public sector.

Meanwhile, rising wage costs have deepened operating losses among SEPs, which already suffer from structural inefficiencies and a difficult economic environment.

The government will need to accelerate the implementation of structural reforms to restore fiscal sustainability while freeing resources for infrastructure investment and poverty-reduction programming.

The government is currently designing measures to limit the growth of the wage bill and taking steps to improve the efficiency and accountability of SEPs. Accelerating growth and re-establishing sustainable fiscal dynamics will require integrating these efforts into a comprehensive reform programme, which includes refocussing public spending on priority capital investment projects and social programmes, improving the business environment through the transparent and consistent implementation of modern investment policies, and addressing the country’s debt burden and governance challenges.

World Bank Report titled Zimbabwe Economic Update, The State of the Economy.