2019 Mid-year budget review Shebo Nalishebo, Research Fellow, Public Finance 12 September, 2019

CHALLENGING Macroeconomic ENVIRONMENT GDP growth (projected at 4%) revised downwards to 2-3%; Immediately sends red flags about revenue targets Despite constrained growth (2.6% in Q1), revenue targets were broadly in line with the targets Inflation breached the 6-8% threshold beginning May Adverse weather conditions undermined agriculture production, culminating into higher food prices. International reserves (expected to be at least 3 months of import cover) depleted to 1.6 months as at end-June 2019 Country more vulnerable to liquidity risks Load-shedding, reminiscent of 2015 when GDP declined from US$27 billion in 2014 to US$21 billion in 2015

BRINGING DOWN THE DEFICIT Government is on track to meet its fiscal deficit target Fiscal deficit target of 6.5% of GDP (down from 7.2% in 2018) The fiscal deficit in H1 was 2.9% of GDP well within the 6.5% annual target due to higher than projected revenues largely due to improved collection of non- tax revenue, and the scaling down of recurrent expenditure But spending is being squeezed by higher than planned debt servicing costs and capital expenditure and capital expenditure Capital expenditure K3 billion above target has already used 73% of total planned capital expenditure for 2019 Debt interest payments K2 billion (or 27%) above target already gorged 65% of the approved budget on interest payments in H1 alone, squeezing out other domestic spending.

REVENUE Revenue collection in H1 was higher than planned K32.6 bn in revenue and grants, equivalent to 10.9% of GDP (2019 target: >18% of GDP) Amounts to 56% of the approved revenue target for 2019, and 8% above the projection for H1. VAT performed better than target projections Other major tax types disappointed Against a target of K7.5 bn, the actual VAT collections were K8.7 bn Impressive collection in non-tax revenues K7.0 bn, which was 50% above target. This is due to higher than anticipated dividends and increased collections for user fees, fines and other charges

RISKS TO REVENUE PERFORMANCE Unfavourable mining fiscal regime: mining sector bombarded with a number of tax measures Increased mineral royalty rates by 1.5 percentage points at all levels of the sliding scale and introduction of new tiers Made mineral royalty tax non-deductible for income tax purposes Introduced an import duty at the rate of 5% copper and cobalt concentrates Introduced an export duty on precious metals (which included gold, precious stones and gemstones) at the rate of 15% Lifted the suspension of the export duty on manganese ores and concentrates which was put in place in 2012 and increase this duty from 10 to 15% Business uncertainty brought about by planned introduction of the non-refundable Sales Tax in place of VAT VAT refunds risen as businesses look to make claims ahead of the sales tax launch date VAT claims have increased from a monthly average of K800m in 2018 to K1.4 bn per month in the first half of 2019 Subdued growth due to the effects of load shedding and increased debt

EXPENDITURE Spending in the first half of 2019 was K2.8 bn above projections mainly due to an additional K2bn on higher than projected interest payments and extra K3 bn on capital expenditure. Capital expenditure was the highest expenditure item. It accounted for K15 bn or 32% of total expenditure. Non-capital expenditure has been restrained. The public sector wage bill, interest payments, subsidies and other recurrent expenditures were 81% of domestic revenues during the first half of 2019 This implies that all recurrent expenditures can be completely covered from domestic revenues. Looking good for fiscal sustainability

RECURRENT EXPENDITURE …IN MORE DETAIL Social benefits hard hit Government only managed less than 20% of projected spend. Arrears build-up due to non-payment for goods & services reported at K17.6 billion end March 2019 Difficulties for businesses in accessing credit from commercial banks Resulting in a reduced pace of economic activity. In August, the Finance Minister proposed a K9.8 billion supplementary budget to cover an emerging financing gap. K6.4 bn of this is required to meet higher than anticipated debt obligations, due to depreciation of the Kwacha against the dollar, and to cover shortfalls over maturities of Government securities. Approximately K8.7 bn is to be financed through the declaration of savings from within the existing budget. Likely to further worsen arrears & funding to social benefits

FINANCING the deficit 6.5% fiscal deficit translates to ~K20bn borrowing Borrowing in H1 was K10.9 bn. Mostly funded by external borrowing and this is likely to continue for the rest of 2019 More external borrowing mitigates the crowding-out effect of private sector borrowing But it makes the country more susceptible to exchange rate risks Govt requires an additional K6.4bn for increased debt servicing costs (supplementary budget) 1.4% of GDP target for domestic borrowing likely to be met, not because of fiscal prudence, but because of no money in the domestic market Domestic markets remain shallow and undiversified limited investor base – mostly banks & pension funds Against a target of 1.0% of GDP in domestic borrowing in the first half of the year, the Government only realised a tenth of that amount.

KEY MESSAGES & RECOMMENDATIONS Revenues were above target partly due to higher than planned income from dividends The reorganisation of state-owned enterprises can bring in more dividends Non-deductibility of mineral royalties for income tax purposes hurting mines’ bottom lines and likely to hurt growth Consider reversal of this measure Sales tax talk has created uncertainty and increased claims Reconsider migration to sales tax given the adverse ramifications such as the cascading effect Continued higher than planned capital expenditure, which is largely borrowed externally, contributing to high debt servicing payments Debt service payments take precedence over other spending, compromising service delivery & increasing accumulation of arrears Ministry of Finance needs to devise an arrears clearance strategy with a phased approach of how the arrears will be dealt with in the short to medium term Government needs to ring-fence social spending

CONCLUSION The Government needs to improve investor confidence and remove uncertainties brought about by the new mining fiscal regime and the impending sales tax Increasing taxes in a constrained growth environment is a definite no-no: Government should instead consider reducing some tax rates (e.g. non-deductibility of sales tax from income tax) to lower business costs and stimulate productivity & production. This will in turn help spur investment, bring back the growth, improve revenue receipts to fund critical social services which are presently under-funded Externally-borrowed funds are mainly used for building infrastructure. This adds to debt servicing costs which are prioritised over other spending. Therefore, capital spending needs to be rationalised.