Infrastructure Development and Debt Sustainability

Shebo Nalishebo, Research Fellow, Public Finance

EAZ Public Discussion ForumSouthern Sun Hotel6th August 2014

Overview

Zambia is faced with huge infrastructure gaps Government has prioritised development of

infrastructure in its development plans The low revenue mobilisation coupled with higher

than planned expenditure has increased the fiscal deficit, and increased the stock of debt

With inadequate tax revenue, Government’s had to consider other financing options (domestic borrowing, concessional & non-concessional external borrowing)

The front-loading of infrastructure projects and rapidly increasing debt has caused public concerns about debt sustainability

Infrastructure gaps clearly enormous

2543 38

67 78

37

7551

86 95

3 9 1634 47

% Household with no access to selected infrastructure, Zambia

Zambia Rural Urban

Source: CSO, LCMS 2010

Prioritising infrastructure development

Infrastructure development, the main anchor of development process in the Revised SNDP 2013-2016

The major areas that are being undertaken during the plan period are: Investment in infrastructure in health, education and water

& sanitation; Increasing the power generation capacity through up-

grading and construction of new hydro-power stations, and use of alternative energy sources;

Improving and expanding the rail network to reduce the burden placed on road infrastructure; and

Constructing additional inter-provincial & inter-district roads to open up the country in line with the Link Zambia 8000 project.

Debt Sustainability Analysis The surge in infrastructure projects partly

responsible for higher fiscal deficits The high deficits have caused concerns

about debt sustainability, which threatens macroeconomic stability and creates heavy repayment burdens

To assess these risks, the Ministry of Finance recently conducted a Debt Sustainability Analysis (DSA) to guide the country’s borrowing decisions and reduce the chances of excessive debt accumulation

Debt Sustainability Framework The DSA is based on the Debt Sustainability

Framework (DSF) for Low Income Countries jointly developoed by the IMF and the World Bank.

The DSF has been criticised for being overly conservative in its assessment of the risk of debt distress, thereby constraining LICs from undertaking the borrowing necessary to finance growth-enhancing investments;

By failing to take sufficiently into account the assets & future income that public investment may generate, LIC-DSAs : give overly pessimistic risk assessments, which in turn discourage potential investors, and constrain how much LICs can borrow

Models to complement DSF

WB & IMF have responded to some of these criticisms: outlined in the 2012 paper “Revisiting the Debt

Sustainability Framework for Low Income Countries”  Paper proposes the greater use of models to better

capture investment-growth linkages Recently Buffie et al. (2012) have put forward a dynamic

LIC-specific macroeconomic model that complements the IMF-WB DSF

The dynamic general equilibrium model : provides a systematic framework for analysing the

interactions between public investment, financing alternatives, the budget, and growth and the implications for debt sustainability

Extension of the dynamic general equilibrium model

The paper by Buffie et. al. does not include the implications for public infrastructure investment in environments where: the recurrent cost associated with the operations of government are

high, when taxation is distortionary, and returns from public investment may not be fully appropriable.

Christopher Adam & David Bevan (2014) extend the model by Buffie et. al. and incorporate these issues;

The paper illustrates the implications of bringing these issues from the periphery to the core of a conventional analysis of public investment, growth and debt sustainability Further work is going on with regard to the tax system, disaggregation

of current fiscal data to bring out actual and efficient operations and maintenance expenditures

political economy and institutional economics of systems of public expenditure and budget management

Can this model be applied to Zambia?

Before this model can be applied to Zambia, a few considerations: Dynamic general equilibrium models are

data-hungry; Zambia data are generally limited; input-output tables & SAM can be constructed from latest economic census

There is also need for an explicit assessment of the trade-offs between the usability and the complexity of using dynamic general equilibrium models

The recent fiscal story

The fiscal deficit story

11,016

500 - 300 2,528

11,897

1,122 1,610 2,311 3,612

These 5 categories accounted for about 65% of the fiscal deficit in 2013 (millions of

Kwacha)

Budget Outturn

Source: Ministry of Finance

The fungibility problem

2012 2013 20140.2

0 0

1.4

0.9 0.9

Foreign loans, % of GDP

Budget supportProject loans

Due to problems of implementation, donors prefer project support rather than budget support

Budget support has therefore dwindled

Source: Ministry of Finance

The need for tax reforms to reduce distortions

2012 2013 2014

8.0 6.8 6.5

3.7 5.1 4.9

1.7 1.6 2.0

1.6 1.2 1.4

Tax revenue as % of GDP

Income taxes Value added taxExcise taxes Customs duties

Income taxes on the decline Is the reduction of capital

allowance from 100% to 25% hurting investment + corporate income tax receipts?

Personal income tax paid by about 50% of formal sector workers (around 400, 000).

What about the 10% self-employed who are above the PAYE threshold?

Is it a fair tax? Source: Ministry of

Finance

The need for tax reforms to reduce distortions

Value added tax as % of GDP lower in 2014 compared to 2013 Should we apply the standard VAT

rate of 16% across the board? Should we increase the VAT rate &

broaden the tax base? What impact will it have on the

poor households? Or should we reduce the rate to

insulate the adverse effects on the poor?

How do we improve compliance especially in the retail – the largest sector of the Zambian economy?

2012 2013 2014

8.0 6.8 6.5

3.7 5.1 4.9

1.7 1.6 2.0

1.6 1.2 1.4

Tax revenue as % of GDP

Income taxes Value added taxExcise taxes Customs duties

Source: Ministry of Finance

The need for budgetary reforms Government recently launched the Budget

& Planning Policy Signals commitment to budget reforms

Recent wage increases have squeezed out other spending, such as operations & maintenance (O&M)

There is need to capture information on the depreciation of existing capital stock

The depreciation figures will then be used to estimate the optimal budget for O&M expenditures

The need for a National Infrastructure Plan

Informed by the recently conducted DSA, and complemented by a general equilibrium model, Government should develop a long term planning framework [National Infrastructure Plan]

The Plan will Help address historic problems of short-term

decision making, uncertainty in funding and financing, and failures in delivery

Improve transparency in how eurobond money is utilised

Integrate operations & maintenance expenditures Identify funding sources and financing gaps, and the

action the government will take to address these funding gaps

Last word … The preservation of the country’s long-term fiscal

stability means the government should consider the ideal balance of financing options that will ensure debt sustainability The right mix of taxes, grants, domestic borrowing,

foreign concessional & non-concessional borrowing Going forward, there is need for our economic

decisions to be informed by the recently conducted DSA, complemented by such macroeconomic models as proposed by Prof. Adam

Thank youEnd of presentation