Infrastructure Development and Debt Sustainability

1. Shebo Nalishebo, Research Fellow, Public Finance EAZ Public Discussion Forum Southern Sun Hotel 6th August 2014 Infrastructure Development and Debt Sustainability

2. 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

3. Infrastructure gaps clearly enormous Source: CSO, LCMS 2010

4. 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.

5. 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

6. Debt Sustainability Framework • The DSA is based on the Debt Sustainability Framework (DSF) for Low Income Countries jointly developoedby 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

7. 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

8. Extension of the dynamic general equilibrium model • The paper by Buffieet. 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

9. 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

10. The recent fiscal story

11. The fiscal deficit story Source: Ministry of Finance

12. The fungibility problem • Due to problems of implementation, donors prefer project support rather than budget support • Budget support has therefore dwindled Source: Ministry of Finance

13. The need for tax reforms to reduce distortions • 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

14. 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? Source: Ministry of Finance

15. 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

16. 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

17. 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

18. Thank you End of presentation