101704 WORLD BANK GROUP DECEMBER 2015 I 6 th Z A M B I A E C O N O M I C B R I E F POWERING THE ZAMBIAN ECONOMY December 2015 @ 2015 The International Bank for Reconstruction and Development/THE WORLD BANK 1818 H Street NW Washington, DC 20433 USA All rights reserved This report was prepared by the staff of the Macroeconomic and Fiscal Management and Energy and Extractives Global Practices of the World Bank Group. The findings, interpretations, and conclusions expressed herein are those of the authors and do not necessarily reflect the views of the World Bank’s Board of Executive Directors or the countries they represent. This report was designed and edited by Katarina Zeravica, Lusaka. Cover design: Clement Masiye Daka Photos: World Bank, Zambia ICONTENTS Acronyms i Foreword ii Acknowledgements iii Executive Summary 1 Section 1: Recent Economic Developments 3 A. Regional Economic Developments 3 B. The State of the Zambian Economy 7 C. Economic Outlook, Risks and Policy Challenges 13 Section 2: Powering the Zambian Economy 16 D. The Electricity Challenge 16 E. Zambia’s Power Crisis 18 F. Managing the Cost of Mitigation 20 G. Graduating to Sustainable Supply 24 References 26 Notes 26 Boxes 1 Huge recent subsidy bills for government 11 2 Hydro-Electricity in Zambia 18 3 Scaling solar in Zambia 21 4 Diversification and demand-side measures in Ethiopia 25 Figures 1 Commodity prices have continued to fall in 2015 3 2 Current account and fiscal balances are growing 4 3 The US$ has strengthened against frontier market currencies 5 4 Sovereign bond spreads have widened 5 5 Growth in SSA and developing countries has slowed 6 6 Global copper prices have been falling since 2011 7 7 The kwacha has deprecated considerably 2015 8 8 Inflation increased substantially in Q3 2015 9 9 Growing and repeat fiscal deficits 11 10 The Trade Balance has become negative in 2015 12 11 Electricity generation capacity fallen below Demand 17 12 Power deficit trends in 2016 22 13 The cost to government of emergency power depends on the tariff 23 Tables 1 Fiscal trends 10 2 A power generation deficit in 2015 19 3 Private power plant contract status 20 4 A power deficit is expected in 2016 21 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y IACRONYMS BoZ Bank of Zambia BSA Bulk Supply Agreements CEC Copperbelt Energy Corporation CFL Compact Fluorescent Lamps CSO Central Statistical Office DAM Day Ahead Market DFID Department for International Development ERB Energy Regulation Board FDI Foreign Direct Investment GDP Gross Domestic Product GWh Giga Watt Hours IDC International Development Corporation IMF International Monetary Fund IPP Independent Power Producers KW Kilo Watt LCMS Living Conditions Monitoring Survey LCPDP Least Cost Power Development Plan LPG Liquefied Petroleum Gas MW Mega Watts PSA Power Supply Agreements SAPP Southern African Power Pool SSA Sub-Saharan Africa US$ United States Dollar USc United States Cent VAT Value Added Tax WBG World Bank Group ZRA Zambezi River Authority ZMW Zambian Kwacha i 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y IFOREWORD I am pleased to share the sixth Zambia Economic again face a similar crisis in the near future if struc- Brief with a focus section on the power sector. This tural weaknesses in the sector are not adequately Brief is part of a series of short economic updates addressed. There remains a need to shift from be- produced twice a year by the World Bank. Each Brief ing reactive to anticipatory or preemptive in dealing includes two sections: the World Bank’s assessment with reduced generation capacity. Additionally, the of recent economic developments and outlook in need to increase access to electricity in the country the short- to medium-term, and its analysis of a spe- should not be neglected. cific development topic or theme. Previous Briefs covered opportunities for mining, human develop- We hope that the findings of this Brief will stimulate ment, jobs, trade, and financial inclusion. a healthy debate around these questions so that Zambia can weather the current economic difficul- Zambia faces its toughest economic challenges in ties and power crisis and shift to inclusive growth at least a decade. The economy has come under underpinned by a reliable power supply. strain in 2015 as external headwinds and domestic pressures have intensified. Insufficient fiscal buffers were built up in the times of higher copper prices, limiting the room to maneuver now that prices are low. Stark trade-offs exist between cushioning peo- ple from the impact of the power crisis by sourcing emergency electricity and reducing the fiscal deficit to restore confidence and fix the underlying prob- lems in the economy. Ina Ruthenberg In the power sector, global experience shows there Country Manager for Zambia is no substitute for effective planning. Zambia may The World Bank ii 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y IACKNOWLEDGEMENTS The sixth Zambia Economic Brief has been prepared jointly by the Macroeconomic and Fiscal Management and Energy and Extractives Global Practices of the World Bank Group. The team was led by Gregory Smith, and included Zivanemoyo Chinzara, Joseph Kapika and Raihan Elahi. Simon Davies and Annelies Raue (UK’s DFID) provided peer review and useful comments were also received from Catriona Purfield and Tobias Ras- mussen (IMF). Jumbe Ngoma led the dissemination activities with support from Wisdom Mulenga, Hellen Mungaila, Mofya Mwanalushi, Kelvin Ng’andu and Gebisa Chisanga. Gebisa Chisanga and Hellen Mungaila provided adminis- trative support. Ina Ruthenberg, the Zambia Country Manager; Mark Thomas, Practice Manager for Macro- economic and Fiscal Management Global Practice; and Catriona Purfield, Program Leader, provided overall guidance. iii 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y EXECUTIVE SUMMARY Regional economic developments have reduced the agricultural incomes of 62% of the As African economies face difficult global conditions population living in poverty. combined with domestic challenges, Sub-Saharan Africa’s (SSAs) economic growth will continue to Medium-term outlook slow in 2015 to 3.7% from 4.6% in 2014, according The outlook for 2016 has become more sombre fol- to World Bank projections. The end of the commod- lowing announcements of expected mine closures, ity price super cycle − with a substantial drop in the the severity of the power crisis and the rapid depre- price of oil, copper and iron ore; a slowdown of the ciation of the kwacha. Given the external and do- Chinese economy; and tightening global financial mestic challenges, we expect GDP growth to drop conditions underpin the deceleration in growth. to 3 to 3.5% this year and next, before returning to potential (5 to 6%) by 2018 as copper prices stabi- Worsening current account and fiscal imbalances lize and domestic pressures ease. Tough action is have propagated a depreciation in most resource- required in 2016 to curb runaway expenditures, dependent currencies. This depreciation has been double digit inflation and growing twin deficits. Fis- compounded by a general increase in the demand cal policy should be put center stage and efforts for the United States dollar (US$) in anticipation of made to shift the country back onto a sustainable an increase in the US Federal Reserve rate. Domes- fiscal path. tic factors have also weighed on some currency de- preciation. The outlook is subject to downside risks, both do- mestic and external. Externally, a further slowdown Another recent trend is increased access to interna- in China’s economy would weigh on the demand for tional debt markets by low income and lower-mid- Zambia’s exports by further reducing copper prices, dle income countries. But the cost of borrowing has and would severely affect Zambia’s prospects. Fur- increased sharply in 2015 for many sovereigns and thermore, strengthening of the US$ in the event of the spreads on African countries’ Eurobonds have the Federal Reserve increasing interest rates would widened over uncertainty about government poli- lead to added volatility of the kwacha. cies and a slowdown in the economies. The spreads have increased the most where market confidence The main domestic risks are threefold. Firstly, that is weakest. the power crisis will worsen. This could occur via delays in new generation coming online or a fur- The state of the Zambian economy ther reduction of generation capacity at the main Zambia faces its toughest economic challenges in at hydropower plants. Secondly, a deterioration of least a decade. The economy has come under strain confidence in the economy, leading to further weak- in 2015 as external headwinds and domestic pres- ening of the currency and increased levels of infla- sures have intensified. Growth of the economy is tion. This might result in the absence of measures expected to drop beneath 4% in 2015 for the first to curtail runaway expenditure and failure to make time since 1998, resulting in only marginal growth any substantial dent in the fiscal deficit. In this event, of per capita incomes. The external headwinds in- external financing would also become more costly clude slower regional and global growth (crucially in and put further pressure on the 2016 budget and China who purchase 40% of global copper produc- for years to come via increased debt service obliga- tion) and a US$ that has strengthened considerably tions. Lastly, a bad harvest that serves to increase against the kwacha. Domestic pressures include a food prices and reduce rural and agricultural in- power crisis impacting on all sectors of the econo- comes, with the greatest impact falling on the poor- my, repeat fiscal deficits that have reduced inves- est households. tor confidence, and low and poorly-timed rains that 1 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Policy challenges a reduction in hydroelectric generation due to low Commodity-exporting countries’ policy makers face water levels at the country’s main reservoirs. This increasing challenges across the globe. Zambia is no has increased power outages and impacted on all exception and must grapple with multiple challeng- aspects of the economy, contributing to slower eco- es as the economy slows down. Falling copper prices nomic growth in 2015 and higher production costs. and a power crisis could be met with fiscal buffers, Since July 2015, ZESCO has increased the extent of but in Zambia no savings were made, or stabiliza- rolling black-outs (load-shedding) to at least 8 hours tion measures carried out when the economy was per day on a rotational basis for the majority of its prospering. Furthermore, debt levels have soared household, commercial and industrial consumers. following repeat non-concessional borrowing mak- And although they are not subject to rotational load- ing it more expensive to borrow from international shedding, ZESCO has requested the mining industry debt markets. to curtail its load by 30%. This is in order to manage a power deficit of around 591 MW each month (Sep- This leaves the government with little room for tember to December 2015), representing approxi- maneuver, limited fiscal space to compensate for mately 34% of demand. slower growth and recent job losses, and only hard choices. Trade-offs exist between cushioning peo- Mitigating the power crisis ple from the impact of the depreciation and power Power is essential for the Zambian economy to func- crisis by subsidizing the cost of fuel and electricity, tion. Despite new generation projects, the modelling and reducing the fiscal deficit to restore confidence of different hydrology conditions shows that even in to fix underlying problems in the economy. These a wet (above average rainfall) scenario, current pow- trade-offs are particularly stark in 2016 given it is an er shortages will continue through to at least 2018. election year. For 2016, the authorities have decided to increase the import of expensive emergency power options. Large fiscal deficits and inefficient government This puts huge pressure on the budget at current spending persist as sources of vulnerability for Zam- tariff rates, in tough economic conditions, and un- bia. Strengthening the fiscal position and restoring less tariffs are revised upwards, the government’s fiscal buffers are necessary to increase confidence subsidy of the sector will rise dramatically. At No- in the economy, reduce the need for costly borrow- vember 2015 tariff rates, the government will need ing and build resilience against further exogenous to provide ZESCO with an additional US$ 340 million shocks. Fiscal adjustment would also put less pres- in 2016 to meet the cost of emergency power. How- sure on monetary policy and potentially make space ever, the financing requirement can be substantially for interest rates to be reduced, easing the pressure reduced if the average tariff is increased. on individuals and firms. Keeping inflation expecta- tions anchored in single digits remains critical to Key to note is that an increase in tariffs to cost-re- maintaining macroeconomic and wider develop- flective levels is necessary but not sufficient to in- ment objectives. crease private investment in electricity generation in Zambia. There are many other hurdles to overcome With market access comes greater scrutiny and pol- as well. Management and regulation of the sector icy responses are judged by real action that affects have been improving, but there is still substantial the interest rate paid on new borrowing. Eurobond work to do. Particular efforts are needed to improve issuance has also increased international inter- sector planning and the procurement processes for est in the Zambian economy and events are being large power projects. watched much more closely than prior to 2012. To help maintain confidence in the economy, and Zam- Graduating to sustainable supply bia as an investment destination, better dialogue The new generation capacity and emergency meas- on the economy should be targeted and confusing ures for 2016 will help in mitigating the impact of messages avoided. the power crisis in the coming year, but global ex- perience shows there is no substitute for effective In addition, the commodity price shock highlights planning. Furthermore, Zambia may again face a the need for Zambia to reduce its dependency on similar crisis in the near future if structural weak- copper, a challenge it has been grappling with for nesses in the sector are not adequately addressed. over 50 years. Talk about diversification and grow- There remains a need to shift from being reactive ing manufacturing needs to be met with a clear and to anticipatory or preemptive in dealing with a re- realistic strategy and structural reforms aimed at re- duced generation capacity. Additionally, the need to moving impediments to private sector activity and increase access to electricity in the country should improving the business environment. not be neglected. Powering the Zambian economy Economic progress since 2000, driven by mining production and services, has substantially increased the demand for electricity in Zambia. A growing shortfall in supply has been exacerbated in 2015 by 2 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y 1 RECENT SECTION ECONOMIC DEVELOPMENTS A. REGIONAL ECONOMIC DEVELOPMENTS As African economies face difficult global conditions combined with domestic challenges, Sub-Saha- ran Africa’s economic growth will continue to slow in 2015 to 3.7% from 4.6% in 2014, according to World Bank projections. The end of the commodity price super cycle − with a substantial drop in the price of oil, copper and iron ore; a slowdown of the Chinese economy; and tightening global financial conditions underpin the deceleration in growth. The World Bank’s Africa Pulse published in October 2015 highlights that continued dependency on oil and commodity exports has left the Sub-Saharan Africa (SSA) region vulnerable to periodic shocks from the prices of international commodities. The region remains a net exporter of oil, minerals, and agricultural commodities. Specifically, ener- China’s slowdown gy (oil and gas) and minerals comprise two-thirds of SSA’s exports.1 International com- and economic modity prices have steadily softened since early 2014, although they remain above the transition has levels experienced during the 2008 financial crisis. In August 2015, oil prices reached direct spillover their lowest level since the end of the financial crisis (figure 1). Similarly, copper prices effects. fell to their lowest level since August 2009. The slowdown and economic transition in China has been a driver of weakening international commodity prices. China is SSA’s largest trading partner and its slowdown and economic transition has direct spillover effects, especially to the oil-exporting and mineral-rich SSA countries. Angola, Democratic Republic of the Congo, Mauritania, Republic of Congo, Sierra Leone, Figure Commodity prices have continued to fall in 2015 1 130 120 110 100 Weakening oil and 90 mineral prices have propagated 80 a deterioration of 70 the terms of trade 60 of oil-exporting 50 and mineral-rich economies. 40 30 01/01/2014 15/01/2014 29/01/2014 19/02/2014 04/03/2014 17/03/2014 28/03/2014 11/04/2014 25/04/2014 12/05/2014 23/05/2014 09/06/2014 20/06/2014 03/07/2014 17/07/2014 30/07/2014 12/08/2014 25/08/2014 09/09/2014 22/09/2014 10/10/2014 23/10/2014 05/11/2014 18/11/2014 02/12/2014 15/12/2014 29/12/2014 13/01/2015 27/01/2015 09/02/2015 02/03/2015 13/03/2015 26/03/2015 10/04/2015 23/04/2015 07/05/2015 20/05/2015 03/06/2015 16/06/2015 30/06/2015 14/07/2015 27/07/2015 07/08/2015 20/08/2015 02/09/2015 18/09/2015 Oil Copper Iron Ore Agriculture Source: World Bank (2015) 3 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y The Gambia, and Zambia have been the most affected given that 40% of their exports go to China. Central Africa Republic, Eritrea, Mali, South Africa, and Zimbabwe have also been affected as their exports to China are above 20% of total exports. Conse- quently, the growth of SSA is expected to slow to 3.7% in 2015 on the back of poor growth performance in the oil-exporting and mineral-rich economies. Domestic factors such as poor agricultural yields due to drought (e.g. Zambia), power supply bottlenecks (e.g. South Africa, Nigeria, Zambia), political instability (Burundi, Burkina Faso, South Sudan), and insurgency (e.g. Nigeria, Cameroon, Chad, Niger) are expected to further Worsening current drag down growth. account and fiscal imbalances have Nevertheless, in the majority of oil-importing countries, particularly those that are non- propagated a mineral rich, growth is expected to remain robust. Notable examples include Cote depreciation in d’Ivoire, Ethiopia, Mozambique, Rwanda, and Tanzania, where growth will not only be most resource- driven by low oil costs, but also by government investment in infrastructure, and an ex- dependent panding services sector. However, in some economies, there is a risk that low growth in currencies. the oil-exporting and mineral-rich countries will spill over to some of the non-resource rich economies through reductions in intra-regional trade and investment. Weakening oil and mineral prices have propagated a deterioration of the terms of trade of oil-exporting and mineral-rich economies. This has led to weakened current account positions for most of these economies (figure 2). For example, in Nigeria, the current account deficit widened from 0.6% of GDP in Q4 2014 to 3.6% of GDP in Q1 2015. In Zambia, the current account deficit deteriorated to 3.4% of GDP in 2014 from 0.8% of GDP in 2013. Furthermore, in countries such as Angola, Nigeria, and Zambia, where oil and mineral exports contribute to part of the government revenue, the fiscal deficit has widened (figure 2). However, in other cases, fiscal imbalances have been worsened by recurring domestic factors, among others, which include rising wage bills, large expend- iture on infrastructure, and high expenditure on subsides. In countries such as Ghana and Zambia, these fiscal deficits have been financed by borrowing in the international debt markets, resulting in substantial increases in the debt to GDP ratios. Figure Current account and fiscal balances are growing 15 2 10 5 % of GDP 0 Depreciating currencies have -5 exposed countries to inflation through imported inputs -10 and consumables. -15 Angola Nigeria Zambia South Africa Kenya Ghana Tanzania Fiscal balance 2008 Fiscal balance 2014 Current Account Balance 2008 Current Account Balance 2014 Source: World Bank (2015) Worsening current account and fiscal imbalances have propagated a depreciation in most resource-dependent currencies (figure 3). This depreciation has been compound- ed by a general increase in the demand for the US dollar in anticipation of an increase in the US Federal Reserve rate. Domestic factors have also weighed on some currency depreciation. For example, in Zambia, investors’ concerns about the government’s com- mitment to reining in the fiscal deficit has caused volatility in the Zambian kwacha. De- preciating currencies have exposed oil-exporting and mineral-rich countries to inflation through imported inputs and consumables. Having remained stable over the past few years, and declined to 5.9% in 2014 from 6.1% in 2013, inflation rates in the SSA are expected to increase to 6.5% in 2015. 4 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Domestic factors such as fiscal expansion in the lead-up to elections, and poor agri- cultural harvests and electricity bottlenecks, are also going to be drivers of inflation in some countries. At the sub-regional level, the Central African region is set to continue being the least inflationary. This is mainly because of the common monetary policy pursued by most countries in this region (being administered by the regional central A recent trend is bank ― the Bank of Central African States, through pegging of their common currency, increased access to the CFA franc, to the Euro). international debt markets by low income and lower Figure The US$ has strengthened against frontier market currencies middle income 3 0 countries. -10 -20 Cumulative Depreciation (%) -30 -40 -50 -60 -70 -80 -90 -100 -110 -120 -130 -140 2014-Apr 2014-Aug 2015-Apr 2015-Aug 2014-Nov 2014-Sept 2015-Sept 2014-May 2015-Feb 2015-May 2014-Jul 2015-Jul 2014-Feb 2014-Oct 2015-Jun 2015-Oct 2014-Jun 2014-Dec 2014-Mar 2015-Mar 2014-Jan 2015-Jan 2015- Nov South Africa Nigeria Kenya Zambia Source: World Bank (2015) A recent trend is increased access to international debt markets by low income and lower-middle income countries. Since 2007, 17 SSA countries, in addition to South Af- rica, have tapped over US$24 billion, typically at fixed interest rates, with bullet repay- ment structures and in US dollars, thereby adding foreign currency risks that these countries need to manage. The cost of borrowing has increased sharply in 2015 for many sovereigns, with Ghana issuing US$1 billion (15 year tenor) at 10.75% and Zambia US$1.25 billion at 9.375% (11 year tenor on average); rates that are much higher than Spreads on previous issues. Further, having narrowed in April and May 2015, the spreads on Afri- African countries’ can countries’ Eurobonds have widened over uncertainty about government policies Eurobonds have and a slowdown in the economies. The spreads have increased the most where market widened over confidence is weakest (figure 4). uncertainty about government policies and a slowdown in the Figure Sovereign bond spreads have widened economies. 4 1000 Africa region Emerging markets 800 Basis points spread Ghana 600 Namibia 400 Nigeria 200 South Africa 0 Zambia 02/01/2014 02/03/2014 02/05/2014 02/07/2014 02/09/2014 02/11/2014 02/01/2015 02/03/2015 02/05/2015 02/07/2015 02/09/2015 02/11/2015 Source: Bloomberg 5 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Outlook for Sub-Saharan Africa In the medium term, the overall growth for the SSA region is expected to rebound to Power bottlenecks, 4.4% in 2016 and improve to 4.8% in 2017, albeit with mixed recovery across countries fiscal consolidation due to domestic factors (figure 5). In some of Africa’s frontier markets, medium-term and high costs of growth recovery is expected to be much quicker on the back of rising oil production, imported inputs easing external and fiscal imbalances, and continued large investment in infrastructure. will drag on growth However, factors such as power bottlenecks (in Nigeria, South Africa, and Zambia), fiscal recovery in SSA. consolidation and high costs of imported inputs imposed by weaker currencies (Nige- ria, Zambia), political instability (Burundi and South Sudan), and policy uncertainties will also drag on growth recovery in the region. Figure Growth in SSA and developing countries has slowed 12% 5 10% 8% 6% 4% 2% 0% 2008 2009 2010 2011 2012 2013 2014 2015f 2016f 2017f China Developing countries excluding China Sub-Saharan Africa Zambia Source: World Bank (2015) and staff projections The medium-term growth outlook of the region is subject to several downside risks. Policy buffers are The global risks include the slow growth and economic transition in China, which is ex- lower than before pected to spill over to the SSA region through depressed prices and volumes of oil and the global financial mineral exports. Furthermore, an anticipated increase in the US Federal Reserve inter- crisis, making it est rate is expected to tighten global financing conditions and investment flows into the more difficult for countries to grow. SSA region, and possibly cause further weakening of regional currencies. Countries with large external and fiscal imbalances are expected to be the most vulnerable to these factors. In this regard, fiscal consolidation and structural reforms can potentially help countries to contain the effects of these shocks. Domestically, the risks include politi- cal instability in Burundi and South Sudan, and security risks caused by insurgency in parts of Nigeria, Cameroon, Chad, Niger, and Kenya, while weather-related shocks are expected to negatively affect medium-term growth prospects. When the global financial crisis hit the region, some countries were able to use govern- ment investment in infrastructure and other built-in buffers to finance policy responses to enable growth. Overall, the analysis shows that before the current bout of global difficulties, these policy buffers were already showing signs of vulnerability from over- valued currencies and growing fiscal deficits. Today, these policy buffers are lower than before the global financial crisis, according to the report, and will make it more difficult for countries to grow in the current situation. 6 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y B. THE STATE OF THE ZAMBIAN ECONOMY Zambia faces its toughest economic challenges in at least a decade. The economy has come un- der strain in 2015 as external headwinds and domestic pressures have intensified. Growth of the economy is expected to drop beneath 4% in 2015 for the first time since 1998, resulting in only marginal growth of per capita incomes. The external headwinds include slower regional and global growth (crucially in China who purchase 40% of global copper production) and a US dollar that has strengthened considerably against the kwacha. Domestic pressures include a power crisis impacting on all sectors of the economy, repeat fiscal deficits that have reduced investor confidence, and low and poorly-timed rains that have reduced the agricultural incomes of 62% of the population living in poverty. The Zambian economy grew at an average annual rate of 6.4% between 2010 and 2014, above the overall growth rate of SSA and on the back of high copper prices, foreign direct investment (FDI) in the manufacturing and mining sectors, government investment in infrastructure, and expanding private sector investment in construction and services. Until recently, inflation remained stable due to prudent monetary policy, the currency remaining relatively stable, and good agricultural harvests recorded. Min- ing and fiscal pressures have been building since 2012-13, but in 2015 the economy The slowdown in China and fall has slowed considerably as global headwinds and domestic pressures have intensified. in international commodity prices The slowdown in China and fall in international commodity prices is having a ripple ef- is having a ripple fect globally and particularly so in Zambia. Some relief has been provided in the form effect globally and of lower global oil prices, but the dominant effect is negative and comes via low copper particularly so in prices, which have been falling since 2011. The Zambian economy remains dependent Zambia. on copper mining, including for 77% of its exports, and the decline in global copper prices, falling 20% in 2015 and ever since its 2011 peak, has put additional pressure on the sector (figure 6). Mining companies are looking globally to scale back operations in high-cost environ- ments and low copper prices have meant that in Zambia, copper mines are being closed, new investment is being delayed and substantial job losses have started in the sector (7,700 between January and end-November 2015). In addition to lower prices, the mining sector is being impacted on by the current power crisis and uncertainty from frequent changes to the mining tax and royalty regime and the back-log of VAT refund payments.2 Figure Global copper prices have been falling since 2011 6 275,000 10,000 250,000 9,000 225,000 8,000 200,000 7,000 Growth in 2015 is 175,000 expected to fall 6,000 to a range of 3 to 150,000 5,000 3.5% highlighting 125,000 the impact of the 100,000 4,000 lower copper prices 75,000 3,000 and domestic pressures. 50,000 2,000 2005 Q3 2006 Q1 2006 Q3 2007 Q1 2008 Q1 2008 Q3 2009 Q1 2009 Q3 2010 Q3 2011 Q1 2011 Q3 2012 Q1 2013 Q3 2014 Q1 2014 Q3 2005 Q1 2007 Q3 2010 Q1 2012 Q3 2013 Q1 2015 Q1 2015 Q3 Domestic Copper Production, MT(LHS) World Copper Price, US$/MT (RHS) Source: Bank of Zambia, Ministry of Finance and World Bank staff calculations Despite decreasing copper prices and declining mining output, growth in 2014 was supported by a good harvest (maize production increased 32% relative to the previous year), expanding services and construction sectors (both growing just above 7%), gov- ernment investment in infrastructure, and rapid growth in the transport (12.5%) and financial and insurance sectors (up 13.2%). Contrastingly, growth in 2015 is expected 7 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y to fall to a range of 3 to 3.5%, highlighting the impact of the lower copper prices and domestic pressures such as a poor maize harvest and the current power crisis. Low rainfall has reduced agricultural production, harming rural households’ incomes. Food prices have The 2014 -15 agricultural (October-March) season was characterized by extensive rain- been increasing fall deficits resulting in markedly below average end of season vegetation (World Food steadily and high Program3). This has reduced agricultural production for 2015 and increased the prices prices for mealie- of food items. Recent drier weather patterns have been strongly influenced by the El meal and meat Niño, an event active since March 2015 and expected to last into Q1 2016. Furthermore, have repeatedly hit climate change has increased the frequency of floods and droughts over the past three the headlines. decades and will continue to have an impact on climate-sensitive sectors such as rain- fed agriculture, fishing, and forestry. The contribution of the agriculture sector to economic growth is expected to be nega- tive in 2015 (preliminary estimates are for a 7.5% decline in output from agriculture, forestry and fishing this year). Food prices have been increasing steadily and high prices for mealie-meal (the main staple in Zambia) and meat have repeatedly hit the headlines. The November 2015 bulletin from the Central Statistical Office (CSO) shows maize grain prices have increased by 32% (year-on-year). While a small proportion of farmers have benefited from the higher prices and sold their maize abroad (especially to the US dol- lar denominated Zimbabwean economy), the vast majority of rural households’ incomes have been hit hard by lower production in 2015. Slower growth and reduced agricul- tural incomes are likely to halt poverty reduction, given the sector is the primary source of income for close to three-fifths of poor households. The current power crisis, discussed in Section 2, is impacting on all sectors of the econ- Global headwinds omy. Like mining, the manufacturing and services sectors have been hit hard as costs have combined have increased and margins squeezed, leading to 7,700 job losses in 2015 and lower with domestic output. pressures and ebbing confidence Sharp kwacha depreciation followed by an inflationary spike in the economy As is typical in this part of Zambia’s copper price cycle, the kwacha has depreciated resulting in huge considerably (the kwacha tends to depreciate as the copper price falls and appreciate shifts and market as it rises). However, on this occasion, global headwinds have combined with domestic turbulence. pressures and ebbing confidence in the economy, resulting in huge shifts and market turbulence. While the strength of the US dollar fused with worsening current account and fiscal imbalances have propagated a depreciation in most resource dependent cur- rencies, the kwacha’s decline stands out (figure 2). There have been three distinct phases to the kwacha to US dollar exchange rate be- tween January and November 2015 (figure 7). There was the gradual depreciation be- tween January and mid-August, where the kwacha depreciated by 21% over 30 weeks, moving from ZMW 6.4 to ZMW 7.9 per US$. Next followed huge volatility and a steep de- cline in the exchange rate and in the 10 weeks to end-October, the kwacha depreciated Figure The kwacha has deprecated considerably in 2015 7 20% 10% 0% -10% At the end of -20% November, annual -30% inflation reached -40% 19.5%. -50% -60% -70% -80% -90% -100% US$ GB£ Euro Rand -110% 09-Jan-15 23-Jan-15 07-Aug-15 21-Aug-15 06-Feb-15 20-Feb-15 18-Sep-15 26-Jun-15 04-Sep-15 02-Oct-15 30-Oct-15 01-May-15 15-May-15 29-May-15 16-Oct-15 06-Mar-15 20-Mar-15 12-Jun-15 10-Jul-15 24-Jul-15 13-Nov-15 03-Apr-15 17-Apr-15 Source: Bank of Zambia 8 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y by 69% to ZMW 12.5 per US$. By November 11, 2015, the exchange rate reached ZMW 14.2 per US$ but by the end of that month had recovered to ZMW 10.3 per US$, an ap- preciation of 27% in 19 days. The net effect is that the kwacha depreciated by 61% over the 11 months to end-November 2015. Put differently, the kwacha lost 38% of its value. Over the 11 months The recovery in November is linked to a belief that the decline of the kwacha had been to end-November over-blown, as well as better targeted and timed intervention by the Bank of Zambia 2015, the kwacha (BoZ), who look to calm the volatility in the foreign exchange market but not set its rate. lost 38% of its Furthermore, it was recognized in September and October that the rule governing for- value. eign exchange trading did not perform well during days of thin markets and large shifts in the exchange rate. Between January 2012 and September 2015, inflation remained stable at an average rate of 7.2%. Low inflation was attributed to low oil prices, a stable currency, and pru- dent monetary policy by the BoZ. In 2015, inflation fell consecutively during Q1 and Q2. However, since mid-2015, inflationary pressures began building up due to the depreci- ating kwacha. However, October inflation (year-on-year) jumped to 14.3% and Novem- ber inflation to 19.5% (figure 8), a shift driven by food inflation that increased to 16.2% in October and 23.4% in November, from 8.1% in August 2015. The basket of food measured includes both domestically produced foods, where price is largely depend- ent on the quality of the harvest, and imported foods where prices are impacted by the depreciation of the kwacha. Non-food inflation also rose to 15.5% in November from just 7.3% in September, on the back of increased transport costs as vehicles and car parts became more costly to import. The big jump in inflation is consistent with expectations about the pass-through from The big jump currency deprecation to inflation in Zambia. There is often a lag in pass-through and in inflation is consistent with the effects can still be felt up to 9 months after an episode of depreciation. Zambia is expectations about viewed as having a relatively high rate of pass-through as even firms producing goods the pass-through for the domestic market rely on the import of parts and intermediary goods. Many food from currency products are also imported. Food inflation has been a big factor and in response to deprecation to concerns about the affordability of core staples, the government, via the Food Reserve inflation in Zambia. Agency, has announced its intention to sell grain below market prices to mills that are contracted to sell mealie-meal to consumers at lower cost (the target price is ZMW 65 for a 25 kg bag, while actual prices ranged between ZMW 65 to 105 across the country in November 2015. Figure Inflation increased substantially in Q3 2015 8 28% 23% 18% 13% Fiscal policy has been expansionary, 8% monetary policy shouldered 3% the burden of Mar 2014 Mar 2015 Apr 2014 Oct 2014 Apr 2015 Jul 2014 Aug 2014 Jul 2015 Aug 2015 Oct 2015 Sep 2015 Feb 2014 Sep 2014 Dec 2014 Feb 2015 Jan 2014 Jan 2015 Jun 2014 Nov 2014 Jun 2015 Nov 2015 May 2014 May 2015 moderating inflation. Inflation rate BOZ policy rate Avg. interbank rate Avg. T-Bill rate Source: Bank of Zambia and Central Statistical Office In 2014 and 2015, while fiscal policy has been expansionary, monetary policy shoul- dered the burden of moderating inflation. In Q1 2015, the BoZ increased the statu- tory reserve ratio to 10% from 14%, but kept the policy rate constant at 12.5% until November 3, 2015 when it was increased to 15.5% (figure 8). Caps on lending rates were removed to improve the functioning of the credit market. The rising interest rates 9 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y have helped moderate inflation, but at a cost. Higher interest rates increase the cost of borrowing and make it even harder for firms and individuals to access credit. In a 2013 published Enterprise Survey of 720 Zambian firms, access to finance was highlighted as the largest business environment constraint.4 Fiscal policy has been loose, and Fiscal policy continues to be expansionary expenditure has Over the past few years, fiscal policy has been loose, and expenditure has increased increased from from around 22% of GDP in 2012 to an average of 24.5% of GDP since then (table 1). around 22% of To fund these higher levels of expenditure, that have exceeded revenues and grants, GDP in 2012 to an large fiscal deficits of 6.7% and 5.5% of GDP (cash basis) were realized in 2013 and 2014 average of 24.5% respectively. The underlying fiscal deficit has been higher still (10.6% in 2014), reflecting since then. an accumulation of VAT refund claims and expenditure arrears. External borrowing has plugged this gap between what was spent and what was earned in tax. External financing was 5.3% of GDP in 2014 and is expected to end 2015 around 6.6% following the issuance of Eurobonds in each of the two years. The increased expenditure in 2015 has been absorbed in several areas. First is an in- crease in public investment from 5.6% to 6.0% of GDP, focused on tackling core infra- structure bottle-necks. Second is the increasing costs of debt servicing, as a result of the non-concessional borrowing at high interest rates and depreciation of the kwacha (the external debt is serviced in US dollars). Third is a huge unbudgeted outlay on sub- sidies, especially fuel, but also for emergency power; up to 4.3% of GDP 2015 from 2% of GDP in 2014. Fuel subsidies have cost the government US$300 million in 2015 and some payments There’s been a will be carried over into 2015 (box 1). This subsidy is equivalent to ZMW 3,300 million, huge unbudgeted outlay on subsidies, ZMW 220 for every Zambian. The cost of emergency power in 2015 has reached ZMW especially fuel, but 493 million (US$45 million) (discussed in Section 2). also for emergency power. Table Fiscal trends 1 2012 2013 2014 2015 Actual Actual Actual Budget Proj. Total Revenue and Grants 19.1 18.4 19.3 19.7 17.8 Tax 15.0 14.7 15.8 13.7 13.8 Non-Tax 2.4 2.2 2.7 5.3 3.6 Grants 1.7 1.5 0.8 0.7 0.4 Expenditure 22.3 25.1 24.8 24.3 25.8 OW Recurrent 16.1 18.8 19.4 18.6 19.8 Personal Emoluments 7.3 8.2 9.6 9.0 8.5 Goods and Services 3.6 3.3 3.1 2.4 2.9 Revenues have Interest Payments 1.4 1.5 2.3 1.9 2.6 fallen short of Subsidies 1.5 3.5 2.0 2.0 4.3 expectations at the Other Recurrent 2.3 2.3 2.4 3.3 1.5 time of budgeting OW Public Investment 6.2 6.3 5.4 5.7 6.0 as growth of the Fiscal Deficit (cash basis) -3.2 -6.7 -5.5 -4.6 -8.0 economy has slowed. Financing 5.4 -0.6 9.4 4.6 6.4 Net Domestic 1.7 -1.0 4.1 1.7 -0.2 Net External 3.7 0.4 5.3 2.9 6.6 Source: Ministry of Finance and staff projections Revenues have fallen short of expectations at the time of budgeting as growth of the economy has slowed. Tax revenues will end the year around 13.8% of GDP, slightly above target, but non-tax revenues (that include royalties) will end 2015 at 3.5% below the target of 5.3%. Grants also fall short of the target by 0.3% of GDP. The extra expen- ditures and revenue shortfalls will result in an estimated fiscal deficit of 8% of GDP in 2015, considerably higher than the budgeted 5.7% and the deficits recorded in recent years (figure 9). 10 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Figure Growing and repeat fiscal deficits 9 25% Typically fiscal 20% consolidation involves lower 15% expenditure, but in this fiscal plan, 10% expenditure was increased to 25.8% 5% GDP. 0% -5% -10% 2010 2011 2012 2013 2014 2015f Revenue + Grants Expenditure Fiscal Deficit Source: Ministry of Finance and staff projections In October 2015, the government presented its 2016 national budget, aimed at: “Fiscal Consolidation to Safeguard Our Past Achievements and Secure a Prosperous Future for All”. The Minister of Finance called for moderation of the expansionary fiscal stance of the past four years given global economic conditions. Typically, fiscal consolidation involves lower expenditure, but in this fiscal plan, expenditure was to increase to 25.8% Substantial new GDP, leaving all the hard work with improving domestic revenue collection. Plans to expenditure increase domestic revenue to 20.4% in 2016 (from 17.8% in 2015), perhaps possible pressures have also over the medium term, are extremely optimistic. Especially given the recent slowdown emerged since the budget, including in the mining sector and deteriorating economic conditions in the second half of 2015. increasing debt service costs. Substantial new expenditure pressures have also emerged since the budget, including increasing debt service costs and a planned increase in emergency power imports. If the government is to reduce the fiscal deficit in 2016, the framework will require close review. At a press conference on November 26, 2015, the President of Zambia an- nounced some ‘austerity measures’ including expenditure reductions, and reiterated the government’s commitment to cost-reflective tariffs for electricity and to removing the subsidy on fuel. The expenditure measures included now new capital projects, a re- view of government emoluments and benefits (including cars), and restricted overseas and domestic travel. No time frame was given, but the announced measures would help in the move towards fiscal sustainability. Box Huge recent subsidy bills for government 1 When asked about fuel subsidies, many people respond that they are cost-reflective prices and no subsidies are in place in Zambia. However, a consequence of the rapidly depreciating kwacha has been a mismatch between revenues from electricity tariffs and pump prices (paid in kwacha) and the cost of supply of emergency electricity and fuel (paid in US dollar). This leaves the Ministry of Finance having to pay the difference. The Energy Regulation Board (ERB) sets wholesale and retail fuel prices according to a formula that marks up the landed price of each shipment of oil as it arrives in Dar es Salaam by the cost of transporting, refin- ing, and distributing fuel in Zambia. The stated objective of ERB’s cost-plus pricing model is to ensure that all costs relevant to procurement are recovered through sales of petroleum products. Fuel pump prices were increased on July 13, 2015, but between then and end-November, the kwacha-US dollar exchange rate depreciated by 31%, and no changes have been made by the ERB. This meant that the government had to contribute US$50 million in October alone to cover the cost of supplying fuel. In Octo- ber and November, prices were less than US$1 per liter, an event that last occurred beyond the memory of most fuel consumers. These expenditures are not pro-poor and are arguably unaffordable as the economy slows down and the cost of borrowing increases. 11 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Public debt looms large Large exchange rate depreciations carry the risk of balance sheet effects, especially where there is substantial offshore foreign currency borrowing by the government and corporations. Foreign currency risks have become a reality in Zambia in 2015, as the weakening kwacha has increased the level of external debt and cost of servicing the borrowing. The repeat fiscal deficits of the past The repeat fiscal deficits of the past four years have been financed by external non- four years have concessional borrowing. In July 2015, Zambia issued its third Eurobond for US$1.25 been financed billion (with an average tenor of 11 year) at a considerably higher cost (the yield at issue by external non- was 9.375%). These Eurobond issues now total US$3 billion and have sharply increased concessional overall debt levels. The recent and rapid depreciation has also pushed the kwacha cost borrowing. of repaying and servicing this external debt much higher. In consequence, public debt is now around 55% of GDP, representing a near doubling of debt levels (as measured in local currency) since 2012, raising important issues of debt sustainability. In light of the economic difficulties and deterioration of fiscal metrics, Moody’s down- graded Zambia’s government issuer rating from B2 to B1, and its outlook from negative to stable (25 September 2015), thereby aligning their rating with those of other rating agencies. The consequence of higher levels and lower ratings is that access to interna- tional debt markets, where opportunities are already narrowing for frontier markets, will be more costly for Zambia in 2016 and going forward. Trade imbalances emerge Zambia relies on copper for 77% of its exports and as global prices have fallen, the cur- rent account surpluses enjoyed between 2009 and 2012 have been replaced by small deficits. Trade deficits have been recorded in each of the first three quarters in 2015, led by a decline in the amount and value of copper exported to international com- modity firms and directly to China, following lower global demand, softer global copper prices, and an increase in the value of imports following the depreciation of the kwacha (figure 10). Figure The trade balance has become negative in 2015 10 19,000 17,000 The BoZ’s 15,000 November 13,000 Millions ZMK 2015 monetary 11,000 policy statement 9,000 highlighted a 7,000 widening of the current account 5,000 deficit in Q3 to 3,000 US$401 million. 1,000 -1,000 -3,000 -5,000 Imports Exports Trade Balance 2014 Q1 2014 Q2 2014 Q3 2014 Q4 2015 Q1 2015 Q2 2015 Q3 Source: Central Statistical Office Preliminary data suggested year-to-date copper exports were valued at US$4.1 billion in September, down 28% from US$5.7 billion the previous year. Non-traditional exports (i.e. goods other than copper and cobalt) declined sharply in 2014, reversing a trend of previously steady growth and similar levels of performance have been recorded in 2015 as other trading partners’ economies continue to grow slowly. Key non-copper export destinations are the Democratic Republic of Congo (7.7% of exports and mainly sulphuric acid for mining) and South Africa (6.8% of exports). 12 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y The BoZ’s November 2015 monetary policy statement highlighted a widening of the current account deficit in Q3 to US$401.0 million from US$305.9 million recorded in Q2, on account of higher import related service payments and the increase in income on equity payments by foreign-owned enterprises . The benefits of The cost of imports increased in Q2 and Q3 2015, following the depreciation of the recent GDP growth kwacha. Given the rising costs of imported goods, consumers will, where possible (e.g. have accrued imported food items), shift to domestically produced goods and otherwise reduce their mainly to the consumption, serving to reduce the trade imbalance. population in urban areas. Poverty levels and shared prosperity The benefits of recent GDP growth have accrued mainly to the population living in ur- ban areas. Almost 90% of Zambians living below the extreme poverty line are concen- trated in rural areas, and the poverty gap index (a measure of how far average incomes fall below the poverty line) is far higher for the rural population than their urban coun- terparts (20% and 3.7%, respectively, as of 2010). Real income growth between 2006 and 2010 was greatest among those with higher incomes and relatively weak for those with lower incomes. Incomes of the poor have not been growing rapidly enough, or at all, to lift them out of poverty, with households at the bottom 40% experiencing very modest real consumption growth below 1%. As a result, although poverty rates were declining until the mid-2000s, poverty in Zambia remains high, with an estimated 62% of Zambians living on less than US$1.90 per day (2011 PPP). Forthcoming results of the 2015 Living Conditions Monitoring Survey will provide the first firm update on poverty levels since the 2010 survey. Zambia also has one of the most unequal distributions of income in SSA, with a Gini co- efficient of 57.5. Many of the gainful economic activities in the country are concentrated primarily along the rail line in the highly urbanized Copperbelt and Lusaka regions. The rest of the country is fairly underdeveloped, and its labor depends primarily on subsist- ence agriculture. C. ECONOMIC OUTLOOK, RISKS AND POLICY CHALLENGES The outlook for 2016 has become more somber following announcements of expected mine clo- sures, the severity of the power crisis and the rapid depreciation of the kwacha. Given the external and domestic challenges, we expect GDP growth to drop to 3 to 3.5% this year and next, before re- turning to potential (5 to 6%) by 2018, as copper prices stabilize and domestic pressures ease. Tough action is required in 2016 to curb runaway expenditures, double digit inflation and growing twin deficits. Fiscal policy should be put center stage and efforts made to shift the country back onto a sustainable fiscal path. Medium-term outlook The outlook for the Zambian economy is underpinned by three main trends. i. The current low price of copper, on which the economy depends for revenue and foreign currency, will pressure fiscal and current account balances. World Reflecting the Bank forecasts suggest commodity prices, including copper, are likely to stay in external headwinds the doldrums throughout 2016, but should start to pick up in 2017 and beyond. and domestic pressures, the ii. There is huge uncertainty about whether persistent and growing fiscal deficits can expectation is be reined in. Zambia has been able to issue three Eurobonds in four years to fund its that GDP growth exuberance, but as markets tighten and Zambian debt levels have soared, the costs of will remain in the borrowing will remain much higher than when the Eurobonds were issued in 2012 or region of 3 to 3.5% 2014. in 2016. iii. The severity of the power crisis, and the government’s ability to mitigate it by sourc- ing emergency power and ensuring the cost is affordable via tariffs that better reflect the rising cost of supplying electricity. Reflecting on the external headwinds and domestic pressures, the expectation is that GDP growth will remain in the region of 3 to 3.5% in 2016, before reaching potential (between 5 and 6%) in 2017 and 2018, as new power generation capacity comes fully online and global copper prices stabilize. Despite the current problems, long-term in- vestment in the mineral and non-mineral sectors in Zambia remains attractive. 13 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y The government remains committed to a target of single digit inflation, set as part of the 2016 budget, but this appears ambitious given the recent rapid depreciation of the kwacha. However, given the extent of the recent depreciation, it is likely that prices will The outlook increase and peak in Q2 2016 before recovering to an average of around 15-20% for is subject to 2016. downside risks, both domestic and Risks to Zambia’s economic outlook external. The outlook is subject to downside risks, both domestic and external. Externally, lower than predicted growth in China would weigh on the demand for Zambia’s exports, fur- ther reducing copper prices, and would severely affect Zambia’s prospects. Further- more, strengthening of the US dollar, in the event the Federal Reserve increase interest rates, would also likely add volatility to the exchange rate. The main domestic risks are threefold. First, that the power crisis will worsen. This could occur via delays in new generation coming online or a further reduction of generation capacity at the main hydropower plants, serving to reduce both mining and non-mining activity, increase joblessness and push the economy into contraction. Second, a dete- rioration of confidence in the economy, leading to further weakening of the currency and increased levels of inflation. This might result in the absence of measures to cur- tail runaway expenditure, especially in the run-up to the 2016 elections, that would make any substantial dent in the fiscal deficit. In this event, external financing would also become more costly and would put further pressure, via increased debt service obligations, on the 2016 budget and for years to come. Lastly, another bad harvest that serves to increase food prices and reduce rural and agricultural incomes, with the greatest impact falling on the poorest households. Commodity- exporting countries’ Policy challenges policy makers Commodity-exporting countries’ policy makers face increasing challenges across the face increasing globe. Zambia is no exception and must grapple with multiple challenges as the econo- challenges across my slows down. Falling copper prices and a power crisis could be met with fiscal buffers, the globe. but in Zambia, no savings were made or stabilization measures carried out when the economy was prospering. Furthermore, debt levels have soared following repeat non- concessional borrowing making it more expensive to borrow from international debt markets. This leaves the government with little room to maneuver, limited fiscal space to com- pensate for slower growth and recent job losses and only hard choices. Trade-offs ex- ist between cushioning people from the impact of the depreciation and power crisis by subsidizing the cost of fuel and electricity and reducing the fiscal deficit to restore confidence, and fixing the underlying problems in the economy. These trade-offs are particular stark in 2016, given that it is an election year. The 2016 budget puts all the pressure on revenue, but year-on-year increases to public expenditure, funded by borrowing, should be center stage. Large fiscal deficits and inef- ficient government spending persist as sources of vulnerability for Zambia. It is neces- sary to strengthen the fiscal position and restore fiscal buffers to increase confidence in the economy, reduce the need for costly borrowing and build resilience against further exogenous shocks. Fiscal adjustment would put less Fiscal adjustment would also put less pressure on monetary policy and potentially make pressure on space for interest rates to be reduced, easing the pressure on individuals and firms. monetary policy. Keeping inflation expectations anchored in single digits remains critical to maintaining macroeconomic and wider development objectives. Any adjustment should involve a shift in spending priorities that supports both the ef- ficiency of public expenditures and long-term inclusive growth. While in many areas this is difficult to achieve, there are obvious areas for attention including the growing cost of fuel subsides. Policy announcements have been made for cost-reflective electricity tariffs and fuel prices, but the reality is a huge outflow of subsidy from the Ministry of Finance. If the stated intentions for meeting the cost of supply with tariffs were realized, then fiscal pressures would ease considerably. Much better, pro-poor cushioning can be achieved via investment projects targeted at regions, and via targeted cash trans- 14 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y fers, rather than with fuel subsidies. The targeted 2016 fiscal deficit of 3.8% presented in the budget may prove too optimis- tic given the slowdown, but fiscal adjustment is required and would signal the govern- With market access ment’s commitment to fiscal sustainability. comes greater scrutiny and With market access comes greater scrutiny and policy responses are judged by real ac- policy responses tion that affects the interest rate paid on new borrowing. Eurobond issuance has also are judged by increased international interest in the Zambian economy and events are being watched real action that much more closely than prior to 2012. To help maintain confidence in the economy, affects the interest and Zambia as an investment destination, better dialogue on the economy should be rate paid on new targeted and confusing messages avoided. borrowing. In addition, the commodity price shock highlights the need for Zambia to reduce its dependency on copper, a challenge it has been grappling with for over 50 years. Talk about diversification and growing manufacturing needs to be met by a clear and real- istic strategy and structural reforms aimed at removing impediments to private sector activity and improving the business environment. 15 2 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y SECTION POWERING THE ZAMBIAN ECONOMY D. THE ELECTRICITY CHALLENGE Economic progress since 2000, driven by mining production and services, has substantially increased the demand for electricity in Zambia. A growing shortfall in supply has been exacerbated in 2015 by a reduction in hydroelectric generation due to low water levels at the country’s main reservoirs. This has increased power outages and impacted on all aspects of the economy, contributing to slower economic growth in 2015 and higher production costs. Zambia’s economy has expanded by an average of 6.4% per year between 2010 and 2014, and 7.4% over the last decade. This economic expansion has lifted the demand for electricity by 4% per annum over the same period. With very little new generation capacity being brought online in the past 30 years, Zambia has been experiencing a power deficit over the past 4-5 years, characterized by power outages commonly re- ferred to as load-shedding. Approximately 95% of generation Approximately 95% of generation capacity is linked to hydropower plants, hence the capacity is linked to hydropower electricity supply is heavily dependent on hydrology. This puts the country at risk in the plants, hence the event of drought, more so recently as the gap between generation and demand has electricity supply is closed. heavily dependent on hydrology. The mining industry consumes the majority of Zambia’s electricity (55%) using it not only for mining itself, but also processing (e.g. concentrating, smelting and refining) and other associated services such as water pumping. Most mines in the Copperbelt Prov- ince receive their power via the Copperbelt Energy Corporation (CEC) based on prices agreed in long-term Power Supply Agreements (PSAs) that run back-to-back with Bulk Supply Agreements (BSAs) between CEC and ZESCO Limited. For legacy reasons, these agreements are not overseen by the ERB. The ERB does however set tariffs for other consumer categories and provides its consent to ZESCO’s other long-term bulk power agreements. While installed capacity, measured in Mega Watts (MW), has been higher than existing peak demand, available energy generation, measured in Giga Watt Hours (GWh) and which has an approximate linear relationship to the water used, has remained below the country’s total energy demand (figure 11). This has been exacerbated in 2015 due to low water levels in the main reservoirs used for hydroelectric generation (box 2). Despite plenty of warning about dependency on hydro power and rising power de- mand, there has been very little improvement in generation capacity. Until 2006, Zam- bia had surplus power and this partly explains why prior to the 360MW Kariba North Bank Extension that was completed in 2015, the last major plant to be commissioned was the Kariba North Bank in 1977. The history of surplus has also contributed to low 16 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Figure Electricity generation capacity fallen below demand 11 18,000 16,000 14,000 Capacity (GWh) 12,000 10,000 8,000 6,000 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 Annual generation capacity (GWh) Annual demand (GWh) Source: ZESCO and World Bank staff calculations Load-shedding has tariffs which have been one of several barriers to investment in the grid and new gen- been increasingly eration capacity to meet rising demand. common since 2006, but it has Load-shedding has been increasingly common since 2006, but it has got much worse got much worse in in 2015. The shortfall in energy supply has impacted on manufacturing and industry 2015. (including mining), increasing the costs of production, and is negatively impacting on the quality of life of Zambians with access to grid electricity. The power crisis adds to the list of negative shocks impacting on the Zambian economy in 2015 as discussed in Section 1. Adequate power supply and coverage is central to Zambia’s development strategy. Zam- bia’s 2030 Vision highlights that: “Energy is one of the important driving forces behind the development of an economy as it cuts across most economic and social activities.” The Sixth National Development Plan also stresses that: “Poor and inadequate infrastruc- ture remains the major constraint to economic development and poverty reduction”. Pre- liminary results from the Living Conditions Monitoring Survey (LCMS) show the number of households reporting to have an electricity connection grew from 584,000 in 2010 to 948,000 in 2015, an increase of 364,000 households. However, almost all the new con- nections haven taken place in urban areas and just 75,000 or 4% of rural households are connected, compared to 67% of urban households (there are approximately 3 mil- lion households in Zambia). Zambia’s challenges are mirrored in other African countries. Countries across the conti- nent are grappling with the challenge of supplying reliable electricity to meet the needs of a growing economy and providing universal access to electricity in order to improve the quality of life of citizens. The key issues faced in the power sector include poor reli- ability, low access, and insufficient capacity to meet existing demand; some 24% of the population of SSA has access to electricity versus 40% in other low income countries. Excluding South Africa, the entire installed generation capacity of SSA is only 28 GW, equivalent to that of Argentina. 17 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Box Hydro-Electricity in Zambia 2 Zambia is reliant on four hydroelectric power stations: • Victoria Falls, commissioned in 1938 with an installed capacity of 108 MW (since 1972). • Kariba North Bank, commissioned in 1960 with an installed capacity of 600 MW that pro vides power to both Zambia and Zimbabwe. • Kafue Gorge, commissioned in 1971 with an installed capacity of 900 MW since 1977. • Kariba North Bank Extension, commissioned in 2014 at 360 MW. In the 1970s and following the commissioning of Kafue Gorge, Zambia experienced a period of power surplus, during which power was sold and exported to Zimbabwe and South Africa. Falling and low copper prices and a lack of investment (mines were nationalized in 1972) meant there was reduced demand for power. Mining firms are the biggest users of power and as production began to pick up in the late 1990s, and the economy grew robustly, the power surplus slowly decreased. Source: Kapika (2013) and Whitworth (2014) E. ZAMBIA’S POWER CRISIS Since July 2015, ZESCO has increased the extent of rolling black-outs (load-shedding) to at least 8 hours per day on a rotational basis for the majority of its household, commercial and industrial con- sumers. And although they are not subject to rotational load-shedding, ZESCO has requested the mining industry to curtail its load by 30%. This is in order to manage a power deficit of around 591 MW each month (September to December 2015), representing approximately 34% of demand. The decision by ZESCO to limit electricity generation is due to the historically low wa- ter levels at the country’s reservoirs (including Kariba, Itezhi Tezhi and Kafue Gorge) that store water for hydroelectric generation. Prior to the start of the increased load- shedding in July, ZESCO generation capacity was in the range of 1,800 – 2,000 MW. The The reason for the reason for the low water levels is a combination of lower rainfall (during the 2014-15 low water levels rainy season) and increased water usage. is a combination of lower rainfall Zambia’s and Zimbabwe’s water allocation at Kariba dam is regulated by the Zambezi (during the 2014-15 River Authority (ZRA) and in both 2013 and 2014, ZESCO exceeded its allocation by 5% rainy season) and and 22% respectively. The commissioning of the Kariba North Bank Extension project in increased water usage. 2014 contributed to increased water use at the Kariba reservoir and the reservoir has not reached its maximum retention levels since 2010. Water levels in the reservoirs will recover somewhat during the 2015 -16 rain season, assuming usage according to al- location, but it will take several years of rainfall and balanced usage for them to recover to maximum levels. As of mid-November 2015, most areas of Zambia had experienced low rainfall and if this trend continues (the El Niño is expected to last into Q1 2016), there will be only limited recovery in 2016. If, however, reservoir levels continue to drop, ZESCO may be forced to curtail generation at the Kafue Gorge and at Kariba North Bank (including the extension) power stations even more. 2015 load-shedding Given reservoir Initially, the burden of load-shedding was only imposed on households, businesses and levels continue to industry, but excluded the mining sector. In July 2015, however, a decision was made drop, ZESCO may to reduce power supply to the mines by 30% and since then, the mining companies be forced to curtail have been asked to operate within restricted power allocations, been offered additional generation further. power at higher cost and had their compliance monitored by ZESCO. The load-shedding has typically been for 8 hours per day. Between June and August, it was restricted to six hours on the Copperbelt, but since then the country has been without power for on average eight hours per day. The load-shedding aims to reduce demand, but there is not a full saving as often consumers delay some of their consump- tion to times when power is available. 18 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y Given the severity of the power deficit, the government announced several short- and long-term measures to alleviate the situation. To supplement the country’s available generation and reduce the power deficit, ZESCO has entered into contracts with South- ern African Power Pool (SAPP) utilities and emergency power suppliers (including Ag- greko PLC). In November 2015, these contracts totaled 172 MW delivered during differ- ent times of the day. Once domestic generation and electricity imports (as at November 2015) are taken into account, the country faces an average monthly deficit of 591 MW (September to December 2015), representing approximately 34% of demand (table 2). Given the severity of the power deficit, government announced several short- and long- term measures to alleviate the situation. To supplement the country’s available genera- Given the severity tion and reduce the power deficit, ZESCO has entered into contracts with Southern of the power African Power Pool (SAPP) utilities and emergency power suppliers (including Aggreko deficit, government PLC). In November 2015 these contracts totaled 172 MW delivered during different announced several times of the day. Once domestic generation and electricity imports (as at November short- and long- 2015) are taken into account, the country faces an average monthly deficit of 591 MW term measures (September to December 2015), representing approximately 34% of demand (table 2). to alleviate the situation. Table A power generation deficit in 2015 2 Monthly September to December 2015 Average ZESCO Generation 987.5 Lunsemfwa Hydro 22.0 Ndola Energy 41.0 Emergency Imports - Day Ahead Market 38.0 Emergency Imports - Electricidade de Mozambique (EDM) 27.0 Emergency Imports - Aggreko (148MW for 16hrs daily) 107.0 Itezhi Tezhi Power Station - Total Generation 1,222.5 Transmission Losses 73.4 Total Demand 1,740.0 Total Deficit 590.9 Total Deficit 34.0% Source: ZESCO and World Bank staff calculations Note: For the period September-November 2015 2015 tariffs and subsidy The emergency power imported in 2015 has come at considerable cost to the govern- ment. A burden made worse by the rapid depreciation of the kwacha inTotal 2015. Imports Deficit Estimate from Aggreko are costing ZESCO US cents (USc) 18.4 per Kwh, imports from Mozam- bique are priced at USc 7.6 per Kwh and the average tariff on imports September to December 2015 from the day Number of Months Activ ahead market (DAM) has increased from USc 2.7 Kw/h in April 2015 to USc 6.7 Kw/h ZESCO in October Generation 2015, 0 a near doubling of prices. The total cost of emergency power (cost of tariffs)Hydro Lunsemfwa supply minus is estimated at ZMW 539 million or US$44 million in 2015. Greater0 Ndola on transparency what the mines are each paying relative to the cost of supply would Energy 0 greatly improve Emergency public’s -understanding. theImports Day Ahead Market 0 Emergency Imports - Electricidade de Mozambique (EDM) 0 Emergency Imports - Aggreko (148MW for 16hrs daily) 0 Itezhi-Tezhi Power Station Total Generation Monthly Transmission Losses Monthly Total Demand Monthly Total Deficit Monthly Total Deficit Monthly 19 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y F. MANAGING THE COST OF MITIGATION Power is essential for the Zambian economy to function. Despite new generation projects, the mod- elling of different hydrology conditions shows that even in a wet (above average rainfall) scenario, current power shortages will continue through to at least 2018. For 2016, the authorities have made the difficult choice to increase the import of expensive emergency options. This puts huge pressure on the budget at current tariff rates, in tough economic conditions, and unless tariffs are revised upwards, the government’s subsidy of the sector will rise dramatically and will be unaffordable. At November 2015 tariff rates, the government will need to provide ZESCO with an additional US$ 340 million in 2016 to meet the cost of emergency power. However, the financing requirement can be substantially reduced if the average tariff is increased. At present there are six power plants at various stages of preparation/development, At present there are six some of which have been in the pipeline for more than a decade. The total capacity of power plants at these plants is about 1,730 MW (table 3). Generation of between 150 and 300 MW is ex- various stages pected in 2016 from Maamba Collieries (depending on the speed of project completion of preparation/ and the quality of coal used), along with 70 MW from Itezhi Tezhi (60% of its potential development, some capacity due to low reservoir levels) starting in early to mid-2016. The largest, Kafue of which have been Gorge Lower (750 MW), has gone through several procurement/contracting phases, in the pipeline and has recently been contracted at a cost of US$ 2 billion and is scheduled to be com- for more than a missioned in 2020. The remaining three projects are negotiating power purchase and decade. other support agreements with ZESCO and the government. In addition, there are good prospects for solar generation in 2016 and beyond (box 3). The International Development Corporation (IDC) has been working to attract private sector partners for two 50MW solar PV projects, with support from the World Bank Group as transaction advisor. These projects should provide a diversified form of gen- eration in early 2017. There is also potential for thermal power generation by Independent Power Producers (IPP) for 200 MW worth of generation over the coming years, assuming the potential revenues, partly determined by the level of electricity tariffs, are sufficient to attract interest and that other constraints such weak management of the tendering process can be addressed. The prospect of solar and thermal generation in the next few years will help diver- Despite these sify Zambia’s power generation and make it slightly less dependent on hydro. Climate projects, the change has increased the frequency of floods and droughts in Zambia, and the Zam- modelling of bezi river basin will remain sensitive to global warming, adding further justification for a different hydrology gradual diversification to other renewable sources of generation such as solar. conditions shows that even in a wet (above average Table Private power plant contract status rainfall) scenario, current power 3 Capacity Estimated Cost shortages will Project (MW) Primary Fuel (US$ m) continue through Itezhi Tezhi Power Station 120 Hydro 240 2018. Maamba Coallieries 300 Coal 750 Lunzua Power Authority 210 Hydro n/a Ndola Energy Extension 50 HFO 75 EMCO 300 Coal 750 Kafue Gorge Lower 750 Hydro 2,000 Total Capacity 1,730 Source: ZESCO and World Bank staff calculations Despite these projects, the modelling of different hydrology conditions shows that even in a wet (above average rainfall) scenario, current power shortages will continue through 2018. In a dry (lower than average rainfall) scenario, power shortages may continue through 2020. It should be noted that the assumptions in these scenarios do not include tackling the large portion of the population without access to electricity ser- 20 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y vices, which remains an additional and core priority of government which will require even more generation capacity. Box Scaling solar in Zambia 3 Scaling Solar is an open, competitive and transparent approach that facilitates the rapid development of privately-owned, utility-scale solar PV projects in sub-Saharan Africa. It is capable of rapid implementa- tion support, and offers a ‘one-stop-shop’ package of advisory services, contracts, financing, guarantees and insurance. This enables governments and utilities to procure solar power transparently and at the lowest possible cost. The government and IDC hope that this initial 100 MW procurement round for solar generation will ulti- mately lead to a rapid scale-up of solar PV capacity, forming a natural complement to Zambia’s extensive hydro resources. If they and the other public sector stakeholders adhere to the risk allocation under Scaling Solar, it is hoped that these projects will qualify for WBG financing, political risk insurance and partial risk guarantees. Emergency power imports in 2016 Notwithstanding the risk that ZESCO may be forced to curtail generation completely at the Kafue Gorge and at Kariba North Bank, reduced generation is likely from these sources (assuming water quotas are followed) for at least the first half of 2016 until rainfall helps replenish the reservoirs. Maamba Collieries and Itezhi Tezhi, when com- pleted, will provide some relief, but to prevent a large increase in load-shedding ZESCO A substantial is contracting further emergency imports (table 4). In 2016, 300 MW is likely to be avail- increase in tariffs able from two Karpower ships (to be docked off Mozambique), further use of the day will be required to ahead market and a continuation on imports from Aggreko PLC (reduced to 40MW 16 meet the cost of hours daily in 2016). supply in 2016 and any gap between revenues and the The importation of power is complex given the number of wheelers (i.e. number of costs of supply will countries the power must pass through to get to Zambia). Power from Mozambique need to be met by typically passes South Africa, then Botswana or Zimbabwe, to get to Zambia. Some the government. power can arrive directly across the Zambia-Mozambique border, but the grid capacity there is limited to small volumes. The imports are also expensive, with Aggreko tariffs at USc 18.8 per Kwh, Karpower at USc 16.7 per Kwh, and the day ahead market remaining around USc 6.5 per Kwh. If further emergency inland power is sought, then the cost of supply might be as high as USc 25 per Kwh. The new generation and emergency measures will result in an average deficit of 496 MW in 2016 or 26% of demand. The deficit is likely to be highest in Q1 2016, but im- prove as emergency power and new generation comes online (figure 12) in Q2. The Table Emergency power imports for 2016 The imports are 4 Monthly expensive, with 2016 Average (MW) Aggreko tariffs at ZESCO Generation 950.8 USc 18.8 per Kwh, Karpower at USc Lunsemfwa Hydro 22.0 16.7 per Kwh, and Itezhi Tezhi Power Station 70.0 the day ahead Ndola Energy 41.0 market remaining Reduction in Agrekko Imports (40 MW for 16 hrs daily) 40.0 around USc 6.5 per Kwh. Emergency Imports - Karpower Ship (100 MW for 24 hours) 91.7 Emergency Imports - Day Ahead Market 44.0 Emergency Inland power ( 200MW for 24 hours daily) - Maamba Coal 88.8 Emergency imports -Karpower ship (200MW 24 hours) 150.0 Total Generation 1,498.3 Transmission Losses 89.9 Total Demand 1,905.0 Total Deficit 496.6 Total Deficit 26.1% Source: ZESCO and World Bank staff calculations 21 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y new generation and emergency measures will result in an average deficit of 496 MW in 2016 or 26% of demand. The deficit is likely to be highest in Q1 2016, but will improve as emergency power and new generation comes online (figure 12) in Q2. Figure The power deficit in 2016 The issue of 12 2,000 55% electricity tariffs 1,900 50% has been a 1,800 45% longstanding one 1,700 and there has long 1,600 40% been discussions 1,500 35% of moving towards 1,400 30% costs-reflective 1,300 tariffs. 25% 1,200 1,100 20% 1,000 15% 2016 Demand Estimate (MW) (LHS) 2016 Total Generation (MW) (LHS) 2016 Supply Deficit (%) (RHS) 2016 Average Supply Deficit (%) (RHS) Source: ZESCO and World Bank staff calculations Electricity tariffs The issue of electricity tariffs has been a longstanding one and there has long been discussion of moving towards costs-reflective tariffs. In 2008, the tariff was increased 33% with the financial viability of the power supply in mind (Zambian tariffs were some of the lowest across the continent), but the prices have not been inflation linked and have reduced considerably in real terms. On 1 July, 2014, ZESCO was permitted by the ERB to raise tariffs on all customer cat- egories except mining. Accordingly, commercial tariffs were increased by 15.4% and residential consumers’ tariffs by 24.6%. This followed a four-year period from August 2010 where no adjustments were made despite cumulative inflation of 28%. Attempts have also been made to increase tariffs paid by mining firms to cover the actual cost of supply but many hurdles have been encountered. The cost of emergency power in 2016 will substantially increase the cost of supplying electricity as it has in the second half of 2015. In July 2015, and to improve the financial sustainability of ZECSO, the government stated its intention to revise electricity tariffs to take the cost of supply into account. This government statement was repeated several times since July 2015, but as of end-November 2015, no action had been taken. To move towards this goal, ZESCO applied to the ERB to increase most of the various non-mining tariffs and fixed charges from between 167 and 248%. Public consultations were held and as of end-November, no final decision had been made. Despite the large changes to some tariff lines, the proposal kept the R1 tariff (a ‘life-line’ tariff aimed at providing lower pricing to low-income consumers) at US Cents (USc) 1.5 per KWh and increased the threshold to receive this tariff from 100 Kwh up to 300 KWh of consump- tion. The aim of this tariff is to protect low-income residential consumers, but the move to allowing up to 300 KWh will include many of the non-poor as well. In addition, ZESCO, CEC and the mining industry began discussions to renegotiate the agreements under which bulk power sales to the mining industry are governed in order that they include the full cost of emergency power imports. A substantial increase in tariffs will be required to meet the cost of supply in 2016 and any gap between revenues and the costs of supply will need to be met by the govern- ment. Average tariffs, including both mining and non-mining, are currently (i.e. prior to any increase) estimated at between USc 5 and 6 per KWh. At this tariff rate, the govern- ment will need to provide ZESCO with an additional US$340 million in 2016 to meet the cost of emergency power. However, the financing requirement can be substantially reduced if the average tariff is increased and remains at that level (figure 13). For ex- 22 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y ample, if government could move the average tariff to USc 10 KWh, then the required subsidy and associated fiscal pressure will reduce to approximately of US$146 million in 2016. ZESCO applied to Figure The cost to government of emergency power depends on the tariff the ERB to increase most of the various 13 non-mining tariffs 11 and fixed charges Average 2016 Tariff (USc Kwh) from between 167 10 and 248%. 9 8 7 5 0 50 100 150 200 250 300 350 GRZ Subsidy for Emergency Power in 2016 (US$ million) Source: ZESCO and World Bank staff calculations Note: Does not include emergency inland power Key to note is that an increase in tariffs to reflective levels is necessary but not suffi- cient to increase private investment in electricity generation in Zambia. There are many other hurdles to overcome as well. Management and regulation of the sector have been improving, but there is still substantial work to do. Particular efforts are needed to improve sector planning and the procurement processes for large power projects. The impact of load-shedding The costs of emergency power are considerable when compared to existing hydropow- At the national er plants, as is the likely impact of increased electricity tariffs on the economy. However, level, the power so too is the impact of load-shedding. As was highlighted in Section 1, the economy has crisis has already caused reduced slowed considerably in 2015 and is expected to remain at similar levels of below trend output and growth in 2016. The impact of load-shedding is a key driver of the decline, along with redundancies the external headwinds and domestic pressures being faced. across businesses in the services, At the national level, the power crisis has already caused reduced output and redun- manufacturing and dancies across businesses in the services, manufacturing and industrial sectors. Manu- industrial sectors. factures are reporting increased costs of production, as they are forced to run costly generators or switch shifts to when they have electricity (extra pay is often needed for night shifts) and many declare they are only meeting between 30 and 40% of scheduled production. Firms engaging in complex procedures (some machines are designed to run 24 hours and require 3-4 hours of heating before use) and those requiring refriger- ation are suffering particularly badly. The mining sector, already impacted on by lower copper prices, has announced closures, laid-off 7,700 workers and postponed invest- ment. Load-shedding of 30% and increasing costs of electricity have further weighed on mine profitability and production. Added to the economic costs are the social and environmental impacts of the power crisis. It becomes much harder to provide quality health care and education if hospitals, schools, clinics and universities are experiencing electricity power outages. The For- estry Department has reported an increase in land degradation as load-shedding has become worse. The cost of replanting trees and soil degradation must be considered in any assessment of impacts. In 2015, 32.9% of households in Zambia report using char- coal for cooking and 50.7% report using firewood. Only 16.0% report typically cooking with electricity, but a good proportion of those cooking on electricity will have switched to using charcoal, or LPG where available, when load-shedding has denied them power. Zambia produces LPG at the Indeni refinery, but 80% is exported. Encouraging and fa- cilitating the use of LPG would help reduce the demand for electricity and help protect the forest cover around urban areas. 23 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y G. GRADUATING TO SUSTAINABLE SUPPLY The new generation capacity and emergency measures for 2016 will help in mitigating the impact of the power crisis in the coming year, but global experience shows there is no substitute for effective planning. Furthermore, Zambia may again face a similar crisis in the near future if structural weak- nesses in the sector are not adequately addressed. There remains a need to shift from being reactive to anticipatory or preemptive in dealing with reduced generation capacity. Additionally, the need to increase access to electricity in the country should not be neglected. The current power crisis, which impacts considerably on the economy, should be used to correct policy and regulatory anomalies that prevent the sector from achieving its The long-term potential. sustainability of the power sector i. Strengthening sector planning and procurement processes: The long-term to ensure an sustainability of the power sector to ensure an adequate, quality and reliable electricity adequate, quality supply requires a robust planning function. Zambia should develop and update regu- and reliable electricity supply larly, e.g. every two years, a Least Cost Power Development Plan (LCPDP) that lays out requires a robust the investments required in all the segments of the power sector i.e. generation, trans- planning function. mission and distribution. For generation, the LCPDP should contain a pipeline of pro- jects ranked by cost i.e. the most economically and financially viable projects should be developed first. The LCPDP process should be anchored by a load-forecast that is also routinely updated and, given Zambia’s dependency on hydro, the relevant hydrological modelling to guide the extent to which the generation mix should be diversified. Planning on its own is however an insufficient condition for power sector sustainability unless its outputs lead to the procurement of new generation capacity and the related investments in the transmission network. A procurement framework that ensures the transparent and competitive delivery of new plants and which is linked to planning outcomes should therefore be established. Due to the existing structure of the power sector in Zambia, such a procurement framework should also have a mechanism for allocating new build opportunities between state-owned ZESCO and the private sector through Independent Power Producers (IPPs). The current procurement method by which developers enter into lengthy post-award negotiations with ZESCO and govern- ment should be reviewed in order to reduce implementation delays. This could include the development of template agreements (power purchase agreement, implementa- tion agreement etc.) and the establishment of indicative security arrangements. ii. Improving financial sustainability of the power sector: The power crisis has revealed the importance of ensuring that the power sector has sufficient funds for It is crucial that electricity service provision. Inadequate electricity tariffs limit the extent to which the an electricity existing generation and grid network is maintained, and investments in new generation tariff framework capacity and network expansion by either ZESCO or private parties can be made. Elec- that reflects the tricity tariffs that are lower than the cost of service only benefit those with existing elec- costs of efficient tricity connections in the short-term and in the long-term compromise the quality and service provision is established and reliability of supply. Furthermore, low tariffs slow down the rate at which those without effectively applied. access, which is the majority of the population, can receive connections. In addressing financial sustainability, it is crucial that an electricity tariff framework that reflects the costs of efficient service provision is established and effectively applied. ZESCO and other utilities in the sector should be allowed to collect revenues suffi- cient to cover efficient costs, through tariffs charged to all consumers able to pay them. These revenues should also be sufficient to fund a subsidy program (social safety net) aimed at those consumers whose ability to pay is lower than the level that reflects the full cost of supply. In the event that this is not possible wholly or in part, an affordable subsidy program should be provided through direct and transparent transfers from the government treasury. iii. Increasing access to electricity: Given Zambia’s low electrification rate (32% overall), it would also be important to complement the LCPDP with a strategy, complete with action plans to scale-up access to electricity. This should comprise the priorities for electrification, a definition of funding sources (e.g. grants, loans, national budget 24 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y To complement allocations, tariff levies etc.), technical options and implementation arrangements for measures to different geographic locations e.g. urban and rural areas. import electricity and other short- iv. Implementing demand size measures: To complement measures to import term generation electricity and other short-term generation interventions, demand side management interventions, measures should also be considered (box 4). ZESCO previously distributed 1 million demand side compact fluorescent lamps (CFLs) that were swapped with less efficient but cheaper in- management candescent light bulbs, and was able to shed-off approximately 57MW of peak demand. measures should The possibility of a further large-scale distribution of CFLs should be considered. This also be considered. would require an assessment of how widespread the use of incandescent bulbs is. It is also important to recognize that at low tariffs, there is limited incentive to use electricity more efficiently. Box Diversification and demand-side measures in Ethiopia 4 Ethiopia suffered a similar power crisis to Zambia in 2009-10, prior to which diversification of electric- ity generation, away from hydro to some degree, was not among its priorities. However, after experiencing severe load shedding, Ethiopia started to diversify its generation portfolio by investing heavily in geothermal and wind energy to complement its hydro resources. Ethiopia has also aggressively pursued demand side management activities to mitigate the impact of its power crisis and improve the country’s energy efficiency. Central to these efforts was an energy-efficiency program that distributed 350,000 compact fluorescent lamp bulbs free of charge, following lessons from similar interventions in the Philippines, Rwanda, Thailand, Uganda and Vietnam. A recent World Bank evaluation estimates the impact of the program to be about 45-50 kilowatt hours per customer per month, or about 13.3 megawatts of energy savings in total. The study finds that the majority of beneficiaries were low-volume customers— mostly from among the poor—although the program was not specifically targeted. It also suggests that energy savings were larger for the poor. On the downside how- ever, about 20% of the initial energy savings disappeared within 18 months of the program’s completion, suggesting sustained efforts are needed to counter such rebound effects. Source: Costolanski, P., Elahi, R., Iimi, A. and R. Kitchlu (2013) ‘Impact Evaluation of Free-of-Charge CFL Bulb Distri- bution in Ethiopia’, Policy Research Working Paper 6383, World Bank, Washington D.C 25 6 th Z A M B I A E C O N O M I C B R I E F - P O W E R I N G T H E Z A M B I A N E C O N O M Y IREFERENCES Costolanski, P., Elahi, R., Iimi, A. and R. Kitchuilu (2013) ‘Impact Evaluation of Free-of-Charge CFL Bulb Distribu- tion in Ethiopia’, Policy Research Working Paper 6383, World Bank, Washington D.C. Engineering Institute of Zambia (2015), ‘Report of ZESCO Load Shedding’, Technical Experts Team, September 2015. Kapika, J, (2004), ‘The Zambian Power System and Issues Confronting the ERB, Energy Regulation Board, http://www.narucpartnerships.org/documents/zambian%20power%20market.pdf Kapika, J. (2013), ‘Zambia: Looking East for Additional Generation Capacity’, Chapter in Kapika, J. and A. Eber- hand (2013), ‘ Power-Sector Reform and Regulation in Africa’, HSRC Press, Cape Town, South Africa. Smith, G. (2015), ‘Zambia Budget Brief’, Policy Note, World Bank, Washington D.C. Whitworth, A. (2014), ‘Energy Policy’, Chapter in ‘Zambia Book’, Oxford University Press. World Bank (2015), Africa’s Pulse, October 2015: http://documents.worldbank.org/curated/en/2015/10/25116683/africas-pulse-october-2015. INOTES 1 African Pulse, World Bank (2015): http://documents.worldbank.org/curated/en/2015/10/25116683/africas- pulse-october-2015. 2 See the World Bank’s previous Economic Brief (July 2015): Making Mining Work for Zambia. 3 See: http://documents.wfp.org/stellent/groups/public/documents/ena/wfp274160.pdf 4 See:http://www.enterprisesurveys.org/~/media/GIAWB/EnterpriseSurveys/Documents/CountryHighlights/ Zambia-2013.pdf 5 See: http://www.boz.zm/Publishing/Speeches/MPC_Statement_Nov_2015-v2.pdf 6 A simple way of understanding the relationship between capacity and energy is equating this to a truck. In order for a truck to carry a certain load, its engine should at least be of a certain size (capacity). But to do so over a distance, say 100km, requires that the truck has sufficient diesel (energy). 7 Republic of Zambia, Zambia 2030 vision, p.9. 8 These results were presented by the CSO at a 2015 African Statistics Day Event on 18th November 2015. 9 Engineering Institute of Zambia (2015), ‘Report of ZESCO Load Shedding’, Technical Experts Team, September 2015. 26