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Is Zambia contracting Dutch disease?

Working paper

Written by Dirk Willem te Velde, Massimiliano Cali

Working paper

The volatility in commodity prices can still pose serious challenges for commodity dependent economies. In a period of rising commodity prices, understanding the effects of both beneficial and adverse sudden changes in prices is vital to enable a country to use such booms to harness its economic development process. Natural resources booms still prove to be a mixed blessing for developing countries as policy-makers respond to the challenges posed by the booms in very different ways. The recent large increase in copper prices (driven mainly by China and India's boost in demand for copper) offers a valid example of such challenges, as it has had a substantial impact on copper dependent economies, such as Zambia. The copper boom in Zambia has coincided with at least three other factors potentially causing an appreciation of the exchange rate: a write-off of the external debt, an increase in non traditional exports (NTEs) and a higher inflow of foreign aid. These factors have jointly contributed to a steep appreciation of the real exchange rate since 2004 and to a variation of relative prices in the economy, which may have a substantial impact on the country's economic development path. This has spurred a heated debate on the possible policy options to minimise the potential negative effects on the economy. This paper contributes to this debate by analysing the impact on the Zambian economy of the recent large inflow of foreign exchange in the context of the literature on the Dutch Disease, i.e. the adverse impact of a sudden discovery of natural resources on the national economy via the appreciation of the real exchange rate and the decline in export competitiveness. In particular, the study analyses the short-term effects of the copper boom and the resulting exchange rate appreciation in Zambia. Moreover, it suggests possible ways though which long-term effects operate and it discusses what possible policies may help to maximise the benefits from the large inflow of foreign exchange and minimise its potential negative impact.

Massimiliano Cali and Dirk Willem te Velde