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The Fiscal Effects of Aid in Zambia

Working papers

This paper asks what the impact has been on Zambia's fiscal aggregates of the large volumes of external assistance provided to the country, in particular since the mid-1980s, and whether these have prima facie been growth-inducing. It considers the course of fiscal performance, and of its wider economic context, from independence in 1964 to the start of the 21st Century. It applies vector autoregression econometric analysis to data on the main fiscal aggregates.

The paper's principal conclusions are that the main significant net impacts of a one-period injection of aid (ODA and net foreign borrowing) have been (i) sustained higher capital expenditure and (ii) apparently somewhat lower domestic revenue receipts (see below). Recurrent expenditures have also risen contemporaneously with the receipt of aid, as donors have wished. On the other hand, domestic borrowing has also increased in response to injections of ODA, suggesting that, far from using these to stabilise the economy, the government has tended to take the opportunity to relax fiscal and macroeconomic controls. This was contrary to the spirit of the IMF programmes, in the context of which much aid has been provided. Aid has permitted public expenditures to rise well above levels able to be financed from domestic resources, but has not prevented their decline in real terms, nor the decline in the quality and outreach of public services. Large volumes of aid have been devoted to debt and debt-service reduction, the effects of which on fiscal aggregates are diffused through time.

Though the decline of its economy and public expenditures has been prolonged and severe, Zambia's current position is far from being the worst in sub-Saharan Africa. Its per capita income in 2000 in current international dollars was $760 compared with $510 and $1000 respectively for neighbouring Tanzania and Mozambique, and an average for sub-Saharan Africa (including South Africa) of $1800. Its public expenditure was 25% of (conventionally measured) GDP, compared with the regional average of 26%; and its investment rate was 19% of GDP, which exceeded the sub-Saharan African average of 17%.

Zambia's economic history since independence can be divided into three periods: (i) from 1964 until approximately 1975, a time of high copper prices, economic expansion, public expenditure growth and public sector expansion; (ii) 1975-90 when mineral earnings began to contract, bringing economic decline compounded by mounting macroeconomic mismanagement, fiscal and structural difficulties and largely unsuccessful reforms; and (iii) 1991 to the present when radical structural and economic management reforms have been undertaken, but without adequate attention to macroeconomic stabilisation and fiscal discipline.

In the first period Zambia had a resource surplus, though the government borrowed domestically and from abroad to finance its expanding operations, including nationalisation and ambitious infrastructure projects. In the second period, as domestic revenue receipts fell as a share of GDP, the government borrowed heavily domestically and from foreign creditors. Mounting balance-of-payments and external debt problems in the 1980s elicited for the first time significant concessional assistance from bilateral donors, but flows were interrupted by unsatisfactory relations with the international finance institutions. In the most recent period inflows of concessional assistance from bilateral sources have been on a massive scale, and have been joined by significant inflows of concessional credits for structural and sector adjustment from multilateral sources, mainly the IDA. In election year 1991 there was an exceptional, and very pronounced, spike in public expenditure and domestic borrowing.

Budgeting, fiscal discipline, public expenditure management and the effectiveness of public expenditure programmes declined in standards over the decades under review as a consequence of repeated ad hoc adjustments to diminishing resources. There has been repeated recourse to inflationary domestic borrowing. Prior to 2002 there was no effective medium-term expenditure programming. Supplementary budgets have been routine. Dysfunctional cash budgeting arrangements introduced in the 1990s have further blunted the thrust of public expenditure strategy.

The dichotomy has been maintained between the recurrent and capital budgets, with the recurrent budget largely financed by domestic revenue and (largely monetised) domestic borrowing, and over 80% of the capital budget financed from external sources. Falling aggregate real fiscal resources brought declines in all the main economic and functional categories of expenditure, apart from debt interest, between the mid-1980s and mid-1990s. In the later 1990s, however, rising aid inflows and the effects of previous debt and debt-service reduction operations, along with the stabilisation of the domestic economy, helped to stem the tide, leading to increases in real wage and salary payments, other recurrent outlays and expenditure on the social services and transport and communications. The exceptional burden of external debt notwithstanding, debt interest payments have, as a consequence of default and relief, been a less onerous charge on Zambia's recurrent budget than on those of other indebted countries. They peaked at 25% (on average) of the recurrent budgets of the first half of the 1990s, before falling to 10% in the second half.

The story of Zambia's declining economic performance, altering policies and erratic macroeconomic and fiscal management gives rise to the expectation that the fiscal impact of aid on the main fiscal aggregates has been poorly defined because: (i) a substantial proportion of donors' disbursements - on technical cooperation, debt and debt-service reduction, food aid projects, etc. - has passed outside the budget; (ii) Zambia has implemented cash budgeting in an ad hoc manner which has made it difficult to pursue a coherent public expenditure allocation strategy; and (iii) a large share of on-budget disbursed aid has been in the form of balance-of-payments and budget support the domestic expenditure counterpart of which is ex ante unconstrained - though the donors have exerted pressure on the government to use it to rehabilitate and sustain recurrent outlays on certain services deemed to be pro-poor, notably the social services.

The econometric analysis throws some light on these issues. The weakness of the estimated relationships (low R2) tends to confirm the ad hoc character of fiscal resource allocation. The fact that aid has exerted no apparent downward pressure on Zambia's almost constant excessive domestic borrowing also bears witness to the weakness of the budgetary process.

The first principal conclusion of the estimated VAR model is that a one-period injection of external financing appears to have mainly had the effect of promoting a sustained and significant rise in capital budget expenditure (cumulatively by a multiple of itself). The model also reveals a weaker, single-period, effect of aid in raising recurrent expenditure. The strength of the effect on capital expenditure indicates that the practice of dual budgeting - in which external finance is devoted to the capital budget and domestic revenue to the recurrent budget - has survived, in spite of the early unification of responsibility for the recurrent budget and the development plan within one ministry.

The second principal conclusion of the econometric analysis - that aid has had a negative effect on domestic revenues - is harder to explain in terms of policy processes. The IMF and the donors have discouraged any slackening of revenue mobilisation endeavours which might aggravate macroeconomic instability. The result probably reflects the simultaneous effect of Zambia's economic decline and consequential balance-of-payments problems on revenue receipts - from the copper sector and from taxes on trade - and on donors' willingness to assist.

The effects of aid on Zambia's GDP during the long years of decline have been palliative. They cannot be fully inferred from the econometric results on fiscal effects. Aid has (i) financed most of the capital budget since 1970, (ii) reduced somewhat since 1990 the mountain of external debt inherited from earlier years, reducing the costs of its servicing, and (iii) contributed resources to the recurrent budget, both directly and through debt-service reduction. It has thereby helped to mitigate the deterioration of the country's once admired economic and social infrastructure, and to retard the deterioration of its public services. Since the mid-1990s it has assisted the modest revival of expenditure on public services and helped to reverse their earlier deterioration. It played a role in creating the conditions for the slow economic revival begun in the later 1990s.

However, the flow of aid was erratic and unpredictable - even in the 1990s when disbursements were large - because of relationships with donors characterised by frequent interruptions of dialogue. Aid flows were an insecure financial basis for the planning of public-service development, leading to spasmodic and inefficient implementation and outputs of impaired effectiveness. The efficiency and effectiveness of public programmes have in general been low. Moreover, the policy environment has not been such as to inspire the confidence of private investors on a scale sufficient to engender sustained and rapid growth. Aid contributes to growth most powerfully when it complements expansionary forces operating autonomously in the non-governmental sectors of the economy.

Sonja Fagernas and John Roberts