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Caritas concerns on tax proposals

This just through from Caritas Zambia (Formerly (CCJDP)). They have been meeting with MPs to urge rejection of the measures.

CONCERNS ON THE PROPOSED 2009 MINING TAX REGIME

4^th March 2009

This paper looks at the negative effects which may arise from the mining regime changes proposed to Parliament by the Minister of Finance and National Planning, Honourable Dr. Situmbeko Musokotwane, MP during the Budget Speech on 30^th[1] January 2009.

Among the most significant changes to the mining tax regime proposed in the Budget Speech are removal of the windfall tax, 100% capital allowance, and including hedging gains and losses in the mining revenues.

Civil society organisations, organized under Zambia’s newly founded chapter of the global Publish What You Pay (PWYP) campaign,[2] are concerned that the proposed mining tax revision could have calamitous consequences for Zambian development. Specifically, these changes could deprive the country of resources needed to invest in infrastructure, education, health, and other critical sectors. Therefore, PWYP respectfully rejects these proposed changes. In an effort to partner with the Government to secure a mining tax regime that supports people-centred development, PWYP has produced this policy brief to outline the downfalls of the Ministry of Finance’s proposed newly proposed mining tax changes.

This policy brief is divided into four (4) main components, namely:

1. Introduction
2. Discussion of Proposed Tax Changes

(a) Removal of the Windfall Tax

(b) Allowance for Hedging Gains and Losses in Mining Revenues

(c) Increased Capital Allowance

(d) Reduction of Duty on Heavy Fuel Oils

(e) Removal of Duty on Powder, Flake and Blister Copper

(f) Inclusion of Copper and Cobalt Concentrates in Deferment Scheme

3. Recommendations
4. Conclusion

INTRODUCTION

Taxes are one of the major sources of Government revenue. Other sources of government resources may include support from cooperating partners in the form of grants, and borrowing either domestically or externally in the form of loans. The projected Government revenue are indicated in the Fifth National Development Plan 2006-2010. According to preliminary indications, Government is expected to raise 77% of its revenue from taxes and non tax measures, 18% from cooperating partner’s grants, and 5% from loans. The expected resource envelope to run government under the Fifth National Development Plan 2006-2010 is K62,623 billion[3]. The mining sector is the biggest money spinner in the economy and foreign exchange earner. Unfortunately, mining companies’ meagre tax contributions are depriving Zambia of the financial resources necessary for national development. The mining sector should progressively and equitable contribute a meaning share of tax revenue to the government.

Changes to the mining sector tax regime have occurred annually; in fact, the Mines and Minerals Act of 1996 was overhauled as recently as April 2008. The Income Tax Act, Value Added Tax Act and the Customs and Excise Act also endured recent changes. As a consequence of these frequent changes to the tax law, there exists a strong argument that the mining regime lacks stability and predictability. These changes come with both domestic and international costs to Government. Domestically, changes to the tax law that result in slashed taxes on mining companies risk alienating tax payers by depriving them of the benefits of the previous tax scheme before those benefits even materialize. Further, frequent changes in the tax regime erode investor confidence. It is a truism that investors are risk averse; they seek out countries characterized by a stable investment climate including tax regime. Flip-flops in the tax code, while perhaps pleasing to investors in the short term, ultimately threaten Zambia’s ability to compete favourably with other countries as a foreign direct investment (FDI) destination.

It is therefore important that the consequences of changing the tax regime be fully considered before Parliament votes on the National budget’s proposal.

DISCUSSION OF PROPOSED TAX CHANGES

It should be known that if one in a given tax system does not pay his or her taxes, and then someone else will have to pay it in the long run. This creates a financing gap, causing Government to borrow today and raise taxes to offset the borrowing tomorrow. If this principle is true then we will proceed with this argument to analyse the budget speech.

It should be known that the mineral resources of are owned by its citizens.[4] If Zambia’s natural resources are going to be exploited, then the citizen-owners should have an equity share together with the investor-exploiters. This element of Zambian ownership of its natural resources is captured under in current tax regime through resource rent under the variable profit tax and the windfall tax however it is threatened by the removal of the windfall taxation element.

Income Tax Measure- Remove the Windfall Tax[5]

From the design, the variable profit tax would kick in for any particular mine but after the company tax of 30% and when the company revenue become twice the cost of production then the windfall is effected at graduated levels at 25% of copper price at $2.50 to $2.99 and 50% at $3.00 to $3.49, and at 75% at any price at $3.50 and above.. This is the general parameter with no intersection. Where possible over lap were anticipated between variable profit tax and windfall tax allowable deductions were provided for.

The windfall tax captures significant tax revenue during high copper price periods. Since there are only two element of consideration i.e. the selling price and cost of production it’s easy to administer and it is a low cost approach on tax administration.

One of the major voids in our tax laws before April 2008 was the lack of resource rent on exploiting the mineral resource. The sole purpose of the variable profit tax and windfall tax was to give resource rent to the owners, the Zambians. When it comes to the resource rent, this should not be equalled to mineral royalty. Mineral royalty is allowable in Zambia. This means that when a company declares its final profit tax the mineral royalty paid is deductedable. Therefore, the only burden by the mining company is the cash flow element as it does not stick on the company. However resource rent is supposed to stick on the company as it shared during profit periods. Since the windfall taxation has triggers thus makes it’s a conditional position such that during low copper prices the mining companies are not affected as the are not required to pay the tax but during high copper prices which meets the conditional trigger prices (inclusive of the indexation aspects) the mining companies are required to pay the taxes.

Removing windfall taxation is a long term cited position of the mining companies to take the benefit at a future date when the trigger positions are supposed to come into play. It should be recognised that in tax design, elements are not supposed to over lap (taxing one element more than once), in this case the variable profit tax and windfall taxation. The two variables have no overlap or intersection. The elements of consideration particularly the trigger in both variable profit tax and windfall tax are different and provide for both low and high cost mines to operate efficiently and improve in technology to their advantage. If this is the principle then the argument that the variable profit tax will capture some element of windfall taxation is not true.

Income Tax Measure- Allow Hedging Income[6]

Hedging is a normal business transaction were business risks are mitigated. Hedging in simple terms is an insurance portfolio taken by business to mitigate business risk. Therefore hedging is a risk management portfolio though it has an element of speculation which drives the risk.

In 2008, the budget speech stated that, ‘Hedging as a risk management mechanism shall be treated as a separate activity from mining’[7]. This is the correct legal practise under the Income Tax Act which is based on the principle of source rule and activity.

Hedging in practice is a complex transaction which would normally require at least two or more transaction portfolios. The transaction is even complex if these papers (covers of hedging) are drawn in a tax haven jurisdiction for taxes purposes.

Hedging is not a mining activity as such it will contradict the law. There is no justification then why the government should consider it as mining incentives under the 2009 national budget. It will bring a serious juridical conflict as other business undertaking hedging will require to e legally be recognised. This will create among other things erosion of the tax base.

Secondly we will be subjecting our tax base to speculation which history has shown that there is not meaningful gain. in tax design the tax base has to be clearly be defined for purposes of avoiding miss interpretation, avoidance of paying taxes through Non-Arms’ Length dealings and evasions.

Thirdly, hedging being a complex transaction, monitoring, assessing, final tax remittance processes would cause the cost of tax administration to go increase, with no corresponding benefit.

Income Tax Measure- Increase Capital Allowance[8]

Capital Allowance is the benefit that a company accrues in investing in capital equipment through a legally bound depreciation rule enshrined by law.

A twenty five percent (25%) capital allowance means that capital equipment will depreciate to scrap value after four calendar year. This is to say that every year for four years the equipment value is deducted by 25% of the initial cost. While a hundred percent (100%) capital allowance means that the initial cost of the equipment is deducted in the same year that the cost was made or when the equipment is bought.

In a twenty percent capital allowance scenario , 25% is deducted from the value of the capital equipment and other allowable costs, and when the revenues are higher, then the company declares a profit consequently taxes will be due. If this is not the case, the losses are moved to the following financial year as carry forward losses. In the case of 100% capital allowance, the taxes are only due when the equipment cost has been recovered by 100%.

This proposal would reverse the 2008 tax regime[9] gains that were introduced this is because the government will not have any revenue benefit until the company has recovered the full cost of the capital equipment. One wonders what benefit was envisaged last year which, just a year later no longer applies. It is assumed that the 2008 law was analysed in detail by the technocrats.

Business cycle is a natural pattern which involves business going up (booms) and going down (recessions). Business behaviour trends were the 100% capital allowance is in place show that companies will invest to a large extent during booms, allowing them to recoup their investment in a shorter time. Conversely, there are usually no investments during recession. The 100% will make the companies have an incentive not to invest when the copper prices are at the lowest because of prolonged periods to recover their cost. While the 25% was spreading the cost recovery evenly over a period of time meaning companies will invest when it is necessary unlike the 100%. It will then even mean that the companies will wait until the copper prices are high for them to start investing with an incentive that the can claim 100% capital allowance thus having the implication that the government will not benefit in times when there is high copper prices.

The above position should not be taken in isolation as other taxes such as VAT and Customs and Excise duty do not affect the mining sector on capital equipment. There are also other adverse implications on government revenue other than just the 100% capital allowance which will be discussed later.

Internationally this measure of 100% is very common to mainly countries in Africa, South of the Equator, Zambia inclusive. Therefore, one wonders the benefit of tax competition and tax harmonisation that these countries are trying to achieve apart from disadvantaging themselves.

Customs and Excise Measures: Proposal on Reductions Duty on Heavy Fuel Oils[10]

The government has proposed to reduce customs duty on Heavy Fuel Oil from 30 to 15 percent.

The proposal is clearly intended to reduce the cost of doing business for mining companies. Heavy Fuel Oils (HFO) are largely consumed by the mining sector. With the global economy in recession, it is understandable that Government would want to support the mining sector.

However, the better route would be to review the current HFO duty on an annual basis. If the HFO duty is reduced permanently, the long term effect will be an erosion of the tax base for Government revenue and the need to amend the law (Statutory Instruments).

Customs and Excise Measures: proposal to removal of Duty on Powder, Flake and Blister Copper[11]

The government proposes to remove customs duty on copper powder, copper flakes and copper blisters.

Powder, flake and blister copper are above ninety percent copper content, and would be brought into the country for reprocessing to attain the refinement level of approximately 99.9% copper. In short, these materials are intended to enter the country for metal treatment. This incentive is proposed through an amendment to the Customs and Excise Bill.[12] However, the proposal directly conflict with the Mines and Minerals Act 2008, which makes a clear distinction between mining[13][14] It is disingenuous claim that the mining sector is being offered the incentive, just because the material in question is a base metal stock feed. In fact, the incentive is being offered to companies engaged in metal treatment. and metal treatment.

International standard and best practise in mining has shown that metal treatment and mining are considered as two different sectors and enjoy different incentives. For Zambia, to give the same incentives to mine companies and smelters may have a long standing disincentive to core mining, which has high initial and associated development costs.

The proposed measure would immediately benefit the smelter companies. One of the difficulties that this measure will bring in the long term would be to create ambiguity as to whether it benefits mining companies or smelter companies, or both. Smelter have a lower cost of set up than developing a mine , it therefore follows that the heavier the cost the more the incentive- in this case the smelters companies will have a more incentive than the mining companies. If to the benefit accrues to both, then the next question must be whether metal treatment and mining are the same?

It is worthwhile to mention that mining companies with smelters also are controlled to ensure that they do not abandon the associated mine development costs which go with geological survey and mining development activities. However, if the cost of importation is lower than the existing cost of mining the ore and metallurgical processing combined, it would make business sense to import the prescribed stock feed for processing at the smelter plants. The effect for Zambia in the immediate would be no mineral royalty and in the long run, the proficiency which goes with mining in the different disciplines would be lost and ultimately human power would scale down- e.g mine engineers, geophysicist.

The above measure will also increase the cost of tax administration with no corresponding revenue to the government at the time of importation.

Value Added Tax Measure s – Include Copper and Cobalt Concentrates on Deferment Scheme[15]

The government in addition to the above proposals to include copper and cobalt concentrates on the import deferment scheme for VAT purposes. This measure is no different from issues discussed under the customs duty on copper powder, copper flakes and copper blister.

Technically, all registered companies for VAT purposes who are none final consumers of taxable supplies and do not pay Value Added Tax on all taxable supplies they procure. This is true for all large scale mining companies in Zambia. The companies pay the tax and ultimately claim it back within the confines of the law. Mining companies in Zambia do claim the VAT on a preferential calendar than other business sector within a period not exceeding thirty (30) days called “Fast Track Scheme”.

However, this has a hidden cost to the mining companies and this is in terms of cash flow constraint for the period before the refund is actualised. This passes a benefit to Government in that the resources can be used for its operation without going to borrow. Some scholars have justified it as the benefit to the tax administration cost incurred by Government on VAT assessment taken which is also at a cost.

International standards and best practise in VAT deferment scheme has shown that this scheme creates long term benefits on capital equipment than on material in put or otherwise. This is so in the sense that capital equipment creates wealth and enhanced technological improvement.

Copper and cobalt concentrates are not capital equipment as such the should not be listed on the Deferment Scheme. Beyond that we see that there will be suffocation of mine development associated cost, no mineral loyalty paid, no resource rent and there will be an increased tax administration cost.

Historically in Zambia it has been noticed that the deferment scheme operates like it’s an unending give away tax revenues than it supposed to be a moratorium on taxes in a given business climate .

Combined Tax Measure Effects

The measures discussed above are a tip of the actual scenario. The most and biggest problem in the eyes of many people is to compare the taxes by their single elements as they are enshrined by different jurisdictions by law. The best common measure to compare taxes is to analyse the effective tax rate from one jurisdiction to another. What would be more interesting is that Government should be in a position to tell us what the proposed measure sums up to be as the effective tax rate for the mining sector in Zambia given the proposed changes.

Recently, one of the trade unions was quoted as having done a study on the mining sector and came up with a conclusion that it is not true that the mining companies were making losses.

Before the 2008 measures the mining sector tax contributions were only 3.75% out of the revenue inflows of two billion United States Dollars (US$ 2 billion). This was a meagre contribution and the 2008 measures further failed to contribute the estimated revenue[16] partly due to many issues. It is therefore apparent that with these incentives lined up for the mining sector, the owners of the resources, Zambians, should expect even a further reduced tax contribution from the collections of 2009. The Zambian people will be disadvantaged with the incentives if the are passed in parliaments.

Recommendation

It is our sincere hope that the honourable parliamentarians will stand with the concerns of the Zambian people by rejecting the measure there current form and presentation.

Conclusion

1. The removal of windfall tax reduces the element to capture equitable resource rent with no corresponding compensation for the owners of the resources.
2. Capital Allowance of 100% in the year incurred will not benefit the Zambians as the investors will only delay investment until they are sure that they will recoup their investment in the shortest possible time and these will only be in boom times. Capital allowance of 100%, carry forward of losses of ten (10) years is a good recipe to ensure that no resource rent is paid even in boom times.
3. Hedging is a private risk management and allowing it for tax purposes will prove to be a complex exercise with not benefit to the Zambians as this may need huge financial and human capital investment with little no corresponding return in terms of taxes to be paid. If borrowing is capped by 3:1[17]-(Capital to debt ratio) to avoid unconventional dealings such as transfer pricing, while leaving speculation to the wind.
4. The above measures are going to erode the tax base further measuring that our future generation will be born with debts on their heads.
5. The people of Zambia are not currently benefiting from the huge mineral resources in the country and it more likely that the will be disadvantaged further from the above proposes made by the government
6. Poverty is going to increase this year

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[1] 2009 Budget Address, Ministry of Finance and National Planning, Lusaka

[2] PWYP-Zambia, whose Secretariat is hosted by Caritas Zambia, was launched in Lusaka on February 23, 2009. PWYP-Zambia forms part of the global civil society movement to help developing countries such as Zambia hold their governments accountable for the sound management of natural resource revenues. Specifically, PWYP calls on mining companies to disclose the amount they pay to government in tax revenues, and for the government to scrutinize and make public the financial activities of these mining companies.

[3] Fifth National Development Plan 2006-2010- Summary , Ministry of Finance and National Planning, 2006, Page 35

[4] See African Charter on Human and Peoples’ Rights

[5] 2009 Budget Address, Ministry of Finance and National Planning, 2009, Para 143 (a)

[6] 2009 Budget Address, Ministry of Finance and National Planning, 2009, Para 143 (b)

[7] 2008 Budget Address, Ministry of Finance and National Planning, 2008, Para 147 (h)

[8] 2009 Budget Address, Ministry of Finance and National Planning, 2009, Para 143 (c)

[9] 2008 Budget Address, Mininstry of Finanace and National Planning, 2008, Para 147 (h)

[10] 2009 Budget Address, Ministry of Finance and National Planning, 2009, Para 145, Page 22

[11] 2009 Budget Address, Ministry of Finance and National Planning, 2009, Para 145, Page 22

[12] National Assembly Bill ,2009

[13] The Mines and Minerals Act 2008

[14] The Mines and Minerals Act 2008

[15] 2009 Budget Address, Ministry of Finance and National Planning, 2009, Para 145, Page 22

[16] 2009 Yellow Book, The Appropriation Act 2009, Ministry of Finance and National Planning, 2009,

[17] Income Tax Act

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BBC World Service on the downturn

I have just been interviewed for a BBC World Service programme on the impact of the global economic downturn on Zambia. I am pleased with how it turned out. The journalist visits Luanshya and does some interesting interviews with local business and union representatives.
Here's a link to the programme in the BBC's 'iplayer' http://www.bbc.co.uk/iplayer/episode/p0029jl2/p0029jn2/Business_Daily_09_03_2009/

You need to download some software to make that work, so I might try and post a version on youtube later.

Guy Scott on Boom and Bust on the Copperbelt

Dear MineWatchZambia readers.

Sorry to have been away or so long. I have taken a break from blogging to concentrate on other projects. Nonetheless, I am breaking radio silence today to bring you two bits of news.

The first is that I have posted a powerpoint presentation on Boom and Bust on the Zambian Copperbelt that I have been trawling around British Unversities at my academia website http://oxford.academia.edu/AlastairFraser/Papers#d84853. Comments very welcome.

The second is that I have just read an excellent article on the recent revisions to the Mining Tax regime in The Post by PF General Secretary Guy Scott (it's written in a personal capacity).

While he disagrees (as do I) with the Government's recent moves to cut the Windfall Tax at a time when it's not operating anyway, he offers an interesting speculation on what Government negotiators might have been thinking. I was utterly bemused by their moves before I read this, so I'd be interested to know what others make of it.

"Zambia and recession – part 5 Written by Dr Guy Scott

There are more than 100 countries with higher GDP than Zambia. A hundred years of GDP at Zambia’s current level would roughly equate to the size of President Obama’s first (and it is only his first) stimulus package. Given our tiny quantum of economic clout it can safely be said that Zambia will have no role to play in saving the world from recession. Our job is to look after ourselves, perhaps with a now-and-then concerned glance at our neighbours since we do not want unrest across our borders.

There are several ways in which the recession impinges upon Zambia. But first, how long will this thing last? Ben Bernanke, the Chairman of the US Federal Reserve Bank (the “Fed”), is talking about a turn-around within the current year and recovery in 2010. However, the logic of recovery (which is “bubble” logic not “classical” logic) demands the prior restoration of confidence in the minds of consumers and investors. Even if Bernanke thought, as an economist, that the recession might last for several years he would not loudly say so. Part of the job he has, along with many other people, is to create an expectation of recovery that will hopefully become self-fulfilling. (Actually, if you read his statements carefully, you will discover that a “full” recovery is likely to take more than two or three years; so he is covering his professional reputation). Every responsible owner keeps his or her car insured. This is not because they want it to crash or be stolen; nor is it because they expect it to crash or be stolen; it is because they know that it might just, through no fault of their own, crash or get stolen. They hope for the best; but they insure against the worst. With the recession, our leaders may hope for the best, but they must also plan for the worst. Things may get even worse, and the bad times might last long. Now, can we sustain ourselves through a long night if we have to?

The most obvious indicator of hard times in Zambia is the slump in the world copper price; this is accompanied by layoffs of mineworkers and a slowdown in industries servicing the mines. Hard on the heels of all this we will see a drop in tax revenues, and a virtual cessation of new productive investment once unavoidable pre-slump commitments have been fulfilled. Government (particularly Minister of Finance Situmbeko Musokotwane) has been expressing some joy in the fact that current (slumped) copper prices are nonetheless higher that those that preceded the onset of the copper boom three or four years ago. Against this correct observation, however, must be placed the fact that Zambia’s copper output expansion has involved increasingly expensive and capital-intensive extraction – exploiting more and more low-grade or hard-to-access ore. Furthermore, actual extraction is turning out in several new mines to be significantly below projections. So, many mining operations are not actually viable at current price levels of c. US$3,300 per tonne (versus over US$8000 in the middle of last year). The mining industry will shrink, as it has already started to do, unless prices rise.

The Minister of Finance (and National Planning, note) has brought to Parliament a proposal that the mining industry should be relieved of the Windfall Tax and given 100 per cent capital allowances. The windfall tax is a tax introduced to direct some of the excess earnings created by runaway prices into the pockets of Zambians. It was a feature of last year’s budget, following vocal concern by the opposition and some NGOs that Zambia was not receiving her fair share in the boom. Now the windfall tax does not cut in until prices exceed US$5,500 per tonne so it is of no direct short-term relevance in the present market situation. The same goes for capital allowances. These are allowances deductible from profits for the purpose of computing profits tax; in the absence of profits the allowances are meaningless. Why has government made the tax adjustments outlined in the previous paragraph? The logic is funny; indeed it seems to be a form of bubble logic, designed to create an upbeat future scenario rather than directly affect the present. The deal runs like this: If the government promises that it will make life easier and more profitable for the mining companies in the rosy future when prices have recovered then the companies will soldier on, through the dark night, warmed by visions of earnings beyond the dreams of avarice in the good times to come. So the tax breaks are a kind of trick to build hope and confidence, but who is tricking who?

The big problem that emerged during the copper boom was that government had not foreseen the possibility of such a thing when it negotiated “development agreements” during the very hard times of privatisation around the year 2000. The companies managed to get tax concessions galore against the fact they were making no money with which to pay tax anyway. The companies had the whip hand; government’s negotiators – or “negotiators” – were so relieved at being able to unburden the State of the loss-making mines that they completely overlooked the prospect of boom time. What would happen if copper prices went through the roof? Nobody thought; and no provision was made for Zambia to share fairly in any windfall. It subsequently took a lot of campaigning to get an equitable taxation system into place; and now the Honourable minister is proposing to dismantle most of it.

We are almost back where we started, with the companies calling the shots, backed by the implicit threat of more layoffs and consequent political unrest if government does not wag its tail. And how solid is the deal anyway? Has the mining industry stopped laying off workers? As of the week before last it had not. Indeed it may be the case that the promise of the “goodwill” tax concessions being passed by Parliament and coming into being (if not actual effect) on April 1st has prompted some pre-emptive layoffs. (By this I mean that it will be more difficult, morally speaking, to lay off workers once the govt’s promises are actually passed into law than it is now when they are only proposals). And from the government’s side, how firm is the commitment to maintain a company-favouring tax regime once prices rise again, whenever that may be? Some pundits are saying that the future of electric vehicles and similar low carbon technology will propel copper prices into five figures – even as high as US$30,000 per tonne or nearly ten times the present level in a decade or two. Will there still be no windfall tax; will there still be 100 percent investment write offs? Is there any government, even an MMD one, that would sit back and watch our country being bled dry? It is not easy to negotiate in the dark, without a crystal ball or traditional Chienge-style computer to help you gaze into the future. Sure; but then there are people whose profession is to do exactly that though I doubt they have been utilised. My guess is that our team has not been very steely nerved or imaginative about negotiations. I would have been inclined to leave distant taxation off the table and look at ways of helping mines to keep going during the recession. We used to have in Zambia a Selective Employment Tax which embodied deductions for creating and maintaining jobs. Why not bring back such a thing if your primary worry is job losses? But I wasn’t there so I don’t know all the factors that had to be taken into consideration.

Inadvertently, the weakening of the kwacha against the US dollar has actually acted as a subsidy to the employment of mineworkers (since it now cost less in dollars to pay each of them each month). Perhaps in this case economic nature and her mysterious market workings know better than Zambia’s tax bureaucrats. We will have to take a look at the dance of the currencies next week.

Finally, some housekeeping. The views expressed in these articles are merely my own thinking-aloud as a professional economist; they do not represent official policies of the Patriotic Front. And the email address I gave last week was wrong; it is actually mano@zamtel.zm. Sorry for that."

Thoughts on mining, resource security and 'special' relationships between Zambia and China

Dear Minewatchers,

Alastair was recently asked, at a presentation at Oxford, why China appeared to have a ‘special’ relationship with Zambia, and why China would expend diplomatic efforts on Zambia. He asked me the same question, and I wanted to share with fellow Minewatchers my thoughts on this. Of course, the received wisdom suggests that, over the long run, China’s demand for resources is certainly a key element of China’s Africa strategy, together with access to markets and the forging of diplomatic relations. However looking specifically at the case of Zambia, what evidence is there a) that Zambia plays a key role in Beijing’s resources strategy; and b) that this constitutes a ‘special’ relationship that goes beyond diplomatic relationships with ‘traditional’ foreign powers.

Re the role of Chinese investment in China’s resource strategy, the first thing to look at would of course be whether NFCA exports its copper directly to China. However the way the copper markets typically work is that producers sell their copper “at mine-gate”, meaning that they contract (often on a yearly basis) with copper traders like Republic House, Trafigura, Glencore and others (the exception is KCM which markets some of its finished copper directly to end-user consumers – whether this is a legacy of AA’s operation or a practice that came with Vedanta I’m not clear about). These traders are often based in Switzerland, explaining the UNCTAD stats. The copper traders then sell it on en route to consumers across the world. To my knowledge there is no way of seeing how much of Zambian copper ends up in China.

NFCA has been a bit different – without their own smelter they were initially (since production of copper concentrates began in 2005) exporting pretty much all their ore to South Africa (to the processing facilities of Palabora Mining, majority owned by Rio Tinto). I don’t have the stats here but the Palabora annual reports includes the amount of copper concentrates bought from NFCA and I think the majority of the UNCTAD stats on Zambian concentrates exported to SA is from NFCA. I asked NFCA Deputy CEO Gao about direct supplies to China and he said transaction costs in getting the copper to China are high and that “I would much rather sell the copper and deliver the profit”. However, off-the-record interviews with NFCA staff working in finance and exports/imports suggest that direct sales to China have been increasing, and that by the end of 2007 maybe a third of the final product was going to China. The chief accountant told me that all produce had initially gone to SA because NFCA “wanted to test the market” (note that during the time I was in Zambia talking to ppl, the Chambishi Copper Smelter had not yet come online – to serve NFCA, Lumwana and others – and I don’t know if the marketing of CCS finished copper would be via copper traders or direct).

It thus remains unclear just what role NFCA plays in China’s resource strategy. I think it is safe to say that there is no element of the Angola-model (loans-for-resources) at work in Zambia. However my evidence supports an interpretation of investments such as NFCA as a form of *hedge* in China’s resource security. A long-term consultant for Chinese MOFCOM in Beijing told me (in reference to Chinese oil investments) that global commodity markets are generally well-functioning, suggesting that if resource prices spike due to some severe supply disruptions, then Chinese companies (like NFCA) can sell their copper at higher margins and “deliver the profit” (which could then – in theory – be used to subsidise Chinese copper marketed to domestic industries). However, he argued that although resource security is not a problem under normal circumstance, he could envisage a situation where disruption to global supply (of e.g. oil) becomes such that the markets simply cannot physically supply enough of the resource, and in this case China could then instruct overseas companies to supply directly.

Now, I think that the Chinese leadership is keen on letting market forces run their course in business-as-usual circumstances, being well aware that exposing their industries to market forces is the only way for them to become internationally competitive. I agree with Nina that there is probably little political influence over the day-to-day activities of overseas Chinese SOEs (and institutional reforms decentralizing approval process of overseas investment support this). However, I think that Beijing retains the right to intervene in extreme situations. This is made possible by the control that Chinese political leadership still exercises over its SOEs, mainly through its ability to easily replace managers, control funding etc. Here we should note that there is a difference between SOEs and SOEs: the larger central-level SOEs (there’s about 150-odd “national champions” that have been specifically selected for incentives for going abroad) are considered minister-level SOEs, in the sense that their top bosses have the rank of minister in the political hierarchy. These SOEs do not have western-style boards of directors, but are governed by so called ‘party groups’ comprising senior CCP cadres (up to 9 of them, and always an odd-number) who appoint (senior) managers of the SOE. As discussed on the MWZ blog, it is pretty clear that Beijing foreign policy does not permeate the activities of all and sundry Chinese in Africa, but for the central-government SOEs (such as CNMC, parent of NFCA) I would think this influence is certainly there.

To conclude on the role of Zambia in China’s resource strategy, I think there definitely is a strategic element behind these investments, in particular due to the proximity of the Chambishi SEZ to Katanga in DRC. If the Chinese investment into Katanga’s state-owned mines (Gecamines) goes through as part of the $9bn loans-for-resources deal, companies set up in Chambishi are likely to be used to service these mines. The investment pattern around Chambishi already exhibits this pattern of networked businesses providing control throughout the value chain (Chambishi Foundry producing thing mill balls that goes into NFCA’s crusher/concentrator, Sino-Acid producing the acid for NFCA’s leach plant etc., although they all sell to third parties as well). Whether the PRC strategy is effectively implemented or not is another story, given what appears to be a gap between long-term strategic interests and short-term profit objectives of managers on the ground. As I understand it, Chinese managers suffer from insecure ‘internal property rights’ (they are easily replaceable in unaccountable ways, where funding is politically controlled and can be withdrawn if a manager steps out of the ‘party line’). It is therefore ironic, in my view, that this situation is likely to make these managers *more* short-sighted and to promote behaviour (e.g. cut costs on maintenance etc.) that actually undermine the long-term interests of Beijing foreign policy makers that constitute the ultimate shareholders of NFCA!

Turning then to the question of whether or not China has a ‘special’ relationship with Zambia, we know two things for sure, first that everybody seems to think so, and secondly that there is preciously little hard evidence that this is the case! How might such a relationship manifest itself? In trying to sketch this relationship, one thing that jumps out at me is that there appears to be a good ‘fit’ between how the Chinese are used to doing things and how the Zambian leadership prefers to do things. The Chinese like to negotiate and present economic deals within low-transparency contexts that are political as well as informal, as do Zambians (plenty of ‘courtesy calls’ at which projects are announced with scarce detail). So a key feature of this relationship is its general opacity. This implies that that Chinese dealings are seen with much suspicion, and the truth is probably that there may be some preferential treatment going on, but only at the margins. Supportive of the view that GRZ could not – even if it wanted to – ride roughshod over governance rules and norms in its treatment of Chinese interests is the fact that western donors are still providing about a fifth of the country’s budget! Some examples of favours that are granted might include how Mwanawasa gave the go-ahead for BGRIMM to be re-established before impact assessments had been completed. As an official at ECZ notes “of course when the President makes a statement like that, it constrains how we work”. What else might Chinese interests gain from cultivating a ‘special relationship’? Perhaps a willingness of Zambian leadership to expedite Chinese projects, give quick approvals etc. (e.g. Chambishi SEZ where they started clearing the bush as soon as the project had been name-dropped at FOCAC). As noted above, I don’t think there is much political influence in the day-to-day operations of companies like NFCA post-entry, but I do think that the Chinese government plays a role in brokering the entry of Chinese investors.

Then there is the question of what the GRZ leadership might gain from this relationship, i.e. what incentives might there be to offer the Chinese preferential treatment? I have evidence of senior politicians receiving gifts (TVs etc.) imported by NFCA, and there have been some suggestions that the Chinese have provided party funding for MMD (here unfortunately I have no evidence, if anyone does I’d be pleased to hear it). More obviously the Zambian leadership gets access to funding for visible and popular projects that would not have passed western donors’ pro-poorness hurdles (e.g. Ndola stadium).

In general I think the welcoming of Chinese investment also reflects the attitude of the late Mwanawasa that foreign investment was essential for Zambian economic development. As we know the impacts of FDI on growth and development are highly context-specific and by no means automatic, however a WB person I spoke to suggested that Mwanawasa’s non-economist background may have contributed towards an poor understanding (and consequently uncritical stance) towards the development potential of FDI.

To sum up, I think this relationship does not completely mirror other diplomatic relationships, it appears more informal, with greater involvement of politicians rather than technocrats, but probably not exceedingly ‘special’ in its outcomes (i.e. ongoing and systematic preferential treatment of Chinese). Both parties prefer the same low-accountability ways of engagement, but this need not (necessarily) imply significant departures from the legal/established systems, or that special ‘favours’ are granted. Rather it may simply reflect high transaction costs of accountability: even if you do not have anything to hide, having to explain yourself to critical voices is costly and takes time and effort!

I would be delighted to hear what other people think about this, and if it fits with your own experiences. All comments are most welcome.

Dan Haglund
University of Bath
d.haglund@bath.ac.uk