In search of a copper windfall
In recent years, Zambia has enjoyed new-found macroeconomic stability, with GDP growth of around 6% and inflation in single digits - courtesy - initially at least - of the sharp appreciation in the ZMK, but also improved economic management. Gains in metals prices globally have been beneficial for Zambia, leading to increased activity on the copper-belt and a significant rise in FDI. Despite this, the perception that Zambia was not extracting as much as it could from its copper endowments has been widespread. Although copper makes up over 60% of the country's exports, its contribution to government revenue was negligible. The reasons were mainly historical. Following the exit of the largest foreign mining investor, Anglo American, in 2002 (low copper prices as well as the prohibitive costs of developing the Konkola Deep project were blamed), Zambia was forced to seek new investors. At a time of copper price weakness, several development agreements were negotiated with new investors, which typically offered tax concessions, including the setting of mining royalties at 0.6%. According to IMF data, in 2007, total tax revenue from the mining sector was equivalent to only 1.5% of GDP - a low ratio in comparison with other resource-rich countries .
With the dramatic recent rise in copper prices, the issue has become politically charged, with Zambia's populist opposition leading calls for a revision of these agreements. That Zambia needs to create more fiscal resources for spending on infrastructure in order to drive future growth and diversification is a given. Net inflows of donor support - on which the country had traditionally been reliant - were unlikely to be scaled up beyond 5-6% of GDP over the medium term. With a future decline in donor flows more probable, and Zambia's entire macroeconomic adjustment premised on a reduction in domestic borrowing, the country faced few options other than to revisit the mining sector. It had long been encouraged by the World Bank and the IMF, as well as other bilateral donors, to do so.
Unsurprisingly then, the theme of this year's Budget ('Unlocking Resources for Economic Empowerment and Wealth Creation') was to revise the fiscal regime for the resource sector, in order to achieve greater consistency with international standards. Under the new proposal, effective 1 April 2008, the corporate tax rate for mines will be set at 30%, mining royalties on base metals are to be set at 3% of gross value (up from 0.6%), and withholding tax on interest, royalties, management fees and payments to affiliates or subcontractors in the mining sector will be set at a rate of 15%. While many of these measures, especially the increase of royalties had largely been anticipated (having been the subject of previous negotiations), an additional element - the setting of a windfall tax on base metal revenues - appears to have taken mining companies by surprise. Under the budget proposals, a windfall tax, to be triggered at different price levels for different base metals will be introduced. For copper, a price between USD 2.50 - USD 3.00/lb, will attract a windfall tax of 25% from April; between USD 3.00 and 3.50, 50%, and 75% for prices above USD 3.50/lb. At the time of writing, copper prices are around the USD 3.60 level, sufficient to trigger the maximum windfall penalty, generating an additional level of controversy around the proposed changes.
Mining companies have been critical of the revised plans, claiming that they were not fully consulted (especially the proposed treatment of 'windfall profits'), and that any move to a new regime would infringe the legally-binding original agreements. While some mining companies hope to re negotiate with the government, others have threatened legal action. Many have claimed that the promise of a 15-20 year tax holiday was the reason they had invested in Zambia to begin with, and that the promise of preferential tax treatment was key to their ability to raise the financing. Zambia's Chamber of Mines has since argued that the country's ability to attract future FDI has been compromised.
For its part, the government has in recent weeks sent mixed signals on its willingness to negotiate, at times adopting the view that it did not need to seek tax-payers' agreement on the changes. Much rests on the question of whether the development agreements are legally binding, and following the expected approval of the Budget by parliament, some form of international arbitration looks increasingly probable. Ultimately however, it is the government that decides which companies it chooses to licence. With mining corporates already having heavily invested (both Zambia's FDI and trade data is testament to this), the authorities appear to be taking the view that significant withdrawal by mining companies is unlikely. Also, in contrast to the years immediately after privatisation, when the sector was dominated by a single large investor, there has recently been a relative proliferation of private sector investor interest. The authorities are now in a much stronger position to negotiate revised deals, especially since bilateral and multilateral donors are backing revisiting initial agreements. But the most compelling reason for the government to stand firm is the increasingly vocal call by both the political opposition and civil society, to ensure a 'fairer' deal is struck. So what are the likely economic effects?
Zambia's balance of payments looks relatively healthy. Despite booming export prices, imports have risen faster, reflecting increased investment in the mining sector. The current account is in deficit, the result of a substantial deficit in the income account (meaning that Zambia pays more to foreign investors than it earns on its income from abroad). However, this deficit has been easily financed by FDI flows. Even if new FDI flows are now put at risk, it is likely that the deficit on Zambia's income account will improve, providing some offset. Overall, there are few grounds for believing that the macro-economy is vulnerable. Although private sector external debt has been rising (again, reflecting the intensity of new investment in plants and machinery), at USD 980.7mn, in comparison to metals exports of USD 3.4bn annually, export cover is not problematic. The new fiscal regime - if adopted - will reduce mining profitability, but the structure of the tax changes (apart from royalties at 3%, profits are taxed) suggests that most companies can still be profitable. Zambia's low level of external debt in the wake of debt relief (USD 1,054.5mn at the end of 2007) also compares favourably with FX reserves of USD 1,080.2mn, equivalent to 3.6 months of import cover. Moreover, despite booming metals prices, it is Zambia's non-mining, non-traditional exports that have been growing fastest (albeit off a low base). Although many have questioned the benefits of the recent copper boom, Zambia has come a long way since 2002. Its economy is now more resilient to potential shocks.
In recent years, Zambia has enjoyed new-found macroeconomic stability, with GDP growth of around 6% and inflation in single digits - courtesy - initially at least - of the sharp appreciation in the ZMK, but also improved economic management. Gains in metals prices globally have been beneficial for Zambia, leading to increased activity on the copper-belt and a significant rise in FDI. Despite this, the perception that Zambia was not extracting as much as it could from its copper endowments has been widespread. Although copper makes up over 60% of the country's exports, its contribution to government revenue was negligible. The reasons were mainly historical. Following the exit of the largest foreign mining investor, Anglo American, in 2002 (low copper prices as well as the prohibitive costs of developing the Konkola Deep project were blamed), Zambia was forced to seek new investors. At a time of copper price weakness, several development agreements were negotiated with new investors, which typically offered tax concessions, including the setting of mining royalties at 0.6%. According to IMF data, in 2007, total tax revenue from the mining sector was equivalent to only 1.5% of GDP - a low ratio in comparison with other resource-rich countries .
With the dramatic recent rise in copper prices, the issue has become politically charged, with Zambia's populist opposition leading calls for a revision of these agreements. That Zambia needs to create more fiscal resources for spending on infrastructure in order to drive future growth and diversification is a given. Net inflows of donor support - on which the country had traditionally been reliant - were unlikely to be scaled up beyond 5-6% of GDP over the medium term. With a future decline in donor flows more probable, and Zambia's entire macroeconomic adjustment premised on a reduction in domestic borrowing, the country faced few options other than to revisit the mining sector. It had long been encouraged by the World Bank and the IMF, as well as other bilateral donors, to do so.Unsurprisingly then, the theme of this year's Budget ('Unlocking Resources for Economic Empowerment and Wealth Creation') was to revise the fiscal regime for the resource sector, in order to achieve greater consistency with international standards. Under the new proposal, effective 1 April 2008, the corporate tax rate for mines will be set at 30%, mining royalties on base metals are to be set at 3% of gross value (up from 0.6%), and withholding tax on interest, royalties, management fees and payments to affiliates or subcontractors in the mining sector will be set at a rate of 15%. While many of these measures, especially the increase of royalties had largely been anticipated (having been the subject of previous negotiations), an additional element - the setting of a windfall tax on base metal revenues - appears to have taken mining companies by surprise. Under the budget proposals, a windfall tax, to be triggered at different price levels for different base metals will be introduced. For copper, a price between USD 2.50 - USD 3.00/lb, will attract a windfall tax of 25% from April; between USD 3.00 and 3.50, 50%, and 75% for prices above USD 3.50/lb. At the time of writing, copper prices are around the USD 3.60 level, sufficient to trigger the maximum windfall penalty, generating an additional level of controversy around the proposed changes.
Mining companies have been critical of the revised plans, claiming that they were not fully consulted (especially the proposed treatment of 'windfall profits'), and that any move to a new regime would infringe the legally-binding original agreements. While some mining companies hope to re negotiate with the government, others have threatened legal action. Many have claimed that the promise of a 15-20 year tax holiday was the reason they had invested in Zambia to begin with, and that the promise of preferential tax treatment was key to their ability to raise the financing. Zambia's Chamber of Mines has since argued that the country's ability to attract future FDI has been compromised.For its part, the government has in recent weeks sent mixed signals on its willingness to negotiate, at times adopting the view that it did not need to seek tax-payers' agreement on the changes. Much rests on the question of whether the development agreements are legally binding, and following the expected approval of the Budget by parliament, some form of international arbitration looks increasingly probable. Ultimately however, it is the government that decides which companies it chooses to licence. With mining corporates already having heavily invested (both Zambia's FDI and trade data is testament to this), the authorities appear to be taking the view that significant withdrawal by mining companies is unlikely. Also, in contrast to the years immediately after privatisation, when the sector was dominated by a single large investor, there has recently been a relative proliferation of private sector investor interest. The authorities are now in a much stronger position to negotiate revised deals, especially since bilateral and multilateral donors are backing revisiting initial agreements. But the most compelling reason for the government to stand firm is the increasingly vocal call by both the political opposition and civil society, to ensure a 'fairer' deal is struck. So what are the likely economic effects?
Zambia's balance of payments looks relatively healthy. Despite booming export prices, imports have risen faster, reflecting increased investment in the mining sector. The current account is in deficit, the result of a substantial deficit in the income account (meaning that Zambia pays more to foreign investors than it earns on its income from abroad). However, this deficit has been easily financed by FDI flows. Even if new FDI flows are now put at risk, it is likely that the deficit on Zambia's income account will improve, providing some offset. Overall, there are few grounds for believing that the macro-economy is vulnerable. Although private sector external debt has been rising (again, reflecting the intensity of new investment in plants and machinery), at USD 980.7mn, in comparison to metals exports of USD 3.4bn annually, export cover is not problematic. The new fiscal regime - if adopted - will reduce mining profitability, but the structure of the tax changes (apart from royalties at 3%, profits are taxed) suggests that most companies can still be profitable. Zambia's low level of external debt in the wake of debt relief (USD 1,054.5mn at the end of 2007) also compares favourably with FX reserves of USD 1,080.2mn, equivalent to 3.6 months of import cover. Moreover, despite booming metals prices, it is Zambia's non-mining, non-traditional exports that have been growing fastest (albeit off a low base). Although many have questioned the benefits of the recent copper boom, Zambia has come a long way since 2002. Its economy is now more resilient to potential shocks.
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