Domestic debt sustainability analysis: The case for Zambia

Abstract

This study has investigated the sustainability of Zambia’s domestic debt (mainly composed of Government securities). Most of Zambia’s external debt has been forgiven and donors have put in place measures to avoid a repeat of an accumulation of an unsustainable external debt stock. Zambia’s current macro-economic environment is condusive for domestic borrowing (stable inflation, an open economy, relatively stable exchange rate, etc.). This scenario has threatened the sustainability of domestic debt. Government has in the recent past shifted its financing of deficits and projects from external to domestic and specifically through Government securities. Further, demand for Government securities has increased both from local and foreign investors owing to the price and financial system stability prevailing in the economy. The initial analysis of domestic debt sustainability(DDSA) has been done via rules of thumb ratios. These ratios reveal first warning signs as regards DDSA. Sustainability has been measured using the concept of the Present Value Budget Constraint (PVBC) which relies on the empirical strategy of cointegration; cointegration between revenues and expenditures is a necessary condition for debt sustainability, given that both variables of integrated of the same order. The analysis is performed with total revenue (with grants) and also with domestic revenue (without grants). The data was collected from the Bank of Zambia, Ministry of Finance and National Planning and the Central Statistical Office, spanning from 1980 to 2010. Both expenditure with revenue plus grants and expenditure with only domestic revenue were analysed using E-views' Johansen's cointegration test to test for sustainability.Results suggest that Zambia's domestic debt is sustainable whether revenue includes grants or not. This is after cancellation of most of the external debt, relieving the pressures of external debt service. In addition, revenue has been boosted by the high copper prices and GDP has been consistently growing at over 5% for the past 7 years. This scenario has been reducing reliance on cooperating partner budget support. Nevertheless, the sustainability of Zambia's domestic debt is still threatened by its dependency on exports of raw copper as the major source of revenue. There is need to quickly diversify the economy, to widen the tax base and also to build a substantial fund to hedge against oil price shocks while at the same time, shifting towards renewable energy sources to reduce dependency on oil.