Editorial: Variable royalty tax causer of Zambia’s debt concerns…
Variable royalty tax regime was adopted when copper was a lows and mining production costs at ‘alleged’ highs
There are growing concerns being raised by technocrats, economics and finance scholars, and the general public that the country is slowly sliding into a debt trap. Some critics of the current government have pronounced that the country has already landed into a debt trap and it’s only a matter of time before the government defaults on its debt obligations.
These concerns are valid and needs well-meaning citizens to weigh in so that the nation avoids going through meaningless cycles in coming to a decision on how to avoid sliding into a situation where the country
There are growing concerns being raised by technocrats, economics and finance scholars, and the general public that the country is slowly sliding into a debt trap. Some critics of the current government have pronounced that the country has already landed into a debt trap and it’s only a matter of time before the government defaults on its debt obligations.
These concerns are valid and needs well-meaning citizens to weigh in so that the nation avoids going through meaningless cycles in coming to a decision on how to avoid sliding into a situation where the country defaults on its debt repayment obligations, an even greater risk of losing control of the currently and relatively stabilized macro-economic fundamentals.
As the Zambian Business Times, we want to state from onset that we are not opposed to debt contraction as this offers a viable route for funding development and may be the only option to fund large infrastructural projects. Debt contraction and application to well selected and implemented sectors of the economy would actually lead to more national income generation and in effect more tax revenue collection that could then be used to fund other economic and social needs as well as retire and settle the very future debt repayment obligations.
How Zambia has found itself in this debt repayment ‘distress’ situation
The current debt situation is more of a self-inflicted wound. The current government in its 2015 national budget announced the increased mineral royalty taxes together with massive infrastructural projects that would be funded from the increased tax inflows. According to the 2015 budget delivered by then finance minister Alexander Chikwanda, the government was expecting to raise ZMW5.7-billion (about US4570 million) from increased mineral royalty taxes.
A further look at how the Link Zambia 8000 Road Project and various other infrastructure development initiative currently being undertaken shows that they were envisaged to be financed from debt that would be repaid from increased mineral royalty taxes in the short term. This makes this tax revenue gap that was created on dropping the mineral royalty tax as the main cause of the current weak national revenue projections and question being asked on the country’s debt service capability.
This huge revenue and debt financing gap for the current government is coming from the lost or forgone tax revenue from the change in mineral royalty tax revenue thresholds. The higher bands of 8% for underground mines to 20% for open cast mines to the current bands variable bands. (4% when copper prices trades below USD4,500/mt, 5% for when it trades between USD4,500/mt - USD6,000/mt and 6% for prices above USD6,000/mt). This was a significant decline of 10% -12% which has created a funding gap that would have plugged the financing deficit needed for infrastructure projects.
It is easy to blame it on civil servants, citing that government operations and emoluments alone are consuming over 70% of the national budget. The elephant in the room is that there has been a huge revenue loss from the scrapping of a fixed mineral royalty revenue tax methodology.
It's public knowledge that teacher- to-pupil ratio in government schools is still higher than the best practice, let alone the doctor-to-patient or nurse-to-patient ratios. These two ministries have the highest headcount in government, so it’s a fallacy to put the current lack of fiscal space for extra funds to fund infrastructure on our humble teachers and health workers, the problem is pointing to low revenues and directly to the dropped mineral royalty tax bands.
This perhaps explains why the Zambia Revenue Authority is working in overdrive to pick up all sorts of revenues within a short space of time. They have been reporting that they are busting and exceeding their annual revenue collection targets but their actions point in the opposite direction. One need not be a tax expert to tell that tax burden on ordinary citizens is definitely on the ascendance.
Even toll gate charges on Zambian roads are high relative to other jurisdictions when compared to frontier African countries. There seems to be an urgent drive to collect as much revenue as possible from both tax and non-tax revenue avenues. But the risk here is that transferring all the tax burden on the ordinary citizenry is likely to backfire as net incomes available for consumption continue to shrink.
What ZRA would have collected had a fixed mineral royalty tax not been replaced
The mineral royalty tax is a revenue tax. It is calculated as a percentage of revenue generated on gross sales value before cost of production and other operational costs are netted off. This tax is preferable to less complex countries such as Zambia whose tax revenue authorities and expertise cannot match the complex tax planning structures implemented by multinational mining companies, a typical situation we see with the ZRA.
Taking an average annual copper price per ton of US$6,500 and multiplying this at the prudent projected production levels of 850,000 metric tons of copper for 2018, the total annual copper revenues would come to about US$5.5 billion. Applying the lower mineral royalty tax threshold ( before the drop) of 16%, ZRA would have collected about US$884 million.
Forget about the 20% or so ownership of ZCCM-IH ownership in the mines which depend on declared net profits. This usually amounts to almost nothing due to transfer pricing and very complex computations for accounting for costs of production and operations, leading to the local investment holding company remaining with little to nothing to get as dividends. Mineral royalty tax is much more straight forward to levy and collect.
With the above inflows in tax revenue, would the country have struggled to service the current US$9.37 - billion debt? Would the country have trouble even paying off the first Eurobond of US$750million due in 2022? Just how much diversification would the country have funded with the annual mineral royalty tax revenue of US$884 million? With the production levels now being projected to cross 1-million tons per annum in the next two to three years, more tax revenue to fund diversification and infrastructure development would be forgone.
To put the above projection into context, the windfall tax regime (a form of calibrated mineral royalty tax based on copper price bands) that was earlier introduced in the copper mining sector by then President Levy Mwanawasa in 2008 (MHSRIP) was envisaged that the state would realize an average US$415 million per annum. In 2008, the annual copper production ended the year with about 575,000 tons.
Revenue levels determine sources of debt repayment.
When Zambia started tapping the international capital markets to contract Eurobonds (USD denominated debts from international debt markets), there was growing praise both locally and internationally on the country’s economic prospects. Whether this was just a fad or trend at the time remains plausible as more frontier African nations such as Kenya, Ghana, Nigeria had debuts raising similar dollar debt with over-subscriptions being the order of the day.
But concentrating on the Zambia situation, the country then had very little to worry about. It has just come from a situation where there was literally no debt on its books after reaching agreement for debt write off from its lenders (HIPC initiative completion point as it was referred to).
Moreover, the newly installed Patriotic Front (PF) government at the time was also in the process of implementing elevated levels of mineral loyalty taxes to Zambia’s vast copper mining industry. This action was seen to be further boosting the revenue prospects and in effect the sources of funds to be used to repay and retire these debts that were being contracted.
Zambia’s economy is underwritten by copper. The country is currently the second largest producer in Africa to its northern neighbor, the Democratic Republic of Congo - DRC and sixth (6th) largest globally. Zambia and the DRC share perhaps one of the richest copper mineralization vein of Central Africa, running through Zambia’s Copperbelt and North-Western provinces to the DRC’s Katanga region.
The effect of copper production and international copper prices on the Zambian economy is so pervasive such that the metal exports account for well over 70% of the country’s exports values. The other more visible effect of copper on ordinary Zambians has been the steep correlation of international copper prices on the fortunes of the local economy with the copper prices directly correlated to the local unit, the kwacha performance.
Other areas that depict this massive impact of copper mining industry in Zambia was the revelation that energy consumption and therefore the energy sub-sector of electricity is almost 85% consumed by the copper mining industry with its support industries and mine staff households.
The need to fund economic diversification from copper mining industry has been there from 1964.
Zambia’s over dependence on copper has been a hallmark of its economy from the time the country gained political independence on October 24, 1964. The song of diversification has been echoed from 1964 to date with limited success of national alternative revenue generation sources.
The drive towards diversification has been hampered by several factors which include the scanty and sometimes erratic revenues from copper mining industry, the selection of agrarian and low value sectors as the next best alternative sectors for diversification. Copper industry value chain development needs to be aggressively pursued. There is need to get more copper to be locally processed in Zambia to create higher value jobs.
Companies like Zambia Metal Fabricators - ZAMEFA and Neelkanth Cables need to be encouraged to grow. The country needs to attract more upstream copper manufacturing and processing companies to start processing a bigger share of the current raw copper exports. Multinationals such as Glencore parent to Mopani copper mines, First Quantum Minerals - FQM parent to Kansanshi and Kalumbila mines in North western province should be engaged to support the localization of processing of copper into finished goods right here in Zambia.
Different mines in Zambia have different costs of production, there is need to have a more complex taxation regime and mineral royalty system that would lead to the country getting its rightful share, to attain a win-win situation for the local economy, leaving enough for genuine mining companies to make returns on their investments.