Report No. 25388-ZA Zambia The Challenge of Competitiveness and Diversification January 10, 2003 Private Sector Unit Africa Region Document of the World Bank Vice President: Callisto Madavo Country Director: Yaw Ansu Sector Manager: Demba Ba Task Team Leader: Steven Jaffee ACKNOWLEDGMENTS This report was prepared by a team led by Steven Jaffee (AFTPS/PREMTR); Ron Kopicki (AFTPS); Vyjayanti Desai (AFTPS); and Gerald Tyler, Emile Sawaya, Donald Meleki, John Keyser, Julius Chileshe, and Annu Ratta (Consultants). Gaiv Tata (AFrPS) provided advice and conceptual guidance throughout the course of the work. Mehrnaz Teymourian (AFTPS) initiated the study and helped coordinate its field work dimensions. The analysis on non- traditional exports involved close collaboration with Joyce Sikasula and her dedicated team at the Export Board of Zambia. Insights on macroeconomic developments were provided by Hinh Dinh (AFTPl), Abebe Adugna (AFTPI), and Dilek Aykut (PREMTR). Professor Nick Vink and his team prepared a complementary analysis of regional market demand. The report was prepared under the general supervision of Yaw Ansu, Country Director (AFC03), Demba Ba, Sector Manager (AFTSP), and Laurence Clarke, Resident Representative (AFMZM). Peer reviewers were Larry Hinkle (AFIP3), Kees van der Meer (RDV), and Charles Husband (CMNPO). Advice and comments were also provided by Tekola Dejene (AFTRI) and Alex Mwanakasale (AFTRI). The team acknowledges the input provided by the Zambia National Farmers Union and the Agribusiness Forum and greatly appreciates the efforts made by the staff at the Central Statistical Office to pull together a variety of data. The team extends its thanks to the many Zambian firms and farmers consulted for their insights on current developments and future opportunities for economic growth. The team met with a number of donors and NGOs working in Zambia during the preparation of the report. The report builds upon a number of recent analyses including the Public Expenditure Review (2001), the Zamtie Trade and Investment Opportunities in Agriculture report (2001), and the Agricultural Competitiveness Study (2001). A joint GRZ/World Bank conference on growth and diversification was organized in June 2002 in Kitwe to discuss issues raised in the report and more specific options for the Copperbelt area. I Table of Contents Acknowledgments ...................................................................... ii Executive Summary ....................................................................... viii Background ...................................................................... viii Basic Competitiveness Factors ...................................................................... ix Development and Sustainability of Non-Traditional Exports ................................... ....................... ix Recent Dynarnics in Zambian Agriculture and Agribusiness ................................... ....................... xi Copper Mining Linkages ...................................................................... xiii Conclusion and Priorities ...................................................................... xiv CHAPTER 1 .................................................................1 Introduction .......................................................................I CHAPTER 2 BRoAD PARAMETERS OF COMPETITIVENESS .........................................................7 2.1 Factor Endowments .......................................................................8 2.1. 1. Natural Resources ......................................................................8 2.1.2. Location .......................................................................9 2.1.3. Human Capital ...................................................................... 10 2.2 Infrastructure Development, Access and Costs ...................................................................... 12 2.3 Macroeconomic Management and Regulatory Environment ........................................................ 15 2.4 External Chance Events ...................................................................... 17 2.5 Demand ...................................................................... 18 CHAPTER 3 THE DEVELOPMENT AND SUSTAINABILITY OF NON-TRADITIONAL EXPORTS ..... 21 3.1 Findings from the 2001 Exporter Audit Survy ...................................................................... 25 3.2 Textiles ...................................................................... 25 3.2.1. Introduction ...................................................................... 25 3.2.2. Natural Endowment ...................................................................... 26 3.2.3. Enabling and regulatory environment ...................................................................... 27 3.2.4. Infrastructure ...................................................................... 29 3.2.5. Micro-economics and business strategy ...................................................................... 29 3.2.6. Demand ...................................................................... 30 3.2.7. Conclusions and recormnendations ...................................................................... 31 3.3 Engineering ................... 31 3.3.1. Introduction ...................... 31 3.3.2. Natural Endowment ................... 32 3.3.3. Enabling and regulatory enviromnent ........................................ 32 3.3.4. Infrastructure ........................................ 33 3.3.5. Micro-economics, business strategy, and demand ........................................ 33 3.3.6. Conclusions and recommendations ........................................ 33 3.4 Gemstones ...33........................... I ..... 33 3.4.1. Introduction ........................................ 33 3.4.2. Natural endowment ........................................ 34 3.4.3. Enabling and regulatory environment ........................................ 34 3.4.4. Infrastructure ........................................ 35 3.4.5. Micro-economics and business strategy ........................................ 36 3.4.6. Demand ........................................ 36 3.4.7. Conclusions and recommendations ........................................ 37 3.5 Processed Foods ......................................... 38 3.5.1. Introduction ........................................ 38 3.5.2. Natural endowment ........................................ 38 3.5.3. Enabling and regulatory environment ..................................................................... 38 3.5.4. Infrastructure ..................................................................... 39 3.5.5. M icro-economics and business strategy ..................................................................... 40 3.5.6. Demand ..................................................................... 41 3.5.7. Conclusions and recommendations ..................................................................... 41 3.6 Vegetables and Cut Flowers ..................................................................... 42 3.6.1. Introduction ..................................................................... 42 3.6.2. Natural endowment ..................................................................... 44 3.6.3. Enabling Environment and Infrastructure ..................................................................... 44 3.6.4. M icro-economics and business strategy ..................................................................... 45 3.6.5. Demand ..................................................................... 46 3.6.6. Conclusions and recommendations ..................................................................... 47 3.7 Cross-Cutting Issues ..................................................................... 47 3.7.1. Human capital ..................................................................... 49 3.7.2. Availability of key inputs ..................................................................... 50 3.7.3. Access to /cost of finance .....................................................................5 1 3.7.4. Capacity Utilization ..................................................................... 51 3.7.5. Import / expor t i ncentives and VAT ..................................................................... 53 3.7.6. Trade agreements ..................................................................... 53 3.7.7. Technology ..................................................................... 55 3.7.8. Capacity of government ..................................................................... 56 3.7.9. Imposition of levies and taxes ............................................................................ 56 3.7.10. Infrastructure ..................................................................... 56 3.7.11. Electricity and other power costs ..................................................................... 58 3.7.12. Marketing ..................................................................... 58 3.7.13. Conclusions ..................................................................... 59 CHAPTER 4 EMERGING TRENDS AND OPPORTUNITIES IN ZAMBIAN AGRICULTURE AND AGRIBUSINESS ............................................................... 63 4.1 Historical Context ..................................................................... 64 4.2 Broad Structural Features of Zambian Agriculture ..................................................................... 66 4.2.1. Selected Indicators of Agricultural Performance .................................................................. 70 4.2.2. Productivity ..................................................................... 73 4.2.3. Profitability ..................................................................... 74 4.2.4. Cost Competitiveness ..................................................................... 80 4.2.5. Agricultural Export Performance ..................................................................... 84 4.2.6. Domestic M arket and Supply Chain Linkages ..................................................................... 94 4.3 Policy and Regulatory Framework ..................................................................... 95 4.4 Zimbabwe Spillover Effects ..................................................................... 98 4.4.1. Contracting Demand (and a shrinling industry) ................................................................... 99 4.4.2. The Supermarket Revolution ..................................................................... 102 4.4.3. Quality Control and Standards ..................................................................... 106 4.4.4. Raw Material Procurement and Capacity Utilization ......................................................... 108 4.4.5. Agribusiness Strengths, Weaknesses, Opportunities, and Threats ...................................... 110 CHAPTER 5 COPPER INDUSTRY LINKAGES ............................................................... 115 5.1 Introduction ..................................................................... 115 5.2 Copper and Cobalt Mining Industry in Zamia ..................................................................... 116 5.2.1. Copper Mining ..................................................................... 116 5.2.2. The Current Status of the Privatized Copper Companies .................................................... 119 5.2.3. Cobalt Mining ..................................................................... 121 5.2.4. The Privatization of ZCCM ..................................................................... 122 5.3 The Procurement Function at ZCCM and the New Mining Companies ....................... .............. 125 5.3.1. Procurement at ZCCM in the Late 1990s .................................................... 125 5.3.2. Procurement by the New Mining Companies .................................................... 127 5.3.3. Characteristics of the New Mining Company Suppliers .................................................... 128 5.3.4. Results of the Sample Survey .................................................... 129 5.3.5. Problems and Constraints Affecting Local Suppliers .................................................... 130 5.3.6. Advocates of the Mining Company Suppliers .................................................... 132 5.3.7. Support Institutions and Ongoing Initiatives .................................................... 132 5.4 Conclusions and Recommendations .................................................... 134 5.4.1. Conclusions .................................................... 134 5.4.2. Future Prospects .................................................... 135 5.4.3. Recommendations .................................................... 136 Annex I ZCCM: Operations Center Functions .................................................... 138 Annex 2 Retrenchments and Retraining .................................................... 139 Epilogue: Moving the Diversification Process Forward .................................................... 140 References .................................................... 143 EXECUTIVE SUMMARY Background 1. Zambia's economy has long been highly dependant upon the production and export of copper. At independence in 1964, the copper and associated mineral production accounted for 45,% of GDP, 65% of public revenue, and 90% of exports. The collapse of world copper prices in the mid-1970s created an enormous adverse shock on Zambia's economy. Still, the economy remained heavily dependent upon copper as little growth was experienced in other sectors, in part due to the widespread nationalization of productive assets outside of the mining sector. The long- term decline in the international competitiveness of Zambia's copper industry and the huge decline in its copper production and exports over the past fifteen years has had an enormous negative effect on Zambia's overall economy. The country is now among the poorest in the world as reflected in its per capita income ($300) and its very low Human Development Index ranking (i.e. 143 out of 161 countries in 2001). 2. After many years of heavy interventions in factor and product markets, the Government of Zambia introduced an array of reforms during the early-to-mid-1990s, removing exchange controls, liberalizing the country's trade regime, decontrolling food and agricultural prices, liberalizing the banking sector, and privatizing large numbers of state-owned enterprises. The initial gains were impressive, with a substantial reduction in inflation, a rapid take-off of non- traditional exports, and progress toward a more diversified pattern of agricultural production. 3. However, some of these gains were not sustained. In the latter half of the 1990s the country's macroeconomic performance lagged behind expectations. Between 1995 and 2000, GDP growth averaged only 2.1% per annum, implying a continued decline in per capita income. The country's non-traditional exports reached a peak in 1997, and, in aggregate, have failed to sustain their growth since then. Some of the more difficult privatizations-including in the mining industry-were delayed, contributing to continued high quasi-fiscal deficits. This has contributed to persistent high inflation and to very high real interest rates-undercutting private investment and competitiveness. 4. This study was designed to go below the radar of Zambia's macroeconomic developments to examine trends, constraints, and opportunities in specific economic subsectors. It sought to build upon existing and planned analyses within the country in order to better understand: (i) the underlying bases for competitive advantage and disadvantage in the evolving Zambian economy, (ii) the likely sustainability of those pattems of economic diversification which have already taken place, (iii) what linkages have and have not been formed within the agricultural and mining sectors which might still be a basis for future growth, (iv) the specific effects of certain macroeconomic developments and 'extemal' events on different stakeholders and the types of responses they have made to these, and (v) what measures could be taken to improve competitiveness within the Zambian economy and accelerate future growth. 5. The work was designed to complement on-going analytical work, especially by the Export Board of Zambia and the Zambia National Farmers Union, and also complement on-going work to assess the constraints and opportunities facing Zambia's tourism sector. The present study draws upon available data, an updated analysis of agricultural production costs and profitability, and surveys of private agribusiness, non-traditional export, and mining (and mining- viii related) companies. A parallel analysis was undertaken on the food and agricultural import demand into South Africa, a major (potential) destination for Zambian exports. Basic Competitiveness Factors 6. Relative to other Southern African countries, Zambia is relatively well endowed with natural resources, including arable land, ample renewable water resources, extensive forestry and fisheries resources, and large mineral deposits. With the exception of its minerals, much of this natural resource wealth remains highly under-utilized, substantially due to the country's relatively weak infrastructure. Poor conditions and/or high costs of its transport, telecommunications, and electricity, make it difficult for Zambian companies and farmers to be internationally competitive. Infrastructure bottlenecks have been exacerbated by certain policies-including high fuel taxes and inefficient public sector fuel distribution systems-further magnifying the disadvantages provided by Zambia's land-locked position and its relatively large size and low population density. Not only are Zambia's ample natural resources under-utilized but most are subject to little or no value-added within Zambia's production/extraction and market supply chains. 7. The available evidence suggests that Zambia has a cost competitive labor force. However, there are major concerns about current and especially future productivity, in light of declining school enrolment rates, declining indicators of public health and the severe economic and social repercussions of the HIV/AIDS pandemic. These developments place Zambia's human capital at risk, and thus its long-term capacity to compete in manufacturing, agriculture, and service industries. 8. During the 1990s the Zambian government removed many of the protective policies and state administered pricing structures which had long prevailed in the economy. Recent surveys rank Zambia's trade and exchange control regime as being among the most open and liberal. However, the transition to a fully market-determined economy is not yet complete. Within sub- Saharan Africa, Zambia is rated relatively poorly in terms of the effectiveness of its legal system and the quality and efficiency of public administration more generally. The country continues to experience macroeconomic instability, with persistent high levels of inflation, high interest rates, and high volatility in its real exchange rate. Sustained episodes of exchange rate appreciation have undercut export competitiveness and intensified the competition which domestic industries have faced from imports. 9. The competitiveness and viability of Zambian enterprises have also been strongly influenced by 'external chance events', including the substantial and sustained decline in major commodity prices over the past four or five years, political and economic instability in neighboring Zimbabwe and the Democratic Republic of Congo (DRC), and the occurrence of drought over at least parts of the country in three of the past five years. Development and Sustainability of Non-Traditional Exports 10. Between 1990 and 2001, Zambia's total merchandise exports declined from $1.27 billion to $902 million. The primary factor in this contraction was the almost 50% decline in the value of the country's exports of copper and cobalt. During the same period, Zambia's so-called non- traditional exports -defined as all goods and services other than copper and cobalt-increased from under $100 million to around $300 million. Still, Zambia's balance of trade has deteriorated sharply with the contraction of its copper exports. 11. Non-traditional exports (NTE's) increased rapidly in the early and especially mid- 1 990s ix and reached a peak in 1997. Since then, they have leveled off, on an aggregate basis. The country's manufactured product exports have declined continuously over the past five years, although the sharpest drop occurred between 1997 and 1999. Not a single category of manufactured product exports has experienced growth over the past five years. The pattern is quite different for agriculture. Zambia's agricultural exports also reached a temporary peak in 1997 before leveling off, although the aggregate level of trade in 2001 was the highest ever. There have been wide variations in the recent patterns of Zambia's agricultural exports, with sustained growth in its vegetable and sugar exports and year-to-year fluctuations in the trade of most other commodities or products. 12. Sales within Africa account for nearly 60% of Zambia's non-traditional exports. South Africa is the largest single market outlet plus it is the destination for the most diversified basket of Zambian products. Still, Zambia's trade deficit with South Africa is very large and continues to grow. For the most part, Zambia has failed to take advantage of the huge and growing import demand of South Africa for food and agricultural commodities. Zambia accounts for less than 1% of this (import) market, despite having important market access advantages over many of the dominant suppliers. Transport costs (and inefficiencies in freight management) are a barrier to competitiveness for relatively low value commodities, yet the more general problem is a lack of continuity and reliability of supply by Zambia's supply chains. The significant and sustained appreciation of the Kwacha vis-a-vis the Rand over the past five years has posed a major problem for Zambian exporters to the SA market. 13. The DRC is the second largest outlet for Zambia's NTE's and is also an importer of a broad range of Zambian products. Major issues remain, however, in regularizing this trade given current problems of physical and payment security, language and information barriers, and other conditions which result in high transaction costs. Other markets within Africa have been comparatively much less important for Zambian NTEs and this trade tends to be dominated by one or a few products. Western Europe is also an important outlet for Zambian NTEs, although this trade is dominated by the sale of a few products (i.e. vegetables, cut flowers, and sugar). Overall, there has been little diversification of Zambia's NTE market outlets and, through 2001, the country has yet to take advantage of the market access opportunities afforded under the U.S. Africa Growth and Opportunities Act (AGOA)-largely due to delays on the part of the GRZ in putting in place the institutional and documentary arrangements for AGOA eligibility. 14. The paper provides an analysis of recent trends, competitiveness factors, and future opportunities with respect to Zambian exports of textiles, engineering products, gemstones, processed foods, and horticulture/floriculture, plus it highlights a range of cross-cutting issues. In each industry/subsector, Zambia's exports have increasingly become dominated by a limited number of enterprises. The combination of macroeconomic instability, adverse movements in exchange rates, and a sharp deterioration in international commodity and product prices has created an environment which has substantially weakened the viability of many firms (formerly) engaged in NTEs. 15. The analysis of Zambia's recent NTE experience points to the following cross-cutting constraints and challenges. Many of these problems are 'outside' of the capacity of individual or clusters of firms to influence: * Difficulties in exchange rate risk management with many firms incurring costs in US dollars and obtaining earnings in Rand, EUROs, or other currencies; * Difficulties in meandering through 'rules of origin' provisions and a variety of non-tariff (and border delay) barriers for which support from the Zambian government has been x deemed to be inadequate. Government needs to become more effective in supporting the interests of Zambian firms in the context of regional and international trade; * Very high costs for a range of intermediate inputs and services, including fuel, cement, packaging materials, and engineering and legal services; * Inefficient administration of duty drawback, VAT refund and other export incentive schemes. There appears to be an anti-export bias in Zambia's trade regime. This and wider anomalies in the country's tax structure require further analysis and reform; * Lack of effective backward linkages between processors/manufacturers and raw material suppliers which result in low capacity utilization and unnecessary additional costs; * Very high cost of finance, contributing to the concentration of growth amongst foreign firms with access to off-shore finance or other companies with access to concessionary lines of credit; and, significantly, * Unreliable service and/or very high cost of infrastructure and transport services Recent Dynamics in Zambian Agriculture and Agribusiness 16. While declining mining exports continue to dominate Zambia's merchandise exports, agriculture provides employment to some 67% of the labor force and provides raw materials to agro-related industries which account for some 84% of manufacturing value-added. Agriculture and related elements of agribusiness account for more than 40% of Zambia's GDP and 15% of its exports. There is growing awareness of the strategic importance of agriculture and agro-industry for future growth and poverty reduction in Zambia. 17. Zambia has a long history of interventionist policies in agriculture, with public support resting on a commitment to attain national food self-suificiency. The primary focus of agricultural support was on maize with a heavy bias toward this crop in government research, extension, marketing services, and pricing policies. Heavy use was made of input and product subsidies and through the 1970s and 1980s the state played a dominant role in agricultural processing and marketing. This interventionist approach proved to be financially unsustainable plus held back the growth potential of the sector for many years. Major sectoral reforms were introduced in the early-to-mid-1990s which, despite major transitional problems-- resulted in more efficient patterns of resource allocation, a pattern of increased diversification of production, and new investment and entry into agro-processing. During the first half of the 1 990s, agricultural GDP grew by some 4.3% per annum, despite the incidence of drought in several years. 18. Major problems exist in relation to the depth, quality, and consistency of agricultural data and even in the prevailing method for calculating Zambia's agricultural GDP. The picture provided by existing data, supplemented by additional analysis undertaken for this study, suggest that over the past five to seven years there has been: * virtually no growth, on average, of Zambia's agricultural GDP and a per capita reduction in food production; * high year-to-year fluctuations in output, closely related to rainfall patterns, yet in recent years also due to changes in demand and relative prices and to ad hoc interventions by government, especially in the fertilizer market; * a continued (yet recently somewhat slower) diversification in production and consumption pattems, with maize now accounting for about 50% of plantings (rather than upwards of 70% in the 1980s); * a sharp decline in national (smallholder) use of fertilizer and improved seed through to the mid-90s, followed by more stable pattems since then (albeit at historically low rates); xi * a very small increase in the total planted area for crops, reversing the declining trend which occurred during the first half of the 1990s. There have been no discernable (and statistically reliable) trends in productivity, although there is evidence of some recent gains in particular crops (i.e. cotton) and an evident decline in livestock productivity due to disease; * a sharp deterioration in the profitability of most crop enterprises, with this decline being especially large for commercial farmers. While some reductions have been achieved in the unit costs of production and transport over time, these have not nearly compensated for the large reduction in international and (lomestic commodity prices and the increased cost of finance; * the crops which have remained relatively more profitable for farmers are a range of industrial crops which generally are more labor intensive and require relatively high cash outlays. This puts a premium on access to affordable finance (or inputs under contract fanming arrangements) and animal traction ('or other mechanization) for land preparation. There are uncertainties regarding the extent to which seasonal labor constraints represent a barrier to agricultural growth. 19. The production and marketing costs faced by Zambian farmers is compared with that of Zimbabwean farmers (before the recent instabilities there). For the most part, Zambia's smallholder farmers are cost competitive for a variety of industrial and food crops, although there exist major problems in the reliability/continuity of their market supply and in effectively aggregating their supplies given the relatively weak status of farmer organizations and market intermediation services. The cost competitiveness of Zambia's commercial farmers is a more mixed picture, with the most important gaps being for wheat and maize, where import competition is possible. 20. Their largest cost disadvantages relate to transport and fuel costs, on the one hand, and equipment costs, on the other hand. The former is significantly influenced by the high tax structure on fuel in Zambia. However, the recent reduction in the fuel excise duty was found to have a minimal impact on the cost competitiveness of Zambia's commercial farmers. There is no silver bullet to restore farm profitability and competitiveness under the prevailing pressures of international commodity prices, yet further measures are needed in tax reform, infrastructure improvement, macroeconomic management, and the management of Zambia's trade policy. 21. The expected positive effects of agricultural sector reforms and the privatization of many agro-processing enterprises *have been dampened by the broader trends in Zambia's macroeconomy, by the spillover effects of regional instability, and by a surge of imports into a dis-protected sector. With an overall decline in purchasing power, national demand for an array of food products has been stagnant or contracting for a number of years. This has undercut the market for many of Zambia's food processing companies. Exacerbating this problem has been an influx of imports of processed food products from within and outside the region, a pattern which reached severe proportions in late 2000 and through 2001 as Zimbabwean firms sought relief from their collapsing domestic market and made use of the prevailing dual exchange rate to sell a range of products at low cost into Zambia. Large numbers of Zambian food/agro-processing companies have either gone out of business or substantially contracted their operations. Among the casualties have been a range of companies who were active in the sector for decades. Many locally produced products have simply disappeared from the market. 22. In recent years Zambia has witnessed the arrival of the 'supermarket revolution' at its doorstep, with the investments and operational spread of major South African and other supermarket chains. These operations have changed the rules for food and grocery distribution xii within Zambia, bringing new requirements for food safety, product merchandising, and logistical services. The changes have brought large benefits for middle and upper income urban consumers-in terns of product choice, presentation, and prices-yet has had negative collateral effects on the legacy providers of retailing and wholesaling services. 23. The backward linkages of the supermarket system have been uneven. Some Zambia operators have been able to ride the back of the supermarket chains, extending their market and product range and, in so doing, effectively coping with the more constraining overall market environment. However, many Zambian food manufacturers and farmer groups have had difficulty complying with the product and service standards of the supermarket chains. With the overall contraction of Zambia's food processing industry, a very high proportion of the packaged and value-added foods distributed by the supermarket chains within Zambia are now imported. Nevertheless, there are ample opportunities to achieve import substitution, both on fresh and processed food products-yet direct support is needed to re-level the playing field and improve the capacities and products of local suppliers. 24. Another emerging development in Zambia's agro-food system has involved efforts to reconfigure the backward linkages between agribusiness companies and farmers. Prior to market liberalization these links existed between farmer cooperatives and parastatal enterprises, yet an institutional vacuum occurred with the collapse of the former and the privatization of the latter. Open market linkages have proven to be unreliable, with high volatility both in prices and supplies and high transaction costs given the geographic spread of production, the poor communications within rural areas, and the long-standing legacy of credit default. In recent years, a variety of attempts have been made to vertically integrate or achieve contractual coordination between production and downstream processing operations. There have been some encouraging developments and innovations, yet more support is needed to facilitate and render more equitable and sustainable these arrangements. Particularly important in this regard are the 'outgrower' anrangements within the cotton sub-sector, given the widespread participation of smallholders (i.e. 100,000 + households) in this subsector. 26. In general, there are ample opportunities for increasing exports, achieving import substitution, and strengthening inter-industry linkages in Zambian agriculture. Many of the core weaknesses of Zambian agribusiness lie outside its own confines, in the forms of weak overall infrastructure within the country, an unstable and unpredictable exchange rate, extremely high costs of finance, and the weak capacity of government to address trade-related anomalies and problems. Restoring growth and dynamism in Zambia's agro-food system will require concerted actions both at the macroeconomic and micro/sectoral levels. For the latter, there are major opportunities to improve supply chain linkages, for the benefit of farmers, agribusinesses, and consumers. Copper Minina Linkages 27. Although the main objective of the ZCCM privatization was the revitalization of the copper industry, there was also an expectation that the privatized copper mining industry would help to more generally revive the economy of the Copperbelt area through its backward linkages to area suppliers of goods and services. Prior to its privatization, the ZCCM employed an elaborate system of procurement, involving the pre-qualification of suppliers and the implementation of competitive tenders. ZCCM's procurement of goods and services had a huge impact on the local economy, with hundreds of local firms involved. xiii 28. The privatization of ZCCM took over three years and involved the creation of about a half dozen companies through the sale and acquisition of specific mining assets. The extended period of the privatization created enormous uncertainly for many Copperbelt area suppliers and saddled many such companies with unpaid arrears from ZCCM which eroded their financial position and constrained them from re-equipping or otherwise restructuring their operations to service new markets. 29. Once established, each of the new mining companies established their own procurement arrangements. Some of them had initially pressing needs for rehabilitation and restocking. Most of these companies were foreign owned and had little awareness of the capacities and products of local suppliers. They therefore tended to draw upon their own existing regional network of suppliers. With time, these firms began to devote more attention to local suppliers and procurement arrangements, providing would-be suppliers with greater clarity on their operating practices. However, by the time that this mutual awareness improved, much of the needed procurement for rehabilitation had already taken place. Due to this and the overall contraction of the copper industry, the available market for mining-related goods and services had contracted for local firms. Also, many firms were not adequately prepared to respond to the new requirements set by the privatized companies. 30. Data for 2001 suggest that more than 70% of the goods and services obtained by the privatized companies is 'locally procured'. However, with regards to goods, many of the products-including fuels, lubricants, lime, and spare parts-are ones which have a very high import content and for which there is relatively little local value-added. The firms procured a wide range of services, most of which involve very small contracts involving numerous tasks. Given the very large number of 'service providers' (numbering in the hundreds), it is most likely the case that many of the people hired to perform services would have ordinarily been hired on a more permanent basis were it not for the large non-wage costs which employers have to bear (i.e. pension and terminal benefits; housing allowances, etc.). 31. It appears likely that the suppliers of goods and services to the copper mining industry will undergo a further shakeout as a result of the transformation of the industry and increasing competition from imports. Nevertheless, there are opportunities to improve the competitiveness of these local suppliers-by improving their access to existing funds and programs for business development and training and supply chain linkages. There is also a need to ensure a level playing field between local suppliers and imports by reviewing (and reforming, where necessary) existing tax arrangements and exemptions. Conclusion and Priorities Recently the Government has appointed a National Economic Diversification Task Force to chart out and spearhead a strategy to promote the diversification of the Copperbelt and Livingstone areas and to more broadly identify priority policy reforms to promote private sector trade and investment. One of the responsibilities of the NEDT will be to review and draw lessons from successful international experiences in fostering economic diversification. It is imperative, however, that the NEDT also closely re-examine Zambia's own experience in this regard over the past decade. This study has provided a range of insights into that experience and has highlighted the precarious state of much of the new investment which has taken place. The sustainability of many non-traditional exports and the further realization of inter-sectoral business linkages within the domestic economy have been and continue to be threatened by an array of factors which xiv undermine both profitability and competitiveness and which render doing business in Zambia unnecessarily risky. While the evidence is thus far mostly anecdotal, we have observed the exit of a substantial number of small, medium, and larger-scale enterprises only in the past three years. Some of the 'imperiling' factors are largely beyond the control of Zambian authorities and private actors. The volatility and decline of international commodity prices and the periodic (yet increased) incidence of drought are two important examples of these. The contraction of domestic purchasing power continues to weaken the demand for many goods and services, yet this will not be reversed until there is an improvement in employment and other income-earning opportunities. However, many of the other factors which imperil Zambia's diversification efforts are amenable to public action orjoint public-private action. For example, it is critical that: * Macroeconomic stability be restored, thereby providing for more stable and predictable movements in exchange rates and putting downward pressures on interest rates for investment and working capital. To achieve this macroeconomic stability, it is important to reduce the fiscal deficit of the central government, eliminate the quasi-fiscal deficit, and continue to strengthen the effectiveness of public expenditures; * The anti-export bias in Zambia's trade regime and wider anomalies in the country's tax structure be carefully reviewed and reforms undertaken to address the most serious problems. The on-going WTO Trade Policy Review will address the trade regime, yet other work is needed on the broader set of tax issues; * There be more effective consultation between government and the private sector. Government and the private sector should work together in diagnosing the constraints affecting and the opportunities available to particular supply chains and in developing action plans to implement over the short-to-medium term. The formation of the NEDT provides an excellent opportunity to intensify this type of dialogue; * Government officials should be more available to firms and must act more decisively and quickly on trade-related matters. Certain export procedures need to be decentralized as with the issuance of export permits, phytosanitary certificates, etc. Government must. become more effective in supporting the interests of the Zambian private sector in the context of regional and international trade. Safeguard measures may need to be introduced to protect local industry from unfair competition, while restrictive measures adopted by Zambia's trade partners need to be challenged; * Cross-border initiatives be undertaken to strengthen the physical, commercial and institutional infrastructure linking Zambia with the neighboring provinces in the Democratic Republic of the Congo. A potentially large amount of trade in manufactured and consumer goods is being un-realized due to the uncertainty and high transaction costs associated with this trade; * The design and/or implementation of existing incentive schemes such as duty drawback, VAT refunds, and manufacturing under bond arrangements needs to be improved. An upcoming study on 'administrative barriers' to business will examine this more closely and make specific recommendations. Options for establishing and effectively managing 'special economic zones' should be assessed; * Critical infrastructure bottlenecks for specific NTEs and agricultural supply chains with high growth potential be further identified and addressed through joint public and private sector investment. With a view toward further reducing domestic and regional (freight) transport costs, the fiscal implications and potential economic impact of reduced fuel taxes should be examined, the concessioning of Zambia Railways should be finalized and measures taken to accelerate the extension of the Nacala line into Zambia; xv * There be a re-examination of Zambia's labor regulations as these seem to be resulting in either the sustained over-maniiing of fims (to the detriment of their competitiveness) or increased job insecurity as large numbers of people are employed on a temporary basis or as contractors to enable firms to avoid the seemingly excessive non-wage costs of hiring permanent employees; * There be further assessment of the major barriers inhibiting increased inter-sectoral and supply chain linkages within the domestic economy (i.e. supermarket- food supplier; mining company - goods suppliers) and programs developed to address these constraints and reduce the transaction costs associated with such business relations; and * Technical and political support be given to the development and strengthening of private sector representative organisations. Part of this should be geared toward assuring better representation of non-traditional exporters in regional and international trade meetings and negotiating processes. Such organizations can also play an important role in the development and enforcement of quality standards, behavioural 'codes of practice', and other standards for which compliance is becoming increasingly important in international trade xvi IlAX CHAPTER 1 INTRODUCTION At the time of its independence in 1964, the Zambian economy was extremely concentrated around a single sector-the mining sector and copper production. This sector accounted for some 45% of GDP, nearly 90% of exports, 65% of public revenue and the bulk of formal sector employment which was not in public services. In the first decade after independence, Zambia's copper exports reached an all time high, yet the remainder of the economy was stagnant and overall GDP growth-at 3% per annum-lagged behind the rate of population growth. The collapse of world copper prices in the mid-1970s created an enormous adverse shock on the Zambia economy. Equally devastating was the government's response to this shock, comprising heavy international borrowing, the imposition of pervasive controls over an array of factor and product markets, and widespread nationalization of productive assets outside of the mining sector. While partial reforms were introduced during the 1980s and some attempts made to improve incentives for agricultural production and manufacturing, most reforms were short-lived and much of the diversification which did take place was not market-oriented and depended heavily on either subsidies or protection against competition. Zambia's exports continued to decline, its foreign debt mushroomed and the pace of per capita GDP decline accelerated. In the early 1990s a change in government took place and a more comprehensive program of economic reforms was adopted in order to engineer a shift from an unsustainable regime of economic control to one based more on market principles and involving a redefined and diminished role of the public sector. Major reforms included: (i) removal of exchange controls and the floating of the Kwacha, (ii) trade liberalization, including the removal of quantitative restrictions on imports and exports and a reduction of tariffs, (iii) the decontrol of food and other agricultural prices and the liberalization of maize and fertilizer marketing, (iv) public sector downsizing and the privatization of state-owned enterprises, and (vi) the liberalization of the banking sector. Through these reforms, there was an expectation of increased private sector investment, an acceleration of growth, and the progressive diversification of the economy. By the mid-1990s, the results were mixed. Some diversification was beginning to take place within agriculture and some significant growth was recorded in a range of non-traditional exports, albeit from a very low base. Considerable advances had been made in the privatization process-stimulating some inward foreign direct investment in a range of industries-although some of the larger and politically more difficult cases (i.e. mining, electricity, oil refining) were not yet tackled. State-owned enterprises in these industries continued to generate large financial losses. This, together with several droughts and a further deterioration in the country's balance of payments situation, contributed to a highly unstable macroeconomic environment featuring triple- digit levels of inflation and wide swings in the value of the Kwacha. This macroeconomic instability overwhelmed the microeconomic structural changes occurring in the economy and contributed to an overall contraction of the economy. Despite these mixed developments, there was considerable optimism in the mid-1990s that the foundation stones of policy reform and promotion of the private sector would yield favorable results. A World Bank study, published in 1996', argued that Zambia was then emerging from the most difficult stages of its economic transition, and that the long-term decline in the Zambian economy could be reversed provided that: (i) a major restructuring occur within the mining sector-involving private sector capital and management-- to improve its efficiency and competitiveness, (ii) macroeconomic stability would be restored, with inflation brought under control, with an approach taken to exchange rate management that permitted a real depreciation of the Kwacha, and with the international community acting to relieve part of Zambia's debt burden, and (iii) improvements were made in infrastructure and the performance of public institutions. It was expected that the entry of private capital and management within the mining sector would at least curtail the pace of decline in that sector and, because of the evident needs for rehabilitation of some operations, also spur some recovery among firms which could supply the mines with goods and services. The continued growth in non-traditional exports was expected to not only cushion the blow of expected further declines in copper exports, but also to stimulate further growth via backward linkages in agriculture and manufacturing. The reforms which had been adopted in agricultural markets and the entry of private investors in agro-industry were expected to spur an acceleration of agricultural growth and, in so doing, reduce rural poverty. At the macro-level, developments over the past 5-7 years have fallen short of expectations. Over the 1995-2000 period, Zambia's GDP growth averaged 2.1% per annum. While this was an improvement on the early 1990s, this performance lagged behind that of most other countries in Southern Africa (see Table 1.1) and implied a further and continued reduction in per capita income. Zambia finds itself in the unfortunate and unique position of a country which has not undergone the trauma and dislocation of war or civil strife, yet has experienced a virtually continuous contraction of per capita income over three and a half decades (see Chart 1.1). With very slow economic growth and some structural dislocations, the overall incidence of poverty in Zambia has continued to rise, while a range of broad social indicators (related to health and education) continue to decline. Official statistics suggest that both agriculture and manufacturing experienced a contraction between 1995 and 2001, yet increased their share of national GDP as a result of the substantially more rapid decline of the mining sector. Such statistics also suggest that Zambia's short-lived boom in non-traditional exports has, since 1997, given rise to a less stable and probably less sustainable pattern of growth. With a further reduction in copper exports, the country's balance of trade has deteriorated sharply (Chart 1.2). 'Zambia: Prospects for Sustainable Growth, 1995-2005 2 Table 1.1: Comparative GDP I rowth GDP growth (%) GDP growth (%) 1990-1995 1995-2000 Zimbabwe 0.9 1.9 Zambia -1.1 2.1 South Africa 0.8 2.2 Lesotho 4.1 3.3 Malawi 1.6 3.9 Tanzania 1.6 3.9 Namibia 4.6 3.9 Mozambique 3.2 8.7 Source: African Development Indicators Chart 1.1: Zambia, GNP/capita, real, $1995 700 650- 600- 550- Chart 1.2: Trends in Exports and Imports 1500 - 1300 350/ 1300~~~~~~~~~~~~~~~~4- _ _+Exports ofgoods and services 1100 (cu..ent.US.) (rnn) Char1100 TI-Umports of gods and services \ ~~~~(current USS) (mm)n 900 - 1300 - , , I , . . . . . 99o~~~~~~~~ ln9 99 Exprts goodsandso erviceso 9 to suffer from its high dependence on copper. The privatization of the state-owned Zambia Consolidated Copper Mines (ZCCM) was dragged out over an extended period and was not 3 completed until early 2000. During the interim period, ZCCM continued to be a huge fiscal drag on the economy, while the needed investments to rehabilitate certain mines and improve their international competitiveness did not occur. A related and second explanation concerns the 'usual macroeconomic suspects'. While the rate of inflation was brought down from its early 1990s peak, over the 1995-99 period inflation still averaged 25% and reached nearly 30% in 2000. Most of the private sector has faced a financial squeeze with real interest rates going from negative territory to 20% or more. Private investment and competitiveness have been further shackled by a highly volatile and unpredictable exchange rate for the Zambian Kwacha, which appreciated in real terns at several critical junctures when the private sector was seeking to adjust to external market changes. The third set of explanations relate to external shocks, including major reductions in international prices for copper and primary agricultural commodities, partial country droughts in three of the past five years, a civil war in neighboring DRC, and the subsequent dislocations in Zimbabwe and its spillover effects into the Zambian economy. Some stakeholders in Zambia also regard as an 'external shock' the rapid and deep opening of the Zambian market to external competitors under the COMESA Free-Trade Agreement and other trade agreements in the face of very limited capacity within either the Zambian public sector or private sector to adjust to and apply the new set of rules for regional trade. Hence, despite the earlier reforms and only selected backsliding in particular areas (i.e. fertilizer marketing), firms and farmers in Zambia have continued to operate in a highly volatile environment which has not been conducive to sustained investment and market development. Many stakeholders are now questioning the wisdom of the policy reforms themselves rather than the effectiveness and consistency in implementing those reforms. This study was designed to go below the radar of Zambia's macroeconomic developments to examine trends, constraints, and opportunities in specific economic subsectors. It sought to build upon existing and planned analyses within the country in order to better understand: (i) the underlying bases for competitive advantage and disadvantage in the evolving Zambian economy, (ii) the likely sustainability of those pattems of economic diversification which have already taken place, (iii) the linkages that have and have not been formed within the agricultural and mining sectors which might still be a basis for future growth, (iv) the specific effects of certain macroeconomic developments and 'external' events on different stakeholders and the types of responses they have made to these, and (v) the measures that could be taken to improve competitiveness within the Zambian economy and accelerate future growth. The initial design of the study took on a hybrid form, with the work combining specific studies and the provision of technical support. At the initial preparation stage there was a request to the World Bank to assist the Export Board of Zambia (EBZ) to conduct its 2001 Exporter Audit of non-traditional exporters. Over the period from November 2001 to April 2002, both technical and financial support was provided to EBZ for the design of its survey instrument and sample, the actual conduct of the survey, and the tabulation and analysis of results. It was expected that through this support, the EBZ would be able to go beyond the coverage of their previous annual exporter audits to gain additional insights into the underlying sustainability of some non-traditional exports and the strategies which some of the more successful finns were adopting to grow their businesses. The study was also designed to build upon and assist work which had been initiated by the Zambia National Farmers Union to better understand the competitiveness of Zambian 4 agriculture and the policy options available to govermment to improve the viability of smallholder and commercial agriculture.2 The Bank's team focused more on the downstream market dimensions of the agro-food system rather than on farm-level constraints and opportunities.' For this study, incremental work was also undertaken on the linkages between the newly privatized mining companies and local goods and service suppliers based in the Copperbelt area-building upon previous work done by the Intemational Finance Corporation. In both cases, the objective was to identify areas for possible support under World Bank agricultural and private sector development projects which are currently under preparation. The study design was thus pragmatic and operationally focused. It was not intended to provide a comprehensive analysis of the competitiveness of the Zambian economy nor was it intended to provide a blueprint for economic diversification.4 Nevertheless, this study did provide one of the analytical bases for the June 2002 Copperbelt Diversification Workshop where specific proposals were tabled to implement pilot projects in several subsectors highlighted here as having considerable growth potential. The publication and dissemination of this study will also assist the recently formed National Economic Diversification Task Force in its deliberation of policy and operational options to accelerate both the growth and diversification of the Zambian economy. This study is organized as follows. Chapter Two provides a simple framework for understanding the competitiveness of a country or industry and briefly examines the relative position of Zambia according to a range of general competitiveness factors. Chapter Three draws upon and extends the EBZ's analysis of recent developments among non-traditional exports, examining underlying competitive strengths and weaknesses and measures needed to sustain or expand these exports. Chapter Four analyses recent trends in Zambia's agriculture and agribusiness development, discems the underlying competitiveness of different enterprises/sub- sectors, and outlines opportunities for strengthening supply chain linkages and performance. Chapter Five examines recent developments in the Zambia's mining sector and reports on the results from a supplementary survey of mining companies and suppliers to examine trends in the linkages between such firms. 2That work was supported by the Dutch government. 3 However, the paucity of recent data on agricultural costs and profitability required that further work on this topic also be commissioned. See (Keyser 2002) 4A companion report by Vink et al (2002) provides an analysis of the South African (import) market for food and agricultural raw materials and the challenges facing Zambia and other SADC countries in accessing and remaining competitive in that mnarket. Some of the analysis there is summarized in Chapter 4 of the present report. 5 6 CHAPTER 2 BROAD PARAMETERS OF COMPETITIVENESS The profound changes which have taken place in the operating environment for business and for farming in Zambia necessitate adjustments by Zambian enterprises and farmers to enable them to better compete in domestic, regional, and international markets. The changes necessitate a shift from a production focus to a market focus, catering to the requirements and preferences of consumers and intermediate users and competing with a growing array of rivals either on the basis of lower costs or through the differentiation of products and (accompanied) services. This competition occurs less at the national level than in terms of particular industries, industry segments, or supply chains. Porter (1990, 1998) and others have identified a range of country attributes that shape the environments in which local enterprises (and farms) operate and compete and which can provide the basis for competitive advantage. These attributes can be summarized as follows: * Factor Endowments: including the country's human capital, natural resources, climate, and physical location (in relation to international markets); * Infrastructure and Support Systems: including the country's assets and systems for transport, energy, and communications, its systems for research, knowledge management, and technical support, and its banking and financial system; * Government Policies and Regulatory Environment: which influence the broad price and cost parameters in the economy, shape the incentives for trade and investment, and shape the rules of the game under which firms and farmers operate; * Enterprise Structure, Strategy, and Rivalry: the structuring of firms, their supply chain relationships, their particular product and market strategies, and the nature of competition and cooperation among them; * Demand Conditions: including whether domestic demand provides a basis for firms and supply chains to achieve economies of scale or scope and whether the composition or preferences of the domestic market provide an effective platform upon which to service similar forms of demand in international markets. Demand conditions themselves will be shaped by many demographic, economic, cultural, and historical factors. Other important variables relate to the conditions (including preferences) for regional and international market access; * External Chance Events: including short and longer term events over which the country or industry has (virtually) no control yet still may have a profound effect on market opportunities, constraints, and international competition. Examples include major shifts in international financial and commodity markets, political decisions taken by foreign governments, wars or political instability abroad, and natural disasters. This framework is summarized graphically below. 7 Enterprise Structure 3 |- Strategy, and Rivalry lation Factor Endowments |[* , | Demand Conditions 4 4~~~t Policies + Infrastructure and egul tion Support Services l 2.1 FACTOR ENDOWMENTS 2.1.1. Natural Resources Relative to other Southem African countries, Zambia is relatively well endowed with natural resources, including arable land, a favorable climate and pattern of rainfall over major portions of the country, ample renewable water resources, extensive forestry resources, and large and diverse mineral resources. Tables 2.1 and 2.2 provide some illustrative comparative natural resource endowment indicators. Zambia's agricultural and forestry resource base remains considerably under-utilized. Regional land classification studies indicate that Zambia has a much larger proportion of its land classified as medium and high-potential than do most other SADC countries, yet in recent years only about 14% arable land has been cultivated as a result of infrastructure constraints and a lack of adequate farm labor (and compensating mechanization) in many areas. Annual rainfall averages 700 mm. in the south to over 1000 mm. in the north of the country. While evaporation losses are high, a condition of water surplus exists through much of the country. Zambia also has substantial fisheries resources in its many lakes, swamps, rivers, and flood plains and a very large proportion of the local consumption of protein consumed comes from fish. Nevertheless, the country's fisheries resources remain highly underutilized from a commercial perspective. 5 The country's rich natural resources are key to its economic prospects not only through agricultural production, but also through tourism. Zambia has 19 National Parks and 36 Game Management Areas. This vast area has a variety of habitats and most "big game" species. Zambia ranks third in the sub-region, after South Africa and Angola in terms of its vertebrate diversity. 5 See Mapila (2000) 8 The Global Environmental Facility estimates that there are 3,774 flora and 3,637 fauna in Zambia. However, a gap exists between potential and actual revenues from these vast resources. For example, Zambia raises a revenue of only US$0.75 per acre of park land, while Zimbabwe and South Africa obtain US$11.50 per acre and US$17.50 per acre, respectively. Zambian has extensive mineral resources beyond its large (yet declining) deposits of copper and cobalt. Its geology has resulted in the country having a significant amount of the world's emeralds, amethysts, and aquamarines-as well as other stones such as garnets, tourmaline, smoke quartz, and topaz. Table 2.1: Co parison of Agro-Related Endowments Total Arable Avg Proportion Proportion Arable Land per RainfallW of Irrigable of Arable Land capita Year Land Land (million ha) (million (mm) Actually Actually ha) Irrigated Cultivated Mozambique 36.1 2.1 1000 1% 10% Zambia 9.0 0.9 900 10% 14% Zimbabwe 4.8 0.4 600 32% 26% South Africa 15.4 0.4 511 85% 69% Malawi 5.7 0.5 1037 9% 80% Source: Jaffee (1999) Table 2.2: Comparison of Other Natural Resource Endowments Annual Forest Nationally Renewable Coverage Protected Water (000 ha), Areas (000 Resources 1995 ha), 1999 (cubic kin), 2000 Zambia 80 31,355 6,366 Zimbabwe 14 8,626 3,071 Malawi 18 3,213 1,059 Mozambique 100 16,834 4,779 South Africa 45 7,204 6,619 Namibia 6 12,374 10,616 Tanzania 80 1,224 13,817 Source: African Development Indicators, 2000 2.1.2. Location Zambia is a land-locked country bordering on eight countries. This, ostensibly, provides for, ample opportunities for trade and cross-border investment and for combining complementary factors of production to achieve economies of scale or scope. Indeed, a recent analysis of the prospects for the "Zambia-Malawi-Mozambique Growth Triangle" highlighted potential complementarities among these three countries in relation to power, transport, and agribusiness.6 However, six of Zambia's neighbors are low-income countries with low purchasing power, many have similar structures of production in agriculture and industry, and several neighboring countries have experienced either recent (i.e. Zimbabwe) or longer term (i.e. Angola, DRC, and 6See Foreign Investment Advisory Service (2001). 9 Mozambique) political instability or social conflict which has weakened investor confidence in the region and weakened or distorted patterns of trade. Zambia's international competitiveness is also severely constrained by the relatively high transport costs and delays its firms incur as a result of many of its inputs and exported products having to be conveyed overland to the region's ports (see below). 2.1.3. Human CaDital Zambia has a population of 10.3 million people and experienced a population growth rate of 2.9% between 1990 and 2000. Zambia's population features a higher rate of urbanization than that of most countries of Southern Africa, this being a result of its historical development patterns in which mining and closely affiliated industries have played such a prominent part in its economy. In 1998, nearly 40% of Zambia's population lived in urban areas.' This relatively high rate of urbanization fosters a higher degree of local dependency on a well-functioning food distribution system. It has also affected patterns of infrastructure development in the country with a strong concentration in and around the major urban centers, especially Lusaka and in the cities and towns in the Copperbelt. Recent surveys and longer-term social indicator trends suggest that Zambia's human capital is at risk. The 2000/2001 Africa Competitiveness Report rated Zambia as one of the worst of the sampled countries in terms of an array of social indicators (Table 2.3). Table 2.3: Ranking of Zambia's Human Ca ital Human Capital Criteria Zambia's Ranking in Africa (out of 24) Life Expectancy 23 Infant Mortality 17 HIV/AIDs prevalence 21 Primary Education 24 Secondary Education 22 Illness and Disease 23 Source: Africa Competitiveness Report 2000/2001 Table 2.4 provides some comparative education indicators within Southern Africa. Literacy rates for Zambia are average or above average within the region and there have been some improvements over time. Between 1990 and 1999 the literacy levels for the population aged 15 years and above increased from 59 percent to 76 percent. However, school enrolment rates, both at the primary and secondary levels, are considerably lower in Zambia than for many SADC countries plus have been declining over time in Zambia. Primary school enrolment was higher in 1980 (77%) than in 1999 (72%) In addition, the high attrition rate of teachers due to HIV/AIDS and poor conditions of service have worsened the pupil/teacher ratio in recent years, from 37 in 1996 to 47 in 1999. In secondary schools, the quality of teaching and learning is at risk due to a shortage in educational support material and curriculum review. In terms of technical and vocational training, private training has been limited due to limited access of capital and inability to compete with 'For comparison, the urban population constitutes 22%, 34%, and 53% of the total population for Malawi, Zimbabwe, and South Africa, respectively. 10 subsidized public providers. Public training, on the other hand, has not involved employer demands in curriculum development and thus has not been responsive to market demand.8 -___________ Table 2.4: Comparative Education Indicators Adult Male Adult FemaGe Primary School Secondary School Literacy Rate, Literacy Rate, Enrollment (% Enrollment (% of 2000 2000 of total), 1999 total), 1999 Zimbabwe 92.8 84.7 98.5 59.2 South Africa 86.0 84.6 99.9 94.9 Zambia 85.2 71.4 72.4 42.2 Tanzaria 84.7 67.1 47.4 Nd. Namnibia. 82.8 81.2 91.4 80.7 Malawi 74.5 46.5 98.5 72.6 Lesotho 72.4 93.6 68.6 72.9 Mozambique 60.1 28.7 39.6 22.4 Source: World Bank and Human Development Report Incomplete data are available which compare labor costs between Zambia and neighboring (or other competing) countries. The information which is available suggests that rural/farm labor wages are higher than those in neighboring Malawi and Mozambique yet lower than those in Zimbabwe and especially South Africa. Industry wages are also considerably lower in Zambia than in the two larger economies to its south. However, statutory (pension and other) benefits are relatively substantial in Zambia, eroding its industrial labor cost advantages in certain industries. And, wage rates are only part of the picture and one must also consider worker productivity. As is discussed later, there are major concems about worker productivity (and theft/fraud) in Zambia and considerable weaknesses at the junior and middle management levels. Table 2.5: Comparative Wa es Benefits, Avg. Wage: Avg. Wage: Skilled Construction Percent of Agricultural Labor Industry Laborer Base Wage AgriculturalhLbor (US$/month) (US$/Month) (industrial (USS/moath) _______________ ~~Sector) South Africa $85 $280 $195 9-20 Mozambique $17 $45 30-50 Malawi $18 $38 15 Zambia $27 $45 $65 75-300 Zimbabwe $35 $50 $130 10 Table 2.6: ComparativeLabor Rates for Textfle Workers (US $/Hr) Zambia | Pakistan | Kenya | Mauritfus l South Africa 0.43 0.45 0.41 1.55 2.19 Several indicators point to a general decline in the health of Zambia's population. The 2001 World Health Report from the World Health Organization (WHO) ranked Zambia at 188 out of a total of 191 countries in its assessment of the health system, using eight measurements. 8In response, the/Government has planned for reform, with the World Bank supporting the TEVET Development'Support Program aimed to reform the role of the Government from one of provider and financier to one, with main role of regulating, monitoring, and providing finance for demand-driven training. Zambia made substantial investments in healthcare in the immediate post-independence period, but persistent under-spending from the 1980's onwards resulted in an erosion of earlier health gains. Chart 2.1: Health Indicators 120 100 80 Life expectancy at birth, 60 - total (years) -'-_ Mortality rate, infant (per 40 - 1,000 live births) 20 - 20 1980 1985 1990 1995 1999 The main indicators of the population's health point to a dramatic decline, largely due to the high incidence of HIV/AIDS. Current research indicates that one in every four Zambian adults (15 to 49 years old) is HIV positive. The high incidence rate has become more than merely a public health concern; as the pandemic strikes the population at its most productive age, endangering the country's economic productivity and prospects for capacity building. Surveys of businesses in Zambia confirm that illness and disease rank as one of the major concems and high costs. Moreover, the low life expectancy level of 37 years, jeopardizes a long-term vision for society. Short-term planning, coupled with the financial burden of medical care for a family member, are possible causes for the country's non-repayment culture and resulting drain on the financial system. 2.2 INFRASTRUCTURE DEVELOPMENT, ACCESS AND COSTS To achieve higher levels of growth and competitiveness, Zambia urgently needs to strengthen its infrastructure, improving its quality, improving access, and lowering the costs of services. Poor conditions and/or high costs of its transport, telecommunications, and electricity make it difficult for Zambian companies and farmers to compete with those in neighboring countries, let alone more internationally competitive suppliers. The existing transportation infrastructure cannot support the country's desire for export- led growth. Only 6,600 lam of 64,000 lan of total roads in the country are tarred. Moreover, road fright rates are excessively high at US$0.07 to US$0.10 per net ton kilometer.9 The condition of the railway lines and services have been deteriorating, largely due to poor maintenance and inequitable access. Tables 2.7 and 2.8 portray the relatively low percentage of quality roads and the higher transport costs in and out of Lusaka. 9 WorldBank (2001) PubLic Expenditure Review. 12 Table 2.7: Comparative Quality of Roads Paved Roads as a % of Total Roads Tanzania 4.2 Nanibia 8.3 Lesotho 17.9 Zambia 18.0 Mozambique 18.7 Malawi 19.0 South Africa 41.5 Zimbabwe 47.4 Source: Africa Competitiveness Report 2000/2001 As indicated below, road transport costs between major regional ports and Lusaka are considerably higher than between these ports and the commercial centers of Zimbabwe and Malawi. Rail transport is also comparably higher to Lusaka than to other land-locked regional commercial centers. For example, the North South railway from Durban to Harare costs US$1261 per 20 ft container weighing 14 tons. The same transport from Durban to Lusaka costs US$3018. The state-owned Zambia Railways is in the process of privatization, with the hopes of quality improvements and increased access. Zambia's inland port facilities ranks among the worst in Southern Africa, based on surveys of businesses. Table 2.8: Comparative Road Transport Costs External Transport Route - US$/ton/km Lusaka _ Harare Blantyre Beira 0.0995 0.0568 0.0663 Durban 0.0591 0.0561 0.0432 Dar es Salaam 0.0849 0.0651 Source: MITCO Diesel fuel is significantly more expensive in Zambia than in other regional countries (Table 2.9) essentially due to multiple layers and high rates of tax on diesel. Diesel and tires, which are also more expensive in Zambia than elsewhere, contribute over 50% of the costs of transportation. The recent reduction of the excise tax on diesel has only slightly closed the gap in comparative diesel costs. Table 2.9: 1omparative Price of Diesel Fuel (UIS$/liter _ Zambia RSA Tanzania Kenya Zimbabwe Pre-budget Post-budget Reduction in Excise Tax _ 0.86 T 0.73 0.32 _ 0.65 0.59 0.55 Electricity rates are cited as a constant source of complaint by Zambian manufacturers, farmers, and domestic consumers. However, a comparison of electricity rates across other countries within and outside the region suggests that very competitive electricity rates apply in Zambia. However, there are big variations in the quality of the electricity supply in different parts of Zambia-in some areas there is no supply at all while firms around Ndola and Kabwe complain about frequent power outages. While Zambia has installed capacity which is well in excess of current domestic demand-with Zambia exporting electricity within the region-only about 20% of the country's population has access to electricity. Most of the population relies 13 largely on wood fuel. The inconsistency between excess supply and poor access is due to the dominance of the mining industry in the energy sector. Such monopsony power discouraged expansion of the electricity infrastructure to other productive sectors. Table 2.10: Comparative Electricity Costs (US$/ kwh 2001 Zambia Kenya Uganda Madagascar India Bangladesh Sri Nepal South Lanka Africa 0.03 0.05- 0.04 0.06 0.07 0.06 0.06 0.08 0.03 0.07 00 Sources: Firm Interviews; COMESA, I'S Quarter 2001; Indian Electricity Board; World Bank The growth in Zambia's telecommunications sector has been slow. Table 2.11 ranks the SADC countries on various indicators and shows that Zambia has relatively fewer telephone mainlines, coupled with one of the highest costs per minute for local calls. Internet usage also lags that of its neighbors. Table 2.11: Access and Cost of Telecommunications Telephone Avg Cost of Cost of Internet Mainlines Local Call Call to Users (per 1000 (US$ per 3 US (US$ (per 1000 persons) minute) per 3 persons) minute) Malawi 4 Lesotho 0.01 South 1.98 Malawi 1.5 ________________ ~ ~~~~~~~~Africa_ _ _ _ _ _ _ _ Mozambique 4 Malawi 0.03 Zambia 2.57 Mozambique 1.7 Tanzania 5 Zimbabwe 0.04 Namibia 4.28 Zambia 2.0 Zambia 8 Namibia 0.05 Zimbabwe 4.36 Lesotho 2.0 Lesotho 10 Mozambique 0.06 Malawi 12.45 Tanzania 3.4 Zimbabwe 18 Zambia 0.06 Tanzania 13.30 Zimbabwe 4.0 Namibia 63 Tanzania 0.08 Namibia 16.7 South Africa 114 South Africa 0.09 South Africa 56.1 Source: World Bank, 2000 Zambia also ranks among the worst of Southern African countries in access to sanitation facilities and safe water (Table 2.12). This can severely weaken labor productivity. Table 2.12: Access to Sanitation and Water (1993-97) % with access % with Access to Sanitation to Safe Water Facilities Lesotho 8 Mozambique 32 Mozambique 21 Zambia 43 Zambia 23 Malawi 45 South Africa 46 Tanzania 49 Malawi 53 Lesotho 52 Zimbabwe 66 South Africa 70 Tanzania 86 Zimbabwe 77 Source: African Development Indicators, 2001 14 2.3 MACROECONOMIC MANAGEMENT AND REGULATORY ENVIRONMENT During the course of the 1990s, the Zambian government acted to remove many of the protective policies and state administered pricing structures which had long prevailed in the economy. The country undertook one of Africa's more successful programs of privatization and it moved to adopt one of the continent's most liberal and open trade regimes. Based on the International Monetary Fund's 10-point index of trade restrictiveness, Zambia moved from 7 ("restrictive") in 1992 to 2 ("open") in 2000. According to the Africa Competitiveness Report, Zambia ranks as one of the highest Sub-Saharan African countries in terms of openness to trade, a measure of trade liberalization based on levels of import or export restrictions, licensing requirements and exchange controls. Recent analysis also indicates that among Southern African countries, Zambia performs relatively well in terms of the time taken to register a new business (Table 2.13). Table 2.13: Time and Cost for Re tering a Business Total # of Total Time Total Cost CostiGDPPC Procedures (days) (US$) South Africa 9 26 266.68 0.08 Zambia 5 29 193.56 0.61 Zimbabwe 5 47 67.05 0.13 Malawi 13 51 35.83 0.19 Mozambique 19 149 256.35 1.11 Tanzania 13 29 804.48 3.35 Source: Djankov, La Porta, Lopez-de-Silanes, and Shleifer Despite these relatively progressive reforms, the transition to a fully market-determined economy is not yet complete. The legal system needs significant reform and streamlining. The country's weak courts do not serve the needs of the private sector. Inadequate law enforcement, coupled with lengthy and costly trials has restricted the private sector from operating effectively. Additionally, acquiring title to land remains a constraint to new businesses. More generally, the Africa Competitiveness Report found Zambia to rank quite poorly in terms of the reliability and responsiveness of administrative systems for facilitating business and trade. To gain competitiveness going forward, the government needs to strengthen the legal system and continue its commitment to reduce administrative barriers for businesses. Even more problematic for Zambia business and farmers has been the macroeconomic instability faced in the country throughout much of the reform period. This has manifested itself in very high costs of finance and great uncertainty and fluctuations in the exchange rate of the Kwacha. Since the mid-1990s, Zambia has experienced high and volatile real interest rates. Recent analysis suggests that structural factors, rather than monetary factors, have contributed most to the high level of real interest rates. Important among these structural factors have included inflationary expectations, the credit risk of domestic borrowers, high transaction costs of financial intermediation, and overall (relatively high) country risk. The very high real interest rates which Zambia has experienced in recent years have severely undercut the profitability and scope for expansion among domestic firms and tilted the advantage to larger firms who have access to foreign finance through their external affiliates or others. Commercial interest rates have been higher in Zambia in recent years than in many other countries within the region. 15 Table 2.14: Constraints on Private Business Criteria Zambiaos Ranking in Africa jNj; lilmill ~ ~~ ~ out of 24) Openness Openness to Trade 2 Averag te I Institutions ___ Effectiveness of Legal System 17 Quality/Efficiency of Public Securi!y 21 Organized Crime 20 Govt Officials' Willingness to Help 17 Source: Africa Competitiveness Report 2000/2001 Chart 2.2: Zambia: Inflation and Real Lending Interest Rates 200.0 150.0 10.0 C 100.0 ,',' ' . , :, -10.0 "a - 50.o -- -30.0 0.0 .:., I -, r ; , -50.0 199019911992199319941995199619971998199920002001 CPI Inflation, % p.a. + Real lending rate, % p.a. Table 2.15: Comparative (Nominal) Interest Rates on Commercial Bank Loans (lIt Quarter, 2001) Zambia F Kenya I Uganda Tanzania I Madagascar 45% 20-25% 25% 19-25% 20% In 1991, the then new Zambian Government started to eliminate exchange rate market controls after two decades of a pegged/fixed exchange rate system. By January 1994, all capital account controls were abolished and Zambian Kwacha became fully convertible. Since 1991 the nominal exchange rate has depreciated from 43 Kwacha per dollar to 4800 Kwacha per dollar in late 2002. Interestingly, even after the full convertibly, there have been prolonged periods of nominal exchange stability throughout a sequence of internal and external shocks. This combined with high and variable inflation over the decade has generated overvaluation and considerable amount of volatility in the real exchange rate (Figure 2. 1). The volatility of the real exchange rate has several adverse impacts. First, it often translates into a high degree of uncertainty for private investors, regarding both profitability and the cost of investmnent. Second, exchange rate volatility makes local banks less willing to offer 16 credit facilities denominated in foreign currency because of the foreign exchange risk involved. Third, exports may be adversely affected as firms need to absorb the impact of currency risk. Since the mid-1990s, Zambia has experienced a significant appreciation of its REER during two periods: namely, from early 1996 to early 1998 and in 2001. These large appreciations in the REER acted to reduce the competitiveness of Zambian exporters selling into the Southern African region and elsewhere, while simultaneously increasing the vulnerability of domestic- oriented firms to competition from abroad. In other years, including both 1999 and 2000, there have been shorter periods of REER appreciation. Figure 2.1: Nominal and Real Effective Exchange Rates (REER) for Zambian Kwacha in the 1990s (Index: Jan 1990 = 100) Jan 2001 -Government Intervention 170 4000- Oct 1991- Jan 1994 -Full 3500- Exchange Rate Current Account 1997- Copper 2000- 150 System L t Convertibility Price fell 30 % Drought 3000 - Liberalization ll 13 130 2500- 2000 - 110 1500 90 1000 70 500- 0 s 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 - Kwacha / US Dollar - left scale - REER - right scale 2.4 EXTERNAL CHANCE EVENTS An array of external 'chance' events have strongly influenced the operating environment for Zambian firns and farmers in recent years. One major development has been the adverse movement in international commodity prices since the mid-1990s (See Chart 2.3 below). There has been a sharp decline in the international prices for copper and other minerals plus a reduction in the prices of a broad array of agricultural commodities to levels not seen for several decades. The late 1990s financial crisis in parts of Asia together with recession or slow economic growth in Europe and Japan contributed to reductions in world demand for major commodities and, together with supply expansions in some cases, resulted in imbalances between international supply and demand. Zambia has also been adversely affected by the civil war and otherwise general instability in neighboring DRC and by the political and economic convulsions which have taken place in Zimbabwe over the past two years. These developments have disrupted opportunities for 17 Zambian trade, negatively affected the attractiveness of the region as a whole for trade, and in the case of Zimbabwe, resulted in a spillover of goods through the parallel exchange rate system strongly undermining the viability of several Zambian industries (see Chapters 3 and 4). A further external shock to the Zambian economy has been the occurrence of drought in selected or substantial parts of the country, in 1995, 1997, 1998, and 2001. Such droughts have contributed to wide fluctuations in annual production of different crops, necessitated large-scale food imports in certain years, undermined credit recovery in agriculture and, within small farmer areas, frequently necessitated the sale of productive assets-i.e. livestock-in order to maintain household consumption levels. Chart 2.3: International Commodity Price Indices 140.00 .__ 130.00 120.00 CD 110.00 , 100.00 90.00 80.00 70.00 \9<,00 69^> 69 9\D 9^> 99o 993 99> 996 9°° o° -4--Food -- Raw Materials X- Metals and Minerals 2.5 DEMAND With per capita income of approximately US$ 300, Zambia is one of Southern Africa's poorest countries. The 2001 World Development Report ranked Zambia 143 out of 161 countries in the poverty index and currently 85% of its population is classified as living under US $1 a day. Zambia's per capita income is now half of what it was at the time of independence in 1964. While per capita income has been more or less stagnant since the mid-1990s, employment in the formal sector has actually declined. An array of businesses report stagnant or declining purchasing power on the part of their customers, the result being either an absolute reduction in product demand or a shift of customers from higher priced (and quality) goods to lower cost costs, both among manufactured products (i.e. increased purchases of second-hand clothes) and food products (i.e. consumption of less refined maize meal and lower quality cuts of meat. The contraction of Zambia's copper mining production has similarly resulted in reduced demand for associated inputs and services, although this trend was temporarily interrupted by the post-privatization rehabilitation of several of the mines. In the food sector, the modernization of retailing has indeed provided a catalyst for improved product quality and supplier service, yet this has thus far had little spillover effects in terms of better positioning local suppliers for regional and other external markets. (See Chapter 4) 18 While domestic demand has generally not provided a catalyst for improved products, services, and overall competitiveness of domestic enterprises, Zambia has entered into a number of trade agreements or otherwise has been granted preferential access to important external markets which considerably expand the potential demand for Zambian products. Important among these are the COMESA Free-Trade Agreement, the SADC Trade Protocol, the EU Everything But Arms initiative, and the U.S. Africa Growth and Opportunity Act (AGOA). The extent to which Zambian firms and farmers have benefited from such arrangements will be discussed in subsequent chapters. 19 20 CHAPTER 3 THE DEVELOPMENT AND SUSTAINABILITY OF NON- TRADITIONAL EXPORTS Since its inception in 1987, the Export Board of Zambia (EBZ) has sought to compile a database on the country's non-traditional exports, and through an annual Exporter Audit exercise, closely monitor their development and propose policy changes or other measures to alleviate constraints on their growth. In this context, Non-Traditional Exports (NTE) are defined as any products (and services) other than copper and cobalt. While some non-metal products have been exported, off and on, for many years, the EBZ's definition of NTEs is nevertheless useful to help discern the diversification of the country's exports beyond copper and cobalt. The EBZ compiles NTE statistics on a monthly basis and at the end of each year visits companies involved in several specific product groups in order to re-confirm data and address emerging policy issues. Attempts are made to reconcile reported data with the eamings recorded in customs Export Declaration Forms. Over time, the NTE statistics which the EBZ obtains have been regarded as the official statistics on such exports and included as such in the Bank of Zambia's balance of payments analyses. Nevertheless, there are some uncertainties about the accuracy of some data related to NTEs. In the course of the present study it was found that data being reported for the country's floricultural and horticultural exports are actually overseas market values or CIF values, rather than FOB values. In relation to these perishable products, this is not a trivial detail, given the very large proportion in the value chain taken by air-freight, and, in the case of cut flowers, overseas commission costs. Our analysis suggests that current year as well as time series data for cut flowers need to be reduced by 50% in order to make a proper estimation of the FOB value of these exports. In the case of vegetables, the needed adjustment is a reduction of 40%. Making this adjustment, the combined exports of floricultural and horticultural products would be $38.8 million rather than the $70.4 million reported to and officially recorded by the EBZ for 2001.'1 Considering the recorded volume of these exports over time, and comparative unit values from other countries, our assumption is that this anomaly in the data dates back at least to 1995, and, in the case of cut flowers, probably earlier.1' This anomaly in the EBZ (and indeed official) data may be restricted to the horticultural/ flo'ricultural sub-sectors given the common practice of CIF pricing for vegetables and auction pricing for cut flowers. It is unclear, yet unlikely, that firms in other sectors would be recording let alone reporting CIF values. Even if they were, the valuation adjustment needed would be comparatively much smaller for most other agricultural and manufactured export products, which are transported overland and/or by sea. Nevertheless, this is an area where the EBZ might require assistance in order to further improve its system of data gathering and analysis for NTEs. '° This implies a reduction of some $31.6 million, amounting to 10% of the total NTEs as recorded by EBZ. However, there is considerable uncertainty on the actual value of Zambia's gemstone exports. While these are presently recorded as $20 million, there exists informed opinion that the true figure actually exceeds $50 million, thus fully compensating for the 'overestimate' for floriculture/horticulture exports. " Simply over the 1997 to 2001 period, the cumulative "over-estimate" for cut flower exports would be $82.2 mnillion 21 The graph below utilizes the official EBZ data to depict the development of NTE and metal exports since 1990. Zambia's total exports have declined from some $1.27 billion in 1990 to $902 million in 2001, according to EBZ data. The reason for this has been a 50% decline in the country's dominant metal exports. Non-traditional exports, including electricity have, in contrast, increased three-fold from just over $100 million in 1990 to just over $300 million in 2001. The share of NTEs in total exports has increased from only 16% in 1995 to 35% in 2001. What is evident from the graph, however, is that recorded NTEs, after growing rapidly during the period from 1994 to 1997, have been essentially stagnant since then, with 1997 actually being the peak year of such exports at nearly $330 million. Figure 3.1: Zambian Metal and Non-Traditional Exports (US$ Million) 1200- 100 F-,I H LI 600 1 400 -I 1 J. K 2 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 This stagnation in non-traditional exports since 1997 has cut across a very broad range of products. Graph 3.2 indicates that Zambia's manufactured product exports have declined continuously over the past five years, although the sharpest drop-off occurred between 1997 and 1999. Among EBZ's categories of manufactured exports there is not a single category, other than an amorphous category called "other manufactured goods" which has shown sustained growth over the past five years. For most categories there has actually been a sustained decline. The situation with regard to agricultural exports is somewhat different.'2 These too peaked in 1997, yet have more or less remained at similar levels ever since, with the exception of a large drop-off in 2000. As will be analysed further in Chapter 4, among agricultural exports the recent trends have been very varied, with only vegetables and sugar showing both sustained and considerable growth, while most other agricultural exports have experienced high volatility and/or recent declines. A fuller product group breakdown, based on the EBZ's figures is provided in an Annex to this chapter. 12 This analysis is based on our downward revisions of horticultural and floricultural exports to better reflect FOB values. On the particular issues raised in this paragraph, there are no significant differences in the trends portrayed by the two time series, although the graph does reflect our revised agricultural export estimates rather than those of the EBZ. 22 Figure 3.2: Recent Trends in Agricultural and Manufacturing Exports 160 . ---- 140 - 120 i - i looI- - ._ * i ; ! - - rX 1 | |Manu fin N~~~~~ Agri + Wood 8011 60j 40' > 1995 1996 1997 1998 1999 2000 2001 Table 3.1 below depicts the destinations of Zambia's non-traditional exports over the past three years, according to EBZ data. We believe that actual sales to the United Kingdom and to the Netherlands are substantially lower as these are the dominant destinations for Zambia's vegetable and cut flower exports, respectively. Actual exports to the EU in 2001 were probably closer to $80 million'3 Some interesting patterns can be discerned from the data as a whole: * South Africa is the single largest destination for Zambian NTEs, accounting for more than one-fourth of exports. Nevertheless, Zambia maintains a huge trade deficit with South Africa, amounting to R4.2 billion in 2000. * The countries of COMESA are also an important outlet for Zambian NTEs, collectively also accounting for about one-fourth of these sales. Within COMESA the DRC (Democratic Republic of Congo) is by far the most important outlet for Zambian NTEs with sales to most other COMESA countries fluctuating from year to year. Although the table is not organized to discern this, SADC countries account for 46% of Zambia's NTEs in 2001 and this share has been more or less the same since 1998.'4 * There is relatively little evidence of market diversification among Zambian NTEs in recent years, at least on an aggregate basis. Significant exceptions have been the expanded trade in 2001 with Kenya (primarily for sugar) and increased sales to India (primarily of gemstones). Four countries-South Africa, the DRC, the UK, and the Netherlands account for nearly two-thirds of Zambia's NTE sales. * For the majority of countries listed, Zambia exports only one or two NTE products. Zambia's most diversified NTE trade takes place with South Africa, the DRC, and Zimbabwe where some two dozen agricultural and manufactured products are sold. The country's NTE trade is also fairly diversified (i.e. 5 products or more) with Malawi, Tanzania, the UK, Germany, Switzerland, and the United States.'5 The EBZ's database suggests that in 2001 there were 388 'established exporters', more than double the number of such companies in its database in 1997. However, many of these companies are not regular exporters and there is some degree of concentration in the structure of 13, Actual exports to the Netherlands were probably $18-20 million while those to the UK were probably $27-29 million. 14 See EBZ Export Audit 2001, page 46. '5 See the EBZ's Export Audit 2000, page 38. 23 Zambian NTEs. For example, in 2001 the top four exporters accounted for 36% of total national NTE value, while the leading ten companies had a 58% share. These proportions are up somewhat from 1998 when they were 34% and 51%, respectively. The EBZ publishes a list of companies who comprise its 'Million Dollar Club'. In 2001, there were 36 such companies who collectively accounted for 76% of total NTE value. As we will see later, in any particular product category Zambia NTEs are concentrated around one or a limited few companies. Table 3.1: Markets for Zambia's NTES in 1999, 2000 & 2001 1999 Contribution 2000 Contribution 2001 Contribution to % Change MARKET/REGION Value In US S to Region Value In Us $ to Region Value In Us Region from 2000 A. COMESA - Congo DR 34,314,496 41.93% 34,346,982 48.91% 35,884,066 45.36% 4.48% - Kenya 2,744,628 3.35% 3,543,974 5.05% 10,298,796 13.02% 190.60% - Malawi 15,271,958 18.66% 8,982,482 12.79% 9,506,063 12.02% 5.83% - Zimbabwe 10,528,693 12.86% 9,990,942 14.23% 7,040,620 8.900/0 -29.53% - Tanzania 5,676,009 6.94% 5,279,335 7.52% 0 0.00% 0.00% - Rwanda 2,112,535 2.58% 2,061,671 2.94% 3,823,170 4.83% 85.44% - Mauritius 0 0.00% 296,016 0.42% 2,759,160 3.49% 832.10% - Burundi 3,045,090 3.72% 2,755,303 3.92% 2,579,006 3.26% -6.40% - Uganda 5,642,220 6.890/o 1,559,233 2.22% 1,338,268 1.69% -14.17% - Namibia 1,527,169 1.87% 1,081,745 1.54% 735,479 0.93% -32.01% - Other 978,088 1.20% 332,896 0.47% 136,734 0.17% -58.93% TOTAL COMESA 81,840,886 26.88% 70,230,579 26.64% 74,101,361 23.77% 5.51% r~~j' j.p *&iE> a ZW 5r 4WTI B. EUROPEAN UNION - UK 37,386,448 31.86% 33,847,737 35.15% 40,293,487 37.83% 19.04% - Netherlands 40,613,280 34.61% 27,770,974 28.84% 34,367,492 32.26% 23.75% - Germany 21,319,867 18.17% 20,666,775 21.46% 14,435,505 13.55% -30.15% - Portugal 4,848,019 4.13% 6,093,254 6.33% 7,250,019 6.81% 18.98% - Belgium 5,131,549 4.37% 3,936,736 4.09% 3,654,243 3.43% -7.18% - Italy 374,728 0.32% 1,229,726 1.28% 2,447,687 2.300/o 99.04% - Others 1,583,216 1.34% 270,215 0.28% 1,796,099 1.69% 564.69% - Spain 6,055,800 5.16% 1,485,944 1.54% 1,352,287 1.27% -8.99% - Austria 45,937 0.04% 988,924 1.03% 924,192 0.87% -6.55% TOTAL EU 117,358,844 38.54% 96,290,285 36.53% 106,521,012 34.16% 10.62% C. ASIA - India 8,495,710 82.66% 8,604,416 72.34% 12,514,577 68.47% 45.44% - Hong Kong 1,025,445 9.98% 1,662,292 13.98% 3,404,064 18.62% 104.78% - Thailand 255,832 2.48 535,783 4.50% 794,927 4.35% 48.37% - South Korea 15,585 0.15% 13,861 0.12% 771,550 4.22% 5466.34% - Others 459,278 4.46% 380,111 3.20% 676,293 3.700/o 77.92% - Japan 26,249 0.25% 698,035 5.87% 117,029 0.64% -83.23% TOTAL ASIA 10,278,099 338% 11,894,498 4.51% 18,278,440 5.86% 53.67% D.OTHER MARKETS - South Africa 64,802,554 68.20% 59,869,925 70.26% 80,041,362 70.89% 33.690/o - Switzerland 17,877,459 18.81% 12,044,696 14.13% 17,708,313 15.68% 47.02% - Tanzania 0 0.00%/0 0 0.00% 5,014,614 4.44% 0.00%!, - Others 4,416,889 4.64% 4,640,473 5.45% 3,393,167 3.01% -26.88% - Botswana 2,392,548 2.52% 1,708,638 2.01% 3,283,897 2.91% 92.19% - USA 2,588,892 2.72% 6,122,518 7.18% 2,747,596 2.43% -55.12% - israel 2,233,059 2.35% 602,133 0.71% 583,652 0.52% -3.07% - Poland 706,587 0.74% 224,275 0.26% 134,168 0.12% -40.18% TOTAL OTHER 95,017,988 31.53% 85,212,658 32.32% 112,906,769 36.21% 32.50% TOTALEXPORTS 304,495,816 100.00% 263,628,020 100.00% 311,807,581 100.00% 18.28% 24 3.1 FINDINGS FROM THE 2001 EXPORTER AUDIT SURVEY The Audit exercise for 2001 comprised three components, namely: (a) the completion of two survey instruments; (b) firm interviews; and (c) the submission of status reports by selected trade associations. Initially, some 100 firms were sent an extended questionnaire, with a follow up by a second more focussed one to thirty-one of the leading firms in six industry sectors. The firms which received the second questionnaire accounted for 73% of NTEs in the year 2001, while the firms actually interviewed accounted for about 50% of total NTEs. The discussion which follows summarizes the findings in relation to the textiles, engineering, gemstones, processed food and horticulture/floriculture sectors. These account for more than two-thirds of Zambia's merchandise NTEs. The largest missing element here is the category called 'primary agriculture', the analysis of which is covered in Chapter 4. The coverage here on both the processed food sector and that of horticulture/floriculture is also circumscribed because of further analysis which is also provided in Chapter 4. Following the review of sub- sector results below, we highlight a number of cross-cutting issues affecting Zambia's NTEs in general. 3.2 TEXTILES 3.2.1. Introduction Manufacturing processes reported on here in the textiles sector consist of spinning cotton into yarn and garments' manufacture. Cotton yarn and poly-cotton yarn accounts for over 90 percent of textile exports. Textiles was the second biggest NTE sector in 1997, but by 2001 had become the fifth biggest, showing a gradual decline in US$ earnings for the past five years (see Table 3.2 ). This decline is remarkable in view of the sector's growth from exports of US$9.4m. in 1991 to US$50.6m. in 1997, and investment which was made in the sector in the same period. Table 3.2: Textiles exports, 1997-2001 (US $ million) 1997 1998 l 1999 2000 2001 50,639 42,370 36,997 36,034 34,120 Factors external to the textile and garment companies themselves have played a considerable role in these declining exports. These include the decline in world prices for cotton lint and yarn; the Asia crisis; the practice of local ginners to sell lint in US$, at above world prices to Zambian spinners; the purchase by foreign buyers, in RSA, for example, of Zambia's output in Rand; and the entry of Eastern Europe into Zambia's traditional markets. These issues were compounded in the case of the firms which invested heavily in the mid-1990s, expecting the market to behave differently. As a result of the subsequent unfavourable trading conditions, firms have become cash-strapped. Although export sales have been declining, production volumes have increased substantially in the case of the larger firms. The volume of output of the largest one has roughly been double the 1995 output for the past five years. However, its US$ export sales value has only increased by 36 percent due to declining prices. There is no effective trade association for the sector due to the reduction in size of the sector and to the different interests of the different tiers in the industry - if ginners are included. 25 3.2.2. Natural Endowment Zambia's climate and ecology favours the production of cotton, the main raw material for the textiles sector. However, Zambia's textile firms are not able to benefit from this and buy cotton lint at world prices. Cotton represents a significant proportion of the yarn production costs, up to some 67 percent in the year 2001/02. Spinners, such as SSM and Mukuba Textiles, may be paying up to 66 percent more than the world price, indexed in Liverpool, for the lint they need, as shown in Table 3.3. In order to obtain raw material inputs at lower cost, several of the spinners have established their own cotton ginning operations, yet these have been largely unsuccessful due to a lack of working capital either to provide inputs to farmers or to pay on a timely basis for the seed cotton crop. This problem of cash flow and working capital is essentially the same reason why other ginners do not sell the textile firms cotton lint at export parity prices-there is payment risk associated with selling to the spinners. Some of the spinners have also not been reliable clients for the local gimnners, some of whom seek to manage price risks by selling forward their product. Some spinners have resorted to purchasing lint from Tanzania at prices well above those prevailing elsewhere in the region (due to Zambia's land-locked position and high transport costs). Unexpected (upward) movements in raw material prices was the single most important reason given by firms for the reduction in their competitiveness in the past year, far out-weighing movements in exchange rates and changes in foreign market conditions (Table 3.4). Table 3.3: Cotton lint: comparative prices (USD/lb) (a) I World (Liverpool) price | Zambia price T Tanzania price (b) Season 2001/02 33 55 49 Notes: (a) Prices are indicative and may not be exactly comparable due to daily fluctuations. (b) Landed in Zambia Source: Firm interviews, 2002. Table 3.4: Main reasons affecting competitiveness in past year Reason Weighted Ranking _____________________________________________ average Raw material price changes 2.40 I Exchange rate changes 1.00 2 Foreign market conditions' changes 0.80 3 Access to improved technology 0.40 4 Transport cost changes 0.20 5 Zambia's textiles workforce is cheaper than its competitors, according to international trade sources, one-fifth of South Africa's cost, on par with Kenya and somewhat lower than Pakistan (Table 2.6 earlier). Nonetheless, it should be noted that Zambian firms themselves believe labor to be 10 percent cheaper in India and Pakistan. These firms also observe that they have to keep surplus labor to cope with absenteeism and sickness, whereas their Asian competitors have a pool of experienced workers, resulting in a leaner work force. There are widely held views in the sector that skills and technical know-how are lacking, and one of the firms with most experience of international comparisons reports that productivity is only 60 percent of what can be achieved in competitor countries such as China. They report dissatisfaction with the attitude of the workforce, including middle and junior managers, which 26 does not understand the precarious position of the sector and demands pay increases of up to 70 percent for the current year. 3.2.3. Enabling and regulatory environment It' was observed above that exchange rate changes were the second biggest factor last year which affected firms' competitiveness. This is worsened as several firms are buying their inputs in US Dollars , frequently without credit, and selling their products in the buyers' local currency. As firms may be giving their buyers up to 90 days credit for at least part of their deliveries, they are particularly badly affected by currency movements. Complicating matters further is the fact that input prices and output prices are determined by world prices, the exchange rates of the three main currencies--the USD, the Euro, and the Rand-- are fluctuating; and that advantages and disadvantages are obtained by firms depending on the extent to which they contract forward in their buying and selling. One ginner points out that spinners have made some bad buying decisions, committing themselves to buy in advance at a fixed price, only to find that the world prices have declined by the time they come to sell their produce. As noted earlier, some firms invested heavily in the mid- to late-1990s, only to see the markets move against them. Costs and prices and high interest rates have led one firm to observe that the sector is technically bankrupt. Indeed it is reported that 5 to 25 percent of the selling price of yam is made up of financing costs, and firms need the sales price of yarn to be considerably higher than at present for them to break even. During 2001, the sector was not able to benefit from the Africa Growth and Opportunity Act as were other countries in the region. Zambia, as a result of government inactivity, was the twelfth of sixteen countries which have so far become eligible for the Apparel Provision, as can be seen in the Table below. Exporters have been disadvantaged by this inactivity compared with Kenya and Mauritius, for example, whose governments helped their firms take advantage of AGOA one year before Zambia could. Table 3.5: AGOA - date countries became eligible for the Apparel Provision (in chronol gical order) Country Date Country Date Mauritius Jan 18 2001 Botswana Aug 27 2001 Kenya Jan 18 2001 Uganda Oct 23 2001 Madagascar Mar 6 2001 Namibia Dec 3 2001 South Africa Mar 7 2001 Zambia Dec 17 2001 Lesotho Apr 23 2001 Mozambique Jan 8 2002 Swaziland Jul 26 2001 Tanzania Feb 4 2002 Ethiopia Aug 2 2001 Cameroon Mar 1 2002 Malawi Aug 15 2001 Ghana Mar 2 2002 Source: www.agoa.gov/eligibility/ eligible_countries/ Although Zambia ratified AGOA in mid-December 2001, firms were still not able to take advantage of its provisions. Instead of preparing the accompanying instruments in parallel with the ratification process, it undertook measures sequentially. Thus, for example, it is said that the one-page AGOA Textile Certificate of Origin which firms needed to complete, was not available until early February 2002 - although the government could have obtained a model form and copied it from the countries which had preceded Zambia in the process. The costs of this non- aggressive approach to ensure AGOA eligibility are illustrated in Box 3.1. 27 Box 3.1: Costs of Zambia's slow ratification of AGOA It has been noted that it took a long time - some 11 months longer than Kenya - for Zambia to become eligible for the apparel provision of AGOA. Countries which were faster off the mark, scored some impressive victories, as reported in the Times of Zambia. For example, Madagascar has secured investment of USD 100m., while Kenya has an additional 10,000 jobs in the textiles industry. In anticipation of Zambia becoming eligible for AGOA at the same time as its competitors in early 2001, a firm in Mauritius ordered from Zambia, during the first quarter of 2001, up to 126,000 kg of yam per month. When the supplier failed to get certification, it reduced its orders to an average of 76,000 kg per month for the following seven months. In November and December, in anticipation of Zambia's AGOA ratification, it increased its orders to an average of 166,000 kg per month. Once ratification had occurred and Textile Certificates of Origin were available in early February, the orders for February and March averaged 191,000 kg per month. It is estimated that Zambia lost up to 500,000 kgs of business during the period April - October 2001 because of slow implementation. In another case, a Botswana buyer of Zambian yam was so keen to take advantage of Zambia's AGOA status, that it kept calling the US emnbassy in Zambia during 2001 to enquire when Zambia would be eligible. During 2001, this buyer ordered an average of 26,700 kg per month, but in December, for example, could have ordered 100,000 kg if Zambia had been eligible. Since Zambia was ineligible, the firm took its AGOA-driven business throughout 2001 to competitors in RSA, where it obtained yam for about USD2.57 per kg, as against the Zambian price of USD2.63 landed. Fortunately, Zamnbia hopes to win back the business, but industry notes that in cases when a supplier's price is higher than a competitor's price and it fails to deliver it is generally shut out of the market. The delays had the following implications on Zambian industry: (i) the volumes of yam sold were substantially lower than should have been the case, as the above figures indicate; (ii) yam production which could have been sold to AGOA beneficiaries, had to be sold to RSA in Rand denominated prices, and there was a 10% loss of income because of lower market prices and for forex reasons; and (iii) if Zambia had been certified at the same time as Mauritius, the 1,140,000 kg of yam which was sold to Mauritius during 2001 could have been sold at a premium of 10-15%, since AGOA-certified yarn can be sold for USD2.74 compared with USD2.50 without AGOA certification. The position of textiles firms is worsened over delays by the government in refunding Value-Added-Tax (VAT) and duty drawback. In the case of the former, firms report delays of 60 days, rather than the 30 days commitment in the government's regulations. Periods of up to 60 days are reported, too, in the case of duty drawback. One firm observed that its outstanding duty drawback equalled 5 percent of sales, and the loss was being financed by the firm at 50 percent interest. Firms note that if they make an error in their documentation, they are penalised, but if the government does not refund within the time stated in the regulations, the firms are not compensated. One issue which is of particular concern to textiles firms are the Customs and Excise Regulations, 1998, which based the implicit duty on qualifying domestic supplies of raw materials on the reduced COMESA rate for the raw material, rather than on the substantive duty rate. In the case of cotton, this meant a duty of 6 percent, i.e., 40 percent of the substantive rate of 15 percent. In 2000, the COMESA rate was reduced to 0 percent to the dismay of textiles finns. Firms want duty drawback based on the substantive rate which, they report, is acceptable under WTO regulations. They suggest that this is the most appropriate measure if the government wants to favor textile firms, and could be introduced without legislation or a Statutory Instrument - merely requiring an administrative instruction. 28 3.2.4. Infrastructure The supply of electricity and water to textiles firms varies according to their location in the country. In Kabwe, for example, the lack of a continuous supply of electricity and water leads to production losses of 10 percent which is unsustainable where firms have high fixed costs. They complain about the cost of electricity (around USDO.033 per KwH in typical textiles firms interviewed) - though this is cheap in comparison with textile-producing countries such as Kenya (U$DO.05-0.07), Madagascar (USD0.06), and Mozambique (USDO.07-0.1 1). Still, in the Copperbelt, the textile firms look enviously upon the leading copper mining firms which have accessed energy at USD0.02 per KwH. Transport costs place firms at a disadvantage, particularly when they export extra- regionally. One spinner used to sell all its yarn to Germany. It reports the cost of transporting a 40' container from Ndola to Bremen, Germany, as follows: Ndola to Durban - USDI,500; Durban to Bremen - USD2,100. This compares with new competitor countries such as Uzbekistan for which transport costs of USD600 are reported. Telecoms costs are especially high in the areas where the leading textile companies operate. Whereas it costs USD2.10 per minute to call the UK from Ndola, UK callers can call Ndola for half the price. Whereas it costs USD2.10 per minute to call the USA from Ndola, it may only cost USD0.16 per minute to call in the opposite direction. As managers have to travel frequently to Lusaka to deal with bureaucratic issues they want to be able to use mobile phones as a business tool, but report they can only use them in emergencies. Companies which have the most experience of international conditions lament the small scale of the textile sector which results in a lack of supporting industry - eg, button and thread suppliers, agents for foreign equipment, and so on. 3.2.5. Micro-economics and business strateuv The strategies firms adopted in the mid- to late-1990s have had disastrous consequences as already observed. In the case of the only large fabric and garments producer, Zambia-China Mulungushi, foreign investment came at the wrong time, while domestic firms suffered too. Much of this investment came in the wake of liberalization. External factors, such as the Asia crisis, declining prices, and currency movements made this investment costly to the firms and to the whole sector. Managers have had difficulty coping with the unexpected and unfamiliar conditions. Those which diversified their markets putting more emphasis on RSA have experienced difficulties in the past year. Poor finances have prevented firms from securing the same trading conditions with upstream suppliers as their foreign competitors. As we have seen, in the case of 2001/02, spinners bought cotton at higher than world prices. One firn, as shown in the table below, reported that this trend has occurred for several years, stating that it paid some 29 percent more than the world price in 1998/99 and 20 percent more for the season 2002/03. Table 3.6: Lint rices (US cents per lb) 98/99 99/00 00/01 01/02 02/03 World price 59 53 57 44 40 Price paid by representative firm 76 57 56 58 48 Firms, as a result of their high costs and high landed prices on the traditional European market, have been operating at low capacity - some as low as 30 percent. As a result of this there 29 is over-staffing in some firms - one reports it has 140 workers and needs only 60 to handle its volume of business. The high cost of retrenching is the main reason which prevents such firms from downsizing. 3.2.6. Demand The biggest change in the demand in recent years has been the move away from the European market for Zambian spinners of cotton and poly-cotton yarn and the increasing concentration on regional markets. This shift away from Europe has been due to several factors including the weakness of the Euro against the USD; the increasing availability of supply from Eastern Europe and the former Soviet Republic; and competitors' lower transport costs. Since September 11 , 2002 Pakistan has been favourably regarded as a supplier for political reasons, putting additional pressure on Zambia's exports to Europe. Driving the greater concentration on regional markets has been the prospect of Zambia's AGOA status together with the SADC Trade Protocol. This combination of factors has resulted in sales, as indicated in Table 3.7, to Europe declining by 28 percent from about USD26m. in 2000 to nearly USD19m. in 2001, while sales to AGOA eligible countries have increased by some 70 percent from nearly USD8m. in 2000 to some USD13m. in 2001. As suggested earlier, this figure could have been much higher if Zambia had become eligible for AGOA at and earlier time. Table 3.7: Destinations of Zambian Textiles Exports (US $ million) 2000 2001 2000 2001 Germany 12.95 10.00 Mauritius 0.27 2.82 Switzerland 7.32 2.71 Congo DR 0.20 0.38 UK 3.10 1.21 Botswana 0.18 0.86 Belgium 2.48 2.81 Italy 0.16 1.24 South Africa 5.26 8.21 Ireland 0.00 0.18 Tanzania 1.61 0.76 Kenya 0.00 0.11 Zimbabwe 0.73 0.67 Burundi 0.00 0.04 Spain 0.62 0.57 Namibia 0.00 0.02 Malawi 0.31 0.22 France 0.00 0.04 Portugal 0.27 0.63 USA 0.00 0.00 Note: Countries in italics have become eligible for the Apparel Provision of AGOA. The greatest increase in exports was recorded to the South African market. Under the SADC Trade Protocol from which Zambia has benefited, there are two key provisions for textiles. Firstly, by using SADC certificates, the duty paid is half the effective rate. Secondly, under the MMTZ (Malawi, Mozambique, Tanzania, Zambia) provision, duty free access is provided to exporters subject to a quota. The total quota for the MMTZ countries is 8,000 MT, of which Zambia has an allocation of 1,700 MT. Zambian firms note that this quota is too low in its case, pointing out that Mozambique had a quota of 3,600 MT which it has been unable to fulfil. Firms require the government to re-negotiate the quota. However, there have been difficulties in implementation - the two provisions should have been implemented in parallel, but there were reportedly delays within government in dealing with the quota allocations. RSA issued a Statutory Instrument in March 2001, which should have enabled Zambian industry to avail of the quota from May. However, firms were unable to take advantage of the quota until November, giving them two months to avail of a 12-month 30 allocation. Despite the delays, Zambia - as a result of intensive industry lobbying - was the first country to move under MMTZ. There are a number of problems associated with textile exports to South Africa. Firns are commonly paid in Rand; some of them get part of the payment on delivery, with the balance after some 60 days; and yet others sell to buyers without any security and in whom the exporters lack confidence. Everywhere, Zambia has suffered from a swing away from medium-term contracts to spot contracts - buyers have preferred to buy as yarn is needed to benefit from falling world prices. This, in turn, has hindered spinners in entering into medium-term contracts with cotton suppliers and benefiting from larger order sizes. Zambia-China Mulungushi, which sell much of its output on the domestic market, is not in a more comfortable position either. It has about 30 percent of the market for its printed fabrics, and is threatened by producers from India and Pakistan. Although there is a 15 percent duty on the imported products (when the importation is undertaken formally) the imports are still cheaper than the Zambian products. Although the locally-made ones are of better quality, price is particularly important at a time of declining disposable incomes. However, on the other hand, the quality of the firm's production, particularly of garments, is not of a high enough standard to export to the USA and so take advantage of AGOA. 3.2.7. Conclusions and recommendations The textiles sector is in crisis due to changes in market conditions particularly in Europe; unfortunately timed investment in the sector; unfavourable movements in currencies, combined with the purchase of inputs in USD and the sale of outputs in weaker currencies; and a failure to negotiate raw materials at world prices. On the positive side, the sector now is in a position to avail of the SADC Trade Protocol and of the AGOA Apparel Provision. However, government inactivity in some areas has hindered the sector in coping with the changes in recent years: in implementing desirable trade agreements; in providing favorable duty drawback conditions; and in delays in refunding duty drawback and VAT. In some cases, firms have not been able to retrench because of the labor regulations and are working at below capacity. It is a sellers' market for the providers of inputs, and a buyers market for the purchasers of outputs. Firms have little control over their fate. At the spinning level, there needs to be a thorough restructuring of the sector - without this it will not be able to take full advantage of regional demand fuelled by AGOA; be ready for an upswing in world prices; and prospective strengthening of the Euro against the USD. If the government wants the sector to survive, it has to be more responsive to the needs of the sector, and to address the needs in a timely way. 3.3 ENGINEERING 3.3.1. Introduction The engineering sector encompasses the following sub-sectors: semi-finished and finished non-ferrous metal by-products, such as copper rods and cables; finished metal by-products and consumer goods, such as metal railway sleepers; and other engineering products, such as carbon brushes. The export of these products has declined from USD42.2m. in 1997 to USD22.0m. in 2001, and the sector's share of total NTEs has declined from 13 to 8 percent. 31 Table 3.8: Exports of engineerine products (US $ million) 1997 1998 1999 I 2000 F 2001 42.2 31.7 23.2 20.6 22.0 Zamefa, the biggest manufacturer in Southern Africa of copper rods, copper wire, power cables, and the like dominates the sector's export markets with over 90 percent of business. The firm was privatised in 1996, and is now part of the Phelps Dodge Cable and Wire company of the US. Most other firms in the sector are of medium size supplying only the domestic market. Many of them have stopped production in the recent past, e.g., Galco, and Zamula, because of cheaper imports from China, Russia, and RSA and a decline in purchasing by the copper mines. Some are also dependent on government infrastructure projects which have suffered during 2001 - for example, a rural electrification initiative has been delayed. 3.3.2. Natural Endowment Zamefa, as the dominant finn in the sector, depends greatly on locally-available copper, which constitutes some 70-80 percent of its cost of production. As in the case of textiles firms, local raw material availability confers no advantage on the firm. It pays the London Metal Exchange price (USDI,588 per MT in November 2001), payable in U.S. dollars. In 1996, before privatisation, copper was costing the firm around USD100 per MT payable in Kwacha. 3.3.3. Enablinu and re2ulatorv environment Zamefa faces severe problems of exchange rate risk management. The company pays for its primary input in US dollars. Additionally, it pays VAT in USD to the local copper mines on its purchases; the mines in turn remit it to the government in Kwacha; and the firm eventually reclaims the VAT in Kwacha. Seventy percent of production is exported, 65 percent of it to RSA, where its main customer pays for its purchases in Rand. However, its chief competitor, a manufacturer in RSA, buys its inputs in Rand. One bright spot in the performance of the engineering sector during 2001, is the increase in exports of copper cables by 29 percent. However, manufacturers are concemed about the 15 percent duty they have to pay on imported insulation material, although there is no local industry to protect in the case of this commodity. Under SADC, Zamefa was exporting into RSA duty free from March to October 2001, when the rules of origin were interpreted differently by the RSA authorities, leading to the imposition of a 15 percent duty. After many representations, its duty free status was reinstated in early 2002, but the firm had lost 15 percent of its business during the intervening time. The government has not been as efficient as it could have been in assisting the firm. Staff in the MCTI have left, without a proper transfer of responsibilities and knowledge; documents were mislaid and action came to a standstill. Finns report that the views of the industry are not adequately represented at trade negotiations. In the case of COMESA, Zamefa experiences difficulties too. It exports to Kenya and its goods are inspected by the pre-shipment agency. The relevant documents are couriered to the customer who seeks to pre-clear the goods at the border. However, commonly the pre-clearance procedures are not completed before the truck arrives at the border. Of some 60 trucks going to Kenya per year, some 25 of them may have to wait 2-3 days while the clearance procedures are carried out. 32 3.3.4. Infrastructure Zamefa suffers from the same infrastructure problems as other exporters. Some of its exports are to the north and it reports there is a lack of back-hauling from this direction which makes transport costly, e.g., USD7,000 to send a truck to Uganda. In some cases, the ban on trucks loading in third countries, has impacted on firms in the sector. This means that if a truck drives from Dar-es-Salam to DRC to make a delivery, it is not allowed to pick up a load in Zambia on the return journey. 3.3.5. Micro-economics, business strate2v. and demand Zamefa is one of a small number of firms in Zambia which operate within internationally recognised quality standards. It has IS09000 quality system certification. And it is also audited by the South African Bureau of Standards each quarter to ensure it meets RSA standards - a requirement which the firm has to pay for. Zamefa sees potential in the DRC market as, for example, in supplying materials for the rehabilitation of infrastructure and mines. It believes it could treble its sales there. However, although it has an agent in the country with whom it has had a long association, its principal constraint is in getting paid. Another barrier is that marketing staff, whose part-time presence in Uganda is noted in their passports, have been barred from entering the Congo on political grounds. 3.3.6. Conclusions and recommendations The sector has suffered, as far as domestic sales are concerned, from reduced purchasing by the mines and the government - through its infrastructure projects. Firms are hit by imports from cheaper supply countries. Zamefa gets no benefit from being able to obtain its copper in Zambia which is pays for in USD, as it does the VAT on copper. This firm has problems in trading with regional countries, and government support to overcome barriers is inadequate. 3.4 GEMSTONES 3.4.1. Introduction Products of the gemstones sector include, in order of importance, emeralds, tourmalines, aquamarnnes, amethysts, citrines, and garnets. Mining mainly occurs in Ndola Rural (the area of the emerald mines), Itezhi tezhi, Kalomo, Lundazi, Mkushi, and Mumbwa. After declining as a result of the Asia crisis in 1997, the recorded exports from the sector have nearly doubled during the past four years. Such recorded exports may, in fact, represent only a small proportion of the actual level of gemstone exports from Zambia. Some stakeholders indicate that these expects are at least $50 million and there are even suggestions that actual exports approach $100 million. The reason for this uncertainty is the presence of a considerable amount of illegal mining and trading activity. Table 3.9: Gemstones' ex)orts, 1997-2001 (USDm.) 1997 1 1998 1 1999 2000 2001 14.5 11.5 13.8 15.4 20.3 33 The gemstone sector is a fragmented one, with some 454 entities having a 10-year gemstone license, and another 430 individuals having 'artisan mining rights' which need to be renewed every two years. The sector includes four relatively large firms whose mines employ 300 or more workers each. There are then about a dozen medium-sized operators, and a plethora of very small informal ones. There is some evidence that some of the larger firms are taking over the smaller ones. The largest firms use mechanised production techniques, while the smaller ones employ basic hand tools. There are some fifty regular traders of Zambian gemstones. There is no overarching association which represents the interests of the sector.'6 Only a very small amount of value-added in undertaken in Zambia, mainly to semi- precious stones, principally through knocking (to take away poorer quality material) and tumbling (to regularise the shape of, and to smoothen stones). A little cutting of emeralds is carried out. It is estimated that less than 10% of the gemstones exported from Zambia are cut or refined in any way, meaning that the bulk of value-added to these stones is earned abroad by international trading houses, jewellery factories, and others. 3.4.2. Natural endowment Zambia is well endowed in semi-precious and precious stones, but the mining areas are in the remoter parts of the country. Zambia has the second largest deposits of emeralds in the world. The quality of these stones is very good for color and specific gravity but somewhat poorer than competitive Colombian stones in terms of their structure and transparency. The emeralds are harder to mine in Zambia than in Colombia, where extraction costs are said to be 40 percent lower. Zambia has Africa's largest deposits of amethyst and aquamarine, with the quality of the former considered to be amongst the best in the world. There is abundant labor for mining purposes. However, in the case of the larger and formal mines accommodation has to be provided at the mining sites because of a lack of transportation (partly due to poor roads) and for reasons of security. There is no shortage of mining engineers due to the expertise developed by the copper mines, although many such engineers may lack gemstone-specific experience. Skilled labor, however, is relatively expensive in comparison with that in countries where gemstone cutting is widely carried out. For example, such labor may command upwards of US$ 400/month in Zambia compared with only $50 and $25/month in China and India, respectively. The sector is dependent on foreign professionals and a high proportion of the senior management is foreign. The largest gemstone mining company, for example, employs six foreign and four local geologists, and it has three foreign gemologists.'7 3.4.3. Enabling and regulatorv environment The largest mines in the sub-sectors of precious stones and semi-precious stones, (i.e., Kagem Mines and Kariba Mining respectively), are firms in the process of privatisation. This has taken some five years and has greatly constrained their development. For example, one firm has earmarked several million US dollars for investrnent which has been put on hold. This would increase the capacity of the mine by opening up new pits and enable the firm to diversify into 16 The gemstone supply chain begins with a comnbination of legal and illegal mining. The next step consists of a combination of local dealers, local lapidaries, and illegal traders. They then deal with international trading houses, foreign lapidaries, gemstone bourses, and international trade fairs. The cut gemstones are subsequently used by jewellery makers, goldsmiths, craft firms, etc. 17 The capability of the latter may determine whether a stone is worth USDI0,000 or USDI00,000. 34 cutting and polishing. In another instance, a firm is hiring heavy equipment at USD100,000 per month, whereas if it was buying the same equipment it would be paying USD70,000 per month. Firms which are being privatised are having to take over their pre-existing workforce, although in at least one case the firm is 20 percent overstaffed.'8 A wide range of government agencies-including the Ministry of Mines, regional mine bureaus, the Zambia Revenue Authority, the police, and agencies dealing with labor and immigration-play roles which impact on the enabling environment for the sector. The actions of the different agencies are said to be poorly coordinated and gemstone companies must devote a considerable amount of time and resources to interface with these agencies. The Mining Act of 1995 defines the 'rules of the game' for participation in and oversight of the sector, although extra-legal mining and gemstone trading occurs on a substantial basis. Company managers, already in short supply, devote considerable time to processing documents which are connected with marketing and export. Because there is a lack of government services in Ndola, the General Manager of the third largest firm in the sector spends four out of five working days each week when the mine is in full production in Lusaka, processing documents. Not only do managers have to travel to Lusaka, but government officials have to travel to Ndola - a government valuer has to travel there to prepare'a valuation certificate for the stones and such visits may cost the firm over USDI,000 each visit. Travelling of this kind reduces the effectiveness of the government which already lacks qualified professionals to effectively regulate the sector. Although the Ministry of Mines has an office in Ndola, it does not provide the range of services which firms in the area need. To compensate for this, in part, one firm hires an office in Lusaka for USD18,000 per year to facilitate it in the work it has to do in the capital. The firms interviewed complain they are treated neither as traditional exporters nor as non-traditional exporters. They do not get duty and VAT exemptions as do copper mining firms, nor do they get lower rates of corporation tax as do non-traditional exporters. In addition, they note the introduction of local council taxes, seemingly at inflated rates, while enjoying few, if any, benefits from them. 3.4.4. Infrastructure There are many concerns over infrastructure - according to the leading companies, it is by far the biggest impediment to full capacity utilisation. See Table 3.10 for some indicators pertaining to the infrastructure constraints faced by the leading firms.19 It is said that 40km of the 65km road from Ndola to Ndola Rural lacks an all-weather surface. One firm is paying USD100,000 per month for self-generated electricity - twice what it estimates it would pay ZESCO if the state provider connected the mine to the grid. This lack of infrastructure contributes to the situation where only one mine operates all year round. Other enterprises cannot afford the cost and time to access the mines during the rainy season, and lack a supply of electricity to keep the mines dry. While security plays a part, one firrn has to use helicopters to bring stones to its bi- The reputation acquired by government in the privatisation process has negatively impacted on foreign investment, although the calibre of some potential investors is uncertain. The effectiveness of the Ministry of Mines in promoting the Zambian gemstone sector abroad is a concem. However, this does not stop several investment opportunities being advertised on the internet by private promoters. Perhaps the inactivity on the -part of government, combined with internet advertising, is leading to the kind of interest Zambia may not desire. 19 The picture of poor infrastructure is shared by at least one potential investor, who was escorted to a gemstone mining area by the Export Board of Zambia. This South African gold miner, who wanted to diversify into gemstone mining in Ndola, was so shocked by the roads that he took one look and vowed not to return. 35 monthly auctions, while another spends USD2,000 for an hour a month to carry ten times that in wages to its mine. Table 3.10: Distance of Leading Firms lperations From Infrastructure (Km.) Locale Metalled Road Electricity Water Health Clinic Primary _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _ _S c h o o l Old Mukushi 100 14 10 100 13 Mapatizya 70 40 Own 40 1 Ndola Rural 50 50 Own Own 10 Lundazi 60 100 100 60 60 3.4.5. Micro-economics and business stratezsl Despite the constraints to their businesses and the uncertainties associated with the privatisation process, the leading firms interviewed indicated that they expected to achieve very rapid growth in sales during the coming year, exceeding 60% in some cases. Investment is occurring in the sector, both in plant and technology, although this is difficult to quantify. Some efficiencies are occurring-- one of the largest mines claims to have reduced its operating costs by one third over the past couple of years. Some costs reductions are important given the relatively high extraction costs in Zambia compared with those of Colombia. Open pit mining of gemstones is more expensive than drilling into the sides of hills, the most common practice in Colombia. Kagem, Zambia's largest company, is now beginning to tunnel from its open pits into the surrounding 'hillsides' to reduce cost. Nevertheless, it has to operate pumps 24 hours a day to keep the pits dry. Grizzly Mining, a new player, is investing in excavators and dump trucks to double its capacity. But the cost of this is exacerbated by the fact that the firm cannot extract any emeralds for perhaps one third of the year due to a lack of infrastructure and the impassability of roads. Several firms are, or are hoping to capture more of the value-added from their gemstones through improved selection, cutting, and polishing. For example, Kagem plans to import lapidary machines from India when privatisation has been completed and increase the value of some of its production threefold by cutting and polishing emeralds. It will hire Indian gemologists and train local workers. However, other firms point out the dangers of this, observing that the market is conservative and that traditional buyers will shun opportunities to buy, suspecting that the best stones have been retained for cutting and polishing in Zambia. Firms which are unable to obtain stones throughout the year, on account of infrastructure problems, will have difficulties developing added value markets. 3.4.6. Demand India is the main market for Zambia's gemstones, accounting for more than half of the recorded export value. By and large, these stones are destined for Jaipur where they are cut and polished and used by the local industry. Increased purchasing from South Africa has resulted in it moving to second place, while a decline in purchasing by the USA has led to a decline in its importance. Table 3.11: Destinations of Zambia's Gemstone Exports (2001; US $ Millions India | HKK R RSA | Thai I Israel | Korea I UK I Switz I USA | France 11.64 1.52 1.48 1.45 1 1.10 I 1.01 l_0.62 1 0.53 1 0.36 1 0.17 Source: EBZ 36 One of the reasons for the decline in US sales was a steep decline in emerald prices following September llth, with firms reporting a drop in value from USD250,000 to some USD150,000 per kg. It should be noted that Brazilian and Colombian prices are higher than Zambian ones partly because they are closer to the market, because these countries have a more consistent output, and because of the competitors' ability to add value. By contrast, Zambia's market changes by the season with, for example, Japanese buyers entering the market ahead of the traditional time for weddings. Kagem is almost unique in its marketing methods - holding some five or six auctions per year in Zambia, which are attended by up to 170 buyers. It believes it would be in the interest of the sector if more suppliers entered the market and marketing was more formal. This would help provide critical mass to attract buyers interested in year-round supply and eventually lead to price increases. Some firms have more personal relationships with buyers advising them individually when supplies are available. Some smaller miners piggy-back on Kagem and seek buyers when Kagem attracts them to its auctions. Other small-scale miners visit India and other markets to sell directly to buyers and to attend fairs. 3.4.7. Conclusions and recommendations The gemstone sector shows considerable potential in theory, though several of the key players doubt whether the potential can be realised in practice. There is a surprising lack of confidence in the sector's development although individual firms show optimism over their own growth prospects in the coming year. There is clearly a market demand for Zambia's production and while the demand and prices for emeralds has peaks and valleys, the demand and price of semi-precious stones like amethysts is more consistent. If output can be increased and sold though formal channels, there would be a the prospect of better markets, like the US, and for higher prices. There are a number of market niches for lower value products, transported by road and sea, which can utilise some of the waste. However, the industry suffers from a tarnished reputation, in the face of a long drawn out privatisation process, the prominence of illegal mining and gemstone trading activity, and the widespread application of blasting techniques which do enormous damage to the gemstone resources available. The lack of infrastructure in and around the gemstone mining areas is a deterrent for investment and it too contributes to a short-term orientation to extract whatever gemstones one can in the shortest period possible. Fostering sustained growth would be assisted by inward foreign investment by intemationally recognised players in order to improve technologies, increase training and management skills; and develop reputable, enduring market linkages. To realize the sector's potential it will be necessary to control and minimize illegal mining and trading activity and the application of inappropriate mining technologies (i.e. blasting). The govemment will need to demonstrate its commitrnent to address the infrastructure constraints facing the industry and then follow up on those commitments. Reputable foreign investors need to be enticed into the country, as much to enhance the reputation of the industry as anything else. Appropriate policies with regard to the importation of stones (for value addition), of machinery, and of skilled workers will need to be put in place. Measures should also be introduced to foster the development of the smaller indigenous mining enterprises to supply bigger firms and to piggy back on the market linkages of the larger existing exporters and new foreign investors. 37 3.5 PROCESSED FOODS 3.5.1. Introduction Zambia's exports of processed foods has been variable in recent years and totalled $43 million in 2001. Sugar accounts for most of these exports, typically 85-90% in any one year. Sugar exports are undertaken by the Zambia Sugar Company, formerly a parastatal managed and part-owned by Tate and Lyle, but since April 2001 owned by the South African firm Illovo. Illovo is Africa's leading sugar producer and a significant manufacturer of downstream products. Headquartered in South Africa, it also has agricultural and manufacturing operations in Malawi, Swaziland, Mauritius, Tanzania, Mozambique, and Zambia. Most of the remaining processed food exports consist of maize meal, wheat flour, and stockfeeds, essentially as an extension of the domestic market for these products. For most millers and animal feed companies, exports constitute a very small proportion of their sales as Zambian- based firms are not regionally competitive in these products, with the possible exception of providing supplies into the DRC. The processed food sector is sufficiently diverse that it is not an especially useful category of analysis in terms of non-traditional exports. Special attention is given here to developments in the sugar sub-sector while further coverage of issues within the cereals milling/animal feed industries is provided in Chapter 4. Table 3.12: Processed food exports, 1997-2001 (US $ million 1997 l 1998 l 1999 2000 2001 30.8 49.4 33.0 35.5 43.0 3.5.2. Natural endowment Firms report on the favourable conditions in Zambia - the amount of sunlight, the quality of the land, and water - when and where available. Zambia Sugar reports that these conditions have contributed to the firm having the second lowest production costs in the region and among the lowest cost producers in the world. Firms have been constrained in the past year, as far as exporting is concerned, by inadequate raw materials due, in part, to climatic conditions. For example, maize production fell from l.lm. MT in 2000 to 0.80m. MT in 2001, compared with a national consumption of 1.3m. MT, leading to a ban on the export of mealie meal. The cane harvest, too, was down from 205,000 in 2000 to 199,000 MT in 2001. Market uncertainty is a sizeable reason hampering optimising Zambia's natural endowment by, for example, irrigating land. In this period of uncertainty, Zambia Sugar, to give an example, seeks to increase yield by introducing new varieties of cane and improving extraction. 3.5.3. Enablina and regulatory environment Zambia Sugar has encountered problems in taking advantage of regional trade agreements. For example, there were constraints in sugar exports to RSA during 2001 due to delays in South African gazetting of the SADC trade protocol under which there is a 9,500 MT quota. This was only done in December after lobbying by Zambia Sugar in South Africa. Even so, there will be difficulties in the smooth operation of this as South Africa requires certificates of origin to be sent in advance of goods being shipped and the firm reports problems matching truck loading with the documents. 38 Elsewhere, Zambia Sugar anticipated benefiting from duty-free access to Kenya under COMESA FTA, but has experienced problems. In early 2001, Kenya complained that Zambia was one of a number of countries threatening its own sugar industry and invoked 'safeguard' measures which are affording protection to the Kenyan industry through the imposition of a quota and tariffs until at least April 2002. This case is detailed further below. In the domestic market, Zambia Sugar has faced competition from Zimbabwe, despite the former being cost competitive and having ample supplies to meet local demand. Zambia Sugar is required to produce vitamin A fortify sugar for the local market, adding approximately US$10 per metric ton to its cost and also reducing its shelf life. Several firms report new charges, or significant increases recently in the cost of complying with government regulations. In Zambia Sugar's case, the processing fees for bills of entry have increased from K 1,800 to K 32,750 per bill of entry - each truck has to have a bill of entry. There are difficulties too over phytosanitary inspections which require provincial firms to get Ministry of Agriculture inspectors from Lusaka - although there maybe nearby ministry offices. 3.5.4. Infrastructure Fimis complain about transport and electricity problems. The impact of the former can be seen - in the table below. In the case of exports to all regional markets, transport was rated as the most limiting factor. While electricity has not emerged as a big problem in the sector as a whole, it causes difficulties in selected firms. For example, in the case of one milling firm, six percent of stoppages are due to power outages. As the firrn notes, if the outages were scheduled, it could undertake routine maintenance at the time of the outages. Zambia Sugar which has considerable regional experience observes that it is "stunned by the cost of services" such as legal and mechanical engineering in Zambia, indicating that they are more than double the cost of equivalent services in RSA. In sharp contrast with the perceptions of textile companies, managers in this sector with intemational experience are, on balance, complimentary about worker productivity and the labor laws. One of the most experienced observes that the labor laws are comparatively benign; that staff do not present problems if treated well - including the provision of medical and housing allowances. However, it is noted that labor is more expensive than in Malawi, and while graduates are good, they are weak at applying their knowledge. Table 3.13: Factors limitingexports to selected Markets RSA DRC Other SADC/ COMESA Weigrhted av. Weighted av. Weighted av. High tariffs on products 0.20 0.40 0.20 Low quota limit 0.40 0.40 0.00 Domestic content requirement in markets 0.00 0.00 0.00 Subsidies to local firms 0.00 0.00 0.00 Rules of origin requirements 0.60 1.00 0.40 Shipping / transport costs to market 0.80 1.20 0.80 Customs procedures in the market 0.80 1.20 0.60 Payment problems with buyers 0.20 0.60 0.20 Restrictive product standards 0.20 0.20 0.80 39 3.5.5. Micro-economics and business strategy Capacity utilisation varies widely in the sector. Zambia Sugar operated at 94 percent capacity, while the milling firms operated at between 30 and 80 percent capacity. Low capacity utilisation presents problems to firms as they become overstaffed and are hesitant to retrench due to high severance costs. In general, no single factor was paramount in lowering capacity utilisation as shown in the table below,unlike in other sectors where, generally, a single factor is overwhelming. Factors affecting competitiveness and capacity utilisation were mainly related to the availability and cost of raw materials. This was true particularly in the case of milling firms. Table 3.14: Factors affecting competitiveness and preventing firm working at full capacity Factors affecting competitiveness in past year Factors preventing firm working at full capacity Weighted Weighted RV. av. Raw material / input price changes 1.00 Others 1.40 Transport / freight price changes 0.80 Unavailability I cost of local raw 0.80 materials Raw material / inputs availability changes 0.60 Unavailability / cost of intermediate 0.60 goods Exchange rate changes 0.60 Lack of working capital 0.60 Changes in foreign market(s) 0.60 Unavailability / cost of imported 0.60 rnaterials Other (please specify) 0.60 Shortage of skilled labor 0.40 Infrastructure supply changes 0.40 Power failures 0.20 Market access regulation changes 0.20 Equipment breakdowns 0.20 Zambia's weak packaging industry is considered a competitive disadvantage. Millers, for example, report that common 50kg polypropylene bags are made in Zambia, but 10kg bags have to be sourced from Zimbabwe (because no suppliers in Zambia attach handles to the bags) as are all smaller bags. Interestingly, distinctive packaging can give firms a competitive edge. Sudan is exporting sugar into the Great Lakes area and taking market share from Zambia Sugar. One of the reasons for the competitive success is that the Sudanese bags have secondary uses, which Zambia Sugar is trying to emulate. Processed food firms are finding it necessary to adjust their products for different markets - tastes vary widely in the region. In the case of sugar, Kenyan consumers prefer bigger crystals and there is a need for a higher proportion of brown sugar. In the case of RSA, Zambia Sugar feels it should promote better types of sugar, such as caster sugar. At least one of the millers is putting nutritional supplements into its flour. There is little investment in product development, but the processed food companies seem to be more proactive than other sectors - particularly those with foreign ownership. In the case of millers, competition is likely to be a contributing factor. Several are a similar size; they have a comparatively similar output per worker per year (some USD4,000 to USD5,000); and, in general, their core markets are in the region in which they are located. There are some signs that these firms are keen to acquire technology. One firm, for example, hired a foreign consultant to benchmark the firm; visits international milling conferences; and meets with other millers. Two firms have IS09000 certification. One modest-sized miller is hiring Zimbabwean professional market research consultants to research the Zambian market and, 40 subsequently, regional markets. Some firms are beginning to cooperate in the purchase of Argentine wheat flour - some of which is needed to improve the quality of Zambian flour. 3.5.6. Demand The DRC accounts for over half of Zambia's processed food sales. The volume of exports to DRC is notable in view of the difficulties in servicing the market, such as delays at the border, border costs, and problems in getting payment. However, one of the benefits of selling to DRC can be the higher prices realized, when considering the high transport costs associated with transporting and shipping relatively low value sugar to international markets. Zambia Sugar is facing increasing competition in the DRC market from Zimbabwe with improved road links and the need of Zimbabwean firms to earn foreign exchange. The Kenya market was developed by Zambia Sugar with the advent of the COMESA FTA but, as noted earlier, protection has been afforded to the industry there. The sector's exports to Tanzania declined partly as a result of its withdrawal from the COMESA agreement. Zambia Sugar has increased its exports to the EU (notably, Portugal) under the Agreement on Special Preferential Sugar and from March 2001 was eligible to benefit from the Everything But Arms (EBA) initiative which will increase the available quota for Zambian sugar by 8% per year (albeit at FOB prices below those obtainable within the DRC). Table 3.15: Destinations for Zambian Processed Food Exports, 2000 and 2001 (US $ million) 2000 2001 2000 2001 DRC 19.2 18.4 Uganda 1.1 1.0 Kenya 1.5 6.8 RSA 0.7 0.7 Portugal 5.8 6.3 Tanzania 1.7 0.4 Rwanda 1.9 3.7 Zimbabwe 1.7 0.2 Burundi 0.6 1.1 Namibia 0.5 0.1 3.5.7. Conclusions and recommendations Recently enacted trade agreements, such as COMESA, SADC, and EBA, present Zambia with an opportunity to expand its sugar exports and, to a more limited extent, its exports of other processed foods. However, within the region, where most of these exports would be directed, there remain concerns about political and economic stability and overall trading conditions which inhibit the development of long-term buyer-seller relationships. The Government must recognise the importance of long-term relationships and, for example, aid firms in importing materials as and when necessary so continuity of supply can be ensured. It must be more supportive in its negotiations with its regional trading partners. Firms report the government to be "slow moving." There is some evidence of inter-firm competition between millers which encourage technology acquisition, but firms are not optimising technology acquisition incentives. Government-to-firm, and firn-to-firm information flows need reinforcing. Firms must transfer best practice between each other, particularly where they are not competing. For example, those which have overcome problems on the DRC market, must advise firms which are experiencing similar trading problems. 41 3.6 VEGETABLES AND CUT FLOWERS 3.6.1. Introduction Zambian air-freighted exports of vegetables and cut flowers to Europe was initiated in the 1980s by a number of commercial farmers who sought access to scarce foreign currency in order to finance imports of equipment needed for their more mainstream activities (i.e. cereals and livestock production). These exports remained at very modest levels until the mid-i 990s when a number of commercial farmers and non-farmer business persons were able to access a concessional line of credit provided by the European Investment Bank to finance the long-term investment costs of floricultural production. Several other low-interest lines of credit were subsequently made available to entrants in the cut flower sector. Some of these cut flower operators subsequently diversified into specialty vegetables for export as well. Important support was provided by the EU's Export Development Project which assisted in the financing of a cold storage facility at the Lusaka airport plus provided financing for the importation of production inputs and the payment of air-freight costs. Both vegetable and cut flower exports accelerated in the mid-1990s and by 1998, Zambia had become Africa's third largest cut flower exporter.20 While the available data on the volumes of Zambian cut flower and vegetable exports is considered accurate and reliable the same cannot be said for the data being reported to and by the Export Board of Zambia for the values of such exports. Cross-checking the EBZ figures with those of the Customs Department does not provide clarity because at the time of export the actual value for these exports is frequently not known due to the manner of transactions abroad(i.e. auction sales for cut flowers). Apparently, some of the customs declarations are simply left blank. In any case, the values being reported by the EBZ cannot be FOB values, considering comparative unit values from closely competing countries.2' Recent discussions with exporters and officials from the Zambia Export Growers Association suggest that the figures being reported to EBZ are estimates of overseas market values (i.e. for cut flowers) or CIF values (for vegetables). To adjust the EBZ data to obtain more realistic FOB estimates one would need to reduce the cut flower estimates by at least 50%, given an average commission rate of 15% and air-freight costs accounting for at least 35% of the final value. In the case of vegetables, the appropriate adjustment would be a 40% reduction, this being the approximate portion of CIF 20 Other incentives provided to the sector included a 15% corporate tax (compared with 35% normally), a five-year exemption on dividends from farming activities, customs duty exemptions on most capital equipment, duty free imports of agro-chemicals, and generous depreciation allowances on machinery used in agriculture. 21 For example, in the case of cut flowers the unit FOB value for Kenyan exports in 2001 were $3873/ton, while the requisite unit value for Zimbabwean flower exports was $3409. Based on EBZ numbers the unit value for Zambian cut flower exports would have been $9060/ton in 2001. While the varietal mix of Zambian flowers may well yield a small premium over that of its main competitors, this would be no more than 10%, meaning a unit FOB value of perhaps $4000. The latter figure would imply FOB earnings of some $15 million in 2001, less than half of the EBZ's figure. A similar anomaly applies to vegetable exports. In 2000, the unit value for Kenya's vegetable exports was $1617/ton while the EBZ data imply a unit value of $561 1/ton for Zamnbia vegetable exports. Again, the Zambian vegetable basket may indeed have a slightly higher unit value than that of Kenya, yet nothing of the order of magnitude implied by the EBZ figures. Assuming a 20% unit value premium this would imply an average FOB value of just under $2000/ton for total exports of $9.7 million (approximately one-third the EBZ figure). 42 values which must be applied to air-freight and other overseas handling activities. Table 3.16 includes the EBZ reported values and our adjusted values based on this approach. It is our view that even these adjusted estimates still overstate the true level of FOB earnings from cut flowers and vegetables. The overestimate could still be rather considerable in the case of cut flowers. Table 3.18 provides Eurostat data on cut flower imports into the European Union. These are presumably based on CIF values. Through to 2000 these import values from Zambia never reached 20 million Euros in any one year. Further work is needed to re-assess the value of Zambia's vegetable and cut flower exports and to put in place an improved system for recording these values on an annual basis. Nevertheless, both the EBZ figures and our revised estimates suggest that while Zambia's vegetable exports continue to expand, those for cut flowers reached something of a plateau in 1999 and have been lower since. Table 3.16: Estimated Vegetable and Cut Flo er Exports (US$ Million) 1998 1999 2000 2001 Vegetables EBZ 17.5 21.0 20.0 35.9 Adjusted 10.5 12.6 12.0 21.5 Cut Flowers EBZ 32.9 42.6 33.9 34.1 Adjusted 16.4 21.3 17.0 17.0 Table 3.17: EU Cut Flower Imports from Africa (000 EUROs) 1994 1995 1996 1997 1998 1999 2000 KENYA 65889 75686 84203 99056 110771 130137 153014 ZIMBABWE 27721 36012 39974 45291 50377 51166 66121 ZAMBIA 3422 4394 6816 8475 12188 15969 17468 UGANDA 1017 2134 3212 4402 4791 5605 10625 RSA 7637 8343 8137 8583 8220 8281 9081 TANZANIA 2285 3220 3845 5125 5443 7627 8393 OTE D'IVOIRE 1912 1519 1644 1812 1911 2051 2775 MAIJRITIUS 1921 1626 1375 1824 1917 1510 1647 otal 113798 134929 151202 176565 197616 224345 271124 Source: Eurostat. Adapted from COLEACP Zambia's vegetable exports consist of a range of speciality items including snow peas, green beans, baby corn and carrots, chillies and a range of other items. There are about a dozen sp,ecialized commercial growers of these crops with an estimated irrigated area of 5000 hectares. While many of these growers used to export thernselves, at present two companies account for virtually all of the exports with these other growers selling to them on an out-grower basis. Most of these growers were unable to make the necessary adjustments when the trade moved from a distribution system built around London's wholesale markets to one featuring direct contracts with supermarket chains. Only the two dominant firms have been able to regularly meet the requirements of the supernarket chains for quality, continuity, and reliability. Recently, one of the.large vegetable export companies has entered into an arrangement with some 500 smallholder out-growers. This program is being carefully watched to determine the feasible scope for further broadening participation in this sector. 43 With regard to cut flowers there are some thirty-one registered growers, with some 145 hectares under roses (about 60 different varieties) and, until recently, about two dozen hectares under a range of summer flowers. Increases in air-freight rates have rendered trade in most of the latter to be unviable. Among the registered rose growers at least half have gone or are approaching bankruptcy, including the majority of two hectare operations started by local entrepreneurs in the late 1990s. A combination of inappropriate technical advice, weaknesses in management, financial overgearing, adverse movements in both flower market prices and the Guilder/US$ exchange rate, and other factors have doomed many of these start-up growers. Most of the remaining flower growers have larger operations (i.e. 5 hectares or more) and some have absorbed the infrastructure of the bankrupt growers. A rapid process of consolidation is occurring within the industry. Despite the present precarious market situation for roses, there has been some new FDI in the sector in part due to concems about the future viability of the cut flower industry in Zimbabwe. Between cut flowers and export-oriented vegetables, approximately 12,000 people are employed on a regular basis. The Zambia Export Growers Association (ZEGA) is an important participant in the sector, promoting the interests of all fresh produce and flower exporters by lobbying government; providing an air freight service; coordinating the purchase of inputs and technical assistance; advising on finance; and providing market information. 3.6.2. Natural endowment Fimis note the strengths which Zambia has as a producer of horticulture, such as its climate and the quality, availability and low price of land. The location of Zambia means that the flying times to the main markets in Europe are not dissimilar from those of Kenya or Zimbabwe. However, in order for Zambia to take advantage of these natural endowments, the costs of production and transport must be similar to those in competitor countries. In floriculture, Kenya has some advantages over Zambia. It has a cooler climate and can grow larger roses with bigger heads. In Kenya, roses can be cut in 50 days (with 35 flowers equalling one kg.), whereas in Zambia they can be cut in 35 days (where 65 flowers equals one kg.). North Africa is a competitor, but it's too hot to grow big roses. Labor costs are higher too in Morocco, for example, at USD 6 per day, compared with USD 1 per day in Zambia. Compared with either Kenya or Zimbabwe, Zambia is still at a disadvantage in terms of the pool of skilled horticultural/floricultural workers and managers available to existing or new growers. However, ZEGA has recently established a National Training Trust at the Natural Resources Development College to train middle-level greenhouse and pack-shed managers and other technical staff dealing with roses and export vegetables. 3.6.3. Enabling Environment and Infrastructure Long-term finance is an over-riding problem for the development of the sector. Industry insiders suggest that export-oriented vegetable production could grow by 30 percent a year if long-term finance was available at- competitive rates. This is confirmed by visits to UK supermarkets which buy some 80 percent of Zambia's output. However, there are significant barriers to entry - it is reported that USDIOm. is needed to establish a viable vegetable export business. Still, there may be scope to expand the system of outgrowers linked to the leading vegetable exporters. One of the major impediments to this broadening of participation is poor infrastructure, particularly the availability of roads and water. The dominant exporter reports that it could bring 44 500 or more smallholders into its system if there were improvements in roads and available small-scale irrigation facilities. At present, much of the sector is located within 20 km of the airport and the strengths of the availability and price of land and competitive labor rates will not be sustainable in the long-term without greater disbursement of production. The availability of economical air transport is a central challenge to the further development of the sector. Presently the largest producer avails of chartered flights, supplementing them with cargo space on passenger planes. The surplus capacity of these charter flights is used by smaller exporters coordinated by ZEGA. Constraints include the need to plan one year in advance and have sufficient supply to justify chartered freight, or the need for extra passenger flights if production capacity and planning is lacking. Economies of scale have to be achieved to warrant chartering, or the tourism sector needs to be developed to increase cargo capacity via passenger flights. At present air freight rates are competitive, even though aviation fuel is considerably more expensive in Zambia than in other countries as a result of taxes and the relatively high operating margin of the local oil marketing company. In the medium-term there may be further competition from North Africa for certain vegetables from where goods are trucked to EU buyers for USD0.50 / kg. ZEGA notes that the government has not yet permitted the industry to have an Air Service Permit to enable the sector to make beneficial air freight arrangements. Speed and cost to markets are vital when it is recognised that, in the case of roses, 50% of their cost is transport and that market prices obtained are half those obtained by Netherlands' growers because Zambian roses are two days old by the time they reach the market. Table 3.18: Frei ht costs to Euro e (US $ er kg) Vegetables Floriculture 'Zambia Kenya Zimbabwe Zambia Kenya 1.60 1.50- 1.60 1.65 1.85 1.75 Source: firm interviews 3.6.4. Micro-economics and business strateev The most significant constraint preventing firms working at full capacity, as shown in the table below, is the lack of working capital. This is exacerbated because, in the case of floriculture fot example, most of the inputs are quoted in USD and most of the flowers are sold by auction in the Netherlands in Euros which declined by about 5 percent against the USD during 2001. Medium-sized firms, notably, highlight a shortage of skilled labor - the second biggest constraint which reduces capacity. One of the biggest problems faced by firms is the weakness of supervisors and managers. There are also problems in optimising the capacity of out-growers. Eriterprises note the better educated the farmer, the better the outputs are - for example, in compliance with standards over the application of pesticides Table 3.19: Factors (in order of severity) preventing working at full capacity Weighted average Lack of worldng capital 1.83 Shortage of skilled labor 1.33 Unavailability / cost of intermnediate goods 0.50 Lack of sufficient dernand 0.33 Poor infrastructure 0.17 Unavailability / cost of local raw materials 0.17 Others 0.17 45 In this sector, not only is critical mass becoming more important, but so are (a) quality; (b) the ability to trace the supply of individual products to the farmer and determine the methods used in production; and (c) 'ethical' or 'social' concerns including the treatment and remuneration of labor. Retailers (and flower distributors) are becoming increasingly demanding on these issues and stepping-up monitoring activities all the time. This imposes considerable costs on suppliers, and serves as a partial deterrent to firtns contemplating expanding the range of smallholder outgrowers. ZEGA has become increasingly active in promoting a 'code of practice' related to production and post-harvest management, developed in conjunction with COLEACP and several other African fresh produce export associations. One of the larger firms has sought to gain price premiums by developing the largest area of certified organics production in Africa. The same company has participated in an 'ethical trading' program, in conjunction with its UK buyers. Floriculture also requires economies of scale, and the plight of smaller growing operations was noted earlier. Experts note that firms made errors when establishing their businesses. One of the main ones being their investment in steel greenhouses, which cost some USD250,000 per ha., when the emerging trend elsewhere (i.e. in Zimbabwe) was for wooden structures costing some USD150,000 per ha. These mistakes are exacerbated by the fact that at least some of the small producers did not commit themselves full time to the industry. Even for the larger growers the profitability of cut flowers has declined enormously over the past three to five years and necessitated cost economies and technical changes to retain viability.22 As has occurred in the more mature cut flower industries within Africa (i.e. Kenya; Zimbabwe), there are initial signs in Zambia of the development of local support services and backward linkages, including the development of local nurseries for plant material propagation and the development of local suppliers of greenhouse materials, including wood poles.23 Such developments are important in lowering the costs of the industry and also in increasing its multiplier effects. At present, there is relatively little local value-added in the industry (perhaps 10-15% of export value) given that all capital equipment and most material inputs are imported. 3.6.5. Demand In Zambia's traditional market for vegetables, the UK, there remains considerable growth potential in the range of products which Zambia sells, including vegetables grown under organic conditions. Trade sources point out the potential for vegetable sales into other EU markets where channels of distribution are less consolidated (in the UK, the largest six food retailers have 76 percent of fruit and vegetable sales); of markets in RSA for cabbages and tomatoes24; and of markets in the Middle East. Such markets, it is reasoned, could be supplied by smaller producers. In addition, specialists suggest that even in the UK market opportunities exist for smaller prQducers in organics and exotics. There may be opportunities to take over some of Zimbabwe's traditional market, but UK buyers note that they have had relationships with Zimbabwean exporters for up to 18 years and do not want to switch to other countries unless forced to do so. 22 One interesting development has been the planting of roses in a medium of cocoa shells rather than soil. This method has apparently contributed to the reduced incidence of disease, better water absorption, and imnproved yields. 23 See Thoen et al (2001) for a review of the Kenyan experience. 24There is already a small trade in this direction with baby corn and other speciality vegetables. 46 Table 3.20: Market rowth in selected commodities 2001 estimated % Supermarket Vegetables Legumes (un-prepared) Vegetables (mixed I Organics Exotics prepared) M&S 16 8 29 plateau-ed n/a Sainsbury's n/a 15 n/a 20-25 15 Source: UK firm interviews However, market development strategies demand much investment in market research and planning. For example, UK retailers point out that organics is not an easy option - they take more skill to grow to the required quality than regular chemical-assisted vegetables (and require certification from a third-party organization, typically based in Europe). Research too is needed to identify crops in decline, such as runner beans. Firms point out that much work has to be undertaken by the government to establish a favourable image for Zambia - in the eyes of consumers the country is sometimes confused with countries which have an unfavourable image. With regard to cut flowers, the market context is different. Firms observe that the market is oversupplied, prices are depressed, and that more r oses continue to be planted in other competitor countries. On the other hand, Netherlands' growers are getting out of short-stemmed roses and planting long-stemmed ones suggesting some market opportunity. Market leaders are sitting on the fence before committing further investment in the sector. In general, the main marketing challenge has been to sell to buyers direct, rather than going through the Netherlands' auctions. Exporters which do sell direct, note that they get a 5 percent price premium and are able to substantially reduce commission costs. However, quality and reliability have to be better to retain the confidence of direct buyers. In addition, it is desirable to specialise in specific varieties which other suppliers are not strong in and which are not relatively common in the auctions. 3.6.6. Conclusions and recommendations Export-oriented vegetable production has the potential to grow considerably though there will be increased competition from both existing and new supply countries. Firms, or groupings of firms must acquire sufficient critical mass to invest in added-value activities, in cost-effective transport, and in quality systems. Marketing skills remain limited in Zambia and the current market outlets are relatively narrow. More investment is needed in market research related to other potential outlets and in enhancing the overall awareness and image of Zambia as a supplier country. On-going steps to upgrade and broaden the range of horticultural/floricultural management skills should be continued. Access to finance at. competitive rates should be facilitated, especially in export-oriented vegetable production where there remains further scope for out-grower development. The near-term future of the cut flower industry is probably one of further consolidation until the time that there is some recovery in market prices. Even for the larger entities to remain profitable there is a need for further improvements in technologies, the selection of varieties for which relatively better market prospects exist, and increased gains in direct marketing of flowers. Continued effective management of air-freight arrangements is also vital for sustained profitability. 3.7 CROSS-CUTTING ISSUES Zambian statistics on non-traditional exports look satisfactory on the surface, yet, as seen above, they mask many underlying problems at both the sectoral and general levels. In fact, when firms were asked about the main reasons affecting their competitiveness during the past year, most of the reasons were negative factors. Table 3.21 shows that only when the seventh 'main 47 reason' is reached--access to improved technology-- is the factor one which increases competitiveness. While this table presents an accurate overall picture, it masks several sectoral variations. For example, six firms placed raw material price changes as their number one reason for a change in competitiveness. Four of these number one reasons were in the textiles sector. On the other hand, in the horticulture and floriculture sector raw material price changes were almost insignificant. In the case of the biggest reason - raw material price changes - it is significant that the raw materials prices firms complain about are locally available materials, such as cotton, which are priced in USD which, as shown in Table 3.22, has strengthened considerably against the currencies of Zambia's key trading partners. The Euro, Rand, and Kwacha depreciated between 5 and 65 percent against the US dollar between early January 2001 and early January 2002. In several sectors it is usual for the Zambian exporter to be paid in the local currency, so the inputs are bought in USD while the outputs are paid for in local currency. Exchange rate changes have also had an impact on other reasons affecting competitiveness, such as transport costs which are commonly denominated in USD. Table 3.21: Main reasons affectin competitiveness in past year Reason Firms placing Weighted Rankdng reason No. I average Raw material price changes 6 0.87 1 Exchange rate changes 4 0.77 2 Transport cost changes 2 0.61 3 Foreign market conditions' changes 3 0.58 4 Infrastructure supply changes 3 0.48 5 Raw materials availability changes 2 0.35 6 Access to improved technology 1 0.23 7 Other, e.g., September 11 0 0.23 7 Market access regulations 1 0.16 9 Labor costs 0 0.13 10 Table 3.22: Exchange rates (US $ compared with selected currencies, 2 Janua 2001 and 2002) Date USD / Euro USD / Rand USD / Kwa 2 January 2001 1.05652 7.569 2880 2 January 2002 1.1073 12.47 4047 Depreciation (percent) 4.81 64.75 40.52 In a number of leading sectors for non-traditional exports-- including textiles, engineering, and primary agricultural commodities-the primary export markets since the mid-1990s have been within the region, and most particularly with South Africa. Zambian firms have been periodically handicapped by non-tariff barriers in selling into these markets. However, on a more sustained basis they have found their competitiveness (and profitability) reduced by an almost continuous appreciation of the Kwacha vis-a-vis the currencies of leading regional trade partners. This development is akin to having the exporters running into a steady and strong wind. 48 Figure 3.3: Real Effective Exchange Rates (REER) for Zambian Kwacha against Other currencies (Index: 1990 =100) 190 - - South African Rand / Kwacha 170 - -- Zimnbabwe Dollar/ Kwacha - - - - Malawi Kwacha / - - . - 150- Kwacha 130 - 110 90 70 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Source: Staff calculations and Intemational Financial Statistics, IMF. 3.7.1. Human capital Most of Zambia's NTEs involve labor-intensive production practices. Even in a sector like textiles, where there is more mechanization than in most sectors, the chief raw material, cotton, is hand-picked. In the main, firms have a limited knowledge of comparative labor costs, or of comparative productivity figures in different countries. They have particular difficulty in benchmarking themselves with competitor countries and may be unaware of their strengths and welknesses in comparison with their neighbours. As indicated earlier, Zambia's agricultural wages are competitive with those of Zimbabwe and especially South Africa, while its textile industry wages are competitive with those of several countries both within and outside the region. However, wages cannot be looked at in isolation - worker productivity must be considered too. This is particularly true in Zambia where wage and productivity levels camot be too far out of line with its competitors - and these include its partners in COMESA and SADC as well as competitors in other markets, particularly within the context of WTO. However, in general, productivity in Zambia appears to be low in international terms. One would expect firms which are members of international groups to be have higher productivity than indigenous firms because of technology transfer and higher investments in machinery. As noted earlier, Zambia Sugar is reputed to be one of the lowest cost producers in the world - due not only to worker training and management but also to the amount of sunlight, the quality of the land, and the availability of water. On the other hand, in the case of a textiles firm which has international experience, it notes that labor productivity is only some 60 percent compared with similar factories with similar equipment in Europe or China. Productivity seems to be particularly low in the case of fully indigenous firms with limited access to foreign technology and management skills. Table 3.23 suggests productivity in Zambia in the furniture sub-sector, which is amongst the lowest in the world. One of the main problems in countries like Zambia in which industry was dominated by the state, is that many firms have a 49 comparatively old workforce with attitudes inculcated during centrally-controlled regimes. Such workers are hard to retrain and it may be costly to retrench them. As a result it is difficult to raise productivity and to introduce new technology. Output per worker, of course, is not just a function of worker skills, but also of the capability of management (as well as of the equipment used). Too often the Zambian worker is blamed for low productivity, but management allied to a lack of technology must share much of the responsibility. Table 3.23 Output per worker in typical furniture factories (IJS $ per worker per year) Zambia Bangladesh Jamaica I Romania Philippines | Ireland 3,590 3,668 10,500 28,000 30,000 115,000 Source: Firm interviews, Tyler Associates Many firms find weaknesses in junior and middle managers. In the case of new graduates, these include (a) work attitudes which are self-serving rather than serving the interests of the employer; (b) poor capability at applying academic knowledge; (c) a lack of computer literacy; and (d) inappropriate previous work experience. In the case of managers with previous work experience, their weaknesses may include having a government rather than private-sector mentality. In some of the sectors, professional skills are lacking and may be expensive. In the case of the gemstones furm Kagem, while six out of seven mining engineers are Zambian, all six geologists are expatriates, and gemmology skills are reported to be lacking. The hire of expatriates can be costly for firms which are trying to reduce costs in this area. 3.7.2. Availability of key inputs The availability of key inputs locally has not conferred any advantage to Zambian firms in a number of industries. While raw material inputs may be available in Zambia, the price which downstream manufacturers pay for them renders the firms uncompetitive. Examples highlighted here include those of Zamefa which has had to pay for copper in US $ at the prevailing London Metal Exchange Price, and the textile firms which have had to pay import rather than export parity prices for cotton lint. The price of cement, too, is a considerable problem for downstream manufacturers generally and for the building sector in particular. Table 3.24: Cement prices: Zambia compared with other countries (US $/MT) Average _ Typical Landed price Average RSA international Germany from international Zambian cement price price seltin(price price Zimbabwe production cost ({) (est) 18-25 50 92 25 30-40 45 60 (a) Since mid-2000. Before Lafage ownership, Chilanga Cement undertook differentiated pricing. (b) Source: ThisDay, Nigeria, 17 April 2001. (c) Price is reported to be the highest price in the developed world. Source: ThisDay, Nigeria, 17 April 2001. In some cases, raw materials are available but the government has taxed them so heavily that firms are rendered uncompetitive. For example, heavy fuel oil comprises 57 percent of the cost of the ex-works price of the limestone firm, Ndola Mines. The firm believes that over 60 percent of the price is due to taxes and VAT. Partly as a result, the price of the firm's quicklime is USD90 / MT, compared with a South African landed price of USD70 / MT. So far, the superior quality of the Ndola product has led to it retain market share, but it worries that as its customers cut costs, the South Africa product will triumph. On the RSA market, the landed price of quicklime is USD120 / MT, compared with a South African competitor's price of USD30. 50 3.7.3. Access to /cost of finance As noted above, NTE exporters reported that the main reason for their firms not working at full capacity was the lack (and cost) of working capital. The relative difficulties of firms accessing finance, are shown in Table 3.25 - high interest rates is the most severe financial factor, followed by the collateral requirements of banks and by a lack of access to export finance. Table 3.25: Severity of financial factors on business development No. of times issue is ranked as very Weighted av. substantial (a) Collateral requirements of banks 13 1.52 High interest rates 20 1.94 Need for special connections to banks 7 1.13 Banks lack money to lend 7 1.00 No / limited access to foreign banks 8 1.13 No / limited access to equity investors 11 1.19 No / limited access to specialized export finance 11 1.48 No / limited access to lease finance for equipment 6 1.06 No / limited access to suppliers credit 5 1.00 Other 1 0.11 (a) The survey question was: How severe are the following financial factors to your business development? Mark the relevant factors as follows: I = minor difficulty; 2 = moderate difficulty; 3 = very substantial difficulty. As indicated earlier, the cost of capital in Zambia is significantly more than in other COMESA countries - roughly twice the rates in Kenya, Tanzania, and Uganda, and more in other countries. During the interviews, firms commonly reported paying around 55 percent interest and up to 60 percent with bank charges of 4 percent. Finns are in a bind - their input costs are high; they maybe buying inputs in USD, and being paid in local currency for their outputs; and the cost of interest is two, or more times that of their partners. In several cases, firms which used to enter into long-term contracts with materials' suppliers now undertake spot buying because they cannot finance the contracts - thus losing out on more favourable prices. 3.7.4. Capacity Utilization With the cost of money so high; firms must operate at high capacity in order to amortise their investments over as many products as possible. As Table 3.26 demonstrates, among a small sample of firms, capacity utilisation averages 62 percent, ranging from 33 to 95 percent. Separating locally-owned firms from those with foreign ownership suggests that locally-owned firms have a capacity utilisation of 52 percent while firms with foreign ownership have a utilisation which is some 20 percent higher. Table 3.26: Capacity utilisation in selected Zambian firms by sector (%) Construction Primary Processed food Engineering Textiles Average agriculture Firm A Firm B Firm C FirmD D Firm E Firm F Firm G Firm H 50 40 50 80 95 60 33 85 62 Source: Firm interviews 51 Firms were asked for their three main reasons for not working at full capacity, and these are shown in Table 3.27. As in the case of the lack of competitiveness, there was marked differences between sectors. In fact, there were four different 'main reasons' in the six sectors surveyed. Overall, the biggest reason was lack of working capital, which was also the main reason in the horticulture and floriculture sector. As will be noted later, the lack of working capital is often a result of the cost of finance - with firms generally reporting paying up to 60 percent interest. In the textile sector, every firm reported a lack of demand as being the main reason for a lack of competitiveness - this is particularly worrying when the raw materials are in Zambia; the opportunities provided by Africa Growth and Opportunity Act (AGOA); and the regional trade agreements which have come on stream in the past year or so. On the other hand, poor infrastructure, which paled into insignificance in the case of textile firms, was overwhelmingly the biggest problem in the case of the gemstones sector, which is unfortunate when lack of finance was comparatively unimportant. The second biggest reason for not working at full capacity was poor infrastructure which was of particular concern to the primary agriculture sector - though of less concern than in the gemstones sector. In the other sectors, poor infrastructure was relatively unimportant. The next biggest impediment to full capacity - but having the biggest number of firms noting it as the number one problem - was lack of sufficient demand. However, as was noted earlier in the case of the textile finns, there is a demand, but the prices of the yarn which the spinning companies sells is too high. Other reasons given for low capacity utilisation are judged less important on the weighted average scale and include a shortage of skilled labor, the unavailability and/or cost of raw materials and intermediate goods, and power failures. The unfortunate matter is that the issues which firms are adversely affected by mainly relate to issues external to the firm rather than internal matters which they should be concentrating on - such as market development, production technology, skills upgrading, and product development. Land-locked, world-commodity-price-dependent non-traditional export firms must be given the opportunity to focus on supplying pro-actively selected markets with products of the right quality and price which are delivered on time. Table 3.27: Main reasons for rirms not working at full capacity Reason Firms placing Weighted Ranking reason No. 1 average Lack of working capital 5 0.81 1 Poor infrastructure 4 0.77 2 Lack of sufficient demand 7 0.74 3 Shortage of skilled labor 3 0.48 4 Unavailability / cost of local raw materials 0 0.42 5 Unavailability / cost of intermediate goods 3 0.39 6 Others, e.g., cost of power / machinery 1 0.39 6 Power failures 1 0.35 8 Other utility failures, e.g., water, telecoms 0 0.23 9 Equipment breakdowns 0 0.13 10 Unavailability / cost of imported raw materials 0 0.13 10 Not only does this low utilisation mean that the cost of capital is high per unit of output - in the case of one leading exporter, financing costs equalled 25 percent of the ex-works price of the product, but it saddles firms with high labor costs. Firms are frequently overstaffed. In one case, an exporter operating at under 35 percent capacity employs 140 workers, but only needs 60 at current levels of operation. The firm reports it is too costly to downsize, but the firm's inability 52 to downsize may put it out of-business before business picks up and justifies such a workforce. Because there are few firms in each subsector, if firms downsize, it's hard to expand if business improves as there isn't a pool of labor. This makes it doubly difficult for firms to reduce their labor force and firms are keeping more workers than they need. 3.7.5. Import / export incentives and VAT Most firms report bad experiences with import and export measures and with input VAT. As noted in the table below, VAT causes firms the most difficulty. Firms note that whereas it should take 30 days to reconcile input and output VAT and make refunds if relevant, it can take up to 90 days, though some report improvements since November 2001. While machinery is generally duty free, there are complaints about the treatment of spare parts. Gemstone firms believe they should be treated like some mining firms and not pay VAT. Other firms note that textile parts are exempt from VAT, but parts such as bearings which are not specific to textiles are liable to VAT. There are similar complaints with duty drawback over the amount of time it takes to drawback the duty. It is not uncommon for firms to report a period of 45 days rather than the 30 days from submission of documents within which ZRA undertakes to settle claims. In the case of one firm, drawback of Kwa300-400m. is typically owing to the firm each month, which represents some 5 percent of sales. The firm has to borrow this money at an interest rate of 50 percent for up to 60 days to compensate for government delays. Some firms do not bother to register for duty drawback, believing the process to be too much trouble. Other firms would appear to be eligible for implied duty drawback (i.e., the import duty paid by upstream suppliers in producing raw materials and intermediate goods which are sold to exporters), but are unaware of it. These issues were highlighted in the RIFF / TWG Draft Report in September 2001, as summarised in the Box below. 3.7.6. Trade aereements Exporters note that they have suffered from delays and problems in implementing trade agreements such as SADC Trade Protocol, COMESA FTA, and AGOA. It took Zambia eighteen months to ratify the SADC Trade Protocol, during which time there was a reported 10% decline in the profit margins available to textile firms selling into South Africa, as a result of the appreciation of the Kwacha against the Rand and market price movements more generally. While Zambia did obtain duty free access to the South African market for its textile products subject to a quota, and half the effective rate of duty for products over and above the quota, there was little scope to take advantage of this in 2001. As noted earlier, there has been disquiet about implementation of some SADC Protocol provisions on the RSA side. Zambia Sugar, which is meant to have duty free access subject to a quota, reported "foot-dragging" by the South African authorities. Zamefa, the engineering firm, lost 15 percent of its business when the South Africans started to impose duty on its products after allowing them in duty free from March to October 2001. After intense lobbying, duty free status was restored in early 2002. 53 Box 3.2: Findings, conclusions, and recommendations on duty drawback. The RIFF / TWG Draft Report is founded on a detailed survey of firms, combined with firm interviews. The study was conducted to address the following problems: . The perception that ZRA needs to improve the administration of the DDB scheme particularly with regard to prompt payment of claims. * The imbalance between the number of commercial exporters (300), those registered under the DDB scheme (63), and the number of regular DDB claimants (20). . The possible inadequacy or delays in the provision by government of funding for the DDB scheme. The findings of the study included: . the DDB scheme is considerably under utilized; . many more exporters should be registered under the scheme; . several companies already registered have yet to make a claim; * refund payments are often delayed (sometimes up to four months); . the ZRA DDB unit is adversely under-staffed; * funding by MoFED for the scheme is irregular in timing; . most companies perceive the DDB as a complicated system, especially the establishment of the coefficient - the figure representing the aggregate duty component on inputs used in producing output for export, calculated as a proportion of the export selling price. (The report notes that if an weighted average coefficient of 0.04 was applied to all NTEs (April 1998 - February 2001) the amount of duty drawback that would have been payable amounts to K82bn, as opposed to the K16.3bn actually paid). The report's conclusions and reconmmendations included the following: * The DDB scheme needs restructuring and re-advertising; . the business sector must be more proactive if it hopes to compete in the era of duty-free regional trade; * the monitoring committee which is supposed to oversee the DDB scheme must be established inmmediately; * the ZRA DDB unit must be strengthened; and * the DDB scheme must be streamlined and refund payments must be made promptly. Zambia joined a select number of countries in the COMESA FTA to avail of duty free access into each others markets from October 2000. Among NTE firms, there are mixed attitudes regarding the benefits of the FTA. Many firms note that competition has increased and has impacted negatively on their domestic market sales; some, however, recognize the opportunities it affords them. However, the critical issue for Zambia in an environment of free trade is whether Zambian firms can take advantage of the opportunities to the extent its trading partners can. Is the playing field level? With regard to a number of basic competitive factors, such as interest rates, fuel prices, cement prices, etc., Zambian firms compete from a disadvantaged position. However, further to this, there is a general perception that while Zambia is playing according to the letter and spirit of the agreements, others are not. It is not possible to generalize about this although it does seem evident that some other countries have been more aggressive in pursuing benefits under the agreements, while still invoking selective safeguards to protect threatened industries. These are allowed for under the FTA. 54 Box 3.3: Safeguards and the COMESA FTPA: One Case In early 2001 Kenyan sugar manufacturers complained about cheap imports coming into Kenya from other countries including Zambia, Malawi, and Swaziland. COMESA undertook a number of verification missions and came to the conclusion that Kenya was a high-cost producer. While Kenya produces sugar for USD590 per MT, Swaziland lands it in Kenya for USD190, Malawi for USD 235, and Zambia for USD240. COMESA concluded that Kenya's competitors in COMESA were conducting their businesses fairly. As permitted, however, Kenya invoked under the COMIESA agreement the 'safeguard' clause arguing that its sugar industry was 'under siege,' the survival of local industry was threatened, and that some protection was required. COMESA found that the consumption of sugar in Kenya was 600,000 MT per year, while local production was some 400,000 MT, and that to ban the import of sugar would harm the local population. It recommended that, in addition to existing contracts, 200,000 MT should be imported duty free, while any additional importation should be subject to quota. This measure was put in place for a period of 12 months (expiring in April 2002), after which an extension for a final period of 12 months can be introduced, providing it is approved by COMESA's Council of Ministers. The COMESA Secretariat notes that in terms of quality of enquiry, those from Zambia are mostly of a routine nature. On the other hand, the most challenging ones come mostly from Kenya and Mauritius which enquire about the safeguard and trade remedy provisions of the COMESA Treaty; how to invoke them; their duration; what constitutes local value added in the value added criterion; how to calculate local content or value added; the definition of dumping; and so on. Zambia, COMESA reports, is very good at complaining, but without wishing to substantiate their complaints, indicating a lack of market aggression and ingenuity in diversifying its market portfolio. The lack of aggression on the part of Zambia in implementing trade agreements was seen earlier with regard to meeting the requirements for AGOA eligibility, with the extended delay resulting in lost business for some textile companies. Box 3.4 : Difficulties at Zambia's borders. One of Zambia's largest exporters to Kenya reports that the Kenyan requirement for pre-inspection results in delays to its supply to Kenya. In the past year, some 25 of its 60 truckload deliveries have been delayed by 2-3 days each - despite paying 1.5% of the CIF value for the pre-inspection service. The firm's mrethodology is as follows: it prepares an invoice for the consignment; the goods are inspected by the pre- shipment inspectors; and the documents are couriered to the customer, who tries to pre-clear the goods at the border. However, the pre-clearance procedures not unusually cannot be completed before the truck arrives at the border, leading to the delays. Not only is the cost of transport increased, but payment for the goods is delayed by the same time as the hold-up at the border. A substantial exporter to Malawi, notes that it could double its exports there but for valuation problems at the border. Because of currency movements, the invoiced value of its goods are about half what they were twvo years' ago. This has led border officials, and the government, to accuse the firm of dumping its products in Malawi. The hassle of tackling the issue has constrained the firm in its exports resulting in a loss of up to USD300,000 in 2001 to the firmn 3.7.7. Technolouv Firms should be investing in new technology to take advantage of the new trade opportunities which have been presented to them - albeit belatedly - within COMESA, SADC and AGOA. Table 3.28 shows where furms have been making their technology investments. Ranked 55 number one is information technology in which some 95 percent of (reporting) firms have invested - invariably in computers and software. Ranked last by far is investment in design and product development. This, allied to the middle-ranking investment in marketing know-how, suggests that firms are not undertaking market research, developing new products, manufacturing and exporting them. Consequently, firms may not be taking advantage of market opportunities and, by targeting niche markets and adding value through design and marketing, offsetting their disadvantages in infrastructure, low productivity, and so on. Searching for, acquiring, and absorbing new technology is made particularly difficult in Zambia because the scale of the different sectors precludes the development of specialist support services. Table 3.28: Investment in tech ology Av. weighted mark Ranking Information technologies 0.71 1 Production technologies 0.55 2 Marketing know-how 0.48 3 Management know-how 0.39 4 Design and product development / foreign licences 0.16 5 Source: firm survey, EBZ, 2002. 3.7.8. Capacity of government The private sector requires the government to support it at all levels: in its approach to economic development, and in the formation and implementation of policies and regulations. Overall, firms credit the government with its desire to liberalize the economy, to support the private sector, and its privatization program. At the policy level, firms seek consistency, but report this has not happened, pointing for example to frequent changes in ministers of industry and of agriculture. Many firms straddle agriculture and industry ministries and observe that there is a lack of coordination between them. In implementation, they note that frequently where the minister has the will to do something, "down the line nothing is done ... the person delegated to undertake the work just vanishes." 3.7.9. Imposition of levies and taxes Firms note a worrying trend on the part of local government and government institutions to impose, or raise levies and taxes. Examples include the Zambia Bureau of Standards which is reputedly proposing a levy on any export which has not been certified by it; the forestry department has an export levy; and at least one district imposes a levy of 3 percent on any timber processed in the district. District councils also impose a grain levy which in some districts costs more than the crop is worth. In Ndola, one gemstone firm reports getting a demand for Kwa36m. as a land rate for a retrospective two-year period - though the recently enacted bye-laws state that a firm of its size is liable for Kwa24m. per year. In some cases, firms which lack political muscle have to pay levies and taxes which stronger firms would not pay. For example, Ndola Mine pays a 2.6 percent minerals royalty, while the large mines only pay around 1 percent. Quite often such favouritism is applied in other areas such as import duties. 3.7.10. Infrastructure As noted earlier, certain supply and changes in infrastructure, especially transport, electricity, and telecoms, are reported to be contributing to declining competitiveness and to many firmns operating at well below their capacities. An adequate road network is lacking and is constraining devi 56 The cost of road transport presents firms with difficulties due to the structure of the haulage industry; the land-locked state of Zambia; and the cost of trucks, parts and fuel. It is reported that cross-border trade by Zambian truckers was insignificant prior to 1991 and that this, combined with other factors, has resulted in some 60-70 percent of exports being carried in foreign (mainly Zimbabwean and South African) trucks. There are comparatively few firms with economies of scale in Zambia. For example, there are a couple of big firms with over 100 trucks, but many small ones with 10-15 trucks. Growing into a medium-sized firm requires a much bigger infrastructure, such as several serviced depots, which is difficult due to the costing and pricing structure of the industry. As noted earlier, diesel fuel is significantly more expensive in Zambia than in many other countries in the region as a result of relatively high rates of taxation. Compounding this problem is the fact fuel consumption is generally higher in Zambian trucks as the fleet is older than in the case of its main competitors. These older trucks are substantially less fuel efficient than many of the newer models. Truckers report that the 15 percent import duty on trucks is a major factor in the age of the Zambian fleet and recommend that there be a moratorium on duty for some years as was the successfully done in the case of mini-buses to expand and renew the passenger transport fleet. In the transport industry there are indications that labor costs are higher in Zambia than in Zimbabwe and South Africa. Although the cost of a mechanic is lower in Zambia than in Zimbabwe, the quality and productivity of the latter's mechanics is considered substantially better. By and large, Zambian firms try to minimise their costs by buying fuel and tyres in neighbouring countries where they can get the best deals. Although they seek to control their costs, it is reported that the prices are generally set by the foreign competitors because of their market dominance - thus reducing margins and putting a further brake on the development of the transport industry in Zambia. This foreign-market-pricing leads to a considerable difference between the cost of transportation for export and for import loads. Table 3.29 shows that import transportation may be twice the cost of export transport - because export transport consists mainly of back-haul loads for foreign truckers. Table 3.29: Cost of unport and exort transp ort (US $ per MT) Im ort Export Johannesburg - Lusalca Joanebrg-Ndl Lusaka - Johannesburg 75 80 45 The cost of transport is influenced too by delays at the borders. In moving goods to and from Johannesburg, for example, there may be a delay of two days at each border crossing. It is, therefore, not unusual for the journey to Johannesburg to take seven days - three days driving and four days getting through the borders. When the Chirundu crossing between Zambia and Zimbabwe was visited by a firm in December 2001, there was a queue of 157 trucks waiting to cross the border. There are problems going into DRC with perhaps USD500 being charged per truck at the border. Such costs might include charges for a visa and for vaccination (USD20 and USD30 respectively). The difficulties are such that even a Congolese wholesale and retail chain has its distribution centre in Ndola where it offloads goods for DRC, including shipments from Europe and India, and loads them onto sealed rail wagons for despatch to their final destinations. 57 The cost of road transport, particularly when combined with sea freight, places exporters at a significant disadvantage in comparison with their competitors. In the case of a yam exporter facing competition in the German market from competitors in Uzbekistan, transport costs for the Zambian firm may be six times higher than those of its competitor. It is not uncommon for the road transport costs to/from Durban at around USD75 per MT to exceed those of sea transport at around USD55 per MT between Durban and Europe. 3.7.11. Electricity and other power costs As noted earlier there are large variations in the quality of the electricity supply in different areas in Zambia. The gemstone mining companies in Ndola Rural lack a supply from ZESCO and so, in the case of one firm, the cost of self-generated power is about USD100,000 per year compared with a cost of USD50,000 if the mine was on the national grid. The lack of a ZESCO supply is one of the reasons why only one gemstone mine is operational throughout the year. This, in turn, has a knock-on effect because the sector cannot offer the market a continuous supply of stones which could result in lower prices and also prevents downstream, added-value processing of stones. In the case of Ndola Mine, if there is an electricity outage for five hours, its vertical kiln has to be cooled for five days, and the succeeding start-up takes eight days. Outages of this kind, with 13-days lost production on each occasion, happened four times during the last rainy season. During such outages, the firm switches over to its rotary kiln, but this needs a start- up time of 36 hours and is inefficient to use. Heavy fuel oil, which accounts for 57 percent of its production cost (of which it believes 60 percent is due to tax and duty) and the govemment- driven burdens of outages and fuel costs which are said to make the firm internationally uncompetitive. The largest fabric producer claims it loses 10 percent of production, perhaps equalling one million yards of fabric a year, due to electricity and water failures. 3.7.12. Marketing Firms have difficulties in addressing foreign market demand for a variety of reasons. In some industries, firms face so many challenges at home that they cannot effectively focus on foreign markets.25 Even when market opportunities are present, exporters may not recognise them and lack the skills to exploit them.26 Often the market is not sufficiently developed in Zambia for firms to develop and test market products before launching them on regional or extra- regional markets. Domestic markets in some instances should provide exporters with economies of scale but, even in the case of sugar, it's noted that discretionary spending is low in Zambia and hoped-for economies cannot be realised. Finally, the markets for Zambian products may change frequently. For example, relationships were started by exporters with sugar importers in Kenya; with maize distributors in 25 It is uncommon to find market-led firms, such as Malar Industries. This firm saw market potential for "Dogs' Chew" - imitation bones made from the waste from tanneries and abattoirs - for which there is a demand in the US for 1,000 containers per year. It developed a marketing strategy: to penetrate the European mnarket initially (using the Netherlands as a "gateway" to Europe) because the logistics are simpler, and later selling to the US - the firm's ultimate goal. Having established the market demand, identified the global competitors in the niche, and developed a marketing strategy, the firm then established a manufacturing unit and hired foreign technicians to run it. 26 An expert noted that a handicrafts firm exhibited in a major European fair where it received 27 enquiries. These enquiries were not investigated, prioritised and followed up in a structured way. They included global brand leaders such as Armani; basketry specialists distributing through Europe; and the principal niche importers in Germany for African products. As a result the potential business did not materialise and the reputation of Zambia damaged in the eyes of these buyers. 58 Malawi; with buyers in Tanzania and in South Africa. These nascent relationships have been dashed by issues such as COMESA safeguard measures; a ban on the export of maize; the withdrawal of Tanzania from COMESA FTA; and the interpretation of SADC rules of origin. In many cases, exporters have suffered from distant shocks during the past year as in the case of September 1 t, which led to a withdrawal of KLM from the Zambian market to the detriment of gemstone exporters and to a decline in market prices for some products. As a result of the local, regional, and extra-regional market problems, many exporters have concluded that DRC is the market with the most potential for many of them. However, for most the over-riding factors of servicing the market are hassle and costs at the border; delivering into the DRC; establishing the reputation of buyers; and getting paid. In many cases firms observe that sales could be three times higher if these difficulties were addressed. 3.7.13. Conclusions Zambia has several advantages in its natural endowment. It has raw materials, such as copper and gemstones; the chance to grow material inputs, such as cotton; and the potential to grow exportable products, such as vegetables. In all these areas, there are opportunities to add value and earn foreign exchange. In all these areas, there is a growing world-wide market demand. However, for a variety of reasons, the international competitiveness of many of Zambia's NTEs is currently at risk and many, if not the majority of firms involved in these industries'are in a weak financial position. The combination of macroeconomic instability, adyerse movements in the exchange rate, and a sharp deterioration in international commodity (and some value-added product) prices over the past four or five years has created an environment which has substantially weakened the viability of many firms engaged in NTEs. Those (minority of) firms which have continued to thrive and not merely survive in this environment have needed to improve their efficiency and supply chain relationships. International competitiveness is not just a matter of the competitiveness of individual firms, or of favouring specific sectors with, say, lower duties. International competitiveness is a question of focussing on whole supply chains and ensuring the individual tiers in the supply chain are com,petitive and that the linkages between them work efficiently. It seems illogical, for example, to lower the duty to favour individual sectors but, on the other hand, to have a policy which leads to high transportation costs for the same sector. In the case of gemstones, it appears perverse to firms for the government to cooperate in a donor-funded project to develop small-scale miners if the miners remain 40km from a road, and have to travel to Lusaka to complete the documents to export their production. Throughout NTEs, it appears as if the government is helping firms with the one hand, and pulling them back with the other. Where government has assisted export firms, the help has generally been applied in a horizontal manner. That is, assistance may have been provided to individual sectors, or to firms which import directly, process the inputs and export, but assistance has not been provided to the upstream suppliers or the downstream buyers or to the linkages between them. Help at one level is negated by a lack of help at another level. In international trade, one of the main criteria for success is the reputation of the country. Time and time again, firms note that little is beings done to promote the country abroad and that foreign buyers consider conditions in Zambia to be similar to that in neighbouring countries. Where the government, in cooperation with donor-aided projects, has sent firms to foreign trade fairs, buyers note that many of the firms do not respond to market enquiries, and so lower the reputation of the country from which the capable firms suffer more than the incapable ones. It has to be said that there are examples of where trade attaches in some cases, for example in Brussels, have done good work for exporters, but then the same firms are suffering from government 59 inaction in some other area which is needed to take advantage of the opportunities identified in Brussels. More market research and market development needs to be undertaken by individual firmns. Quite often these firms have so many problems at home that they cannot focus on market research and development. One over-riding difficulty firms face in researching markets, in penetrating and in developing them is that there is so much political and economic uncertainty in regional markets. Firms which may have spent money in developing sugar exports to Kenya, maize exports to Malawi, footwear exports to Zimbabwe, or furniture exports to DRC, may have wasted their investment for a variety of factors beyond their control and which were hard to predict. Of course, the private sector should shoulder responsibility for export marketing, but the risks are high. Perhaps there is room for government to share some of the risk or to provide supply-chain specific support. Firms note, for example, that government representatives in neighbouring countries could do more to identify big-project contracting opportunities for them. Surprisingly, even the biggest firms have difficulty in monitoring on a regular basis the market prices in regional countries for the products they can produce and export. If we examine the linkages between the market and the exporter, we see that transport is costly; that firms have difficulty in some markets of establishing the reputation of buyers; that channels of distribution are unclear; and that financial transactions between buyers and suppliers may not be working well, as in the case of the DRC. In many instances, individual firms have solved individual problems, but best practice is not being transferred within the exporting community. Transferring such information generally does not threaten the giver of information, because there are few export firms which produce the same products. At exporter level, firms are not doing enough to acquire technology - whether this is market know-how, or production technology, or new product development, or quality systems, or information technology. The majority of firms were unaware of existing technology acquisition programs, such as the European Union's EBAS project which shares the cost of a wide range of technology acquisition activities. In other countries within the region, such as Uganda, South Africa, and Mauritius, there have been country-specific donor-funded technology acquisition schemes which firms have used to great effect. In the case of supply chains, many Mauritius exporters have obtained IS09000, a quality system monitored by internationally accredited agencies which ensures that firm-specific best practice is implemented through the company. These exporters, in several cases, then have ensured that their suppliers obtain IS09000, that partner firms do in their trade association or in their group, and that their transport firms obtain it. Thus linking as much as possible of a supply chain in a seamless dedication to quality. Finally, moving further upstream, many examples were found where exporters and manufacturers have encountered severe problems in procuring necessary raw materials as a result of infrastructure constraints, climatic variability (and limited irrigation development), and/or restrictions on imports. In addressing these constraints closer coordination is needed amongst different government agencies as between industry and agriculture and between these and various agencies involved in the provision or regulation of infrastructure. 60 _______ Annex Table 3.30: Zambia Non-Traditional Exports* 1990 1991 1992 1993 1994 1995 19 197 1998 1999 2000 2001 us se000 us s'000 us soou o us s'ooo us s'ooo us s'ooo us s'ooe us s'000 us s'000 us $'000 us s'000 us $'000 ANIMAL PRODUCTS 2,291.48 1 84.52 456.00 740.00 355.18 1,403.73 1,719.03 3,412.64 4,149.71 4,374.08 3,373.77 3,062.48 FLORICULTURAL 1,050.00 1,902.00 2,986.64 5,505.64 9,110.35 13,533.97 18,299.84 21,242.15 32,855.48 42,677.14 33,863.39 34,078.18 HORTICULTURAL 4,543.64 5,806.71 2,934.00 2,391.19 2,420.86 4,023.39 8,858.74 15,859.27 20,557.35 23,871.12 27,355.30 36,383.92 PRIMARY AGRIC. 14,542.40 22,761.00 19,968.46 25,071.82 10,007.51 24,079.94 37,853.19 90,918.65 62,244.74 72,501.11 37,102.50 51,359.02 PROCESSED AGRIC 6,196.49 10,188.76 9,946.74 13,300.86 9,437.07 25,207.53 33,834.93 30,851.52 49,407.11 33,034.75 35,553.40 43,008.50 WOOD PRODUCTS 791.00 520.38 647.48 550.12 893.00 1,417.77 1,843.02 3,375.75 3,192.44 3,044.30 3,893.34 3,761.68 BUILDING 3,597.30 3,699.07 3,838.25 3,694.99 3,048.25 5,220.45 7,941.42 12,000.96 8,582.73 10,184.70 8,674.06 7,148.31 CHEMICAL 3,089.53 2,551.13 1,966.95 . 1,005.83 2,249.31 2,441.14 3,057.95 7,816.07 6,895.49 5,942.17 7,046.98 5,961.84 ENGINEERING 19,989.16 27,866.98 24,903.58 31,303.74 34,545.92 39,402.93 36,536.75 42,420.04 31,672.12 23,211.98 20,605.94 21,253.15 GARMENTS 2,513.80 2,566.20 1,360.40 687.76 500.60 145.63 138.16 258.19 417.41 449.33 394.04 221.07 HANDICRAFTS 187.00 95.00 63.87 80.49 85.00 82.99 217.72 95.52 162.70 208.15 250.75 227,07 LEATHER 1,039.09 675.10 375.00 1,259.00 1,234.94 1,944.23 2,093.93 2,221.49 3,133.94 2,000.00 4,330.99 3,916.46 NON-METALLIC 1,712.85 1,823.98 1,548.00 1,361.41 820.94 703.67 672.85 541.11 532.08 981.97 1,136.85 878.00 TE-XTILES 8,585.83 9,380.00 13,669.56 11,062.00 28,461.00 39,146.02 40.450.21 50,639.14 42,369.89 36,997.48 36,034.04 34,144.22 OTHER MANU *1,086.00 907.40 389.00 30.00 27.50 530.00 1,475.20 3,021.85 3,090.12 6,500.00 4,359.05 9,152.51 PETROLEUM OILS 11,144.00 3,742.00 1,081.00 173.34 3,917.33 11,360.75 5,694.83 1,807.83 6,813.27 6,411.84 439.05 1,641.91 GEMSTONES 7,637.58 4,757.50 14,177.44 15,117.25 22,192.82 7,539.51 10,894.35 14,543.79 11,584.54 13,835.94 15,435.09 20,328.59 SUB-TOTAL 89,997.15 100,427.73 100,312.37 113,335.44 129,307.99 178,183.77 211,582L18 304,773.12 287,661.12 286,226.06 239,848.51 276,533.84 RE-EXPORTS 0 0 0 0 0 0 4,091.27 3,882.30 3,656.00 2,685.13 3,958.36 4,230.18 SCRAP METAL 0 0 0 0 0 0 10,729.64 6,019.26 4,210.20 6,120.06 5,103.83 4,060.72 MINING 0 0 0 0 0 0 0 3,747.15 12,232.77 3,337.07 7,326.77 17,647.9 TOTAL VISIBLE NTE 89,997.15 100,427.73 100,312.37 113,335.44 129,307.99 178,183.77 226,403.02 314,674.68 307,760.09 298,368.32 256,23747 302,472.70 ELECTRICITY 12,205.00 20,893.00 1,658.00 10,756.00 19,551.64 21,100.00 16,152.00 14,813.00 5,627.48 6,127.49 7,390.55 9,341.82 TOTAL NTES 102,202.15 121,320.73 101,970.37 124,091.44 148,859.64 199,283.77 242,555.02 329,487.68 313,387.57 304,495.81 263,628.02 311,807.5 METAL EXPORTS 1,167,500.00 1,041,200.0 1,072,000.0 905,700.00 965,200.00 1,038,700.00 754,200.00 808,595.13 629,740.00 467,563.50 521,100.00 590,000.00 TOTAL EXPORTS 1,269,702.15 1,162,520.7 1,173,970.4 1,029,791.4 1,114,059.6 1,237,983.77 ss6,755.02 1,138,082.81 943,127.57 772,059.31 784,728.02 901,807. *EBZ data. As noted in this chapter, the available evidence suggests that the data for floriculture and horticulture are CIF rather than FOB values. The former need to be reduced by 50% and the latter by 40% to better reflect FOB values. 61 62 CHAPTER 4 EMERGING TRENDS AND OPPORTUNITIES IN ZAMBIAN AGRICULTURE AND AGRIBUSINESS With its extensive natural resource base, Zambia has substantial, yet highly underdeveloped potential for agricultural production, processing, and trade. Historically, agriculture was regarded as a secondary sector, the primary functions of which were to provide a source of food and raw materials and to serve as a sort of population holding station for the 'real' economy in mining and in urban-based manufacturing. Only in the face of a rapidly declining mining sector and the heavy and sustained loss of jobs in manufacturing, has the strategic position and the specific growth potential for Zambian agriculture and agribusiness come under the spotlight of policy-makers and the financial and business community. While declining mining exports continue to dominate Zambia's merchandise exports, agriculture provides employment to some 67% of the labor force and provides raw materials to agro-related industries which account for some 84% of manufacturing value-added. In 2001, agriculture, forestry and fisheries accounted for approximately 20% of national GDP, while other elements of agribusiness-including agro-industry, food distribution, and agricultural trade contributed a further 21% of GDP27. Hence, the agro-food complex accounts for more than 40% of Zambia's GDP and about 15% of its merchandise exports. This chapter draws upon available data and existing studies, an updated analysis of farm enterprise costs and profitability and surveys of selected agribusiness firms both in Zambia and in the region (i.e. South Africa) in order to highlight emerging trends in the structure and performance of Zambian agriculture and agribusiness, to evaluate the sector's competitiveness, and to lay out some specific measures which may contribute to the realization of more rapid, sustainable, and broadly based growth within the agro-food system in the future. A major challenge in understanding the performance and competitiveness of Zambian agriculture and agribusiness stems from the unreliability of production-related agricultural statistics and the paucity of available data pertaining to agro-industry. There are wide variations among production statistics reported by different sources and a high level of uncertainty regarding the accuracy of data on plantings, production, and yields for most crops.28 Data on livestock production and marketing is even more tentative. There are serious problems with both the, methods and underlying data used to calculate agricultural GDP in Zambia. Available data on agricultural trade probably represent a reasonable approximation of actual trade flows, although much of the informal cross-border trade in food may not be regularly measured. The depth and quality of available agricultural statistics are not sufficient to subject this data to sophisticated analytical techniques. The chapter is organized as follows. The first section provides a short historical perspective on the development of Zambian agriculture and agribusiness. This is followed by a brief overview of the agrarian structure, agro-ecological distribution, and crop and livestock composition of Zambian agriculture. The subsequent section reviews major structural changes 27 59% of wholesale/retail GDP is attributed to the agro-food system because this is the share of household expenditures on food. A conservative estimate of one-third of transport, storage, and communications GDP is attributed to the agro-food system. 28 The two most important sources of agricultural statistics are the Crop Forecasting Survey and the Post- Harvest Surveys. The former are supposed to include a representative sample of all types of farmers, while the latter do not include results from commercial farmers. 63 and patterns in the performance and competitiveness of Zambian agriculture since the mid-i 990s, and analyzes recent agricultural export performance. This is followed by an analysis of recent developments in the domestic food processing and distribution industry. A set of conclusions and recommended actions completes the chapter. 4.1 HISTORICAL CONTEXT29 The development and composition of Zambian agriculture has historically been heavily biased by government interventions. From independence through to the early 1990s, public support to agriculture rested on a commitment to food self-sufficiency. The primary objective was to provide inexpensive food to mine workers and other urban consumers. A secondary objective was to use support to food production as a means of distributing wealth to rural areas and improving equity. The primary focus of agricultural support was on maize, with a heavy bias toward this crop in government research, extension, marketing service, and pricing policies. The policy and institutional framework applied during the 1970s and 1980s was characterized by: * Official price controls and determinations. Consumer and into-factory prices for food staples and industrial crops were set by government and official producer prices were set or negotiated each year for major crops and livestock products. From the early 1970s onward, producer prices were set on a pan-territorial and pan-seasonal basis, ostensibly in the name of spatial equity; * Centralized delivery of support services. An effort was made to service large numbers of farmers spread over a relatively large geographical area using a centralized system of credit, input supply, extension: and marketing. One channel marketing systems were established (both for inputs and agricultural commodities), first under NAMBOARD and specialized crop development agencies, and later involving provincial cooperative unions; * Concentration and public sector dominance of agricultural trade and agro-industry. Through the nationalization of formerly private companies, the fixed allocation of raw materials to particular factories, and restrictions on imports, new enterprise entry, and operating practices, the processing of foods and other agricultural raw materials and the production/distribution of important agricultural inputs became dominated by one or a limited number of large-scale, parastatal-owned companies, based in one of a few urban areas. This crowded out the private sector and opportunities for rural-based industries, plus created enormous transport burdens and costs; * Extensive subsidies. In order to apply the pan-territorial and pan-seasonal pricing policies, maintain relatively low consumer food prices, and provide incentives for maize production, a broad array of subsidies were applied. These included price subsidies for fertilizer and maize seed, transport subsidies for intra- and inter-provincial maize movements, storage subsidies, processor subsidies (when the allowed margins were inadequate to cover costs) and coupons to disadvantaged consumer groups. The magnitude of these subsidies changed from year to year, yet over an extended period a large proportion of government expenditures for agriculture and rural development went for maize-related subsidies rather than investments in infrastructure and services; * Frequent policy and institutional changes. Especially during the 1980s there were frequent changes in the 'rules of the game' with the periodic redefinition of the roles for 29 This section draws heavily from Jaffee (1996). 64 NAMBOARD, the other parastatal agencies, the cooperatives, and rural financial institutions. A mid-1980s policy reform program was short-lived and wide swings in crop and input pricing policies occurred. During the 1970s and 1980s, large numbers of smallholder farmers essentially became 'maize outgrowers' for the government. The former provided the land and labor; the latter the inputs, guaranteed prices, and collection, storage, and marketing services. The farmer could retain enough maize for subsistence, but was obliged to sell his/her surplus to the state. This was the implicit contract. If the farmer's yield or return were inadequate, the farmer simply did not repay his/her inputs loan, with little or no sanction. Under this arrangement, the production and marketed sale of maize among smallholders became more or less a function of two factors-(l) weather/rainfall, and (2) the magnitude of financial losses which the government was willing and able to incur to promote and market maize throughout the country. Government policies, including price supports, not only directed the patterns of smallholder agriculture but also strongly influenced the direction of commercial agriculture. Commercial farmers also took advantage of the price support system put in place for maize.30 The bias in agricultural policies, together with an overvalued exchange rate, severely undermined the profitability of commercial farm production of such export crops as tobacco, coffee, cotton, and confectionary groundnuts. The overall planted area among commercial farmers reached a peak in the mid-1970s, declining by nearly 25% over the subsequent fifteen years. The policies, institutional arrangements, and subsidies applied during the 1970s and 1980s did partially achieve their objective3', yet at enormous and unsustainable financial cost and with the effect of diverting considerable resources away from activities in which Zambia has a comparative advantage. Direct maize-related subsidies alone accounted for about 9% of the national budget in the early 1980s, rising to over 16% by the end of the decade. The system was constantly running into debt and facing liquidity problems and foreign exchange shortages, resulting in frequent delays in input deliveries and crop collection, and frequent agro-processing factory breakdowns due to lack of spare parts. The policies and administered system left several enduring legacies, ones which Zambia is still struggling to overcome. Within the smallholder sector, the system fostered excessive farmer dependence upon govemment, an irresponsibly lax attitude toward credit repayment, an almost complete lack of understanding of the functioning of markets, a loss of farmer knowledge/skills related to crop rotations, storage, etc., increased dietary concentration on subsidized maize meal, and an almost complete absence of local commercial networks and rural enterprises. In some locations, the adopted production system was either economically or agro-ecologically unsustainable. Maize monocropping had replaced what had previously been a more diversified production system. Though less dependent on government, commercial farmers also became divorced from market signals and pressures, facing negative real interest rates throughout the period and having the 'marketing' of their crops and livestock products consisting of price and delivery negotiations with government bodies or individual parastatals. Following historical elections in 1991, a new government came to power with a commitment to reform the system of agricultural pricing and marketing and to privatize many state-owned companies, including a large number of agro-processing entities. It hoped to reduce the huge financial burden of maize-related subsidies and stimulate private sector and otherwise more decentralized modes of support and marketing services. Although interrupted by drought and 30 Durng the 1975-77 period, maize accounted for 83% of commercial farm plantings. 31 For example, between 1980 and 1989, national maize production increased from 1.08 million tons to 1.84 million tons. 65 some policy back-sliding, the new government moved to eliminate a variety of subsidies, remove price controls, and reduce if not completely eliminate restrictions on private inputs and commodity trade. A privatization process was launched and by 1995 many of the country's cereal milling, cotton ginning, dairy processing, and oilseed expressing enterprises had been privatized. Much of the agricultural sector was unprepared to deal with the risks and other management requirements associated with the shift to a market economy. The retreat of government from agriculture was relatively abrupt with little or no transition involving the fostering of new institutional arrangements to deal with information, financing, and other coordination needs. Nevertheless, the reactions by farmers and the private sector were relatively quick. In the early-to-mid-1990s, there occurred a noticeable shift in production patterns, with a reduction in maize plantings and a corresponding increase in the production of an array of drought tolerant cereals as well as crops which do not require much fertilizer (i.e. legumes). Some renewed interest was taken in growing industrial crops and there occurred an initial spur of growth in non-traditional agricultural exports. The elimination of maize meal and transport subsidies contributed to the rapid emergence of many micro and small-scale milling and oil- expressing operations. Also in rural areas, a proliferation of small, localized commodity traders emerged, taking business away from the formerly protected cooperatives, most of which experienced major financial problems at the time. Networks of private traders and farmer-based marketing companies developed, especially along the Livingstone to Copperbelt 'line of rail' and in surplus producing areas elsewhere. In contrast, in more remote locations, little private trading emerged and smallholder farmers began to revert to more subsistence-oriented production patterns. By the mid-1990s, therefore, there were encouraging signs that a more efficient and diversified agricultural sector was emerging. 4.2 BROAD STRUCTURAL FEATURES OF ZAMBIAN AGRICULTURE The agrarian structure of Zambia consists of the following types of farm categories32: * Small-scale farmers, numbering approximately 800,000 households. These farmers cultivate on average 1.45 hectares of land, generally using low-input, hand hoe technology and relying primarily upon family labor.33 A large proportion of food production is retained for household consumption. The major constraints faced by such farmers are their geographical isolation, seasonal labor constraints, lack of timely availability of inputs, weak market information and (in the south) vulnerability to drought. * Emergent farmers, numbering some 40,000 to 60,000. These farmers cultivate an area ranging from 5 to 20 hectares, typically with draught power and greater use of purchased inputs. Survey evidence has found relatively higher levels of education and a majority with either prior formal sector jobs or other training. These farmers use both family and hired labor. Production, including that of food crops, is predominantly for sale. The vast majority of such farmers operate along the line-of-rail cutting across the country in a north to south line. The leading constraints for such farmers are labor bottlenecks 32 Among different sources there are wide variations in the numbers of different types of Zambian farmers. The numbers provided here is our best estimate. 33 Only 16% of such households own cattle. 66 (especially for land preparation), access to finance, and weak market information. The incidence of animal diseases plus non-availability of affordable working capital has led many such farmers to scale back their operations.34 * Large-scale commercial farms, numbering some 600 to 750. These generally cultivate between 50 and 150 hectares, have extensive mechanization and rely upon a combination of permanent and casual staff. The majorily of these farms are family-owned. Production is for commercial sale (and the feeding of staff). These farms are located along the line of rail, primarily in Central, Lusaka, and Southern Provinces. Major constraints faced by these farmers include high indebtedness, limited access to and high cost of working capital, lack of-capacity to store crops, and weak market information. * Large Corporate Operations, of which there are no more than a dozen. These involve the cultivation of several thousand hectares (or more) of crops and/or one thousand or more head of livestock. These. are managed by hired professionals and most such operations involve vertical integration with agro-processing. Data on the relative shares of these types of farms in the production of different crops and livestock products are not available, although some 'orders of magnitude' can be estimated using national agricultural statistics and information provided by industry and farming organizations. Table 4.1 provides such estimates for a selected range of commodities. Table 4.1: Estimated Shares of Different Farm Types of National Production, (%) Small-scale Emergent Commercial Corporate Maize 60 15 25 Sorghum 90 8 2 T Soybean 20 10 70 Wheat 5 30 1 65 Groundnuts 85 | 10 5 Cotton 98 2 Coffee 5 45 50 Sugarcane | 40 60 Tobacco 60 40 Milk 20 30 50 Poultry 10 T 20 20 50 Source: Staff Estimates While relatively few in number, commercial (including corporate) farms account for a substantial share of the marketed agricultural production in Zambia, including nearly all marketed production of wheat, soybean, coffee, and Virginia tobacco, and a majority of sugarcane, poultry and milk production. Smallholder (and emergent) farmers account for the bulk of national production of maize, sorghum, groundnuts, burley tobacco and cotton. Within the smallholder sector, only a minority of farmers regularly market their crops. According to the Post-Harvest Survey, only 40% of smallholders sold crops during the 1999/2000 season, with this proportion being below 30% in some of the more remote and drier areas (i.e. Western Province). 3 Farm income is also skewed within smallholder agriculture. Zulu et al. (2000) estimate that only 20% of smallholders-meaning about 150,000 households-- account for 60% of the crop value deriving from this sub-sector. 34 One farmer argues that emergent farmers have increasingly become 'submerged'. 35 Institute of Economic and Social Research (2000). Key Performance Indicators at the District Level. 67 Zambia is divided into three agro-ecological regions which are essentially areas of common agricultural activities. The classification system is based on climatic conditions (i.e. rainfall, temperature) and soil types: * Agro-ecological Region I covers the watershed areas of the Luangwa and lower Zambezi Rivers. These are the driest parts of the country with rainfall ranging from 600 to 800 mm per annum. The growing season is relatively short at 60 to 90 days. Soils in this region are either derived from alluvial river deposits or from Kalahari sands. This region experiences frequent droughts and is characterized by low water holding capacity in the soils. Tsetse infestation is a major limitation to livestock production in some parts of this region. More drought tolerant crops such as sorghum, sunflower, cassava, tobacco, millet, and cotton can be supported in this region. Some 48% of the rural population lives in these areas.36 * Agro-ecological Region II stretches from the Nyika Plateau in the northeast to the extreme west of the country. It covers most parts of Central, Eastern, Lusaka, and Southern Provinces. Rainfall ranges between 800 and 1000 mm per annum and is relatively reliable. The growing season ranges from 90 to 190 days. The soils are brown, clayey to loamy types and are moderately leached with medium to high acidity. This region has the potential to support the greatest range of crops and all classes of livestock. Some 43% of the rural population lives in these areas. This region accounts for the bulk of commercialised production of crops and livestock products. Some 53% of the estimated cash incomes of smallholder farmers in 1998/99 were obtained in this region. * Agro-ecological Region III covers the Northern, Luapula, Copperbelt, and Northwestern Provinces and contains the wettest parts of the country, with rainfall generally above 1200 mm per annum. The growing season ranges from 140 to 200 days. The soils are low in fertility and exhibit extreme acidity. However, with the use of lime it is possible to grow less acid tolerant crops in this area. Crops such as maize, bananas, coffee, tea, and rubber grow reasonable well in these areas. Only 9% of the rural population lives in these areas, although some 29% of smallholder farm cash incomes in 1998/99 were obtained in this region. For many years, agricultural GDP in Zambia has been calculated using fixed weightings between traditional crops (60%), livestock (30%), and high-value perishables (10%).37 The basis for these weightings and their retention over time is not clear. Agricultural GDP (and its growth) is essentially calculated by taking production estimates for twelve traditional food and cash crops, multiplying these estimates by 1994 prices and then converting these values to current values by multiplying them by an overarching agricultural price index. Neither shifts in the relative prices among different crops nor patterns of agricultural diversification beyond the traditional crops, are effectively captured by this methodology. These are precisely the types of changes which one would have expected to occur in the face of market liberalization domestically and shifts in international commodity prices.? Despite these limitations, Table 4.2 provides some indication of the structure of agricultural GDP in Zambia and how this may have changed since the mid-1990s. These estimates suggest that there has occurred a reduction in the GDP share of maize and of livestock products and an increased share for cotton, higher-value cash crops, and roots and tubers. 36 Based on the preliminary results of the 2000 census. 37 Inforniation from the Central Statistical Office. 38 Assistance should be provided to the CSO for it to more effectively estimate the value-added from different crop and livestock activities and to track changes over time. 68 Table 4.3 depicts changes in the crop planting patterns in Zambia over the course of the 1990s. The data suggest that overall plantings have increased modestly. This would essentially be due to population growth as official survey data suggest that the average area cultivated per smallholder household has not increased since 1990, nor has the planted area among commercial farmers.39 Plantings of maize declined sharply in the first half of the 1990s and have more or less stabilized since then.40 This lead crop's share of total plantings is now about 50%. Maize cultivation is now increasingly concentrated in agro-ecological Region II. In Region 1 there has occurred a significant shift to drought-tolerant small grains, while in Region m the shift has been to cassava and other tubers.4' Table 4.2: (Estimated) Composition of Zambia's Agricultural GDP(%) 1994-1995 Average 2000-2001 Average Maize 26 19 Cotton 15 19 Fruit/Vegetables/High-valUe Cash Crops* 8 14 Other Cereals** 8 7 Oilseeds and Legumes*** 8 7 Roots and Tubers 5 14 Livestock Products 30 20 Total 100 100 *Would also include coffee, tobacco, and spices. ** Includes wheat, millet, sorghum, and rice. ***Includes soybeans, sunflower, groundnuts, and mixed beans Sources: Central Statistical Office; Modified by Author to reflect estimates for root and tuber crops, not included in the CSO calculations. From the CSO data a downward adjustment was made in the estimated 2000-2001 contribution for livestock products (from 30%) and cotton (from 23%). National plantings of groundnuts and mixed beans have increased, both as a source of food and to enhance soil fertility at a time when fertilizer use is declining (see below). National plantings of industrial crops has increased, although cotton plantings have shown considerable year-to-year fluctuations in recent years. Plantings of oilseeds and of wheat have declined from earlier levels, with the country becoming further dlependent upon imports of these crops and their derived products (see below). 39 It was 1.42 ha. in 1990 and 1.45 ha. in 2000. 40 Maize plantings averaged 741,000 ha. over the 1985-90 period, 627,000 between 1990 and 1995, and 610,000 between 1995 and 2000. 41 See the analysis in Kane Consult (2002) 69 Table 4.3: Changes in National Cropping Patterns 1990/91 1994/95-1995/96 1998/99-1999/2000 Maize 639390 597865 581074 Cassava 103159 120000 131768 Millet 45270 75370 78404 Sorghum 31790 44102 37022 Groundnuts 80470 94960 140875 Mixed Beans 28940 42351 39368 Sunflower 36490 40027 12987 Soybeans 29200 23559 11720 Wheat 11849 9067 8086 Sugar 8603 9539 15000 Cotton 74020 50709 71312 Tobacco 4705 3563 7936 Coffee 1530 1700 2800 Total 1,095,416 1,112,812 1,113,852 Maize 58.2 53.7 51.0 Cassava 9.4 10.8 11.6 Small Grains 7.0 10.7 10.1 Legumes 10.0 12.3 15.8 Industrial Crops 8.1 5.9 8.6 Oilseeds + Wheat 7.3 6.6 2.9 Sources: Zambia Agricultural Statistics Bulletin; FAOSTAT (for sugar) With this shift in cropping pattems has come incremental changes in dietary pattems. Analysis of Post-Harvest Survey data (covering small and medium holders planting less than 20 ha.) shows that food production expressed in energy terms is holding steady or increasing slightly, at least through 1999. The share of maize in total energy has fallen from 74% in 1993/94 to 55% by the end of the decade. During the same period, the share of tubers increased from 17% to 31%. Other crops gained marginally. Overall, smallholders in rural areas seem to be retuming to more traditional and diversified cropping and consumption pattems which were in place before the widespread introduction of maize and the pattem of maize monocropping. Table 4.4: Energy produced from smallholder food crops (kCal/ru al person/da ) Season Maize Other grains Tubers Legumes Oil seeds Total kCal %share kCal %share kCal %share kCal %share kCal %share kCal 1993/94 1,059 74.5 70 4.9 236 16.6 44 3.1 11 0.8 1,421 1994/95 823 71.3 82 7.1 200 17.3 30 2.6 19 1.6 1,154 1995/96 1,528 80.3 115 6.0 169 8.9 53 2.8 38 2.0 1,903 1996/97 1,014 65.6 116 7.5 317 20.5 80 5.2 17 1.1 1,544 1997/98 823 58.8 105 7.5 374 26.7 82 5.9 16 1.2 1,399 1998/99 978 54.6 145 8.1 557 31.1 95 5.3 17 0.9 1,792 Source: Zulu et al, 2000 using PHS data 4.2.1. Selected Indicators of Agricultural Performance According to Zambian National Accounts, agricultural GDP grew at an average rate of 3.9% per annum over the 1990 to 2000 period. This was faster than the population growth of 2.9%, indicating a positive growth per capita. However, the data suggest that virtually the entire growth in agriculture was recorded in the first half of the decade, essentially corresponding to the 70 transitional period from administered to more market-oriented agriculture. By contrast, the data suggest virtually no growth recorded in agricultural GDP in the second half of the 1990s. When one takes into account the estimated 6% decline in agricultural GDP in 2001, the average rate of change between 1996 and 2001 would be -0.25%, with four of those six years recording negative rates of change. As noted above, the methodology used to calculate agricultural GDP does not capture some dynamic changes which are taking place beyond the spectrum of the so-called traditional crops. Such 'below the radar' developments include the development of export-oriented, high value spices, vegetables, and cut flowers and the recent revival of milk and poultry production in certain locations. Nevertheless, these developments-if properly quantified-would probably not cause a very large change in the overall pace of agricultural growth in the period since the mid- 1990s. Table 4.5 compares Zambia's agricultural growth performance with that of several of its neighbors and with a wider set of countries. The picture, if indeed accurate, is a disturbing one. It suggests that Zambian agriculture outperformed each of the comparative countries in the early 1990s yet strongly lagged behind in performance in the period since 1995. For the decade as a whole, the pace of Zambia's growth in food and livestock production lagged behind that for sub- Saharan Africa as a whole, although Zambia achieved a higher rate of growth in non-food production. Table 4.5: Comparative Rates of Agricultural Growth Agricultural Value- Indices Growth Rates (1990-2001) Added Growth Rate 1990- 1995- 1990- Food Non-Food Livestock 1995 2000 2000 Productio Production Production _ n Low and Middle 1.71 1.99 1.95 3.71 0.63 4.90 Income Countries I Sub-Saharan 1.06 3.43 2.70 2.68 2.81 2.09 Africa Zambia 4.31 0.79 3.94 1.02 4.68 1.00 Zimbabwe 0.78 7.52 4.83 2.19 4.00 0.73 Tanzania 2.90 3.34 3.30 0.62 -0.17 1.87 Mozambique 0.53 7.65 5.75 3.94 6.34 0.54 South Africa -2.53 2.81 0.62 1.27 -4.31 -0.07 Sources: Zambian Value Added Data from National Accounts; FAOSTAT for other countries. J Zambian agriculture continues to be characterized by a high rate of volatility in the year- to-year production of major crops. This is partly explained by weather patterns, given the predominance of rainfed production systems. The graph below illustrates the close link between rai,nfall and recorded agricultural GDP. This correlation appears to have been stronger in the first half of the 1990s than in the latter half. The volatility of production is especially large among smallholders, although even crops which are grown predominantly by commercial farmers (including wheat, soybeans, and Virginia tobacco) also exhibit significant year-to-year variability (Table 4.6). 71 Chart 4.1: Ag GDP (US$ mill) and Average Rainfall (mm) 700 ;___---_, -_ 1000 600 ! 900 500 L ;IXt ~- - 4 t800 500 7 1700 *g 400 - g_. ; . . N j . - - ; - . -;.[1 w 600 |VA in Ag 00 -- 500 I+Av. Rainfall cn 300 --. 200 -!- - 100 -- 200 O, , -~ -, a;--'' 100 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Sources: Value Added in Ag from Zambia Public Expenditure Review, 2001. Average Rainfall from Metereological Department reported in Zulu 2000 Table 4.6: Annual Production of Selected Crops (Tons) 1995/96 1996/97 1997/98 1998/99 1999/2000 2000/2001 Maize 1,409,485 921,968 649,537 852,475 971,614 801,877 Cotton 61,200 79,900 104,500 84,700 46,700 72,000 Wheat 51,196 32,456 70,000 69,226 74,700 55,104 Soybean 34,800 29,283 12,322 26,703 22,769 28,311 Va. Tobacco 1,950 3,504 9.675 2,169 3,416 5,640 Sources: Macroeconomic Indicators, June 2001, Ministry of Finance and Economic Development; CSO Agricultural Statistics; Cotton figures from industry sources. A range of factors have contributed to this erratic agricultural performance and overall deceleration of agricultural growth. On the demand side, Zambian farmers are supplying into a domestic market which is experiencing steadily decreasing purchasing power and into an intemational market which has featured sharply reduced prices for a broad range of food, beverage, and industrial crops. The Zambian domestic market has also experienced increased imports of both raw materials and finished food products, creating uncertainty among farmers about actual demand (discussed further below). On the supply side, Zambian farmers have encountered increased liquidity problems, reducing their purchase and use of yield-enhancing inputs and their ability to replace equipment and other aging farm assets. Agricultural borrowing from banks and other financial institutions has contracted considerably due to high interest rates and the collapse of parastatal dedicated rural financial institutions. Input distributors and agro-processing companies have offered inputs on credit to certain farmers, yet the scale and breadth of these initiatives have varied from year to year, depending upon credit repayment performance, market developments, and interventions by government. Periodic policy changes on the part of government-with respect to commodity markets and more frequently with respect to the fertilizer market-have also contributed to the volatility of agricultural production. 72 On a national level, overall fertilizer use and the proportion of farmers using fertilizer dropped sharply in the early 1990s following the removal of fertilizer subsidies. Since the mid- 1990s, however, fertilizer use rates seem to have stabilized as has the overall level of national fertilizer application. As Table 4.7 illustrates, trends in fertilizer use vary between areas, with farmners located along the line-of-rail or Eastern Province maintaining their fertilizer use while farmers located in more remote and less commercialized areas have cut back sharply in fertilizer use. Chart 4.2: Zambia Fertilizer Use (Kg./Ha.) 140 _ 120-- ,J 100 p , -; ; . ,.,s 80-f - - - 60. 20 - .:j X .'l L 1 :j,l - ...;I ' - 1 '- ! L t- 2.: 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 Source: Kane Consult (2002) Table 4.7: Percent of Smallholder Farmers Using Fertilizer by Province Province 1990/91 1995/96 1999/00 Central 51 33 34 Copperbelt 23 33 33 Eastern 38 18 29 Luapula 9 13 8 Lusaka 53 26 37 Northern 39 23 17 Northwestern 15 13 5 Southern 43 27 39 Western 12 4 1 National Average 31 20 23 Source: Knepper, 2002 (MSU) 4.2.2. Productivity No reliable time series data exist which depict broad trends in farm productivity in Zarmbia, whether in terms of crop yields, livestock productivity, or any other useful measure. Among official and other sources of data there are enormous differences in estimated yields, often by a factor of 50% or more. This is illustrated in Table 4.8 showing yield estimates for cotton from different sources. There are huge differences not only in the absolute numbers but even in the general trends depicted. Assuming that the 'industry source' is best positioned to estimate producer yields-given that it is financing a substantial proportion of the srnallholder crop-that would suggest that there 73 has been a gradual improvement in smallholder cotton yields in recent years with farmers benefiting from the supply of improved seed, other inputs, and technical advice through contract farming arrangements with several companies. Between 1997 and 2001 there were also notable improvements in the quality of the seed cotton crop42, enabling ginners to raise their ginning out- turn to levels approaching industry benchmarks elsewhere. Still, Zambia cotton yields lag behind, by a considerable margin, those of Zimbabwe and the average for sub-Saharan Africa as a whole.43 Table 4.8: Cotton Yields: Variations Among Sources, (Kgs/HA) Crop Forecasting Post Harvest FAO Industry Source Survey Survey 1996 617 996 560 1997 913 782 1431 500 1998 1048 915 1324 515 1999 1327 820 1324 538 2000 749 820 567 2001 869 689 Both PHS and FAO data suggest no clear direction in Zambian maize yields over the past decade, with the FAO figures suggesting an average annual growth of 0.68%, yet with most of this occurring in the first half of the decade. Average Zambia yields of 1.4 to 1.6 tons/ha. are similar to those in Zimbabwe and slightly higher than the overall average for sub-Saharan Africa. Both PHS and FAO data suggest no discemable trend and certainly no improvement in Zambian groundnut yields. According to FAO data, Zambia's groundnut yields are only one-half those of sub-Saharan Africa as a whole and one-third lower than those of neighboring Zimbabwe and Tanzania. Data from FAO suggest that Zambian commercial farmers have increased their yields of wheat and soybean since the mid-1990s, virtually closing an earlier productivity gap with their counterparts in Zimbabwe. Livestock sector productivity is constrained by a general failure to improve animal husbandry practices among smallholder farmers. The result has been significant outbreaks and spread of animal diseases, almost on a regular basis from year to year. Among smallholder farmers the productivity of cattle is characterized by slow growth rates (i.e 5-8 years to reach market weight), high calf and adult mortality rates (i.e. 25% and 9%, respectively), and low reproductive perfomiance (i.e. low calving rates and long calving intervals). The smallholder herd growth rate is estimated (optimistically) at 3% with an average off-take of 8%. In sharp contrast, livestock productivity within the commercial sector is quite good with low calf mortality (1%), high reproductive rates (i.e. 65%) and an off-take of some 18%.44 4.2.3. Profitabilitv The period of relatively high growth in Zambian agriculture during the early to mid- 1 990s corresponded with very favorable trends in international prices for food and other agricultural commodities. The World Bank's price index for 'total agriculture' increased by some 30% between 1990 and 1995 and, favorable to farners, there was a parallel modest decline in world fertilizer prices. With the liberalization of Zambia's agricultural and financial markets, some of the benefits from the robust international commodity prices were passed through to 42 For example, in 1998 only 26% of the cotton lint obtained was of the higher grade 1 1/8 staple length. This increased to 98% by 2001. 43 In 2000, 884 kg. and 854 kgs., respectively. "Ministry of Agriculture, Food and Fisheries, Livestock Development Plan, 2000-2004 74 Zambian farmers, resulting in increased profitability and an initial take-off of non-traditional agricultural exports. Since 1997, however, there has been a sharp and in many cases sustained decline in international agricultural commodity prices, with especially large declines for grains, cotton, and beverage crops. The price index for 'total agriculture' fell by 38% between 1997 and 2001 (see the Graph below). At the same time, international fertilizer prices increased during the late 1 990s, although they have come down somewhat over the past two years. These commodity price trends have had an enormous influence on the underlying profitability of agriculture and especially commercialized agriculture in Zambia. Chart 4.3: Agricultural Commodity and Fertilizer Price Indices (1990=100) 150 - 140m I130 * - D 1 0 --Total Agriculture 110 X w--M- Total Food 90 1 . -- Grains 80° Fertilizers 60 50 99 9N99N9b 9, >9090\ '9 O 439 5,z¢0 To examine the effects of commodity price changes on the profitability of Zambian farmers and to otherwise better understand the structure of their costs and their cost competitiveness, detailed representative crop production and marketing budgets were prepared for a range of crops for both smallholder and commercial farms. The methodology used was similar to that deployed in an analysis of the comparative advantage of Zambian agriculture in the mid-1990s45, thus enabling us to make comparisons between financial results for the 1994/95 season and that of the current 2001/02 season. A similar methodology was also employed to examine the financial results of Zimbabwean agriculture during the 2000/2001 season, allowing for some comparisons with that country. For the current season, production costs and (actual or expected) prices were obtained in January/February of 2002. For smallholder farmers, crop budgets were developed for cotton, local and hybrid maize, groundnuts, paprika, and burley tobacco. Distinctions were made between two representative types of smallholder farmers, one employing a low to medium level of purchased inputs (representing the vast majority of smallholders) and the other employing a higher input regime (and obtaining resultantly higher yields), more in keeping with research station recommended practices. The latter represent a minority of smallholders, and perhaps also some types of emergent farmers who are cultivating relatively little land. Most of the smallholder budgets were developed for farmers in Eastern Province, yet some are based on farmers located in Central Province. For commercial farmers, budgets were developed for maize, soybean, wheat, Virginia tobacco, paprika, cotton, coffee, roses, and poultry. Commercial farm budgets were derived for representative farmers in the Mazabuka, Mkushi, and Lusaka areas. 45 Keyser et al. (1996) Zamnbia's Agricultural Comparative Advantage. Prepared for the World Bank. 75 Table 4.9 provides a summary of the results for smallholder profitability with the commodities ranked according to their estimated net profit per hectare in 2001/02. Data are provided for gross profit per hectare, net profit per hectare (taking into account depreciation of farm implements and equipment), and gross profit per person-day of labor. The latter is an important consideration given the labor constraints faced by some smallholders, especially those without access to draught power. Table 4.9: Profitability of Zambian Smallholder Crop Enterprises Ranked by Net Profits, 2001/02 (US$) 1994/95 2001/02 Crop Input Gross Net Gross Gross Net Profit Gross Intensity Profit Profit Profit Per Profit Per Per Profit Per Per Per Person- Hectare Hectare Person- Hectare Hectare day day Tobacco High 620 544 1.91 641 579 1.83 Tobacco Low/Med 316 240 1.17 350 288 1.19 Paprika Low/Med 283 259 1.29 196 182 0.85 Groundnut High 66 64 0.60 151 149 1.37 Groundnut Low/Med 115 113 1.28 122 120 1.35 Cotton High 301 277 2.04 103 89 0.62 Cotton Low/Med 247 223 2.18 88 73 0.69 Hyb. Maize High 34 31 0.35 77 75 0.79 Loc. Maize Low/Med 51 48 0.85 54 52 0.91 Hyb. Maize Low/Med 17 15 0.23 34 31 0.60 Several results can be emphasized. First, a range of industrial crops are considerably more profitable for Zambian smallholders than maize, although at least in agro-ecological Zone 2 the vast majority of smallholders continue to grow maize for their own household consumption and for sale of any surpluses to raise cash. The value of maize for these farmers is thus higher than the potential sales value since the farmers would need to pay substantially more for processed maize products which they would purchase. At the low input level, local maize outperforms hybrid maize on a financial basis, especially when one considers the risk element associated with the needed cash outlay by farmers to cultivate hybrid maize. Groundnuts appears to be an attractive crop for smallholders, yielding a decent financial return (especially per person- day of effort) and, very importantly, because of the minimal cash financial outlay that farmers incur prior to their sale of this crop.46 These attractive characteristics, in addition to their nutritional value, have contributed to the growth in smallholder groundnut production in recent years. Second, of the examined cash crops, burley tobacco and paprika remain the most profitable, by a considerable amount.4' However, both entail a considerable outlay for purchased inputs and hired labor, implying liquidity constraints for those farmers which cannot access credit. The expanded production of these crops has depended on the supply of seeds and, in some cases, other inputs, on credit, by traders or processors. Cotton production is considerably less profitable, a development which is compounded by its high and difficult labor requirements. The returns per person-day for cotton are among the worst of the crops reviewed. Cotton production is "This applies to the more typical pattern of production which involves farmer saved seed and the use of little or no fertilizer on this crop. 47 The continued profitability of tobacco is surprising in the light of reduced prices and trends observed in neighboring Malawi where the Zambian tobacco is processed and re-exported. Zambian growers actually realize higher prices than do Malawian smallholders as the latter face statutory deductions together with relatively high logistics costs. The sustainability of Zambian shipments into Malawi is now being questioned (more later). 76 supported by several ginning companies which provide a package of inputs and technical support. However, the extreme downward movement of international cotton prices (and the high development costs which the ginners have had to bear in promoting the crop) has severely weakened the profitability of this crop to Zambian smallholders. Chart 4.4: Sma,lholder Labor Requirements 350 . 300.--"* - 250 -k - -- -' 200 - . HiredLabor : 150' _ , 1-8 . ] *FalyLabor 4 50, - I k* . Third, comparisons with results from 1994/95 show sharply reduced profits for smallholder paprika and cotton growers, modest improvements for groundnuts and tobacco and little change for maize. Improvements in yields and modest reductions in (variable) costs have generally not been able to counteract declining commodity prices. For example, while yields for paprika growers may have increased from 700 to 800 kgs/hectare and while variable costs have increased only slightly (i.e. from $347/ha. to $364/ha.), profitability has declined due to a 20% drop in farm-gate prices. Chart 4.5: Percentage Change in Net Profits for Smallholder Farmers 1994/95 vs. 2001/02 40 ----- -20 . -40 -60 - . - -80 ~ 7 77 Chart 4.6: Smaliholders Gross Profit Per Person-day of Labor (US $) 2.5 1.5 -0> . ; - -~ ~ ' | 1B*1994/95 0.5- U ,. | | ~~~ ~ I :-, - _ ^ *2001/02 Tobacco Groundnuts Local Maize Paprika Cotton Hybrid Maize Table 4.10 below summarizes the profitability results for commercial farmers for selected crops. The results for poultry are not directly comparable because they are based on production batches of 1000 birds, rather than on a per hectare basis. The results for roses will be discussed in the section below dealing with Zambia's agricultural exports. With commercial farmers there is a significant difference between gross and net profits as many such farmers have major investments in tractors, irrigation, and other farm equipment and buildings whose value depreciates over time. As with smallholders, commercial farmers experience much higher profitability with industrial crops than with traditional food and oilseed crops. However, each of these require a substantially higher cash outlay and, being less amenable to mechanization, require the management of a large labor force. Paprika is very difficult to manage on a large scale due to problems with crop diseases. Coffee has a long gestation period before income is realized. Irish potato cultivation apparently generates very good financial results for farmers, in part due to an innovative marketing arrangement which has emerged in recent years. Table 4.10 Zambia Commercial Farm Profitability 1994/95 2001/2002 Gross Profit Net Profit Gross Profit Net Profit Paprika 3215 2906 2413 2136 Irish Potato 4637 4328 1208 931 Va. Tobacco 950 678 844 588 Coffee 7635 6823 1199 336 Maize 254 120 331 202 Wheat 539 230 351 73 Soybean 136 (173) 135 (142) 78 Chart 4.7: Hired Labor Requirements: Commercial Farms 400 35031,_= 250 s 200 '150031!: -~' - I 100 50 Tobacco Coffee Paprika Cotton Irish Maize Soybean Wheat Potato While commercial farm gross margins are positive for all crops listed, when one takes into account farm asset depreciation, both wheat and cotton become financially marginal and soybeans becomes a loss-maker. Its continued cultivation is as a rotation crop, especially with wheat. At the currently very high market prices for maize (we have assumed here a farm-gate price of $190/ton), this crop is at least temporarily profitable for Zambian commercial farmers. However, under more usual market conditions-when the market sales price would be $100 to 125/ton, maize production is not profitable for most commercial farmers. In our crop budget model, the break-even price for commercial farm maize is $153/ton. The comparisons between the 1994/95 results and those for the current season suggest that commercial farm profitability has fallen very sharply for nearly all crops, the major exceptions being for maize and soybeans which were financially marginal in the mid-90s as well and no further deterioration occurred. Given the collapse of international coffee prices, this crop shows the largest absolute decline in farm profitability. Profits from commercial cotton production have also dropped sharply and this has resulted in the withdrawal of most commercial * 48 farmers from this crop. Chart 4.8: Percentage Change in Net Profitability for Commercial Farmers: 1994/95 vs. 2001/02 40 - -- - 20 0 - - -60 -fI-j -80 I . - . ; . -100 -120 I - Based on the farm models analyzed, the large decline in commercial farm profitability cannot be significantly attributed to an escalation of costs, except, perhaps those for financing. The total variable costs per hectare have increased by 5% or less for most of the crops examined. " Most of the conmmercial farners who still grow cotton do so for the production of seed. 79 Modest yield improvements have been reflected yet these have not nearly compensated for the sharp reductions in commodity prices. The profitability results for Zimbabwean commercial farmers are not directly comparable given that they refer to a prior season (and the prevailing prices then). Importantly, the findings also do not take into account the major disruptions in farm operations which took place during the 2000/01 season yet after the completion of the farm survey there. Nevertheless, the Zimbabwe findings are rather similar to those for Zambian commercial farmers, both in terms of the relative profitability of different crops and in terms of the actual financial returns themselves. Tobacco and paprika are modestly more profitable in Zimbabwe, yet the situation for major cereals and oilseeds was very similar. Table 4.11: Zimbabwe Commercial Farm Profitability, 2000/01 Season Gross Profit Net Profit Paprika 2987 2798 Va. Tobacco 1280 1059 Coffee 975 407 Maize (72) (178) Wheat 356 168 Soybean 182 (6) 4.2.4. Cost Competitiveness A wide range of factors contribute to the relative cost competitiveness of different agricultural producers. These include (i) the farmers' productivity in using natural, human, and man-made resources, (ii) geography, contributing to differential transport costs related to inputs and outputs, (iii) taxes or subsidies on farm inputs or on other goods or services involved in farm product marketing, (iv) the competition within and otherwise the effectiveness of input distribution systems and rural labor markets, and (v) macroeconomic factors, including exchange rates, inflation, etc. For this study a detailed comparative cost analysis for different supply chains was not undertaken. However, some insight into comparative cost competitiveness can be gleamed from our crop budget analyses for Zambia and Zimbabwe. For Zambian commercial farmers, these calculations are for variable costs per ton of commodities delivered to Lusaka. For Zambian smallholders , the delivery point is either Chipata (in Eastern Province) or Lusaka. In the case of Zimbabwe, the costs for both smallholders and commercial farmers are for goods delivered to Harare. Table 4.12 summarizes the comparisons between Zambian and Zimbabwean smallholder farmers. These results exclude interest costs on loans given the wide variability in farmer access to such loans in both countries. The figures in parentheses are the variable costs per ton when the more inputs-intensive, higher-yielding production system is employed. 80 Table 4.12: Smallholder Farms: Comparison of Variable Cost Per Ton of Product (US$) Based on Low/Medium Input M del (High Model in Parentheses) Zambia 1994/95 Zambia 2001/02 Zimbabwe 2000/01 Tobacco 680(652) 517 (491) 391(441) Paprika 402 379 371 Groundnuts 229(362) 233 (261) 210 (166) Cotton* 57 (103) 86 (106) 77 (101) Maize (Hybrid) 86 (85) 74 (75) 74 (71) *Contracted production with ginning company The crop models used suggest that, excluding interest costs, the unit costs of production for Zambian smallholders are currently lower for tobacco, paprika and maize than they were in the mid-1990s, while there has been some increase in the unit costs for cotton.49 With the more common low/medium input production system, Zambian smallholders are more or less cost competitive with their Zimbabwean counterparts for paprika, cotton and maize, yet are higher unit cost producers of tobacco and groundnuts. Table 4.13 depicts changes in the unit costs of production for Zambian commercial farmers, while Table 4.14 provides the comparative numbers for Zimbabwean commercial farmers. Both Tables distinguish results which include and exclude interest costs. Table 4.13: Zambia Commercial Farms: Variable Costs per Ton (US $) 1994/95 2001/02 Excluding Including Excluding Including Interest Costs Interest Costs Interest Costs Interest Costs Va. Tobacco 1303 1430 1237 1435 Coffee 692 824 735 960 Paprika 415 466 410 490 Cotton 278 312 257 307 Wheat 146 161 142 166 Soybean(Irrigated) 161 177 139 161 Maize 119 130 112 130 For Zambian commercial farmers, when one excludes financing costs the variable costs of production have declined since the mid-1990s for each of the reviewed crops other than coffee. Reasons for the unit cost reductions have included lower fertilizer costs, yield improvements, and more competitive systems for agro-chemical supply. Still, these unit cost reductions were generally of a very small magnitude and thus not able to compensate for the significant reduction in commodity prices which has occurred in recent years. Moreover, with applicable interests increasing from 35% in 1994/95 to 56% in 2001/02, the interest costs incurred by commercial farmers have increased considerably, fully erasing the other cost economnies achieved for several of the crops. 50 49 The latter is probably attributable to the higher margins that the ginning comnpanies have needed to build into their inputs supply packages in order to compensate for relatively high rates of credit default due to side-selling by cotton producers. 50 Comparing 1994/95 and 2001/02, the increase in the financing costs incurred by farmers was between $6 and $9 per ton for soybean, mnaize and wheat. For cotton and paprika the increased financing costs were $16-19/ton while those for higher valued tobacco and coffee were considerably higher at $71/ton and $93/ton, respectively. 81 Table 4.14: Zimbabwe Commercial Farms: Variable Costs Per Ton (US$), 2000/2001 Excluding Interest Costs Including Interest Costs Va. Tobacco 1061 1282 Coffee 730 970 Paprika 439 538 Cotton 267 325 Wheat 119 143 Soybean (Irrigated) 139 167 Maize 98 118 In comparison with Zimbabwean commercial farmers, Zambia's commercial farmers are cost competitive for all of the industrial crops reviewed other than tobacco. They are also cost competitive with Zimbabwean farmers for soybean. In contrast, they are not cost competitive with their Zimbabwean counterparts for wheat and maize, although in neither case is the gap larger than the transport costs between Harare and Lusaka. This implies that in serving the Zambian domestic market, Zambia's commercial farmers can compete on a cost basis with their counterparts in Zimbabwe. Outside of this domestic market, however, and especially vis-a-vis markets to the south (i.e. South Africa, Botswana), Zambia's commercial farmers are not generally cost competitive with their Zimbabwean counterparts. 5' In a recent analysis, Kasanga et al. (2001) attributed the relative cost disadvantage of Zambian farmers (for selected crops) to higher fuel and other transportation-related costs, higher electricity costs (for commercial farm irrigation), higher importation costs for key inputs and machinery, and higher costs of finance. Direct quantitative comparisons, however, were only made for fuel costs which are indeed considerably higher than in several countries in Southern Africa as a result of high Zambian taxes and inefficiencies in Zambia's fuel distribution system. Table 4.15: Comparative Cost Structure for Commercial Farm Maize, Wheat, and Soybean: Zambia (01/02) vs. Zimbabwe (00/01) l__ __ __ __ ___ __ __ _ _ |__ Maize W heat Soybean Yield (KglHa) Zambia 5500 5500 2800 Zimbabwe 5500 6250 3000 Seed/Fertilizer/Chemical Costs ($/Ha) Zambia 261.67 271.67 115.07 Zimbabwe 246.09 209.22 146.74 Transport and Tractor R&M ($/Ha) Zambia 228.23 213.22 118.66 Zimbabwe 150.04 157.53 97.27 Hired Labor ($/Ha) Zambia 34.88 25.12 | _27.91 Zimbabwe 41.24 30.55 0.55 Interest ($/Ha) Zambia 96.20 130.89 62.46 Zimbabwe 107.32 150.94 84.12 Annualized Investment Cost ($/Ha.) Zambia 128.95 277.44 277.44 Zimbabwe 106.20 188.11 188.11 51 Interestingly, however, the results suggest that Zambia's smallholder farmers could be cost competitive with Zimbabwean commercial farmers in the latter's domestic market, even taking into account the cost of transport to that market. 82 Table 4.15 directly compares the variable and investment cost structures for Zambian and Zimbabwean commercial farmers for selected crops. The figures in bold print refer to cost elements for which Zambian commercial farmers have a very large disadvantage, amounting to a differential of 20% or more. A number of factors contribute to the relatively high transport and tractor operating costs in Zambia. One is the very high cost of gasoline and diesel fuel, arising from a tax structure which includes a 25% import duty and VAT, excise and other taxes which add a further 60%. Transport costs are also higher because of the poor condition of many (especially feeder) roads, insecurity along some road routes (with theft of trucks and goods), the application of import duties on many truck spare parts, inefficiencies in the loading/unloading of goods, and the inefficiency of the domestic rail system in conveying agricultural commodities. The graph below illustrates the relative significance of high transport and fuel costs across a range of crops produced by commercial farmers. The proportional burden of these costs is greatest for the lower value field crops.52 Chart 4.9: Commercial Farms: Transport and Tractor O&M as % of Total Variable Costs 35~ -1 30 25 = --B1 S_| 20 15- 5 - - L Z Maize Soybean Wheat Insh Cotton Va. Papnka Coffee Potato Tobacco Recently, the govemment lowered the excise duty on diesel fuel from 60% to 30%. This resulted in only a small reduction-about 5%-- in the pump price for diesel fuel for most farmers. This policy change in and of itself will have a minimal impact on the cost competitiveness and profitability of Zambian commercial farmers. Our calculations suggest that this will result in a cost savings of only $2 per ton in commercial farm production of wheat and soybean and increase the net profits of these growers by $11 and $5 per hectare, respectively. Additional tax cuts or rebates and related to diesel fuel53 and improved efficiencies in its distribution will be necessary to have much of an impact on the transport and tractor operating costs of Zambian farmers. However, changes in transport costs (and more specifically, fuel taxes) alone are not sufficient to substantially improve the profitability and competitiveness of Zambian commercial farmers. Recall that commercial farmers are making a net loss of $142/hectare for irrigated soybeans. All other things being equal, they would need to reduce their fuel and transport costs by 52 Of course, transport costs also differ substantially between farmers in different locations. For maize grain delivered to Lusaka, transport would comprise nearly 22% of the delivered price for a Chipata-based farmer. This share would be 4 to 6% for farmers based in Kabwe or Mazabuka. 53 We simulated the effects of the excise duty reduction plus a 20% rebate on agricultural diesel. The latter yields a further $2/ton reduction in the unit costs for soybean and a further $7/hectare improvement in profitability. 83 120% to breakeven. Clearly this is impossible. In order for the unit variable costs for Zambian commercial wheat growers to match those of their counterparts in Zimbabwe there would need to be a 60% reduction in fuel and transport costs. Even if all fuel-related taxes were eliminated (and there were no other policy changes), this result could not be obtained. 4.2.5. Agricultural Export Performance The development of non-traditional agricultural exports is generally considered as one of the more successful aspects of Zambian agriculture and the economy more generally during the 1990s. This development contributed to the partial diversification of Zambia's merchandise exports beyond its long-standing dependence on mineral exports. The sustainability and further growth of these exports is critical to fostering broad-based growth in the economy. Historically, Zambia had a significant trade deficit with respect to food and agriculture. Its agricultural sector was inward-looking and generated very little exports. Still, the sector depended upon imports of fertilizer and agro-chemicals plus Zambia needed to import an array of food products for which it was unable to meet demand from domestic supply (i.e. for rice, wheat, certain fruits, etc.). In 1990, Zambia's agricultural exports totaled only $30 million while its food and agricultural imports (not including agricultural inputs) totaled $62 million54. Zambia's agricultural exports consisted of a broad array of commodities produced primarily by commercial farmers." Between 1990 and 1994, agricultural exports doubled to reach nearly $61 million. This cannot be attributed to the emerging liberalization of the economy as the growth of trade was accounted for by only two products-sugar and cotton-the processing and trade of which still remained under the control of government parastatals. Exports of nearly all other agricultural products experienced little or no growth. With the further liberalization of the economy, the privatization of several parastatals and the advent of low-interest loan programs introduced by several international banks and donor agencies in the mid-1990s, there occurred a rapid and substantial growth and diversification of Zambia's agricultural exports. Such exports climbed to $146 million in 1997, led by a surge in cotton exports (following the privatization of Lintco), considerable growth in vegetable exports and the emergence of a cut flower industry. Favorable international prices, together with the availability of finance (under concessional programs) stimulated renewed interest and investment in several industrial crops (i.e. coffee; tobacco). With this growth in both traditional and non-traditional agricultural exports, Zambia's agricultural trade balance moved into positive territory for the first time in the country's post- independence history. Recent trends in this agriculture-related trade balance are summarized in the graphs below. While overall agricultural exports now exceed those for agriculture-related imports56, the country's specific trade balance for food products continues to show variability from year-to-year, primarily related to domestic weather conditions and fluctuations in staple food availability. 54 This import figure is from FAOSTAT. 55 Even though some of these exports were of marginal profitability, commercial farmers pursued these lines to obtain scarce foreign exchange which enabled them to sustain their more traditional, non-export farm activities. 56 The aggregate of food, live animals, fertilizer, agro-chemical, cotton lint, and unmanufactured tobacco. 84 Chart 4.10: Zambia's 'Agricultural Trade' Balance 160 140 -. | --. , 120 j *TotalAgricultural i 100 t - , , g Exports 80 .Ul , . * Total Agricultural B 80 ; S ' 1 i ,mports 60 40 , l 1996 1997 1998 2000 2001 Chart 4.11: Zambia Food Trade Balance 120 .100 , - > 80 H .Total Food Exports ; 60-I; .U Total Food Imports ~40j 20 7 1996 1997 1998 1999 2000 2001 The graphs above indicate that the fast pace growth of Zambia's agricultural exports in the mid-1990's has not been sustained in recent years. In fact, these exports have been more or less stagnant since 1997, with the exception of a substantial reduction in 2000 due to adverse climatic (and commodity price) conditions.57. The recovery of agricultural exports in 2001 is encouraging, yet it is not yet clear whether this momentum can be sustained in several of the key sub-sectors. Table 4.16 below provides the commodity breakdown -of agricultural exports, illustrating very divergent patterns among different sub-sectors.5" 5 The data used here are a modification of the times series data published by the Export Board of Zambia. The modification made relates to horticulture and floriculture exports. The figures reported to the EBZ have generally been the realized values for these exports in European markets, rather than the FOB values. To reach FOB values one needs to deduct the overseas marketing costs (including commissions) incurred as well as freight costs-the largest cost component in these exports. For cut flowers, the EBZ's data have been reduced by 50% to cover the average commission cost of 15% and the average freight cost of 35% of the realized price. For vegetables, the EBZ's data have been reduced by 40% to reflect the combined mnarketing and freight costs incurred to reach a reasonable estimate of FOB value. 58 See Keyser et al. (2001) for a more detailed discussion of the export systems and prospects for horticulture, coffee, cotton, and paprika. 85 Table 4.16: Zambia's Agricultural Exports: Commodity Composition and Trends ($US Value) Commodity 1995 1996 1997 1998 1999 2000 2001 Sugar 24.7 30.8 26.4 33.2 23.1 22.8 37.0 Vegetables 2.4 5.3 8.1 10.5 12.6 12.0 21.5 Cut Flowers 6.8 9.1 10.6 16.4 21.3 16.9 17.0 Cotton 7.0 9.0 49.1 26.4 39.7 11.2 29.6 Coffee 3.8 4.8 8.1 8.9 5.1 8.6 9.0 Tobacco 5.1 9.1 15.0 17.7 13.2 8.5 10.6 Animal Products 1.4 1.7 3.4 5.0 4.6 6.3 6.5 Paprika 0.2 0.7 2.4 1.5 2.8 1.8 3.6 Other Foods/Feed 8.7 18.0 23.3 18.7 13.9 19.5 14.9 Total 60.1 88.5 146.4 138.3 136.3 107.6 149.7 Sugar has remained Zambia's leading agricultural export throughout the period reviewed and accounted for 21% of these exports over the most recent 1999-2001 period. Zambia enjoys a quota under the EU Sugar Protocol, enabling it to sell at a favorable price of more than Euro 500/ton into the Portuguese market. Otherwise, the bulk of Zambia's sugar exports are within the region, primarily to the DRC and more recently to Kenya. Entry into the latter market was the primary factor in the jump in exports in 2001. Zambia is considered one of the lowest cost producers of sugar in the world and would benefit from the further liberalization of this highly distorted international market. Zambian vegetable exports have continued to rise over the period reviewed. Zambian grower/exporters have focused on supplying supermarket chains in the United Kingdom with baby corn, mangetout peas, fine beans, chillies and selected other non-traditional vegetables which have moved beyond a narrow niche to become more widely consumed. While Zambia's share of the overall U.K. vegetable market is miniscule, it is a relatively important supplier of baby vegetables and mangetout peas, competing head to head with Zimbabwe, Kenya, and others. Zambia's cut flower exports now consist almost entirely of roses as the earlier production of summer flowers in the open air proved to be unviable in the face of high air-freight costs and downward price pressures. Overall, Zambia's cut flower exports have fallen off in the last two years from their peak in 1999.59 The bulk of Zambia's flowers are sold in the Dutch auctions, although some grower/exporters sell direct to buyers in the United Kingdom, Germany, and elsewhere. With exports of less than 4000 tons, Zambia is still a very small player in the European rose and broader cut flower market.60 Over the 1999-2001 period, vegetables and roses accounted for a combined 26% share of total agricultural exports. Cotton, coffee, and tobacco together accounted for a combined 35% of total agricultural exports over the 1999-2001 period. These crops have been grown in Zambia for many years and they accounted for a large part of the country's meager agricultural exports in the 1980s. Zambia's exports of cotton have gyrated wildly from year-to-year. These export patterns reflect an underlying instability in production, the shifting fortunes of Zambia's garment and textile 59 Even with the modification made to the EBZ's floricultural export estimates, there is still a possibility that the figures provided in Table 4.16 over-estimate the actual exports. During the last four years, cut flower exports have increased from 3400 to nearly 3800 tons. Over this same period, the average FOB value for Zimbabwean flowers fell from $4200/ton to $3409/ton. Assuming a similar pattem for Zambia, this would imply that the true value of Zambian cut flower exports may have remained in the range of $13 to $15 million per year. 60 For comparison, Zimbabwean and Kenyan cut flower exports in 2001 were 22,000 and 28,400 tons respectively. Those two countries account for the dominant proportion of African cut flower sales. 86 industries (and its ability to promptly pay for cotton lint), and international commodity price developments. Zambian cotton is considered of low-to-medium quality. While improvements have been made in recent years in lint quality (and ginning out-turns) there is scope for further improvement. Sales are made both to South Africa and Europe. Zambia remains a relatively small player in the international cotton market, yet it could emerge as a leading player within Southern Africa given the growing demand within the region from several garment industries which have geared themselves up to take advantage of the market access opportunities under the U.S. African Growth and Opportunities Act (AGOA).6' To realize this potential will require improvements in infrastructure in the main cotton-growing areas as well as other interventions to render more sustainable existing systems for seed and other input supply, and provision of credit. These measures are needed to increase productivity and reduce unit production and logistics costs. Otherwise, profitability cannot be restored in the sector as there is not expected to be much of a near-term recovery in international cotton prices due to structural imbalances in global supply and demand and the increase in subsidies going to US cotton growers. Improving the competitiveness of this sector is nevertheless of major importance in Zambia's quest to promote rural development given that nearly one in five smallholder households cultivate cotton. Zambia's coffee sector was given a boost by concessional credit programs in the mid-90s, together with the privatization of the government-owned Zambia Coffee Company and the subsequent plantings of nearly 1000 hectares by African Plantations Company. With the maturation of this and other plantings, commercial coffee production has grown steadily, underpinning a rise in exports despite the very unfavorable trend in international coffee prices. Production has grown steadily from 2167 tons in 1996/97 to 5868 tons in 2000/01. Nevertheless, Zambia is a tiny player in the international coffee market62 and, with a relatively high cost structure6 , must position itself in the gourmet, premium quality segment of the market. Zambia produces a washed Arabica coffee regarded as having an acidic taste and thin body, which is in good demand among the world's blenders and roasters. Until recently, the quality of Zambian coffee was considered better than that of many of its competitors. In 1998/99 Zambian coffee obtained an average premium of 17.77 cents per pound above the benchmark New York coffee price. However, over time, the overall quality of the crop has deteriorated somewhat and there has been more mixed grading. Over the past three seasons the proportion of smaller beans, broken beans, and under-grades exceeded 40% of the total crop. The viability of the sector-in the face of expected continued international price pressures-will depend upon its attaining and maintaining a reputation for high quality, and achieving the premium prices which accompany this. Zambia's tobacco exports have shown no discerning trend. Production of both flue-cured and burley tobacco has wavered over the years although there has been some modest increase in recent years with the active participation of major multinational tobacco merchants in the sourcing of smallholder burley tobacco in Eastern Province. The bulk of Zambia's tobacco is currently sold through Zimbabwe and Malawi where there are well-developed auction and processing facilities. Zambia remains a very small player in this trade, with its total production of less than 10,000 tons per year contrasting with Malawian production of 140,000 tons (mostly 6! The leading cotton supplier within the region-Zimbabwe-is not AGOA certified, meaning that firms cannot use Zimbabwean cotton in the production of garments or textile products destined to the U.S. under the AGOA preferences. 62 Within East and Southem Africa, the leading coffee exporters are Uganda, Kenya, Tanzania, and Angola. 63 Zambia is a relatively high cost producer because nearly all production involves irrigation. Based on our farm models, the breakeven price for a well-managed commercial farm is $1 273/ton. 87 burley) and Zimbabwean production of more than 175,000 tons (mostly flue-cured). Nevertheless, the instability in Zimbabwe has led international tobacco companies to search for potential alternative supply sources, including Zambia, Mozambique, and Tanzania.64 Additional investment in production, in marketing facilities, and in transport infrastructure (i.e. the extension of the Nacala rail corridor to Zambia) will be needed to achieve a take-off in Zambian tobacco exports. The balance of Zambia's agricultural exports includes a broad array of products, few of which have experienced significant and sustained growth. Zambia has joined other countries of Southern Africa in targeting the international market for paprika, used both as a spice and as a natural colorant. Production, though small, has continued to grow and there is ample opportunity to increase international market share, especially in light of the problems faced in Zimbabwe.65 Modest growth has been recorded in trade in an array of animal products, including hides and skins, day-old chicks and fresh eggs. However, with problems of disease (cattle) or high costs of production (i.e. poultry), Zambia has largely been unable to develop a trade in meat products, while its vast fisheries resources have not be exploited for exports. Other products which have been exported in varied quantities from year-to-year have included animal feed, maize meal, and various oilseeds, sold within the region. While there are dozens of companies engaged in export activities in some way, Zambia's agricultural exports are heavily concentrated among a few firms and this concentration appears to be increasing in recent years. While in 1999, the largest five exporters accounted for 56% of total agricultural exporters, last year the five-firn share was 64%. In the latter year, only fourteen companies had exports exceeding $1 million. A number of factors have underpinned the broad and divergent trends in Zambia's agricultural exports. On the extemal front there has occurred a substantial decline in intemational commodity prices over the past four to five years which followed an earlier positive movement in such prices. These adverse price movements have been the result of structural over-supplies with overall demand compressed by slow economic growth in Europe and major dislocations in much of Asia. This was accompanied by production growth and unsold stocks in a number of major producing countries. Production subsidies for developed country farmers continue to exacerbate this situation, including for cotton and tobacco. Among Zambia's major agricultural exports only for sugar and vegetables have exporters not seen a significant decline in international prices in recent years. The graph below illustrates the adverse price trends for cotton, tobacco, coffee, and roses, using proxy indicators for these trends. The most dramatic adverse price movement has been for coffee, with Zambia's export unit prices falling from $3529/ton in 1997/98 to $1542/ton last year. 6 In the past year, production in Zimbabwe fell by more than 30%. 65 In recent years, Zimbabwe has accounted for more than 10% of world production of paprika. 88 Chart 4.12: Commodity Price Trend Indices 250 . - I 0200: 150 - - - 100 II L, * ;'!, | ii 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 | Coffee (Zambia) U Cotton (Int'l) 0 Tobacco (Malawi) E Roses (Large;Dutch Imports) I Zambia's exports within Africa have been affected by instability in the DRC, political and economic disruption in Zimbabwe, and various non-tariff barriers to trade with COMESA and/or SADC partners. The DRC provides a potentially enormous market for Zambian food exporters .as the population of neighboring Katanga Province (i.e. 12 million) exceeds that for Zambia as a whole and this is perhaps the only significant market within the region where Zambia enjoys transport cost advantages. In 1997, there occurred a large surge in trade with the DRC following the change of government there and efforts to improve bilateral relations. The subsequent outbreak of civil war in 1998 disrupted many of these trade ties. While political stability has been restored in the DRC, there remain underlying barriers to sustained trade there, including language differences, poor infrastructure, and weak systems to ensure payments and contract enforcement. As a result, most Zambian firms selling into the DRC do so on a cash and carry basis and have yet to develop regular distribution channels for a more sustained trade. The economic upheaval in Zimbabwe has had repercussions for Zambia's agricultural exports and, as will be discussed below, for competition in the domestic Zambian market. With a sharply contracted local market and facing foreign exchange shortages, Zimbabwean food processors and traders have aggressively sought out markets in neighboring and other regional countries, taking advantage of the dual exchange rate system in place to underprice their Zambian (and other) competitors. This has affected Zambian exports into Malawi, the DRC and perhaps other countries. While the assumption of the COMESA Free Trade Agreement in 2000 has opened up some improved market opportunities for Zambian firms within the region, this has thus far not resulted in much expanded trade, partly as a result of the imposition of non-tariff barriers against Zambian products. The most prominent recent case involved the imposition of quantitative restrictions on duty-free access to the Kenyan sugar market as a result of apparent threats to the Kenyan sugar industry from lower cost regional suppliers, including Zambia. Also in the past year there have been periodic restrictions on the cross-border movement of Zambian tobacco from Eastern Province into Malawi, arising out of concems within Malawi about congestion at the Lilongwe auction and the 'leakage' of Malawi's own crop into neighboring countries in order to escape statutory levies, credit repayment, etc. There have been other smaller cases of non-tariff barriers inhibiting cross-border trade in food and agricultural raw materials.66 66 It is reported that in order to sell milk in Zimbabwe a company needs to obtain a veterinary permit from that country. This may take up to six months and require several visits by a veterinary specialist. The Zimbabwean buyer then needs to obtain an import license and a foreign exchange allocation from the Reserve Bank. Labeling must be done in two languages. Responding to this array of barriers, Zambia 89 It has not only been external factors which have driven recent trends in agricultural exports. Macroeconomic instability within Zambia-as reflected in unstable and seemingly unpredictable movements in the Kwacha exchange rate and the persistence of very high real interest rates-have created enormous problems for Zambian agricultural exporters, weakening their ability to plan production and price their raw materials and exportable products, preventing inter- and intra-seasonal storage of raw materials, and generally raising operating costs. Firms have been caught in the pincers between shifting exchange rates with the dollar, European currencies, and the Rand. This problem was highlighted for non-traditional exports as a whole in Chapter 3. Many upstart agricultural export operations have proved to be unviable in the face of adverse price movements and either the high cost or inappropriate structuring of investment finance. This pattern has been most widespread in the cut flower industry where perhaps one-half of the thirty-five previously registered growing/exporting operations have either ceased production altogether or scaled back their efforts to a precarious survival mode. Most of these struggling operators entered the sector in the late 1990s. Few had prior experience with flowers and therefore relied excessively on expensive and not always effective external advice. Many of the new cut flower operations were highly leveraged financially, yet the credit made available was sufficient to only develop a two hectare operation and constraints were faced in accessing working capital. Investment and technical mistakes were made, including purchases of expensive equipment which was unnecessary for the small initial size of these operations, improper selection of rose varieties for planting, and generally improper application of production inputs. In some cases, management oversight was weak because of other business interests by the proprietor. Our crop budget analysis suggests that with prevailing prices and cost structures, these two-hectare flower operations may be losing some $68,000 per hectare when investment depreciation is considered67 In some sectors, the sustained development of exports has been undermined by wide year-to-year variability in domestic raw material production. Climatic variability, shifts in the relative profitability of different crops and the collateral effects of periodic government interventions to promote food security are among the most proximate factors. This instability in raw material supply has been most severe in the cotton sub-sector where production is undertaken by some 125,000 to 150,000 smallholder farmers.68 Cotton production has been affected by climate and by the crop's relative profitability with maize, the latter being influenced by periodic government interventions in the fertilizer and maize markets. Cotton is not the only primary commodity for which there have been wide swings in production from year-to-year, undermining the scope for sustained development of export supply channels. Wide swings in soybean production has made it impossible to developed a sustained export trade, including with South Africa. Table 4.17 below summarizes the destinations for Zambia's agricultural exports. Some 56% of Zambia's food and agricultural exports are sold within the region, the largest single markets being South Africa, the DRC, and Kenya. Most of the remainder of the trade-and most of the country's exports of high-value perishable commodities (i.e. vegetables and cut flowers)-is oriented toward Western Europe, with the U.K. being the single largest determined that mnilk products from Zimbabwe would need to be labeled in seven languages in order to enter the Zambian market! 67And losing $25,000 per hectare when considering only variable costs. 68 This represents by far the largest spread of participation in export-oriented agriculture, with the total number of smallholders involved in all other agricultural exports combined probably does not exceed 20,000. 90 destination. Zambia presently undertakes minimal exports to other regions outside of Africa or Europe.69 Table 4.17: Share of Different Destinations for Zambia's 2001 Agricultural Exports(% * South Africa 22.0 DRC 16.9 Other African Countries 17.4 UK 15.6 Netherlands 11.3 Other European 16.1 Other (i.e. USA, Asia; Middle East) 2.2 Total 100.0 *The calculations do not include the trade in minor export commodities such as maize, animal feed, tea, and seeds, for which trade destination data are not available. Although South Africa is the single largest destination for Zambian agricultural exports-with a value of some $28 million in 2001-- Zambia has thus far taken little advantage of the huge market opportunity presented by this regional powerhouse, whose consumer market represents more than 80% of the total SADC consumer market.70 With extensive reforms implemented in the mid-to-late 1990s both in agricultural and trade policy, South African agriculture and agribusiness has now taken its place as a fully integrated member of the global trade environment, and its trade patterns have shifted considerably over the past decade. Primary agricultural production now receives virtually no domestic support from the state. The regulatory regime which has emerged from trade liberalization measures affords greater protection to the manufacturing sector than to producers of primary commodities, and is intended to favor SADC countries over the rest of the world. In 2000, South Africa's total agricultural and food imports totaled R9.64 billion (equivalent to $1.38 billion), about twice the level in 1994. South Africa imports food and other agricultural products from 152 countries, although five countries account for nearly half of the total value and ten countries for two-thirds of the value. The five largest suppliers are Argentina, United States, United Kingdom, Australia, and Zimbabwe. Almost 50% of the import bill can be attributed to twelve commodities of which rice, wheat, animal feed ingredients, tea, and coffee can be regarded as 'traditional' imports while there has occurred relatively rapid growth in an array of 'non-traditional' imports, including maize, hides and skins, mutton and goat meat, soybean oil, other oilseeds, sauces/preparations, and cotton. Most of these products can be characterized as raw materials used in the processing of food products. In 2000, South Africa imported less than R I billion ($133 million) of agricultural and food products from the SADC region.7' This represents less than 10% of the country's imports of these products.72 Three commodities-cotton, tobacco, and tea-accounted for nearly 53% of South Africa's food and agricultural imports from SADC. Much of the remainder of this trade is also accounted for by other primary commodities, although there has been some trade in higher value products including spices, cut flowers, vegetables, and meat. 69 Its agricultural exports to the United States were only $1.59 million in 2001. 70 See Vink et al. (2002) for a fuller discussion of the opportunities and constraints in servicing the South African market. 7' This is up from R 587 million in 1994. 72 By contrast, South Africa's exports of food.and agricultural products nearly tripled between 1994 and 2000 from R I billion to R 2.99 billion 91 SADC participation in the South African food and agricultural market is not widely distributed. In 2000, Zimbabwe dominated this trade, accounting for 72% of this total. The value of South Africa's food/agricultural imports from Zambia in that year was only R 85 million, representing 9% of SADC supplies and a paltry 0.9% of global supplies to the South African market.'3 In that year, only three commodities-cotton, soybeans, and other oilseeds-accounted for the bulk of this trade, with some limited sales of paprika, hides and skins, oilseed cake, niche market vegetables, and maize. There have been sharp year-to-year fluctuations in Zambia's agricultural export trade to South Africa reflecting the instabilities in Zambian production and the inability of most firms to develop sustained sales channels. In 2001, cotton lint and fuzzy seed together accounted for nearly 75% of Zambia's agricultural exports to South Africa, with most of the balance being accounted for by coffee and paprika. Hence, with some limited exceptions, Zambian suppliers have played an extremely marginal role in servicing South Africa's market for food. The relatively weak market penetration by Zambian and other SADC suppliers into the South Africa market has occurred despite their preferential access into that market for a broad range of products (Table 4.18). Table 4.18: Examples of SADC Country Tariff Advantages in the South African Market Product MFN Tariff (%) SADC Tariff (%) Soybeans 10 0 Oilseed Cake 6.6 0 Tomato 15 0 Potato 44c/bag 0 Chillies 25 17 Paprika 25 0 Tobacco 15 12 Beef 40 16 Maize 10 0 Cut Flowers 20 0 Cotton (ginned) 160 c/kg 90c/kg Cotton seed oil 10 0 Sources: Keyser et al. (2001); Vink et al. (2002) For relatively low value commodities and products, such as cereals, oilseeds, and animal feed, Zambia is generally not cost competitive in servicing the South Africa market, especially any population areas near the coast which can be competitively serviced by overseas suppliers. The primary factor here is transport cost differentials. Table 4.19 provides an illustration of this for maize. It depicts the transport cost for delivery of maize to the Gauteng area (i.e. Johannesburg-Pretoria), and two coastal cities. Zambia suppliers are at a huge transport cost disadvantage-against U.S. and Argentine suppliers-in servicing the coastal cities of Durban and Cape Town. For South African food manufacturers based in the Gauteng area, it is cheaper for them to purchase maize from selected countries within the region, including Lesotho, Mozambique, and Swaziland. Zimbabwe is a more expensive source than importing from the US Gulf Ports but cheaper than importing from Argentina. With respect to transport costs it is cheaper to import from outside the region than to source from Zambia, Tazania, or Malawi.74 Gauteng represents the most important consumer market in South Africa. The cost differential between the Gulf Ports and Lusaka is around 73 Contrast this with the value of South African exports of food, beverages, and cigarettes to Zambia valued at R 186 million in 2000. 74 Note that the road transport tariff not only takes into account direct running costs but also includes items such as toll road costs, cross boarder charges, as well as security costs where applicable. 92 $20/ton, a significant difference in relation to the international price of maize. Nevertheless, there is scope for reducing transport costs from Lusaka, for example by facilitating return loads, improving the physical infrastructure and streamlining bureaucratic procedures. Table 4.19: Transport Cost Comparisons: 1999/2000 (Maize, $ per ton) Destination Gauteng Gauteng Durban Cape Town Rail Road Sea Freight' Sea Freight Us $ US$ Us $ Us $ Origin SADC Maseru 21.3 23.0 Lilongwe 73.7 97.7 Maputo 18.6 24.2 Lusaka 71.6 73.2 Harare 55.5 55.6 Swaziland 26.4 35.1 ar-Es-Salaam 142.1 155.3 South Africa Cape Town 56.8 53.4 Durban 26.0 23.6 Extra regional US GulfPort 51.49 25.49 25.49 Argentina 59.01 33.01 33.01 Note: Includes freight costs, insurance and discharging costs. Insurance is 0.3% while discharge costs were estimated at 7.5% of the product value. Source: As reported in Vink et al. (2002) While comparative costs (and especially transport costs) are a critical factor in some of South Africa's commodity markets, this has not been the primary factor in other markets. For a wide range of products, Zambia is perceived as a non-reliable supplier with year-to-year changes in the capacity of Zambian firms to fulfill supply agreements. For South Africa's very large food manufacturers there is a need for large volume raw material purchases, spaced over time. Zambian suppliers are simply unable to meet these requirements. This need for bulk purchases is apparently less of an issue in the cotton subsector, where buyers are able to work with smaller orders and consignments. The same is also true in the spice industry and for out-of-season and specialty vegetables. In these areas, the challenges are to steadily meet quality requirements and retain the continuity and reliability of supply. There are also a number of niche markets- including for organic soybeans, medicinal plants, essential oils-where Zambian suppliers could develop (or further strengthen) market linkages into South Africa. In addition to becoming a more competitive and reliable supplier into the South African market, other significant challenges facing Zambia's export-oriented agriculture include: Regularizing supply chain linkages into the DRC market and competing there with suppliers from Zimbabwe and elsewhere. The market opportunities there are significant for a broad range of primary and processed food products, yet suppliers must be assisted to overcome existing logistical and institutional constraints which generally inhibit cross- border trade between these two countries. There may be possibilities to establish a 'dry port' or similar trading service center in the DRC within close proximity to Zambia to 93 facilitate logistics, efficient customs administration, payment arrangements, etc..The feasibility of such an investment should be carefully examined. * Re-invigorating the cotton subsector, given its significant regional market opportunities and its broad backward linkages into rural communities. There is an evident need for a sectoral development strategy which forges a joint public and private sector vision and re-defines the appropriate and necessary roles of each as well as that of the Cotton Council. There is a need for a more sustainable means of crop financing, perhaps through a revolving fund from which levies are deducted at the gate of licensed ginners. * Build upon the current platform for horticultural and floricultural exports. In the near- term the primary growth opportunity is for vegetables, taking European market share away from Zimbabwe for specialty items. There is scope to further incorporate smallholder farmers into export vegetable supply chains, although this will require investments in small-scale irrigation, working capital financing, and appropriate technical support and audit schemes. For cut flowers, there is a need to consolidate existing assets among viable companies, to further adopt lower cost technologies, to adopt newer plant varieties, and to continue to build a cadre of technical specialists and managers via the ZEGA Trust program. * Raise the overall quality level of primary commodity exports (especially coffee and tobacco) and take advantage of opportunities to add value to existing products, especially with paprika, other spices, essential oils, and other higher value products. Support could be given to commodity/industry associations to develop and apply improved quality management systems and codes of practice for environmental management and social welfare, increasingly required by downstream distributors and consumers. 4.2.6. Domestic Market and SuDPIV Chain Linkages As noted earlier, policy reforms in the early 1990s moved Zambia away from administered agricultural marketing channels and prices and opened the way for increased private sector involvement and investment in agro-processing and domestic food distribution. The privatization process built on this momentum, with many larger and smaller agro-processing entities being sold off by 1997 or at least put under private management. Some further privatizations have occurred since then as have ownership changes in some of the firms previously privatized.75 In the wake of the policy reforms and privatizations there occurred a considerable level of investment in agro-processing and food distribution, whether to refurbish existing capacity (i.e. in cotton ginning, dairy processing, beer brewing, retail distribution) or to expand available processing capacity (i.e. wheat milling, poultry processing). A very large proportion of this investment was undertaken by regional and international companies (see Table 4.20 below). Most of these companies have been investing throughout East and Southern Africa, although for Dunavant, the investment in Zambia was its first in Africa. South African firms, facing a highly competitive and slow growing domestic market, moved into Zambia (and elsewhere) to generate faster earnings growth and/or to source raw materials for their South African operations. They were hopeful about the scope for income and purchasing power growth 75 The privatization experience in Zambia's agro-processing sector has been a mixed one. The process in the dairy sector has been a notable success where there has been increased availability of fresh milk and a variety of local cheeses, supplied by one larger company operating nationally and a number of smaller ones, operating regionally. Privatization processes which failed to result in sustained and competitive industries include those in the fruit/vegetable processing and tea processing fields. The National Milling Company has gone through three ownership changes since 1997. 94 in reforming economies, were able to acquire relatively inexpensive productive assets, and perceived that they would face less severe competition in these markets. Table 4.20: Examples of Recent Foreign Investments in Zambian Agro-Industry Company Sector Corporate Base Illovo _ Sugar South Africa Clark Cotton Cotton Ginning South Afiica Astral/Tiger Group Animal Feed South Africa South African Breweries Beer Brewing South Africa Ross Breeders Poultry Breeding Stock Zimbabwe Shoprite/Checkers Food/Grocery Retailing South Africa Metro Cash and Carry Food/Grocery Retailing South Africa Dunavant Cotton Ginning United States Seaboard Cereals Milling United States Parmalat Dairy Processing Italy CDC Wheat Milling United Kingdom Tombwe Tobacco Processing Germany Market liberalization, the privatization of many agro-processing entities, and an influx of foreign investment were expected to give rise to a more efficient and dynamic agro-processing sector which would provide more product choice and value for money for Zambian domestic consumers, create an engine to pull Zambian agriculture, and open up opportunities for exports of value-added agricultural products. The actual experience has been mixed, with consumers indeed benefiting, only selected areas where agro-industry has indeed catalyzed increased agricultural production, and, besides sugar, minimal success in increasing competitiveness to permit the exports of value-added products. In recent years, the business environment for agro-processing and food distribution in Zambia has been conditioned by: (i) a significant reduction in the tariff and traditional quantitative restrictions on imported foods and agricultural raw materials, in some cases providing negative protection of the domestic industry against imports; (ii) strong overspill effects from the instabilities in Zimbabwe with firms there making use of the dual exchange rate system to pump their products into the Zambian market; (iii) a contraction of purchasing power within Zambia due to declining per capita income and formal sector employment; and (iv) powerful systemic effects from the 'supermarket revolution' which has arrived in Zambia through the entry and expansion of a major South African retail chain. The joint effects of these developments have been enormous, yet on the whole, not positive for Zambian agribusiness. 4.3 POLICY AND REGULATORY FRAMEWORK Table 4.21 below provides a summary of the policy and regulatory framework for different spheres of agro-processing. Several points can be highlighted. First, there are now very low tariffs on agricultural raw materials, these generally being zero to five percent. There is some escalation of tariffs with finished agro-based products generally carrying a 15-25% duty, yet Zambian processors face disadvantages because of the costs of imported packaging materials (with 25% tariffs plus VAT), duties on machinery spare parts and intermediate inputs, and the domestic tax structure on fuel. Second, while traditional restrictions on trade have been sharply reduced, there has been a recent trend toward greater application of trade restrictions based on sanitary and phytosanitary measures, labeling requirements, and other technical specifications. This has been most prominently applied in relation to livestock products, ostensibly due to the outbreak of animal 95 diseases in certain regional supply countries, although the maintenance of these restrictions over time has served as a powerful protection for local industry. Third, there are now minimal direct interventions to foster competition in the domestic market and/or affect the prices of raw materials or consumer products. A recent exception to this has occurred in the maize sector where government has intervened directly to import maize and then sell it to millers at subsidized prices in order to bring down the price of milled maize to consumers. There has also been a restriction on the importation of wheat during several months in the year in order to ensure a market for local farmers. Fourth, there have occurred minimnal and largely ineffectual arrangements to develop and enforce quality, food safety, or any other standards within Zambia. Most of the standards which have been applied have been done by private entities. Table 4.21: Policy Context for Zambian Agribusiness Cereals and Oilseed Livestock Products Industrial Crops Processin Import tariffs on 5% for non-Comesa and 5% (NC); 0% (C) Cotton lint: 15% agricultural raw materials duty free for Comesa (NC); 10% © Coffee beans: 5% (NC); Import tariff on finished Maize meal: 15% (NC); Generally 25% (NC); Sugar: 25% (NC); 0% product(s) 0% (C) 0% (C), yet for table (C) Wheat flour: 25% (NC); eggs it is 15% (NC); 0% Processed Coffee 25%; 0% (C) (C) 0% c Edible Oil: 25% (NC); Garments: 25% (NC) 20% © 20% 0 Oilseed cake: 5% (NC); 0% D Quantitative restrictions None for maize and None None on imports oilseeds; Wheat grain imports permitted only with proof that all local grain has been purchased. Wheat imports generally banned from September to November. Licensing requirements Import permits required Import permits required Import permits for imports for all products for all products required. Non-tariff barriers on Phytosanitary Phytosanitary certificate Phytosanitary imports certificates required. required. Have been certificates required. Minimum standards 'temporary' bans on Sugar must be vitamin requirement beef, poultry, and A fortified. certain dairy products from Zimbabwe and South Africa on basis of animal disease _____________________ ~~problem s. Government participation Government presently Government involved in None in imports involved in importation importation of semen of maize grain and of veterinary chemicals Tariffs on packaging 5% (NC); 0% (C) Same as for cereals Same as for cereals materials Tariffs on machinery Duty free Duty-free Duty-free 96 Interventions to control Government selling VAT (17.5%) applied VAT applied on sugar or influence prices imported maize to on beef products in and coffee in domestic millers at subsidized domestic market market prices; Presently there Sugar is uniformly are controls on maize priced throughout the meal prices (first time country, retaining the since early 1990s). No customary practice of VAT on staple foods pre-privatization generally although it is applied to vegetable oil Interventions affecting Restrictions on maize None quantities available and maize meal exports Subsector-specific Gov't importing maize Government policy to None subsidies at $260-$280/ton and support smallholder selling to millers at cattle production $160-180/ton through restocking fund and vet. Chemical provision at subsidized rates Other relevant subsidies Gov't importing None fertilizer for distribution in 2002/03 to selected farmers at subsidized rates Official grades/standards Official minimum Bureau of Standards Industry-set standards standards for trying to develop for sugar products, maize/maize meal yet quality standards yet coffee, and cotton lint non-existent little progress. Industry and yarn. Official enforcement; Industry- -set standards applied standard for sugar set standards for wheat for milk quality. involves vitamin A and oilseeds yet limited fortification enforcement . Official inspection and Licensing and official Same as for Same as for others; licensing of inspection of cereals/oilseeds. again not effective. processing/sales premises processing/sales Monitoring is generally premises falls under not effective Bureau of Standards and Local Councils yet inspections are rare Restrictions on None Only licensed dealers None distribution channels may market livestock products, although there is no effective enforcement by __ __ _ __ __ _ __ _ government agencies Application of localized Grain fees are pay in Animal head fee is paid Local fees on seed taxes each district of on each head of cattle cotton and coffee beans I production of $0.12./ton moved out of a district. of $0.12/ton Corporate tax rates Primaril 30% 15% Export taxes Export levy of Charge of $10 for Charge of $10 for US$0.12/ton and $10 export application export application for export application documentation. documentation. Levy of documentation US$0.12/ton for cotton lint 97 Quantitative/other Export permits may not Export permits may not Export permits may not restrictions be given at times of be given for beef during be given for cotton lint short local supply periods of short local during periods of short supply. local supply. Otherwise, no restrictions. Application of quality Lack of clearly defined Lack of clearly defined Clearly defined and control or certification quality control quality control privately enforced processes regulations and regulations and standards applied for enforcement enforcement. sugar. 4.4 ZIMBABWE SPILLOVER EFFECTS The reduction of tariff and other formal trade barriers, movements in exchange rates, and other factors has contributed to a modest overall increase in Zambian imports of food products and agricultural raw materials in recent years. Excluding maize (which has dominated Zambian food imports in some drought years), Zambian food and feed imports averaged $25.2 million over the 1996-98 period, before rising to $35.1 million, $30.7 million, and $38.9 million, respectively from 1999 to 2001. This modest growth in food imports would not seem to be a matter of any great concern. However, this import growth has occurred during a time when the domestic market was contracting and a significant number of Zambian-based food manufacturers either went out of business or experienced a large reduction in turnover (see below). The composition of import growth is also very significant. As the graph below illustrates there occurred a very large increase in Zambian imports of wheat flour, vegetable oil, and animal feed in 2001 and an increase in soybean imports from practically zero in 1999 to $1.3 million in 2001. Chart 4.13: Zambian Imports-The Zimbabwe Spillover Effect 7000000 6000000 5000000 - - 0 4000000 - . :_-0 ; 3000000 - 02001 2000000 1000000 - - ' Wheat Flour Soybeans Sunflower Oil Animal Feed The bulk of these imports originated in Zimbabwe. With the political and economic upheaval there, Zimbabwean food processors and traders have faced a massive contraction in domestic demand and restricted access to foreign exchange to meet their costs of imported spare parts, etc. This has pushed them into an export mode, even to the point of causing shortages in the 98 domestic market. 76 They have been required to convert 40% of their foreign exchange proceeds at the official rate of Z$55 =US$ 1, while the remainder is converted at the parallel black market rate, which reached more than Z$300 to the US dollar in late 2001. This enabled them to aggressively price their products in the Zambian market, more or less being able to land them in Lusaka at a cost below the production costs of Zambian processors. Zimbabwean processors have had a sustained cost advantage over their Zambian counterparts. For example, for wheat flour the Zimrbabwean firms have cost advantages based on greater economies of scale, a better market for by-products (i.e. bran), lower fuel taxes and costs, and a lower cost for wheat. However, in the absence of the exchange rate anomaly, these advantages would not be sufficient to overcome the transport costs of moving relatively low value cereal (and oilseed) products into the Zambian market. The effects of this unfair import competition were significant, with most of Zambia's wheat processing capacity being shut down in late 2001 and with local oil expressors forced to simply trade in the finished product rather than purchasing raw materials and processing locally. The response of the Zambian government to petitions by the Zambia Association of Manufacturers on this matter was very slow and it took more than six months to put in place a system of voluntary constraints on Zimbabwean supplies to Zambia. In the interim period, the market dislocation weakened on-going financing and contracting relationships between Zambian (commercial) farmers and local processors. This experience has had a more general (negative) effect on farmers and industrialists perceptions about the costs and benefits of the various free trade agreements which Zambia has entered into.77 4.4.1. Contracting Demand (and a shrinking industry) In a 1995 survey of food processing companies, some two-thirds of firms interviewed indicated that the primary reason for their operating at below capacity was a lack of sufficient demand for their products. With increased investment in food processing capacity in the late 1990s and with stagnant pattems of per capita income, this problem has gotten much worse, although there is little quantitative evidence to support this. The majority of food processing firms interviewed in late 2001 report either a stagnation, or, more commonly an outright contraction in the demand for their products in the last two or three years. The country's leading supermarket chain reports a 10% reduction in customer clientele between mid-2000 and late 2001. Aggregated data on private consumption expenditures (all goods and services combined) point to a stagnant overall trend since the mid-i 990s (see the graph below), yet specific estimates of aggregated food expenditures are not available for recent years. National accounts data suggest modest growth in the GDP of food/beverages/tobacco manufacturing over the past three years, although a review of the (incomplete) data upon which this is based points to some gains in the 76 One firm which produces animal feed in both Zambia and Zimbabwe reports on a situation where its Zimbabwean affiliate was unable to locally purchase oilseed cake. It needed to buy Zimbabwean oilseed cake in Zambia and then transport it back to Zimbabwe. " The $10-20/ton savings associated with using the dumped Zimbabwean wheat flour has minimal effect on the welfare of Zambian consumers. On the other hand, it sets in place a sequence of reactions which strongly weaken the viability of some Zambian commercial farmers. Large-scale imports of wheat flour (over and above historical levels) undercut the demand by millers for local wheat. This, in turn, undercuts the viability of local soybean production as it is typically grown in rotation with wheat. Should there be an extended withdrawal from soybean production this would have an adverse effect on the price of locally manufactured animal feed which, in turn, would further undercut the competitiveness of the local poultry industry. 99 soft drinks and sugar sectors while the turnover for many of the reporting food processing companies has been stagnant or declining in real terms. Discussions with food processors suggest there has been expanding demand for very few processed products, one being for bottled water for which they are now a large number of firms seeking to serve the market. In contrast, the milled maize product market is reported to be stagnant with several players, large and small, fighting for market share by squeezing profit margins and trying to retain brand loyalty.78 Declining purchasing power has also prevented cereal millers (and others) from passing on higher costs to consumers. The result has been a squeezing of processor margins. Firms with a narrow product range or narrow set of market outlets have been especially vulnerable under these circumstances. Zambian meat consumption has stagnated at 2.4 kgs. per person, about half the average for Africa. The demand for quality beef is said to be declining, while the demand for offals and other 'Grade C' meat products is the only segment which is not contracting. Both in the beef and poultry markets there are an increasing number of players competing over a declining consumer base. Bread consumption, which had been on the rise through the mid to late 1990s is said to be falling as increased costs have put bread outside the reach of some consumers. Chart 4.14: Index of Private Consumption Expenditures (1994=100) 100 ~ 95 t- 90 , :F 85L 75 i I - --1i 1994 1995 1996 1997 1998 1999 2000 2001 The stagnation or contraction of domestic demand for a broad array of processed foods, when combined with increased import penetration and an inability to compete in regional or other export markets, has contributed to high rates of failure and bankruptcy among food processing companies and to changing marketing strategies among the survivors. Industrial census data is either unavailable or unreliable. However, just in the past three years, such long-standing medium-sized food processors as Copper Harvest, Lyons, Sunrise, Reckitt and Colmans, and Cadbury Schweppes have closed their Zambian operations and shifted their production elsewhere in the region (primarily to Zimbabwe or South Africa). Lever Bros. previously produced two dozen food and household product items, yet now produces only one product locally. There has been a more widespread liquidation of assets within the food processing industry, especially among small and medium scale companies.79 78 There are some fifteen larger maize millers with modem equipment who account for a combined three- fourths of the domestic market. The other fourth is serviced by hundreds of smaller millers and hammermill operators. 79 The relatively few medium-sized locally-owned food processors which have survived have featured: (i) family ownership and management, (ii) direct strategies to minimize overhead costs, (ii)a diverse product range, typically of one to two dozen products, and (iv) a diversified range of market outlets. 100 The resultant industrial structure is a bi-modal one, featuring a few larger and generally foreign-owned enterprises now dominating the (contracting) formal sector while a relatively large and unstable number of micro and other very small entities cater to Zambia's (somewhat growing) informal sector.80 Some of the larger firms have attempted to stem the decline in their turnover by seeking to 'formalize the informal sector', by integrating forward and establishing retail distribution outlets in high-density, low-income population areas in and around Zambia's main cities. Box 4.1: Changing Food Expenditure Patterns Periodic household expenditure survey point to modest changes in the structure offood expenditures during the 1990s. At the national level, the proportion offood expenditures goingfor maize and cooking oil declined, while that for cassava, fish, livestock products, and bread increased. For most other products there was little change in their share of the food expenditure basket. In urban areas, the most significant shift was a large proportional increase in bread expenditures, and a corresponding reduction in the proportional share of maize. 1993 1998 Zambia Rural Urban Zambia Rural Urban Beans 4.3% 5.5% 3.7% 4.0% 4.5% 3.5% Bread 4.5% 1.0% 2.3% 5.4% 1.7% 9.2% Cassava 5.0% 12.7% 0.4% 7.1% 12.2% 1.7% Chicken 4.3% 3.7% 4.8% 4.5% 4.0% 5.1% Cooking Oil 7.1% 3.1% 9.9% 5.9% 3.5% 8.4% Fish and Kapenta 9.1% 8.4% 10.1% 10.4% 10.4% 10.5% Fruits 1.2% 1.6% 1.1% 1.7% 2.0% 1.4% Maize 33.9% 39.1% 32.3% 29.3% 31.5% 27.0% Meat 8.3% 5.8% 10.2% 9.0% 9.4% 8.5% Milk and Eggs 3.6% 2.9% 4.4% 3.9% 2.6% 5.3% Rice 1.8% 1.0% 2.3% 1.9% 1.3% 2.5% Salt 2.3% 3.7% 1.6% 2.7% 3.9% 1.5% Sorghum and Millet 1.6% 2.9% 0.3% Sugar 5.1% 3.7% 6.3% 5.2% 4.5% 6.0% Tubers 2.5% 2.1% 2.8% 0.9% 0.5% 1.4% Vegetables 6.1% 5.5% 6.7% 5.5% 4.7% 6.3% Tea/Coffee 0.8% 0.3% 1.2% 1.0% 0.3% 1.6% Total** 100.0% 100.0% 100.0% 100.0% 100.0% 100.0% *includes other cereals w*total is the total for the selected food items 8 Four companies account for more than 80% of the formal sector dairy market, although the informal narket is considered to be of equal size. A similar situation exists for beef where the leading four companies account for two-thirds of the formal sector, while the informal sector is of equal or larger size. 101 4.4.2. The Supermarket Revolution Prior to the mid-1990s, the system of food and grocery distribution in urban areas was highly fragmented involving state-owned retail outlets which carried a limited range of goods, a number of family own medium-scale stores which carried more specialty items and catered to a higher income clientele, and a plethora of small shops carrying basic necessities. Under the privatization process, South Africa's largest food/grocery retailer, Shoprite/Checkers acquired or leased the state-owned retail outlets which were centrally located in most of Zambia's major cities. The company was provided with a number of investment incentives, including exemptions on duties on a considerable amount of equipment and materials used to refurbish the retail outlets, corporate tax-free status for several years, and special exemptions on duties nornally paid on imported food products. Initially the company refurbished existing stores, but went on to invest in several new superstores, including its flagship Manda Hill store in Lusaka. By 2001, Shoprite was operating seventeen retail stores and one wholesale facility and had introduced into Zambia a network of its affiliated fast food Hungry Lion outlets. Shoprite's operations extend to virtually all of Zambia's major towns and cities, with seven of its stores selling a full range of food, grocery, and other household products, while others supply a more limited product range. Zambia's relatively high rate of urbanization has enabled Shoprite to reach a high proportion of the country's consumers of packaged food and grocery products. Its initial growth was also facilitated by considerable pent- up demand, due to the limited consumer choice previously of food and grocery items. The entry of Shoprite, with its aggressive procurement policies and merchandising strategies, has changed the whole dynamic of the Zambian food sector, especially that servicing urban and peri-urban areas. The company has driven down distribution gross margins in Zambia, introduced a new array of product and supplier service specifications, and otherwise forced the longer standing retail operators to adopt new approaches (i.e. in-store design; food display; promotions, in-store bakeries) or to re-position themselves to service more distinct niches in the urban, middle-class market. Shoprite's share of the Lusaka consumer market-where it faces the most competition from existing grocery operators-- is estimated at some 50%. Elsewhere, its market share is considerable higher, although in some towns located near borders (i.e. Chipata and Livingstone), the company faces enormous competition from informal cross-border inflows of staple food products. There have been a number of effects of the 'supermarket revolution' in Zambia. One has been to substantially increase the service and variety of products available to Zambia's higher and middle income population living in urban and peri-urban areas. The choice and variety of products in some of Shoprite's outlets in Zambia match or exceed those of its South African stores. The company has improved the hygienic conditions for food retailing in Zambia and forced its competitors to make substantial improvements in this area. Shoprite, and to a lesser extent its competitors, is strongly affecting both the current and the likely future patterns of food consumption in the country. However, there has been a parallel crowding out of traditional retail operators in several Zambian cities with their inability to match the attractions or the prices provided to the consuming public by Shoprite. Both the product variety and crowding out affects of Shoprite's operations can be gleamed from Zambian import statistics. The graph below illustrates the sizable increase in Zambian imports of fresh and processed fruit and vegetable products, and of 'miscellaneous' higher value and packaged food products. Aggregate imports for these two categories have increased from just over $8 million in 1997 to nearly $22 million in 2001. Part of this expanded imports has undoubtedly been to extend the range of particular products available to Zambian 102 consumers, including certain types of fresh fruit. However, a very large part of this import growth stems from Shoprite's inability to locally source a broad range of fresh and processed products in the volumes, at the quality levels, and/or at the competitive prices that it requires. Table 4.22 summarizes the local availability of the five leading fresh fruit and vegetables sold by Shoprite. Chart 4.15: The Shoprite Effect: Zambian Imports of Higher Value Foods 12 10 2 1997 1998 1999 2000 2001 - Fresh and Processed Fruit and Vegetables U Miscellaneous Foods + Preparations| Table 4.22: Seasonal Availability of Five Leadin Fruits and Vegetables Commodity Jan Feb Mar Apr May Jun Jul Aug Sep Oct Nov Dec Apple 0 0 0 0 0 0 0 0 0 0 0 0 Banana 3 3 3 3 3 3 3 3 3 3 3 3 Tomato 2 2 1 1 1 1 2 1 1 1 1 2 Potato 2 2 1 1 1 1 1 1 1 1 1 2 Onion 2 4 4 4 4 4 2 2 1 1 1 2 0: Not available in Zambia. Fully imported from South Africa 1: Full supply available in Zambia 2: Quality normally not up to standard. Situation varies year to year. 3: Limited supply available but potential to produce full supply and phase out imports. 4: Limited supply available from storage. Quality often not up to standard. Source: Freshmark Zambia The modernization of food/grocery retailing in urban Zambia was expected to have a considerable stimulus effect on Zambian food processing and agriculture, by creating more efficient distribution channels, by stimulating increased demand for a broad array of products which Zambian firms and farmers were already producing, and, perhaps, by some direct assistance that the supermarket chains would provide to would-be suppliers. The actual experience thus far has been very mixed, although some of the initial expectations have not been met. Shoprite reports that currently 60% of the value of food items sold in its stores is locally sourced, with the balance being imported. An even larger proportion of the volume of food items sold (i.e. 70%+) is reported to be of local origin, given the bulkiness of such local products as maize meal and sugar. However, while Zambian products do predominate among bulky lower value items, Zambian products are in the minority in relation to higher value, packaged/bottled food products. One recent study suggested that among this category of goods, local products account for 40% of the products (i.e. number of labels), 30% of the volume, and 103 25% of the value.81 Indeed, a perusal of Shoprite' Manda Hills store in November 2001 yielded the following distribution of Zambian versus imported products. For most packaged food categories, Shoprite typically carries one local brand and several imported brands, most typically from Zimbabwe or South Africa. There are a few products (i.e. ketchup, chillie sauces, potato crisps and beer) for which two or more local brands are sold, together with several imported brands. Otherwise, the Zambian products sold in the store consist primarily of two types. One is lower cost staple food items, such as sugar, wheat flour, and maize meal. The other consists of products for which imports are presently not permitted due to phytosanitary or other restrictions. This presently applies to poultry, eggs, beef and packaged meat products, potatoes, and some dairy products. In the absence of these restrictions, some of these products, including poultry and some packaged meats would not be cost competitive with imports from elsewhere in the region. In addition to these two categories of goods, there has been good progress by some by local suppliers of vegetables. Shoprite reports that it currently has some 140 local suppliers, down from a high of 164 in 2000 and that the turnover of its local suppliers has approached 30% over this period. Most of the net reduction in local supplier numbers has been due to the closure of Zambian companies, including those listed earlier. As a result of these closures, a variety of canned foods, previously locally produced, have been entirely replaced by imports. Other local suppliers have not been able to reliably meet Shoprite demand or product specifications and have therefore not been able to continue deliveries. Table 4.23: Food Product Mix in Major Lusaka Supermarket Entirely Zambian Mostly Zambian Equal Shelf Mostly Imported Entirely Space Imported Milk (Fresh and Cheeses Beer Peanut Butter Pet Food Long-life) Yougurt Bottled Water Potato Crisps Baby Food Fruit Juices Fresh/Frozen Juice Squashes Nuts Marmalade Canned Fruit Chicken* Eggs* Ketshup Jams Canned Vegetables Red Meat/Beef* Chilli Sauce Candy Dried Fruit Packaged Cold Cut Butter Packaged Tea Frozen Vegetables Meats* Wheat Flour Ice Cream Crackers Instant Milk Sugar* Cucumber Tomato Sauce Olives Onions Spices Salad Creams Cabbage Vegetable Oil Canned Fish Tomato Breakfast Cereals Rice Potato* Biscuits Pasta Gourmet Coffee Margarine Honey Citrus Fruit Temperate Fruit Mushroomns _ Carrots __________________ ________________ ~~M argarine Instant coffee *Non-tariffbarrier to imports. 81 This high reliance upon imports is not limited to Shoprite. Other supermarket operators in Lusaka report that only 15% of the individual labels they carry are locally produced, although nearly 50% of their total merchandise costs are for local goods, given the very high throughput of local meat and bakery items in these stores. 104 Shoprite indicates that the majority of Zambian processed food products are not cost competitive, even in the face of import duties of 25% (from South Africa) and additional transport costs amounting to approximately 15% on goods originating from South Africa. This lack of cost competitiveness is attributed to various factors, including: (i) low levels of capacity utilization and limited realization of economies of scale; (ii) much higher packaging costs with no domestic supply of cans or bottles; and (iii) much higher (domestic) transport costs incurred on raw materials and finished products. An indirect illustration of this can be found by comparing prices in Zambia versus those charged in Shoprite in South Africa or elsewhere in the region. Zambian prices for SPS-controlled products are some 50% or more higher than similar products sold at retail level in South Africa. Of the items listed, only for maize meal and tomatoes are Zambian suppliers cost competitive with their South African counterparts. Table 4.24: Comparison of Grocery Retail Prices (December 20OO ) Product Description/Notes South Africa Zambia Malawi Mozambique Price Price Price Price (US $) (US $) (US $) (US $) Eggs 6 x size large (cardboard tray _______ packaging) 0.33 0.53 0.73 0.48 Cooking oil 750ml plastic bottle 0.58 0.88 1.27 0.88 White sugar 2kg bag - paperbag packaging 0.89 1.08 1.27 1.45 Flour 2.5kg all purpose - paperbag packaging 0.82 1.94 3.17 1.08 Chicken Whole fresh chicken per kg - packaging = polystyrene tray and plastic 1.54 2.10 2.22 1.75 Potatoes Grade I per kg -loose sell 0.36 0.51 1.05 0.53 Milk Liter - plastic bag 0.35 0.53 0.79 0.55 Bread Standard brown loaf 0.29 0.36 0.47 0.13 Cheese Yellow cheese per kg - cut from large block - wrapped in plastic 3.48 8.98 7.55 6.01 White Rice lkg bag -sealed plastic bag 0.37 0.74 0.79 0.68 Maize Meal 12.5 kg breakfast meal (roller meal - cloth bag) 3.08 2.46 5.94 4.39 Source: Survey carried out by World Bank Staff and Vink et al. 2002 It is not only a cost issue. Shoprite demands not only low prices, but also precision and consistency in restocking and product delivery, quality, food safety, and in-store merchandising from its vendors. It does not have its own warehousing facilities or transport/logistics system in Zambia and so it demands that its suppliers deliver to each or most of its outlets. This is a logistics nightmare for many companies, especially the smaller ones, although a few third party logistics operators have started to service the industry. Some Zambian companies, again especially the smaller ones, have experienced cash flow problems as a result of Shoprite's payment terms (typically 30 days or more), when combined with their cash outlays for raw materials. Shoprite indicates that at any one time, probably 70% of its out-of-stock items are those which are provided by local suppliers. 105 Food safety assurance is a problem for some Zambian suppliers (see the section below on this subject). Shoprite is moving to require that all packaged foods have 'sell by' dates. At present, only about 20% of locally produced products have such indications on their labels (while virtually all products imported from Zimbabwe and South Africa do). Shoprite is beginning to introduce scanning and bar coding in some of its outlets to improve its stock management and better track customer purchasing patterns. With these and other measures, Shoprite continues to change the rules of the game for food distribution in urban Zambia and continues to challenge local suppliers to meet its standards and requirements. Several such small (family-run) companies have continued to do business with Shoprite, providing it with a broad array of packaged food items for which their local brand is well recognized by local consumers. At the same time, Shoprite has provided a major boost in the sales of a variety of meat and dairy products with this distribution channel critical to the current commercial viability of most firms within these subsectors. The company has helped some of its local suppliers with their labeling designs, although it has not provided any broader technical support to would-be local suppliers. Its affiliated firm, Freshmark, has been actively seeking additional suppliers for fresh produce, not only to substitute for current imports but also having the prospects for exports to the region. The latter consideration offers a potentially attractive opportunity for some Zambian agribusiness entities or farmer organizations. Shoprite has established operations in many other countries, including in neighboring Malawi and Tanzania, and there is scope to supply specific products to a number of these locations. At present, such 'piggy-backing' has occurred with only a few products and there has not yet emerged any back-hauling of Zambian food products to South Africa on trucks which bring goods from that country. Shoprite reports that there are ample opportunities for import substitution and/or product extension by local suppliers, yet they must be cost competitive and the company will not relax its quality and safety standards. There is a more general opportunity here for local food manufacturers and farmer organizations to service retail distributors, whether foreign or the legacy operators. In addition, there are opportunities to increase supplies to fast food establishments which have recently emerged as well as to tourist lodges and facilities. Again, such organizations have exacting standards for quality, reliability, portion control, packaging, etc., which may require some upgrading of product and service by local companies. In this context, there is scope for developing a 'Quality Vendor' support program which could provide technical assistance as well as working capital to local firms and farmer organizations to upgrade their products and improve their supply chains to better enable them to take advantage of the market opportunities provided by the modernization of retailing and the expansion of tourism within Zambia. 4.4.3. Oualitv Control and Standards Giovannucci et al (2001) depict a seriously deficient system of design and enforcement of quality, food safety, and other standards throughout Zambia's agro-food system. They found severe capacity constraints within the public sector which have only partially been compensated for by measures taken by private companies and/or associations. They found little coordination and collaboration among the various standards bodies within government or between these and the private sector organizations which have become more active in standard-setting and enforcement. Within the public sector, several agencies, including the Zambia Bureau of Standards, the Food and Drugs Control Board, the Plant Quarantine and Phytosanitary Service, the National 106 Livestock Epidemiology and Information Center, the Seed Control and Certification Institute, and the National Institute for Scientific and Industrial Research, all, ostensibly, have important functions in setting and enforcing standards which should govern agricultural production, food processing and food distribution. However, all of these agencies are characterized by severe staffing and funding problems which strongly inhibits their functioning. The Zambia Bureau of Standards has set very few standards for agriculture--most having to do with animal feed--and is considered to be essentially unresponsive to the needs of producers and agribusinesses.82 Anecdotal evidence suggests that the lack of consistent and well-known quality standards for agricultural raw materials is a significant problem facing Zambia's agro-processors, leading some to rely at least partly upon imports for which they have greater confidence in quality (consistency). For example, it is reported that there has occurred a significant decline in the quality of local groundnuts, making much of the product unsuitable for the confectionary market. Wheat millers report that local wheat supplies are of variable and unpredictable quality. Dairy processors indicate that some existing local demand goes unserved because of inadequate raw milk supplies which meet their quality specifications. Significant problems are also apparent in relation to the monitoring of domestic food safety. While the Food and Drug Regulations were updated in 2000 and appear to be in line with international standards with respect to expiration dates, label accuracy, and traceability of hazardous substances, there is generally little awareness about the Regulations and the responsible enforcement authority--the Food and Drugs Control Board-has little capacity to perform this enforcement function. The same Board is responsible for pesticide regulations and monitoring that the maximum residue levels (set under the Codex Alimentarius) are not exceeded. However, little monitoring actually occurs by the Board. City Councils have the inspection authority for the food service industry and food processors, while the Ministry of Health provides inspectors in rural areas. Inspector capacity is very limited at each level and it is reported that only the larger enterprises are inspected on a regular basis. The Plant Quarantine and Phytosanitary Service does distribute official notices to several farming organizations yet these may be difficult to interpret and there is little coordination with other agencies to ensure that farmers, traders, or customs officials fully understand the implications of standards affecting regional or international trade. While several government testing/laboratory facilities have been upgraded, most are not up to international standards and cannot provide results within the timeframe regarded as acceptable by private agribusiness firms. In the face of limited official standards (and standards enforcement) elements of the private sector have taken steps to develop standards. In the domestic market, one observes milling companies applying their own standards for wheat and maize quality and moisture content. Dairy companies are trying to apply raw milk standards similar to those employed in South Africa. As n'oted above, Shoprite and other retailers are moving to enforce labeling, date of expiration, and packaging requirements. In export-oriented operations, firms and associations have set their own standards in accordance with market demand and requirements of downstream distributors. The most advanced such system is the code of practice established by ZEGA which entails several stages of certification for compliance with environmental, worker welfare, and product quality/safety standards. It is modeled on European and international standards (i.e. COLEACP Harmonized Framework and EUREP) with some adaptations. Other sectors-i.e. paprika and coffee-are also in the process of developing industry-wide codes of practice. 82 ZBS reports that of the 300+ standards-that have been set in Zambia, about twenty relate to food and agriculture. Most of those in food-for grains and fruit and vegetable products-are derived from CODEX standards. 107 While the private sector is making some headway in this area, considerably more needs to be done and there is still a need for more effective public institutions to ensure domestic food safety and to ensure that inspection systems and laboratory structures in place meet the increasingly strict requirements of importing countries. There is a justification of deploying public resources to support private capacity-building in this area given the effects on health, country reputation and sustained international market access, and given the particular difficulties which smaller firms and farmers face in acquiring information, capacities, and adapting practices to meet the standards. In this regard we echo the proposal of Giovannucci et al to establish a Quality Systems Initiative which would provide technical assistance to implement international standards and to further develop industry-led codes of practice, perhaps through public/private cost-sharing arrangements. 4.4.4. Raw Material Procurement and CaDacity Utilization Another emerging development involves attempts to re-configure the backward linkages between agribusiness companies and farmers or farmer groups. Prior to market liberalization these links existed between farmer cooperatives and parastatal enterprises, under a system of directed raw material allocations and administered prices. With liberalization, there was an institutional vacuum to coordinate production and downstream requirements. An attempt to develop a commodity exchange was largely unsuccessful. This was also the fate of several mid- 1990s attempts by large (international) commodity brokers to contract and trade cereals and oilseeds. Periodic threats of government market interventions increased the risk associated with such activities. In general, the firms which invested in the privatized agro-processing enterprises have encountered great difficulty in meeting their raw material requirements. The transaction costs for such procurement has been very high given the geographic spread of agricultural production in Zambia, poor communications with and within rural areas, a long-standing legacy of credit default, and prohibitive financial costs which have inhibited the medium term storage of commodities. As a result of the latter and the fact that most crops are grown under rain-fed conditions, there are wide intra-annual swings in raw material prices. With a general dissatisfaction with procuring raw materials through open market transactions, many if not most agro-processors have moved to obtain a large proportion of their requirements through contracted production. Nearly one in four Zambian smallholder farmers and a majority of its commercial farmers now participate in one or more arrangements involving forward contracting and, typically, some types of pre-financing or other production support. This, increasingly, has become the dominant means by which Zambian farmers have accessed credit for 83 purchased inputs. Considerable variation exists in the breadth and intensity of these arrangements. By far the most extensive development of contract farming occurs in the cotton sub-sector, where Dunavant and Clark Cotton have input supply and crop procurement systems which incorporate some 125,000 smallholder farmers. Their systems differ with Clark directly contracting with individual farmers and farmer groups, while Dunavant has developed a network of farmer/intermediaries who manage the interface with individual farmers/groups and administer the credit program. Most of the paprika trading companies also procure the bulk of their materials through a contractual framework in which field agents provide advice while policing the crop. Most of the domestic wheat crop is now either vertically integrated with milling operations or 83 One recent study found that of 118,000 rural households obtaining credit, some 82% did so under some form of contracted production arrangement with a downstream buyer. 108 involves production contracts between millers and commercial farmers. Variant forms of contract farming are also being implemented in the dairy, vegetables, tobacco, and poultry subsectors. The Zambian experience in contract farming has been a mixed one. Contract enforcement problems remain widespread-especially in the sectors with greater competition-and not everyone is satisfied with the terms and outcomes of these of these interlinked factor and product market arrangements. In the cotton subsector there has been a persistent problem of farmer 'side- selling' of the seed cotton crop, with the low credit recovery rates in some years having to be reflected in the pricing structure for farmers. The general situation here could be regarded as precarious given the uncertain ability or willingness of some of the major firms to continue to finance the crop in the face of widespread side-selling. This should be considered a serious matter in that the failure of the cotton outgrower systems would have large repercussions, not only for the growth prospects of this particular subsector, but also for the national commitment to base its agricultural growth primarily upon the further commercialization of smallholder agriculture. There are a number of on-going efforts to bring greater transparency to so-called 'outgrower schemes'. A draft 'code of practice' is being considered which will provide a governance structure for contracting companies and farmers. However, the problems and challenges in expanding and deepening the contract grower arrangements differ from subsector to subsector and require some concerted actions at that level. Despite efforts to improve backward linkages, raw material supplies to much of the agro- processing industry remain unstable and unpredictable. In some sectors, especially for cereals and oilseeds, but also for vegetables, there are wide price swings in the course of the year as a result of crop harvesting patterns, the absence of bulk storage facilities, and the high financing costs of carrying inter-seasonal stocks. With uneven and unreliable raw material supplies and in the face of constrained domestic demand for a range of products, much of the agro/food processing sector is operating at relatively low rates of capacity utilization (Table 4.25) Utilization rates are low both in industries which are demand-constrained (i.e. soybean processing; maize milling) as well as in some industries those which are not demand-constrained (i.e. cotton ginning; dairy processing). The highest rates of capacity utilization are occurring among firms which are partly or substantially vertically- integrated, as with Zambia Sugar Company, and Mpongwe Milling. Table 4.25: Reported Rates of Capacity Utilization Subsector Capacity Utilization (%) Sugar 94 Eggs 70 Dairy 50 Animal Feed 45 Cotton Ginning 45 Wheat Flour Milling 30-80% Hides and Leather 33 Maize Milling 33 Soybean Processing 30 Beer Brewing 25 Sources: Staff and EBZ Surveys Such problems in raw material procurement and capacity utilization result in the failure of most Zambian agro-processors to achieve any economies of scale, thus exacerbating the cost disadvantages they face due to relatively high fuel, transport, and packaging costs. This failure to 109 achieve economies of scale actually applies throughout many Zambian supply chains, given that relative few Zambian smallholders have organized cooperatives or other groups which can engage in collective input purchases, crop transport or sales, or other functions. There are also few intermediaries who serve to aggregate supplies from numerous farmers and/or multiple locations for delivery to food manufacturers. In this regard (and for its potential to increase the availability of finance for agricultural marketing), on-going plans to develop a warehouse receipts system should be brought to fruition. Most of the firms interviewed are not thinking to add capacity or to further modernize their factories. Instead, their attention is focused on improving linkages to raw material suppliers and on extending the markets for their products. For most agro-processing the focus of market extension efforts is domestically and/or into neighboring countries. Domestically, there is a combined race to the top and to the bottom. At the top end, they are seeking to satisfy the requirements of supermarket chains and other disceming distributors/customers. Under present economic circumstances that segment is unlikely to experience much growth. As noted earlier, firms are also looking to service the informal sector and the lower middle class population by establishing distribution outlets in high-density population areas. This strategy is apparent in the meat, dairy, bakery, and milling sectors. Firms are also interested in extending their market into neighboring countries. DRC is potentially the most attractive, provided that problems associated with physical security, payment security, information and logistics can be reduced. As of now, only a few firms have established regularized distribution arrangements there. Much smaller potential is seen for supplying Malawi and Tanzania, although a few firms have ridden on the back of Shoprite operations there. The situation is very different in the sugar and cotton ginning sectors where Zambia is internationally competitive plus has preferential access into important markets. While noting that there has been little new investment in agro-processing in the last two years and some (considerable) liquidation of food processing assets, it is not an exaggeration to say that a substantial proportion of the remaining agro-processing capacity is at risk unless there are considerable improvements in the macroeconomic environment in Zambia and a more effective facilitation of private agribusiness and smallholder commercialization in the very near term. Any further dis-investment in agro-processing, especially in the more strategic sub-sectors would have substantial adverse consequences for Zambian farmers and for future prospects for agricultural growth. 4.4.5. Agribusiness Strengths, Weaknesses, Opportunities, and Threats Table 4.26 below provides a summary analysis of the strengths, weaknesses, opportunities, and threats associated with Zambia's agro-food processing industry. The industry's growth potential stems from Zambia's strong natural resource base, the sunk investment by and the capacities of an array of intemational caliber companies, a core set of industry associations with adequate analytic and management capabilities, and the growing recognition by govemment of the strategic importance of the sector and the need for fostering (rather than hindering) its competitiveness. Many of the core weaknesses of Zambian agribusiness lie outside its own confines, in the form of weak overall infrastructure in the country, an unstable and unpredictable exchange rate, extremely high costs of finance, very high costs of domestic and regional transport, and a weak capacity of govemment to address trade-related anomalies and problems. The threats to the industry come from within and from outside. The former include the specter of social and economic erosion due to the HIV/AIDS pandemic and the continued decline in domestic 110 purchasing power. External threats include political/economic instability within the region, fair and unfair competition from within the region, and the specter of sustained depressed international commodity prices. Nevertheless, there are ample opportunities for growth, both through import substitution and through expanding exports within and outside of the region. Some of these specific opportunities are highlighted in the table. There are also opportunities to improve the physical and institutional infrastructure which can render Zambian agro-industry more competitive and enable the wider spread of benefits from this development into rural areas. The improvement of roads and the further development of physical infrastructure in and around major areas of smallholder commercial production would appear to be a major priority. At the local and community levels, this could be complemented by an intensified program to develop and strengthen the management and commercial capacities of farmer organizations, and by integrating certain community development initiatives with on-going outgrower schemes. Support for market intermediation functions and more general market infrastructure is also required. For example, existing plans to develop a warehouse receipt system should be brought to fruition. This would help hamess private sector financing of grain trade, promote the development and implementation of grain standards, and facilitate more efficient storage and aggregation of grain supplies. The domestic market for fresh produce might benefit substantially from the development of a modern wholesale facility in or around Lusaka. The feasibility of this should be examined. An array of options are available to support improved supply chain linkages within Zambian agriculture and agribusiness. We have mentioned the possibility of a 'quality vendor program' to provide technical assistance and/or working capital to food processors or farmer organizations to upgrade their products and services to better meet the requirements of supermarket chains, fast food operators, and tourist facilities. Other interventions are possible to increase the participation of smallholder farmers in export-oriented supply chains for high-value specialty products (i.e. vegetables, spices, essential oils), perhaps through support for the development of partnership companies between farmer groups and existing exporters and the development of improved systems for quality control and production system auditing as increasingly required by international buyers. In certain strategic sectors there may be a strong rationale to support on-going contract farmer programs or modified arrangements (i.e. inputs revolving funds) to improve smallholder productivity and linkages with agro-processors. I However, recent experience has shown that the above types of investments and micro-level initiatives can have only limited (and probably unsustainable) impact if the broader macroeconomic environment in Zambia is not substantially improved. Zambia's farmers and agribusiness firms have had to fend off an array of external shocks, such as drought; adverse commodity price movements; and the spillover effects of an imploding Zimbabwean economy. They have tried an array of coping and business strategies, yet some of these have been blown off course by the gale force winds of Zambian macroeconomic instability--with persistent high inflation, extremely high financing costs and unpredictable movements in exchange rates. This has reduced their competitiveness and lowered the return on most investments in the sector. Restoring growth and dynamism in Zambia's agro-food system will thus require concerted actions both at the macroeconomic and micro/sector levels. Table 4.26: Zambia Food and Agro-Processing SWOT Summary Strengths Weaknesses Physical and Human Resources Physical and Structural * Large fertile and under-exploited land * Land-locked and generally surrounded by low base income countries * Abundant water supply * Limited transport and conmmunications * Abundant hydro-electric power infrastructure capacity * Especially weak infrastructure in some areas of * Labor force with industrial experience good agricultural potential and generally poor smallholder access Institutional and Policy * Dualistic agricultural sector with relatively * Presence of several large international- small commercial farm base caliber companies * Very limited and contracting set of affiliated * Core set of industry associations with services for manufacturing (i.e. packaging) analytic and management capabilities * Lack of approved/accredited quality standards * Investment incentives which in many subsectors encourage certain types of non- traditional exports Economic/Financial * Increased recognition of importance of * Stagnant economy and declining consumer agriculture/agribusiness and of export purchasing power diversification to the future economic * Instability and unpredictability of exchange rate growth in the country * High cost of local finance * Presence of an array of technical and * High cost of (imported) ingredients and financial assistance programs for PSD packaging and agribusiness linkages * Very high cost of domestic and regional transport/freight * Expensive and unreliable telecommunications/intemet services * Widespread and significant capacity under- utilization in manufacturing * Low tax base, leading to further raising of revenues from shrinking formal sector Government Policies and Services * Weak capacity to address trade-related complaints/disputes * Primarily 'food security' agricultural orientation of GOZ with its attendant politicization * Weak provision of product testing and certification services Human Resources * Limited marketing skills within most Zambian firms * High incidence of theft of goods in stock or transit (5-10%) * Shortage of management skills and limited training programs * High benefits burden substantially raises the cost of labor * High incidence of HIV/AIDS 112 Opportunities Threats Domestic Market . Competition from COMESA and SADC * Import substitution of milk and other countries dairy products, vegetable oil, certain * Zimbabwe dumping of products into Zambia's fruits (i.e. bananas), and an array of market and elsewhere in the region packaged/ processed foods (i.e. jams, * Mis-assignment of countries of origins for condiments, spices) products imported from outside of the region * Improved linkages between (i.e. palm oil) supermarket chains and local food * Conflicts in neighboring countries processors and farmers (through a * Continued decline in domestic purchasing 'quality vendor' program) power * Development of a more orderly * Sustained depressed international commodity distribution system for fresh produce prices and of facilities for bulk handling and distribution of cereals Export Markets * Expand cross-border agro/food trade as with dairy products (to DRC, Tanzania, and Malawi),poultry products (to DRC), beef and chilled meat products (to DRC and Malawi), sugar (to DRC), animal feeds (to DRC, Tanzania, and Malawi), selected vegetables (i.e. cabbages, onions, potatoes) to DRC, and bread/baked products (to DRC). * Strengthen agro/food trade linkages to South Africa/SACU as with cotton lint (for textiles) and cottonseed (for animal feeds), soybeans (especially to smaller scale crushers), paprika (and perhaps other spices), selected vegetables (i.e. miniature veg; mangetout) and fruit (watermelon); and packaged/graded groundnuts. * Expand trade and improve international competitiveness for roses, packaged high-value vegetables, coffee, tobacco, sugar (to preferential markets), and spices (including taking away Zimbabwe market share for several of these products) * Take advantage of AGOA opportunities, especially by expanding garment exports to the US and by supplying cotton lint to South Africa and Mauritius as Zimbabwe cotton is not AGOA-certified. Infrastructure and Institutional * Strengthen physical and commercial infrastructure linking Zambia with the economy of Shaba Province, DRC 113 * Improve the access of Eastern Province to regional and world markets through the extension of the Nacala rail line into Zambia * Re-establish viable packaging industry * Develop and apply accredited quality standards linked to international standards and further build management skills in this area at the national and regional levels * Extend the ZEGA Trust training concept to provide a center of agribusiness management training for the country * Build upon on-going outgrower initiatives to further strengthen smallholder-market linkages and facilitate further community development * Facilitate the migration of selected Zimbabwean commercial farmers to Zambia in order to supplement existing comnmercial farm entrepreneurial skills and to accelerate the development of selected subsectors. 114 CHAPTER 5 COPPER INDUSTRY LINKAGES 5.1 INTRODUCTION The mining sector has been an important generator of economic activity in Zambia throughout the twentieth century. Although Zambia is endowed with precious metals, gemstones, and agro-industrial minerals, the mining sector is dominated by copper mining. Cobalt acquired some importance beginning in the mid-1980s because the proportion of copper ore associated with cobalt increased about this time. The mining sector contributes between 6% and 9% of Zambia's GDP and accounts for about 10% of formal sector employment. The exports of mineral products, mainly copper, still contribute about 70% of the country's foreign exchange earnings. Following independence in 1964 the copper industry was expected to generate the resources required to implement Zambia's economic development strategy. This strategy relied upon central planning, administrative controls and public-sector ownership and investment to generate economic growth, employment and development. To underpin this strategy, the Government of the Republic of Zambia (GRZ) acquired in the late 1960s majority ownership of the two privately owned companies that dominated the copper mining industry at that time, but left them under private management. To strengthen the link between the copper industry and the public sector, the Government combined the two companies under one company called Zambia Consolidated Copper Mining (ZCCM) and took control of the management. In the early post-independence years when the resources generated by the copper industry were insufficient to cover the needs of the industry and the Government, Zambia resorted to external borrowing. As borrowing became more difficult, the proportion of the resources being generated by the copper industry going to the Government's budget increased. This was largely done at the expense of reinvestment in the copper industry itself. The lack of reinvestment led to declines in productivity and frequent production problems. Lacking the resources to revitalize the copper industry, the Government decided in 1995 to privatize ZCCM. The privatization of ZCCM was completed in early 2000. Although the main objective of the ZCCM privatization was the revitalization of the copper industry, there was also an expectation that the privatized copper mining industry, through its linkages to other economic activities on the Copperbelt--primarily its suppliers of goods and services-- would revitalize the economy of the Copperbelt. This chapter reviews recent developments in the copper mining industry and provides a preliminary analysis of the emerging linkages between the privatized mines and local suppliers of goods and services. Field work for this review was conducted in November 2001 and involved interviews with all the new mining companies as well as a sample of thirteen local suppliers of goods and services .84 One of the original objectives was to identify opportunities to provide support in order 8 The study team was able to review the KCM-IFC' Study, which proposed an initiative that has two components: the first was setting up, a joint IFC/ KCM Zambian Copper Belt Sustainable Development Fund, and the second was to provide technical assistance to SMEs. The objective was to strengthen the SMEs operating in the area and enable local firms to take advantage of new outsourcing opportunities provided by KCM. The Fund component of the initiative was dropped in November 2001 when KCM's proposed 2002 budget showed that losses would be continuing at an unsustainable rate. The work on the second component continues. The team working on the KCM-IFC initiative had undertaken interviews of 115 to strengthen mining company-supplier linkages. Part of this effort was overtaken by events, in particular the announcement by Anglo American Corporation in January 2002 to pull out of Konkola Copper Mines (KCM), the country's largest mining company. This announcement has re-directed the attention of policy-makers and the World Bank away from linkage issues and towards finding a solution for the KCM crisis. The findings of the work are nevertheless put forward to be used for follow-up planning once the on-going transition is completed. 5.2 COPPER AND COBALT MINING INDUSTRY IN ZAMIA 5.2.1. Copper Mining Large-scale copper mining85 in Zambia began in the 1920s. Over the next few decades, output increased until it peaked in 1969 at 748,000 tons. Shortly thereafter, it began what eventually became a long-term declining trend until it reached the level of 257,000 tons in 2000. This amounts to an average annual rate of 3.5%. Annual production averaged 665,000 tons in the 1970s, an average of 515,000 tons in the 1980s, and an average of 350,000 tons in the 1990s. Copper exports followed more or less the same pattern. The declining trend in production was more pronounced in the 1990s (about 6.5% p. a.) as shown in Chart 5.1 below. The most notable change in this period is the total replacement of copper production from the parastatal ZCCM by production from several privately owned and managed copper mining companies. Production rebounded to a level of 299,000 in 2001 despite the fact that one of the privatized companies, RAMCOZ, went into receivership early in that year. The main reason for the recovery was the progress being made by the remaining companies on rehabilitating their operations. Chart 5.1: ZCCM & Non-ZCCM Copper production ' 500000; -+ T., 450000 Production 400000 350000 -U-- ZCCM 300000 - Production ° 200000 -Non-ZCCM ' 150000 - Production 100000 r_ C; 50000 -Linear (Total 0 O', - -;Production) N N0 N ~C N Source: ZCCM, BOZ Bulletin The total production of copper in Zambia was projected to decline sharply by about 100,000 tons around the tum of the twentieth-first century when the copper ore from the Nchanga small and medium scale enterprises. For the purposes of this analysis, account was taken of the findings of the KCM-IFC study and the summaries of the interviews done for it. 85 As of the mid-1980s, the use of the phrase "copper mining industry" should be understood to include cobalt mining, which became an increasingly inportant by-product of some copper mining activities in Zambia. 116 to strengthen mining company-supplier linkages. Part of this effort was overtaken by events, in particular the announcement by Anglo American Corporation in January 2002 to pull out of Konkola Copper Mines (KCM), the country's largest mining company. This announcement has re-directed the attention of policy-makers and the World Bank away from linkage issues and towards finding a solution for the KCM crisis. The findings of the work are nevertheless put forward to be used for follow-up planning once the on-going transition is completed. 5.2 COPPER AND COBALT MINING INDUSTRY IN ZAMIA 5.2.1. Copper Minine Large-scale copper mining85 in Zambia began in the 1920s. Over the next few decades, output increased until it peaked in 1969 at 748,000 tons. Shortly thereafter, it began what eventually became a long-term declining trend until it reached the level of 257,000 tons in 2000. This amounts to an average annual rate of 3.5%. Annual production averaged 665,000 tons in the 1970s, an average of 515,000 tons in the 1980s, and an average of 350,000 tons in the 1990s. Copper exports followed more or less the same pattern. The declining trend in production was more pronounced in the 1990s (about 6.5% p. a.) as shown in Chart 5.1 below. The most notable change in this period is the total replacement of copper production from the parastatal ZCCM by production from several privately owned and managed copper mining companies. Production rebounded to a level of 299,000 in 2001 despite the fact that one of the privatized companies, RAMCOZ, went into receivership early in that year. The main reason for the recovery was the progress being made by the remaining companies on rehabilitating their operations. Chart 5.1: ZCCM & Non-ZCCM Copper production i 500000 450000 Production 400000 . 350000 --_ZCCM 300000 - Production 250000 . 200000 - Non-ZCCM X 150000 Production C 100000 50000~~ ~~~ -Linear (Total 0 Production) Source: ZCCM, BOZ Bulletin The total production of copper in Zambia was projected to decline sharply by about 100,000 tons around the turn of the twentieth-first century when the copper ore from the Nchanga smnall and medium scale enterprises. For the purposes of this analysis, account was taken of the findings of the KCM-IFC study and the summaries of the interviews done for it. 85 As of the mid-1980s, the use of the phrase "copper mining industry" should be understood to include cobalt mining, which became an increasingly important by-product of some copper mining activities in Zambia. 117 open pit was expected to be exhausted86. ZCCM had been planning to expand copper ore production at the Konkola mine, through what is called the Konkola Deep Mining Project (KDMP), which is a project to mine the ore body at levels below current mining operations. ZCCM was unable to embark on this project because it was unable to secure the necessary financing. The desire to realize the KDMP project was one of the main reasons for the Government's decision to privatize ZCCM. The adverse impact of the declining trend in copper production during the last three decades of the twentieth century was accentuated by the declining trend in the price of copper over this period. The Chart below shows the movement in, and relative volatility of, the nominal price of copper over the period 1991-2000. The declining trend is very pronounced, amounting to an average annual rate of about 3.4%, although there was a period in the mid-1990s when the price of copper was significantly above the long-term trend. The price of copper is expected to move cyclically in response to the pace of world economic activity, but the long-term trend will remain negative. Structurally, the copper mining industry will remain subject to a significant degree of product substitution effects. Recent projections of world demand for copper have been less bearish than about a year ago. Demand is expected to increase by about 2% a year for the next few years. However, the long-term trend in the real price of copper is expected to continue to be declining, but at a slower rate (about 2% p. a.) than in the last decade. This underlines the central challenge to copper producers which is to continue to reduce costs in order to remain in business. Chart 5.2: Average Annual Realized Copper Prices 1.00 0.60 1 _ 0.00 I- I.a]-.II, ,,,1. 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 Source: ZCCM, CSO, BOZ Bulletin Zambia's copper industry used to set the pace for the world copper mining industry. However, in recent years it has become decidedly less cost competitive (Chart 5.3). There are several contributing factors to this. First, the proportion of copper ore that is high in grade and is easily accessible from all the former ZCCM's mining operations has decreased significantly. Second, the parastatal ZCCM was highly over-staffed. Even after shedding 4,000 workers in 1994, the company still had a total labor force of 46,000 at the end of December 1994, just before the decision to privatize ZCCM was announced. Third, and probably most importantly, there was little if any investment in the company to improve its productivity and cut costs, especially during the period starting in the early 1980s and continuing over nearly two decades to its eventual privatization. All of this was happening at a time when copper producers in other countries, for 86 The Nchanga open pit produced about 25 million tons of copper ore during the period 1995-2000, containing copper of about 542,500 tons, or an average annual of about 90,430 tons of contained copper. 118 example Chile, were opening vast new mines and investing in new and improved technology to cut costs significantly. Recently, many of the high cost producers in the US, Canada and Australia have been forced to close down. The fate of the Zambian copper producers will almost certainly be the same unless they cut costs and improve competitiveness. Chart 53: Comparative Copper Cash Costs of Production, 2001 1 00 90 -.;;---,1 80it- e 70 -4 ~60f Q) 404-- *~30 20 0 C0 CD 0 0 0 a 0 0 0 CD o 0 0 0 0 a 0 0 0 0 o o o 0 0 a 0 0 0 0 . c IT Le C (0 - (0 a) 0 Cumulative Production (000 tons) Source: Minecost.com, ZCCM, CSO, BOZ Bulletin A recent international study covering ninety-five copper mines (and accounting for 83% of world production) compared the cash costs of copper production per pound. The most efficient world producers have production costs below US$0.10/lb., while other major suppliers have production costs of between US$ 0.30 and US$0.45/lb. Fully one-half of world copper production is undertaken at or below that latter figure. In contrast, the weighted average costs of Zambia's copper mines is estimated at US$0.58/lb. This puts Zambia about the 85h percentile in the world. While this represents a modest improvement over status cost competitiveness at the beginning of the privatization process in 1995 (when it was above the 90kb percentile), this clearly illustrates the precarious position of the industry in light of international copper price trends. The table below provides the specific ranking of individual mining operations in Zambia. Several mines, including those at Konkola and Nkana are among the highest cost producers in the world. Table 5.1: Comparative Cash Cost of Copper Production, 2001 Name Rank By Unit Cost Percentile by Cumulative Among 95 Mines Production Nchanga TLP 35 56 Nchanga 47 73 Mufulira 65 86 Konkola 84 95 Nkana 91 98 Weighted Average 58 85 Source: Survey and Bank Staff Estimates Zambia spent considerable time and effort in the mid-1990s to reform its mining policy and the laws and regulations applicable to mining to make Zambia a hospitable country for investors and their treatment equal in terms of licensing, regulation, incentives and taxation 119 competitive to that in other countries where mining is a significant economic activity. The provisions of the laws and regulations were revised and mainly enhanced further in favor of investors on a case-by-case basis for the copper mining industry at the time of the privatization of ZCCM. This created problems among the new owners, who subsequently and repeatedly made representations to Government about the inequity of treatment, especially in areas related to incentives such as taxes, customs duties and the costs of some inputs, like electricity and lime. However, the copper mining industry in Zambia is a higher cost industry by comparison to other world copper producers because Zambia is a land-locked country, very far from seaports, and because the mining method is predominantly under ground mining, which is usually a more expensive mining method. These two inherent cost raising factors are compounded by the fact that some of the institutions, organizations and providers of inputs and services are inefficient, which adds to the costs of inputs and ultimately the cost of production of copper in Zambia. For example, significantly large proportions of the Zambian copper industry inputs and output come in and go out, respectively, by rail on Zambia Railways. The latter's inefficiency, operational problems and lack of reliability adversely affect Zambian copper producers by increasing their costs and the reliability of receipt of inputs and delivery of output. Zambia Railways is now in the process of being concessioned and restructured, which hopefully would lead to improvement in efficiency and reduced cargo rates. Similarly, ZESCO, the only provider of electric power, sells about two-thirds of its output to the copper mining companies. This too is a major cause of high production costs for most, if not all, the copper producers. The tariff charged by ZESCO to the copper mining companies is set at a level that: (i) provides a margin for ZESCO regardless of its efficiency; an exceptionally high proportion of more than 50% of ZESCO's generated load is lost through technical losses, unaccounted for power deliveries and uncollected billings; and (ii) aims to provide a subsidy from the copper mining industry to individual consumers. This policy may have been "tolerable/less objectionable" at the time when ZCCM was a majority-owned parastatal and was making profits. However, the copper mining industry in Zambia is now privatized and is facing severe problems. There are signs that some improvement is being realized at ZESCO, which would, if it continues, lead to cuts in costs to the copper mining companies. There is also discussion of plans to concession and privatize ZESCO. In the meantime, the industry has made strong representations to Government to level the playing field by charging all copper producers the same tariff and to look at other ways of relatively quickly reducing the electricity tariff. Consideration is being given now to the applicability of an indexed pricing system that links the price of power to the price of copper to help modulate the cash flow impact of the cost of power on the copper mining companies, which would be very helpful to the copper producers in periods of low copper prices. 5.2.2. The Current Status of the Privatized CopDer Companies Despite the high hopes of the late 1 990s, the copper industry in Zambia is currently suffering due to its inability to restructure and adjust quickly enough to escape the recession in the world 87 Prior to the privatization of ZCCM, ZESCO had to negotiate the tariff it charges the copper industry with ZCCM, the parastatal and only producer of copper. ZCCM had strong leverage over ZESCO because it had resources and amnple foreign exchange, both of which ZESCO needed. The copper mining industry is now privatized and the terms and conditions of supply of electric power by ZESCO are subject to long term agreements that were concluded at the time of the privatization. 120 economy and the severe drop in the world price of copper. Moreover, companies, such as KCM, who have a significant amount of the associated product cobalt, have been hit even harder by the proportionately larger drop in the price of cobalt (see below). This situation has aggravated the problems that some companies were having: * Roan Antelope Mine Company of Zambia (RAMCOZ), which bought the Luanshya division and the Baluba mine (October 1997) is now in receivership. The sponsors of this company looked more qualified on paper at the application stage than in practice after the sale. RAMCOZ was having operational problems and delays in its rehabilitation program. When the price of copper fell it began accumulating arrears and had no choice but to cease activity and furlough about 4000 workers who are owed US$35 million in terminal benefits * Chibuluma Mine Company, established in September 1997 by a South African mining company (Metorex). It bought Chibuluma mine and was doing well. It had expanded its operations by opening an open pit at Chibuluma South in May 2001, but had to close this new operation by late 2001 because of the low price of copper, as well as metallurgical problems with its oxide ore and penalties imposed on it by the local smelters.. * Mopani Copper Mines (MCM), established in March 2000 as a joint venture between Glencore Intemational and First Quantum. It bought the Mufulira division and Nkana underground mine and was doing well financially, although its rehabilitation program was behind schedule. It is now suffering from low copper prices because its forward hedging contracts on copper expired in December 2001. It needs to cut costs further, which may mean additional retrenchments to those undertaken prior to and at the time of the privatization. Operational and managerial control over MCM passed in February 2002 from First Quantum to Glencore Intemational, when the latter diluted the stake of the former as a result of the injection of needed capital that First Quatum did not particiapate in. * Konkola Copper Mines (KCM), established in March 2000 as a joint venture between Anglo American Corporation/Zambia Copper Investments, the Intemational Finance Corporation, the Commonwealth Development Corporation, and Zambia Consolidated Copper Mines-Investment Holding. It bought the Konkola and Nchanga divisions and the Nampundwe pyrite mine. It had lost about US$108 million in the 21 months ended December 2001. KCM has been incurring operating losses because of the low prices of copper and cobalt. The delays in and higher costs of the rehabilitation program aggravated the problem. The losses undermined the rationale for the KCM Consortium88 and are the main reason why the largest KCM shareholder (AAC through its subsidiary ZCI) has decided not to inject any more funds in KCM. This will effectively close down KCM unless a solution is found for the problem. * Chambishi Metals Company was established in September 1998 and its main shareholder is Anglovaal Minerals (Avmin) of South Africa. Its main objective is to treat materials from the Nkana smelter slag dump and is projected to produce about 4,000 tons of cobalt a year. However, the bulk if its revenue so far has been from the toll treatment of cobalt concentrates for KCM, MCM and RAMCOZ, before the latter's going into receivership. It has built a new plant for the treatment of the slag, but this is now facing technical problems and is far short of design capacity. This, together with the low price of cobalt, has resulted in large losses for Chambishi Metals. * Bwana Mkubwa Mining company is doing well. This is a relatively small operation, owned by First Quantum, which focuses on the processing of tailings through a leaching process. This is now by far the most efficient and least costly copper processing operation in 88 strategy of AAC/ZCI aimed to finance a significant proportion of the cost of developing KDMP with cash generated by the ongoing operations. The on going losses made this strategy infeasible and are the main reasons for AAC deciding to pull out of KCM. 121 Zambia. It uses a tailings leaching process and produces acid in quantities exceeding its own needs, which it sells on the market to other copper producers. Its cash cost of production is US$0.35Ab of copper, and only US$0.18/lb after acid credits. It was making operating profits even in November 2001, when the price of copper was US$0.59/lb, almost an all-time low price for copper. This company is also processing high grade oxide copper ore that is trucked in from Lonshi in the Democratic Republic of Congo (DRC), which is about 40 kilometers from Ndola, the city closest to the Bwana Mkubwa Mining Company. The development of KDMP was considered to be crucial for the survival of the Zambian copper industry and the growth of the Zambian economy by filling in the gap in copper production that would occur when the Nchanga open pit runs out of ore. The drop in the price of copper and the increasing projected costs of investment and production have eliminated any prospects for obtaining financing for KDMP on reasonable terms, and have effectively eliminated KDMP as a revitalization prospect for the Zambian copper industry in the medium term. KDMP will now have to be promoted and developed as a project on its own merits. This effectively puts KDMP on hold and improves the relative competitive position of other, smaller copper industry project. 5.2.3. Cobalt Mining Large scale recovery of cobalt in Zambia began about the mid-1980s and it quickly acquired importance because it augmented the earnings from copper mining. Cobalt is recovered as a by-product of copper ore, mainly from ZCCM's Nchanga Division, Baluba mine, the Nkana Division, including Chibuluma mine, and more recently in the Nkana slag dumps, which were bought by Anglovaal of South Africa during the privatization. The Chart below shows the evolution of cobalt production in Zambia in the 1990s. The production of cobalt in Zambia is expected to remain at about the same level, around 5,000 tons per year. The drop in production due to the closure of the Nchanga open pit is expected to be made up by increased production by Chambishi Metals from the cobalt rich Nkana slag dumps. Chart 5.4: Zambia, Annual Production of Cobalt 6,000 r 3,000 4,000 *K_ in F _ 0 E0i -E i L3 LiJ; U~~~F~ °L~ f E, I I I 1994 1995 1996 1997 1998 1999 2000 Source: ZCCM. CSO, BOZ Bulletin Just like the price of copper, the price of cobalt has been on a declining trend, although a less steep one. Its lower rate of decline, when coupled with increases in production in special cobalt mining campaigns has tended in some years in the late 1 990s to mitigate the impact of the sharp decline in the price and production of copper on Zambia's foreign exchange earnings. The price of cobalt has moved substantially in recent years in response to events that affected the 122 demand for, and supply of cobalt on the world market. On the demand side, the prolonged economic expansion during the 1990s sustained a high level of demand for cobalt in the industrialized countries. On the supply side, the events in Zaire (now DRC) affected Gecamines, a major producer of cobalt, very adversely, which reduced world supply and increased the share of ZCCM, and its successors, in the world market. However, the decision inl999 by some industrialized countries, mainly the US, to reduce their strategic stockpiles of cobalt increased the supply and led to a decline in the price of cobalt. The recession of 2001 in the US, coupled with the events of September 11, led to a collapse in the demand for, and the price of cobalt. At US$6.5/lIb in November 2001, the price of cobalt was one third the price in 1997 and about two- thirds the price in 2000. Chart 5.5: Zambia, Exports of Copper and Cobalt 1400 -1200 - 1000 800 _ lExports of Cobalt 25600- o400- 200 0- Exports of 0 Copper w~~~~~~l 15. 0@1, r Q rc ' S_ .; -l o.oo - l F r Iq Nq =l NID -" Nq - Source: ZCCM, CSO, BOZ Bulletin Chart 5.6: Zambia, AverageCRealized Price of Cobal 20.00- 5.2.4 The rivatzatio of CC The new government that came to power in late 1991 was reluctant to privatize ZCCM, but by late 1994 it became increasingly obvious that ZCCM was having serious problems and that Government needed to change its policy. The company needed new capital, technology and better management to re-establish its competitiveness in the world copper industry all of which it 123 could not provide. Thus in January 1995 the Govemment announced that it would privatize ZCCM by the end of June 1997. With resources from the World Bank, intemationally reputable and experienced investment and legal advisors were recruited to help GRZ privatize ZCCM. They formulated a ZCCM Privatization Plan, which was implemented in the summer of 1996, but it took nearly three and a half years to complete.89 Of ZCCM's copper mining and processing operations only the Nkana Smelter and Ndola Lime remained unsold by the end of March 2000. The smelter was put under a management contract and was to be operated by AAC and rehabilitated with funding from the UK Govemment. Also Ndola Lime, a subsidiary of ZCCM, was unsold at that time because of protracted negotiations with investors9o. The extended course of the privatization process had very far reaching implications on the Zambian economy and the copper mining industry in Zambia, the well being of the businesses that are dependent upon the copper industry and the communities that are linked to the copper industry. After privatization, the copper industry was expected to have diversified ownership. However, during the second half of the 1990s, uncertainty prevailed and this had a knock-on effect on the turnover and financial position of large numbers of Copperbelt area suppliers of goods and services. In addition to selling the operating assets, there was an effort made to transfer to the investors or to privatize many of ZCCM's central operations as independent businesses. A few functions (e. g., group winding, metal sales) were taken over by the new companies. Some, like metallurgical testing, were privatized, and a few were the subject of management buy-outs (e.g., information technology). However, many of the central staff were retrenched and paid compensation. A detailed list of central units that were privatized and many of the retrenched employees planmed to become ZCCM suppliers and contractors is set out in Annex 1. In order to make the ZCCM assets more attractive to investors, ZCCM prepared a Labor Reduction Program, the bulk of which was implemented with assistance from the World Bank through the GRZ. The retrenched workers were paid terminal benefits and given additional assistance in the form of counseling, retraining, job placement, and help to plan for and start new 89 Initial delays in the privatization process arose because of changes in the management of the process and the relatively aggressive or even confrontational position that the ZCCM negotiating team adopted vis-a-vis the bidders. This led to an impasse with, and ultirately the departure of the Kafue Consortium, the only bidder for a large package of ZCCM mining assets (the Nchanga and Nkana mining divisions). This put GRZ and ZCCM at an adverse negotiating position vis-a-vis Anglo American Corporation, the largest private-sector minority shareholder of ZCCM. Agreeing with AAC on a deal was only reached in late 1999 and the deal could only be closed at the end of March 2000. 90 Which packages/assets of ZCCM were privatized and at what date is shown below: UNIT/DIVISION DATE OF SALE Kansanshi Mine January 1997 Chibuluma Mine October 1997 Luanshya Mine October 1997 Power Division November 1997 Chambishi Mine July 1998 Precious Metals Plant September 1998 Chambishi Cobalt & Acid Plants September 1998 Chambishi Mine and Concentrator June 1997 Nchanga, Konkola, Nampundwe March 2000 Nkana, Mufulira March 2000 124 businesses (Annex 2). Many of these workers, some of whom are experienced and qualified individuals, aspired to become contractors and suppliers to the new mining companies. The long span over which the privatization transactions were completed was marked by wide swings in the world price of copper. The earlier transactions were able to benefit from the relatively high prices of copper in 1997-98 and from the fact that the supporting businesses and institutions were still relatively healthy and could cope with gradual change in business relationships. They also did not suffer as much as the later transactions from the uncertainty and inevitable disruptions during the long privatization process. During the delay in the privatization, ZCCM continued to incur losses and accumulate arrears, having a severe adverse impact upon the suppliers and contractors dealing with the company. The current problems of the copper industry present Zambia with opportunities that should not be missed. First, they give the Government and the mining companies, particularly KCM, an opportunity to develop a feasible program to operate these mines until their natural end of life in a manner that provides for an orderly closure over a reasonable period of time and avoids any major sudden shocks. Second, the fact that a major dip in copper production in Zambia is now inevitable means that the Government will have to study and define the macroeconomic consequences of this outcome. It should also inject more vigor into the economic diversification effort, particularly of exports. Third, the Government should take this as an opportunity to take a fresh look at the prospects and opportunities within the copper sector. There are other copper projects in Zambia besides KDMP, albeit smaller ones. These projects have the advantage of requiring smaller amounts of investment, would thus be of interest to more investors, and can be implemented faster than very large projects like KDMP. Since these projects will likely need infrastructure, the Government should, if necessary, play a role to facilitate and support investment by the private sector. All of this will affect the type and level of demand from the suppliers and contractors dealing with the copper industry in Zambia. However, despite these declines, the copper industry will likely remain an important factor in Zambia's economy, particularly if the private companies, who have bought ZCCM's assets, can weather this period of low prices and complete their rehabilitation and investment programs. Only a very rapidly growing copper mining industry can invigorate the activity of the goods and services suppliers. A stagnant, or even a slowly growing copper mining industry, will only exacerbate the current crisis that the suppliers linked to it are experiencing. 125 5.3 THE PROCUREMENT FUNCTION AT ZCCM AND THE NEW MINING COMPANIES 5.3.1. Procurement at ZCCM in the Late 1990s During the 1990s ZCCM undertook several attempts to reorganize and reform its procurement activities, each time realizing that this function could be improved further. Members of the ZCCM Board, especially those representing the "B shareholders"9' gave the impression that there was still room for further efficiency improvements. An underlying strategic issue was the extent to which ZCCM should contract out the procurement of goods and services function. An example of this debate was whether the police who guard ZCCM's assets (mines, processing facilities, offices, etc.) should be recruited and employed by ZCCM directly or through a contract with another company. GRZ was also interested in the procurement function at ZCCM. Indeed, the Government requested the World Bank in mid-1 995, as part of the program to stabilize ZCCM operations and restore production, to include an assessment of ZCCM's procurement function. A procurement specialist was included in the team to make recommendations for improvement. However, contracting out was by no means the only major objective of the reforms. Another important objective was putting in place a system that was less susceptible to abusive and fraudulent practices. While the system described below was the official formal system, in reality is was more susceptible to being taken advantage of by people who succeeded in developing and maintaining an "inside track" and who managed to secure repeated contracts/orders, sometimes in direct contravention of ZCCM's procurement policies. In this analysis we focus on the system that prevailed at ZCCM for the few years prior to its privatization. This is the system that was partly responsible for the management of supplies in warehouses, which many of the new mining companies described to be less than satisfactory at the time they took over. This was also the system that created the suppliers' expectations-at least in part- about the post-privatization period of the copper industry. ZCCM's Group Supply Services under the Operations Center in the Copperbelt was the direct corporate interface to the suppliers. It was established to provide direction for contracting and purchasing policies, to formulate procedures to manage shipping/logistics, to consolidate divisional requirements for bulk ordering of stock items, and to manage procurement under loan and non-loan funded non- stock items and other capital requirements. ZCCM's formal procurement policy was intended to encourage public procurement not only to attain efficiency, but also to allow for equal opportunity to eligible Zambian suppliers. Suppliers of goods and services were required to register with ZCCM. Registration was centralized and managed by the Group Purchasing Unit on behalf of the operating divisions who needed to procure similar types of stock items on a repetitive or continuous basis in order to establish reliable and regular sources of supply. Registration aimed at building and maintaining a profile for each supplier regarding information on general particulars (i.e. postal and physical address, firm portfolio, ownership, etc), type of business, products or services rendered, past performance record and so on. Interested suppliers were required to apply, providing the essential information for pre-qualification and paying a fee. 9' The "B shareholders" include individual, corporate and institutional private sector investors, the largest among them was Anglo American Corporation. 126 Registration campaigns were advertised and they started with the applicant submitting a completed form supported by full documentation92. Four lists of approved/registered suppliers and contractors [general supplies, specialized supplies, services (consultants) and works (contractors)] were sent to all the operating units/divisions of ZCCM. Registration was granted initially for one or two years, depending on the nature of the product or service being provided. In exceptional circumstances, indefinite or no-terminal date contracts could be entered into. Registered firms, which obtained orders from any ZCCM operating division during this period and performed satisfactorily, would normally have had their registration extended for a further period of 1 or 2 years. The registration of suppliers was not intended to restrict competition or eliminate competitive tendering. However, only registered and pre-qualified suppliers were invited to submit sealed bids. Registration and pre-qualification did not mean that orders for goods and corntracts for services would be automatically awarded to the pre-qualified suppliers. In most instances, the procurement was competitive rather than sole sourced and business contracts were only awarded after an evaluation of all the sealed bids received. In cases where there was no competition, materials and supplies were sourced on a single source basis. In cases of an emergency, a sole source process was used. An order was placed by divisional procurement unit to a registered supplier. Advantages that accrued to suppliers from being registered with ZCCM included: Preference or priority access to the bidding process. Tender notices announcing formal or advertised open tenders were sent to pre-qualified firms whenever they were eligible to supply the goods, services or works that were the subject of the tender. * Limited/selective tender enquiries were sent to registered pre-qualified firms, whenever they were eligible to supply the goods, services or works. * Creation of long-term business relationship between the suppliers and ZCCM emerged. Zambian Suppliers during the registration process were required to produce evidence that they were: (i) Zambian manufacturers having their own or leased works/factory, or a contractor with equipment and personnel to undertake the job; (ii) an authorized agent or distributor for Zambian manufacturers - provided the manufacturer is registered under the Companies Act. No. 26 of 1995; and/or (iii) a stockist of imported goods, a claim that ZCCM had to verify prior to registration by confirming the availability of stockcs at their stores/warehouses. Foreign Suppliers were required to produce evidence during the registration process, together with their authorized Zambian agents if they had any, that they are bona fide manufacturers and/or foreign suppliers. ZCCM could, in its own interest, order the suspension of business dealings with a firm, whether they were registered or not. The company normally notified the concerned supplier in writing about the intention to suspend it, indicating the reasons for taking such action. The firm was allowed to exculpate itself. On receipt of a written reply, the company examined the response and took the appropriate decision and informed the firm accordingly. Suspension of business dealings were either for a specific or indefinite period, the latter being imposed only in ca$es where the contractor had committed a grave offence. 92 The list of documents included: audited accounts, copy of certificate of incorporation, copy of agency/distributorship agreement (if applicable), banker's reference, VAT certificate of registration or VAT exemption certificate, list of customer references (at least three), one set of catalogues (including price-lists, if available), evidence of payment of non-refundable registration fee. 127 5.3.2. Procurement by the New Mining Companies Almost all of the new mine companies have policies and procedures for the management of procurement, although some of these are better articulated than others. For example, KCM has produced a booklet to provide to suppliers which explains how to do business with the company. By and large, the new mining companies have tended to adopt policies and procedures for the procurement of goods and services which are modeled on those applied by their parent companies. The policies for the procurement of goods are generally similar to those for services, aiming at achieving the 'best possible value at the lowest possible cost'. The general policy is to procure by competitive bidding from registered suppliers and contractors. This implies that they have to take into account price, quality, quantity and delivery lead times. The supplier's performance is measured and follow-on contracts awarded on the basis of how well a supplier has performed on an ongoing basis. The evaluation is thus based on the extent of conformity to specifications and the observance of standard commercial terms and conditions. For the major industry players, like KCM and MCM, comprehensive bid documents are in place. Although none of the new mine companies have adopted an explicit policy of giving local suppliers a "price preference," or margin, some have indicated their willingness to allow a 'reasonable' additional mark-up from local suppliers. The way the new mining companies organized their procurement function depended upon how many mining operations they had and the degree of support they could count on from their parent companies. Those that had more than one mining location have set up central procurement units to undertake the major procurement, especially that of items common across locations. They have also kept the procurement units at the level of the individual operation that they inherited from ZCCM to undertake the procurement of goods and services that can be done at the local level. Those companies, however, whose parent company had an established procurement function, have depended on the latter in cases where the transaction could benefit from regional or intemational competition . KCM, for example, relies on Anglo's procurement unit in Johannesburg for this type of procurement. At the time of taking over the ZCCM assets, the new owners found that they needed to restock the warehouses and, in addition, they had to procure the goods and services they needed for their rehabilitation programs. This amounted to a larger procurement program than usual. The fact that they were not familiar with the local suppliers and not confident in the latter's ability to supply goods, or undertake contracts, added to the pressure to quickly replenish warehouses and stores. Since many of the new owners were regional or intemational businesses, they had current ongoing relationships with suppliers outside Zambia and knowledge of their capabilities and confidence that they would perform well. Thus, early in the post- privatization period a significantly large proportion of the goods procured and the contracts awarded went to non-Zambian suppliers. This raised concern among Zambian suppliers and led to accusations that the new owners were favoring foreign suppliers. This situation was exacerbated by the fact that some of the suppliers - the so-called brief-case suppliers -- did not appear to be legitimate and qualified. They were thought to be "fronts" for parties from outside Zambia. With time, some of the new owners/managers realized that they had to pay more attention to their relationship with the local suppliers. Some arranged special meetings to explain to the suppliers their procurement policies and procedures and to identify what measures could be taken to help the local suppliers to take better advantage of the potential for procurement by the new mining companies. For example, some of KCM's suppliers felt that they were disadvantaged vis- a-vis foreign suppliers because when KCM imported directly from outside suppliers, it did not have to pay customs duties and the VAT. To compensate the local suppliers for this problem, for 128 example, KCM stated that it was ready to assign its duty and VAT exemptions to the local supplier if he had to import materials, parts or components. Also with time, the new mining companies concluded that it is better to do certain things (i.e. maintenance services) on an in- house basis rather than resort to outside contracting. This added to the shortage of demand for the goods and services of the local suppliers and contractors. Based on discussions with the new mining companies-and data submitted by KCM and MCM93-- it is possible to draw some conclusions that may be applicable to the rest of the industry. Taking the supply of bulk goods first, about 72% of the total, or an estimated total of US$129 million was locally procured in 2001. Of this 'local procurement', approximately 55% (US$71 million) consisted of diesel and other fuels, lubricants, acid, lime and reagents; 41% (US$52.5 million) consisted of capital goods, spare parts, components and similar products; and 4% (US$5.5 million) consisted of other items. For most of these products there is relatively little value-added done in Zambia. Fuels and lime (US$41 million) are bought locally from old established operations and about 50% (US$15 million) of the acid is actually imported. It is unlikely that there will be expanding operations in the near future or that there will be new entrants into this market. Acid may present some potential for expansion. If that happens, it is likely to be as a part of a mining operation, or linked to it. Even so, given the nature of the process, the additional employment will be limited. The capital goods, spares, components, detonators and explosives category presents a limited potential for increasing the share of the local suppliers, but the level of requirements will be linked to the total output of the copper industry and this will likely be slow. Finally, the last goods category, "other," is very small and does not present much potential. Given general uncertainties in the industry and the nature of the available data, it is not possible to sub-divide the data into two components: one that is sustainable or recurrent over the long-term by mining operations and another that relates to the rehabilitation program that would cease when rehabilitation is completed. The combined total value of the services performed or contracts awarded by KCM and MCM, was estimated at US$53.5 million in 2001. Of this total, US$39.5 million, or 74%, was for services from/contracts awarded to local suppliers. These include all types of contracts, such as maintenance, rehabilitation and repair at mines, processing plants and company housing, and consulting services, etc. A snap shot was obtained by reviewing a list of service contracts at KCM at the end of October 2001. The list covered 236 contracts at the Nchanga and Konkola mines and the Nkana smelter, valued at about US$0.7 million. These were at various stages of processing, from the invitation to bid stage to the extension and renewal, when needed. Most of these contracts were very small, valued at less than K5 million (US$1,250), and for numerous tasks. Also, most of these contracts were generated by KCM either centrally or at the mine level, but there were a few contracts that were generated by Anglo. Given the very large number of registered 'service suppliers', it is most likely the case that many of the people hired to perform services would have ordinarily been hired on a more permanent basis were it not for the large mandatory non-wage costs which employers need to bear (i.e. pension and terminal benefits, housing allowances, etc.). 5.3.3. Characteristics of the New Mining ComDany Suppliers 93 Which together accounted for 65% of total copper production in 2000 and nearly 95% of this production in 2001. 129 A small sample of thirteen local goods and service suppliers located on the Copperbelt were interviewed in order to gain information on their pre- and post-mining company privatization experience and on the overall status of their businesses. The companies interviewed were randomly selected from a December 2000 list of suppliers and contractors to whom ZCCM had owed funds. The selection process proved very difficult because many of the originally selected firms could not be reached by phone or otherwise, this being an indication that many such suppliers and contractors had either gone out of business, or are inactive from low demand. Our analysis below also takes into account the findings of the KCM/IFC study for which an additional twenty-four firms were interviewed. 5.3.4. Results of the Sample Survey The products and services of the 13 surveyed companies ranged broadly, including among others, manufacturers of paints and allied products, electrical switchgear, steel fabrication, injection molded plastic products, provision of metallurgical and analytical services to electricity supply. A summary of the main characteristics is presented below: (a) Age: Most of the supplier companies in the survey were well established; seven of them were established over 10 years ago. Most are also registered as limited liability companies; only one company was registered as a partnership. In all cases, the accounts are audited, but are not publicly published. Five companies were formerly under ZCCM ownership and are now under private ownership. In terms of participation in ownership/shareholding by former Zambian ZCCM employees, this was only evidenced in four companies out of the 13 companies in the sample. (b) Target Market: The main geographical market for the suppliers is the Copperbelt region, although some companies had products that were being sold in shops and other outlets in other parts of Zambia. The Democratic Republic of Congo was one market that was significant for some of the suppliers, but it is no longer so because of the earlier civil war and instability in the parts of the country adjacent to Zambia. Because these companies were primarily established to service the mining companies, they have remained heavily dependent on them. Other than ZCCM, and subsequently the new mining companies, all the sample suppliers do not have major clients that account for 5% or more of their total sales. (c) Growth vs. Stagnation and/or Decline: Approximately 80 percent of the companies have been in decline over the past several years when accounting for Kwacha depreciation. The very few companies that registered positive growth attribute their success to several key factors: * A diversified customer base on the Copperbelt outside of the mining companies (two-thirds of the frms surveyed showing growth had a diversified base of customers); * Increased demand from the new mining companies due to increased capital expenditures in the first year of privatization. However, this increased capital expenditure may have been a one-time investment, and thus the growth was unsustainable; and * Sufficient resources to rehabilitate their plants and workshop areas. Those companies with declining or stagnant demand and sales attribute the negative trend to the following: 130 * Low demand and reduction/freezing of capital expenditures by the new mine owners, by cutting down on major rehabilitation and capital expenditures due to declining copper and cobalt prices * Preference to foreign suppliers (notably South Africa) at the expense of local suppliers and contractors. * Policy of new mine owners opting to do 'everything' in-house. 5.3.5. Problems and Constraints Affecting Local SuDDliers The interviews of suppliers suggest that the owner's/manager's willingness to embrace change was a crucial distinguishing factor between those firms that did or did not perform in the post ZCCM-privatization era. Most suppliers assumed that business would remain as usual. Many also assumed that "connections" and "inside track" as witnessed with ZCCM would be sufficient. Instead, the new mine owners implemented new policies/procedures and replaced procurement managers and other procurement decision-makers. Therefore, only those suppliers that anticipated change and accommodated it flexibly did well. These, by and large, were the suppliers who were not totally dependent upon the copper mining industry, and who foresaw that they will have to measure up to a more stringent standard of performance and prepared for it by updating their facilities, and in some instances, increasing their capacity. Chart 5.7: Dependence (%) on Mining Companies ,12 - ~lo U 30-59% ffi 6- __ _ *~~~~~~~~~U60-89% S ~~~~~~~~~~~~~090-100% 6-4 - - 2 0 1999 2000 2001 Source: World Bank Survey of Mine Company Suppliers The chart above, however, portrays the heavy dependence of many of the firms on the mining companies. This overdependence is a deterrence to flexibility, adaptability, and innovation. The firms which have successfully diversified away from complete dependence on mining companies account for two-thirds of the firms which showed positive growth during the 1998-2001 period. The local suppliers have had to overcome major constraints. Fifty-five percent of the sample cited lack of access to working capital and high cost of borrowing. As previously mentioned, a majority of the established suppliers were dependent upon ZCCM for most, if not all, of their business. The accumulation of ZCCM arrears undermined their financial position. Many had anticipated the delays in payment from ZCCM, but few expected the delay to be so long. The imputed interest they included in their invoices was insufficient to cover their 131 indebtedness. Once repaid, the bankers would be reluctant to take on credit risk again. Those that did not meet their criteria had no alternatives and thus failed to secure orders and contracts. Bankers would not agree to extend credit against orders/contracts unless the new mining companies agreed to pay in advance the full amount of the contract promptly, regardless of whether the supplier/contractor performed fully satisfactorily and in a timely manner. Even some of the suppliers/contractors, who had the resources to cover their requirements during the production/mobilization stage, could not get the credit to take on new orders/contracts. In the cases where banks were ready to discount invoices, the discount rates they applied and the security margin they demanded were extremely high. The access to term resources was equally difficult as the access to overdrafts and working capital loans; borrowing costs have been very high, credit standards very stringent and transaction costs high because most of the providers of term funds operate out of Lusaka, not the Copperbelt. Second, many of the local suppliers and contractors were not competitive. Most of the suppliers did not realize the need to revise their pricing policy. They did not change the premium they had imposed on ZCCM for delayed payment, despite the new owners prompt payment. The new mining companies compared prices with those of imports and foreign contractors and were not willing to pay too much, or be overcharged. In addition, locally manufactured goods are subjected to duties, which could be as high as 50% on their imported inputs and VAT at a rate of 17.5%. In contrast, the new mining companies were exempted from them. This has severely disadvantaged local companies as they are required to pay VAT. This affected the smaller suppliers because they were not as prepared and able to take advantage of such schemes as duty-drawbacks and assignment of VAT exemptions by the new mining companies. Another obstacle to suppliers' competitiveness was the uneven quality of goods they supplied and services they performed. To overcome this problem, some of the suppliers have considered twinning and joint-venture arrangements, however these are often difficult and time consuming deals to negotiate. They also require owners/mangers with the capacity to evaluate the future benefits against the loss of control and ownership that these arrangements imply. In addition, these arrangements are not as useful for smaller suppliers, which constitute the majority of companies in Zambia. Finally, suppliers were subjected to relatively transparent and more rigorous competitive bidding policies and procedures than under ZCCM. The suppliers are expected to be in compliance with mine-company tender documents and specifications. The bid documents are comprehensive, covering product description, unit prices, extended validity of prices, allowed discounts, special VAT treatment, delivery deadlines, minimum stocks on hand, etc. These documents were prepared in-house by sales/marketing staff in collaboration with finance and production personnel, usually with participation of senior management. Thus, the prices of inputs were given adequate attention throughout the process. One company reported that the prices it pays for inputs comes up regularly during management meetings and informal discussions. About half the interviewed supplier companies prepared some form of a business plan. These "business plans" were very short-term in nature and their emphasis was different from one enterprise to another. Some prepared operating one-year budgets outlining levels of sales, production, etc.; others prepared "business plans" for investment purposes, taking into account estimated increases in demand and market trends. At the same time, some companies have halted business planning as they are now operating in 'survival mode' until the activity at the mining companies picks up again. The reason is that the demand from the mining companies- is at present unpredictable and this has derailed their business plans. However, they know the basic 132 information about their own cost structure, and by and large fully intend to cut them to match the sales revenue that they are able to achieve. 5.3.6. Advocates of the Mining Company SuDDliers The relationship between ZCCM and its local suppliers changed during the last few years prior to privatization and changed even more with the new mining companies. ZCCM's build up of arrears strained its relationship with suppliers, particularly with small- and medium-sized suppliers. ZCCM had little, if any, leverage on the large suppliers. They stopped deliveries if arrears built up too much. To avoid shutting down operations, ZCCM gave higher priority to paying the larger suppliers, especially those supplying key inputs, such as fuel, detonators, explosives, etc. However, because of competition and the availability of alternative suppliers, a small- or medium-sized supplier did not have such leverage. Because ZCCM is a local company, majority owned by the government, it was above suspicion of favoring foreign suppliers. Consequently the suppliers did not feel that they needed to have special advocates or their own pressure groups. Except for the accusation of preference for foreign suppliers by the local suppliers and their supporters, the relationship between the new mining companies and the local suppliers of goods and services has, by and large, been good. The new companies paid their bills on time and because of their large rehabilitation programs they were able to give the local suppliers more business than ZCCM. Even so, some suppliers felt they were left out. Their cause was taken-up by the recently established Mines Suppliers and Contractors Association (MSCA)94. When the prices of copper and cobalt started declining rapidly in 2001, the cutback on investments and rehabilitation work adversely affected the local suppliers. In addition, more emphasis was put on "lowest cost" procurement, which affected the local suppliers adversely too because of their lack of competitiveness. Thus it appeared as if the new mining companies favored foreign suppliers, especially those from South Africa, the country of origin of many of the new investors. The mining companies attempted to address the accusation of preference for imports at various meetings between the mining companies and representatives from Government, Mines Suppliers and Contractors Association, Chamber of Commerce, Banks etc. It is not clear whether this was adequate. The decision by Anglo American Corporation to pull out of ZCI, its subsidiary, that is a shareholder in KCM has added to the concerns of the local suppliers and their advocates. 5.3.7. Support Institutions and Ongoine Initiatives Except for financial services, there does not appear to be many major constraints on the a'verage copper industry supplier and contractor from the supporting institutions, and if there is a problem in specific instances it is more a problem of affordability rather than availability. There appears to be adequate support when needed and sought from accounting and auditing firms and book-keepers, engineering offices, equipment agents and importers, repair shops, etc. However, the commercial banks and other financial service institutions seem to be a constraint for the reasons mentioned above. For good reasons, the banks have not been ready to provide the The MSCA is an Association that was set up about two years ago to specifically represent the local suppliers and contractors. It has about 400 members. At first, it seemed that there will be a conflict in mandate and mission with the Zambia and the Kitwe Chambers of Commerce and Industry. An agreement was reached between the Chambers and the Association that the latter would be the representative of the suppliers and contractors vis-ai-vis the mining companies. 133 required funding to allow the suppliers to be responsive to the new setup in the copper industry. The suppliers are financially weak, are high credit risks, and the financial institutions find it difficult to relax their credit qualification criteria. However, there are in Zambia other ongoing initiatives that can help redress the financial deficiency and some of the other constraints that the suppliers are confronting. These include: The Enterprise Development Project: This IDA project whose objective was to help spark increased activity by Zambian businesses includes two main components: a matching grant facility, and a multi-purpose credit facility, which provides both short- and medium- and long-term investment credit indirectly through pre-qualified participation financial institutions. The following is a brief description of each: The Matching Grant Scheme (MGS) has been in operation for over three years. It aims to finance up to 50% of the cost of technical assistance tasks to help Zambian businesses improve their operations. It is managed by PriceWaterhouseCoopers out of Lusaka. It has received 113 application for US$1.16 million and approved 53, but it has only disbursed against 22 approvals, for a total of US$0.44 million. Of the 22, only 6 are from the Copperbelt. The problems being encountered by the MGS include slow econornic activity, firms lacking interest and/or resources to access the MGS, lirnited appreciation for the value of technical assistance, but also limited knowledge of the MGS by the potential target Group. The MGS has effective competition from other similar programs, funded mainly by the EU, and from volunteer business Services being assisted by USAID, British Expert Service Oversees and the Dutch Volunteer Service, which are largely free. The Multi-Purpose Credit Facility has two components: (i) a pre-shipment export credit facility that provides working capital financing to firms against firm export orders. The mine service companies are eligible under this facility because they are considered to be indirect exporters; and (ii) an investment credit facility, which provides the term resources to companies to help finance their investment projects. This component got off to a slow start , mainly because it was uncompetitive, but demand has picked up after the pricing formula was adjusted. The European Union has two programs that provide assistance to micro, small and medium size business enterprises. The first is Private Sector Development Program: Non- Financial Support to Micro Enterprises and SMEs: This program supports enterprises directly by financing the cost of technical assistance, feasibility studies; and indirectly, by supporting the strengthening of the capacity of service providers. Its assistance is similar to the EDP, but with different eligibility criteria and different, more generous terms and conditions;, and providing short and long term loans. The second program is the Private sector Development Program, which provides direct support to small and medium enterprises, together with professional associations. It is managed by the Center for the Development of Enterprise in Lusaka. It can share up to two-thirds the cost of the assistance. The EU-supported PSDP program still has significant amounts of uncommitted funds that could be made available to help improve the capacity of the local suppliers of the copper industry and meet a part of their credit requirements. However, both are managed and operated from Lusaka, which makes it difficult for the suppliers who are predomninantly located on the Copperbelt to deal with the staff of these programs. Both have made promotional visits and publicity campaigns, which need continuous follow-up and support to generate results. The 134 design of any initiatives focusing on helping the mining company suppliers will have to include as an element the review of all these programs to determine what exactly needs to be done to improve access on the Copperbelt. 5.4 CONCLUSIONS AND RECOMMENDATIONS 5.4.1. Conclusions The transformation that the copper mining industry in Zambia has gone through over the past few years as a result of the privatization of ZCCM and the developments in the world copper market, has had a major impact upon the suppliers of goods and services to the copper mining industry. This has been reflected in: changed way of interaction between the copper nfining companies and their suppliers of goods and services, * variance in procurement policies, procedures and strategies, due to more companies operating in the industry instead of only ZCCM, f many of the suppliers of goods and services, especially those that have been in operation for about five years or longer were adversely affected by ZCCM's severe arrears problem, and * greater vulnerability to market forces, particularly in periods of slowdown. The implementation of the ZCCM privatization was slower than originally planned, which prolonged the period of uncertainty during which the ZCCM assets deteriorated, resulting in greater need for more costly rehabilitation when the new owners took over. Also production declined, leading to a decrease in the demand for goods and services from the suppliers. KCM undertook many functions in-house, particularly those that were common across operating divisions. Some of these functions/units were privatized and became suppliers to the new mining companies. Also, as a result of the ZCCM privatization, many ZCCM staff, at all skill levels and from both operating divisions or central units, who were not required in the new companies were retrenched. Many of these hoped and actually set themselves up as contractors and suppliers to the new mining companies. The combination of declining demand and greater competition appear to have resulted either in a high attrition rate among the newly established suppliers, or inactivity. Many of the suppliers, even those who have been in business for a few years, were not adequately informed about, or prepared for, doing business with the new mining companies. They thus failed to secure adequate amounts of business. Many of these have gone out of business or suspended operations. Although there is no reliable register, data base or other source of information, it is very likely that the number of mining company suppliers, is very large. It is likely that the predominant majority of these are individuals. This is really an alternative way for the new mining companies to hire workers to meet periodical needs for workers i.e. contract labor. Hiring workers under short-term contract relieves the new mining companies from having to bear the high cost of benefits, especially terminal benefits that would be associated with full-time employees, who would be unionized and govemed by the Collective Bargaining Agreement. 135 5.4.2. Future Prospects It appears likely that the suppliers of goods and services to the copper mining industry will undergo a major shakeout as a result of the transformation the industry is going through and the more keen competition. Copper mining will continue to be particularly tough in Zambia because the industry is consolidating and the present outlook for the world copper industry is slow growth at best. Zambia's copper industry will continue to suffer from its higher relative costs. The total output of copper now will almost certainly fall sharply, by about 100,000 tons per year around 2004 because of the closure of the Nchanga open pit when it runs out of ore. The development of the Zambian copper industry beyond 2004 depends upon the future outlook for the price of copper, the evolution of world copper production and consumption and Zambia's ability to attract new investment. Even more important for the future development of the copper industry in Zambia is the fate of KCM. Non-dooms-day scenarios of future development will have to based on the assumption that KCM would be restructured as a going concern. A high case scenario would assume that world consumption of copper, estimated at about 15 million tons per year in 2000-01, would increase modestly, by about 2% p.a.; the price of copper would be at the top of the analysts' forecast range , at US$1.18/lb of copper in 2005 and beyond; and KCM would be able to fundamentally revise the mining and engineering plans for KDMP to reduce investment and operating costs and improve profitability so that it can attract investor interest to finance KDMP in time for it to enter production in 2010. It is also assumed that there is investor interest in some of the smaller promising ore bodies, such as Kansanshi. Under such a scenario, Zambia's copper output could rebound by about 100,000 tons around 2007-08 and increase further, by about 150,000 tons per year around 2010 when KDMP comes on line. In this case the outlook for the suppliers of goods and services to the copper industry would be for a shakeout in the near term, and slow revival in the medium term on account of the higher level of investment in mine development, as well as the increase in the industry's output. A low-case scenario would assume that world consumption of copper would at best stagnate at about 15 million tons per year, if not slowly decline in 2003 and for a few years beyond; the price of copper would be at the bottom of the analysts' forecast range, at US$0.95/lb of copper in 2005 and beyond; and although KCM would be restructured as a going concern, its mining operations would cease at about 2010 when the ore bodies at existing mines are exhausted and it would be unable to realize the KDMP project. Also Zambia would be able to attract a limited amount of investment for some of the smaller copper ore bodies. In this case the outlook for the suppliers of goods and services to the copper industry would be very bearish, on account of the low level of investment in mine development, as well as the decrease in the industry's output. 136 Chart 5.8: Zambia, Copper Production Scenarios u 450 ..- . . .......... °400a ° 350 -- -- 300- *.: 250 -]. 4-. - - J i ' - +High-Case Scenario - 200,--U-_ . S _Likely Scenario ;, 200 ff -- - - : - ' * K Low-Case Scenario a150; 4h100 b irs u 00 , , I An in-between scenario is more likely. The underlying assumptions would be that world consumption of copper increase very modestly, by about 1% p.a.; the price of copper would be in the middle of the analysts' forecast range , at US$1.07/lb of copper in 2005 and beyond; and KCM would run out of copper ore about 2010 and would be unable to finance KDMP, but other investors would succeed in bringing into production some of the smaller copper ore bodies, such as Kansanshi. Under such a scenario, Zambia's copper output would still fall during the period 2004 to about 2006, but it would rebound gradually until about 2009, but it will start declining again by about 40,000 tons per year around 2010. In this case the outlook for the suppliers of goods and services to the copper mining industry would be contraction over the next two to three years, followed by very modest growth, mainly on account of the investment in new mine development. In the light of the above, it should be apparent that even if the linkages between the copper mining industry and its suppliers of goods and services is very strong, the prospects of the supplier industry are modest. This should be another reason and motive to develop plans and strategies to diversify the economy of the Copperbelt. 5.4.3. Recommendations In the light of the above analysis, the following are recommendations, most of which would need to more fully elaborated in the context of an action program. Specifically, it is recommended that: * GRZ establish a new or open up an existing credit guarantee scheme to enable the suppliers who are marginally credit-worthy but otherwise qualified to access credit. This should be a cost-sharing scheme between the participating financial institutions and the suppliers and should aim to provide pre- and post-shipment credit. This is justified in this instance by the market failure that requires special treatment. * Measures be taken to increase awareness of availability of funds, especially from the donor agencies, EU, World Bank, etc and facilitate access to these funds by the suppliers of the copper mining industry. Opening up regional offices would be one way of doing so. 137 * Access to such programs as the EDP matching grant scheme be opened up to those suppliers that want to improve the quality of the goods and services that they supply to the copper mining industry. * A program should be established to sponsor efforts to provide business training, especially in business management and planning, bid preparation and contract management, * The mining companies be encouraged to sponsor, together with such organizations as the MSCA and/or the Chambers of Commerce and Industry, initiatives to encourage interaction between the suppliers and the mining companies procurement managers. * Mergers between supplier companies should also be encourage whenever opportunities arise. This should also include twinning arrangements and joint ventures with foreign suppliers when possible. * GRZ should investigate the impact of the import duty and VAT exemptions that were given to the mining companies on the suppliers to the mining companies with the objective of taking those measures that will ensure a level playing field. The analysis in this report has been limited to the identification of linkages and general relationships and tendencies. In order for the above conclusions and recommendations to become operationally relevant and feasible, they need to be pinned down more accurately and quantified so that they could provide the basis for the formulation of specific recommendations for action. The following areas appear to be important and deserve high priority and further attention in the program preparation phase: • The link between copper and cobalt output and the demand for goods and services is positive, but on the basis of the work done so far it cannot be quantified. Further work needs to be done to determine the degree of responsiveness in terms of categories of goods and services to given changes in copper production. There are industry norms. These need to be vetted to determine that they are relevant to the copper mining industry in Zambia, and if not, how should they be modified. The response observed so far is combined for both changes in output and an exceptional program of rehabilitation. Separating the two components of the response could help better determine the scale of a sustainable supplier industry; and * The funding and technical assistance needs have been identified in broad terms. These need to be analyzed in more depth and detail to come up with more specific recommendations about financial constraints and how best to address them and know- how needs and how best to meet them. 138 ANNEX 1 ZCCM: OPERATIONS CENTER FUNCTIONS The Centralized Services Divisions from the former companies were comnbined into one Centralized Division that became known as Operations Center with specialized services in:- Finance, Geology, Industrial Relations, Staff Development, Training, Research and Development, Computer Services (IT), Operations Research, Mining Support Services, short and long range planning, Metallurgical Accounting, Purchasing and Stores and Public Relations. Over the years, the center responded to the changing needs of operating divisions and specialized functions were set up where cost effectiveness dictated a centralized function. At the time of privatization, many units at both Corporate Head Office and Operations Center were not required by the new mine owners and employees in those functions thus became surplus to requirements and were retrenched. However, were some functions were absorbed by the new mine companies (Group Winding, Mine Police, Metal Sales), some transformed into independent units under private ownership (Group Quality Assurance and Analytical services, Metallurgical Investigations, Information technology) others reverted to Divisions. Full details are shown below: Function Absorbed/Retrenched Mining Support Services Retrenched Geological Services Retrenched Metallurgical Support Services Group Quality Assurance Services Alfred H Knight Production Planning Alfred H Knight Metallurgical Investigations Alfred H Knight Group Environmental Services ZCCM IH Engineering Support Services Group Engineering Services Alfred H Knight Group Winding Plant Engineering KCM Group Maintenance Engineering Reverted to Divisions Industrial Engineering Retrenched Group Capital Projects Reverted to Divisions Financial Services Operations Accounting Retrenched Internal Audit Retrenched Metal Marketing And Sales KCM Human Resources Manpower Planning and Development Retrenched Industrial Relations Bureau Retrenched Mine Police KCM Education Services Retrenched Others Corporate Affairs Retrenched Corporate Planning Unit Retrenched Group Supply Services KCM Information Technology Coppemet Solutions Legal Department Retrenched Property Management Retrenched Safety Management Unit KCM Corporate Head Office Retrenched 139 ANNEX 2 RETRENCHMENTS AND RETRAINING As part of the disbursements under the Development Credit, the Bank of Zambia received US$68.5 million towards the retrenchment and retraining of ZCCM surplus employees. The first component of the Credit, constituting US$48.5 million, was set aside for retrenchment of 7,337 employees specifically identified to the IDA in the ELD report. At 31 July 2000, out of 7,337 employees originally identified 4,825 employees had been retrenched. The retrenchment costs amounted to US$ 30,900,478. The shortfall in retrenchments arose for a number of reasons which came in the main from delays in the privatization; in certain cases there were delays while prospective new owners decided which hospitals, schools, clinics and the other ancillary functions they wished to take over. In other cases it was assumed certain functions could be out sourced while in practice this proved impractical and in some cases employees had died or resigned in the intervening period. ZCCM retrenched 1615 employees that were identified as surplus to KCM's requirements at Nchanga, Konkola, Nampundwe and Nkana Smelter. Terminal benefits amounted to US$ 9,179,295. Mopani Copper Mines Plc opted to takeover existing labor prior to vesting and only effected retrenchments (1,586) within 12 months of takeover at a cost of US$9,487,261. Retraining The second component released under Development Credit from Bank of Zambia, representing US$7,337 million covered costs of retraining the employees to be retrenched under the first component of the credit. With the delays and difficulties in meeting the target of 7,337 retrenchments, the full amount payable under the second component was also not fully disbursed. The counseling and retraining programs covered four major components: Social Counseling seminars on coping socially and financially with Retrenchment Job Search for those with the potential for formal Employment prospects Small Business Awareness schooling for those opting for self employment Skills Training focusing on vocational computer and other basic Training. 140 EPILOGUE: MOVING THE DIVERSIFICATION PROCESS FORWARD This study was undertaken in order to go below the radar screen of Zambia's persistent macroeconomic problems in order to examine recent trends, prevailing constraints and unrealized opportunities in specific economic sub-sectors. The study was designed to examine the underlying bases of competitive advantage and disadvantage in the evolving economy, to assess the depth and likely sustainability of those patterns of economic diversification which have taken place since the early to mid-1990s, and to identify opportunities to strengthen inter-sectoral and supply chain linkages in major parts of the economy. A series of firm-level surveys provided insights into these issues. With the announcement in January 2002 by the Anglo-American Corporation of its decision to stop further investment in the country's largest mining operation, the relevance of our analysis increased significantly. In response to a request for assistance by the Government of Zaimbia, the World Bank mobilized a task force to examine the potential macroeconomic impact of the Anglo decision, to assess the options for the Konkola Copper Mines, to assess the social impacts of the potential mine closing, and to intensify discussions regarding the economic diversification options for Zambia. The draft findings of this study served to inform the work of that initial task force and to provide one of the bases for the organization of a public/private workshop in June 2002 in Kitwe to examine the specific options for fostering the diversification of the Copperbelt region. Based on our initial findings and more detailed follow-up work, specific proposals were developed for a pilot "Agribusiness Linkage" program to strengthen the ties between agricultural and food processing companies and outgrower farmers in selected subsectors. If the pilot program is successful, a larger initiative will likely be included in future traunches of the Support to Economic Expansion and Diversification (SEED) project. Since the June workshop, the Government has appointed a National Economnic Diversification Task Force (NEDT) to spearhead an initial set of initiatives in the Copperbelt and Livingstone areas and to advise government on the critical policy reforms needed to foster private sector investments in these areas and elsewhere. One of the responsibilities of the NEDT will be to review 'and draw lessons from successful international experiences in fostering economic diversification. It is imperative, however, that the NEDT also closely re-examine Zambia's own experience in this regard over the past decade. This study has provided a range of insights into that experience and has highlighted the precarious state of much of the new investment which has taken place. The sustainability of many non-traditional exports and the further realization of inter-sectoral business linkages within the domestic economy have been and continue to be threatened by an array of factors which undermine both profitability and competitiveness and which render doing business in Zambia unnecessarily risky. While the evidence is thus far mostly anecdotal, we have observed the exit of a substantial number of small, medium, and larger-scale enterprises only in the past three years. Some of the 'imperiling' factors are largely beyond the control of Zambian authorities and private actors. The volatility and decline of international commodity prices and the periodic (yet increased) incidence of drought are two important examples of these. The contraction of domestic purchasing power continues to weaken the demand for many goods and services, yet this will not be reversed until there is an improvement in employment and other income-earning opportunities. 141 However, many of the other factors which imperil Zambia's diversification efforts are amenable to public action or joint public-private action. For example, it is critical that: * Macroeconomic stability be restored, thereby providing for more stable and predictable movements in exchange rates and putting downward pressures on interest rates for investment and working capital. To achieve this macroeconomic stability, it is important to reduce the fiscal deficit of the central govermment, eliminate the quasi-fiscal deficit, and continue to strengthen the effectiveness of public expenditures; * The anti-export bias in Zambia's trade regime and wider anomalies in the country's tax structure be carefully reviewed and reforms undertaken to address the most serious problems. The on-going WTO Trade Policy Review will address the trade regime, yet other work is needed on the broader set of tax issues; * There be more effective consultation between govemment and the private sector. Govemment and the private sector should work together in diagnosing the constraints affecting and the opportunities available to particular supply chains and in developing action plans to implement over the short-to-medium term. The formation of the NEDT provides an excellent opportunity to intensify this type of dialogue; * Govemment officials should be more available to firms and must act more decisively and quickly on trade-related matters. Certain export procedures need to be decentralized as with the issuance of export permits, phytosanitary certificates, etc. Govemment must become more effective in supporting the interests of the Zambian private sector in the context of regional and intemational trade. Safeguard measures may need to be introduced to protect local industry from unfair competition, while restrictive measures adopted by Zambia's trade partners need to be challenged; * Cross-border initiatives be undertaken to strengthen the physical, commercial and institutional infrastructure linking Zambia with the neighboring provinces in the Democratic Republic of the Congo. A potentially large amount of trade in manufactured and consumer goods is being un-realized due to the uncertainty and high transaction costs associated with this trade; * The design and/or implementation of existing incentive schemes such as duty drawback, VAT refunds, and manufacturing under bond arrangements needs to be improved. An upcoming study on 'administrative barriers' to business will examine this more closely and make specific recommendations. Options for establishing and effectively managing 'special economic zones' should be assessed; * Critical infrastructure bottlenecks for specific NTEs and agricultural supply chains with high growth potential be further identified and addressed through joint public and private sector investment. 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