The World Bank presents the first edition of the Zimbabwe Economic Update (ZEU). The objective of the ZEU is, first, to provide a World Bank perspective on Zimbabwe’s recent economic developments, and second, to profile recent progress in a key sector or a key issue in detail. In this edition, we discuss the ongoing progress in improving health outcomes and review some of the policies and practices the sector has adopted in response to its challenges.

Over the last five years, Zimbabwe has made significant progress in stabilizing and revitalizing its economy. The economy grew at an average of six percent annually, while inflation has been kept low. A steady, albeit gradual, sequence of economic and institutional reforms is gaining momentum, and is reflected in the World Bank’s annual Country Policy and Institutional Assessment (CPIA). With strong Government commitment, steadfast household investments and substantial donor support, considerable progress has also been made towards regaining Zimbabwe’s past performance in social outcomes, particularly in health and education. The authorities are now implementing a number of reforms to strengthen the financial sector, in particular, and to improve the business environment, in general.

Yet significant challenges remain. The economic boom that followed the introduction of the multi-currency system in 2009 appears to have run its course and the economy is facing significant headwinds. The Country was adversely affected by a drought in 2015, and is starting to experience the effects of El Nino this year, in particular on agriculture, energy and water supply. Industry remains subdued due to a challenging policy environment, shifting terms of trade and infrastructure weaknesses. The services sector, however, continues to grow, building on Zimbabwe’s skilled labor force.

A high public debt overhang still constrains and raises the cost of capital for investment. Successfully addressing the arrears to mulitlateral and bilateral partners would enable relations with external creditors to be normalized. This would strengthen investor confidence and increase private financial flows, as well as allow partners to fully support Zimbabwe's development and to help protect the poor.

To raise growth, Zimbabwe will have to correct key macroeconomic imbalances in particular, the high current account deficit, which will require real improvements in investment, productivity and adjustments in public spending. Indeed, without substantial improvements in the allocation and efficiency of public spending, the poor will bear the brunt of the headwinds ahead.

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Executive Summary

Recent Developments

Trend economic growth is now around 2-3 percent per annum following the end of the dollarization boom in 2012. Prices have stabilized, and the turbulence of the 2000s is giving way to a restructured Zimbabwean economy. Agricultural production now represents a broadly constant share of total output, while the service sector is experiencing dynamic growth. However, the manufacturing and mining sectors are struggling to cope with rising capital costs, a difficult business climate and a decline in external competitiveness. As a result, there has been a shift in economic activity from industry to services.

A poor growth and worsening external environment contributed to a deceleration in 2015 and growth is projected to remain at 1.5 percent in 2016. The GDP growth rate slowed from 3.8 percent in 2014 to 1.5 percent in 2015 and 2016, due largely to the impact of an ongoing drought, which is taking a heavy toll on agriculture production. The depreciation of the South African rand against the US dollar has weakened Zimbabwe’s competitiveness vis-à-vis its main trading partner. Exchange-rate dynamics are having an especially negative impact on the mining and manufacturing sectors, which already face considerable challenges in attracting investment. The mining sector is experiencing a structural transition as the commodity super-cycle ends. Growth in the service sector particularly finance, insurance and construction has accelerated.

Weather-related shocks to the agricultural sector have had an especially negative impact on the poor. Over 90 percent of Zimbabwe’s extremely poor live in rural areas. Of these households, the overwhelming majority depend directly or indirectly on agriculture. The drop in agricultural output in 2015 is estimated to have temporarily increased the poverty rate by about 1.5 percentage points, marginally reversing the substantial gains in poverty alleviation that were achieved during the stabilization period. Projections for a poor harvest in early 2016 suggest that poverty may increase further this year.

Low export prices and high production costs are contributing to a persistent deficit in the external accounts. Despite narrowing somewhat in recent years, Zimbabwe’s current account deficit remains much larger than those of comparable countries in the region, and exports currently amount to just over half of imports. A decline in global prices for gold, platinum and other mineral commodities, coupled with unresolved supply-side constraints, has reduced the value of mining exports. Zimbabwe has also benefited from lower oil prices, butrising import volumes largely offset the impact on import values. Remittances gradually increased during 2010-2015 and are estimated to have reached almost 7 percent of Gross National Income (GNI) in 2015. The deficit is primarily financed by capital inflows, especially foreign borrowing, but unfavorable terms contribute to making this model unsustainable over time.

Growth has been largely driven by consumption, while both public and private investment has fallen substantially since 2011. Aggregate consumption exceeds GDP and has made a disproportionally large contribution to economic growth during 2010-15. Public sector investment is constrained by severely limited fiscal space for non-wage expenditures and scarce external borrowing opportunities. Investment fell to an estimated 13 percent of GDP in 2015, as a high cost structure and a difficult business climate continued to erode firm competitiveness. Capital inflows, including external borrowing and asset sales are sustaining consumption growth, but this is untenable over the long-term.

The domestic financial sector is slowly recovering from a post-dollarization credit boom and interest rates remain elevated. The Central Bank has stabilized the financial sector, a recent growth of broad money looks robust and bank lending has become market-driven. But still only blue-chip borrowers are able to access financing at competitive rates. The authorities are taking measures to update Zimbabwe’s credit infrastructure, strengthen oversight and restore the regulatory framework.

Zimbabwe is experiencing a deflationary trend in response to these macroeconomic imbalances. The multicurrency regime, adopted in 2009, limits monetary policy instruments available to the authorities but also provides a level of fiscal and economic restraint. As competitive pressures increased, the consumer price index fell -2.5 percent, year-on-year, at end-2015. Declining prices should help to restore competitiveness over time, but should be accompanied by efforts to raise productivity at all levels of the economy.

The Government has maintained a tight fiscal stance in recent years and the primary deficit remains small and manageable. Fiscal revenue represented over 25 percent of GDP from 2011 to 2015, but the public sector wage bill accounts for more than three-quarters of total spending during recent years. A tight fiscal envelope has encouraged the authorities to adopt innovative financial management strategies in the health sector, improving health outcomes and generating important lessons for other sectors.

Outlook and Challenges

Zimbabwe’s economic outlook is subdued, and growth is projected to remain at 1.5 percent in 2016 as El Nino related weather conditions depress agricultural output, but growth is expected to revert to trend growth of 2-3 percent in 2017-18. However, these projections are subject to upside and downside risks, both of which are intensified by the economy’s dependence on a limited range of key sectors. Unfavorable weather conditions compounded by the 'ElNino' weather, power shortages,insufficient liquidity in agricultural markets and limited access to agricultural credit will continue to threaten agricultural production over the projection period. Meanwhile, a further decline in global commodity prices, an economic shock in South Africa, or the further depreciation in the South African Rand against the US dollar could put Zimbabwe’s recovery at serious risk. Finally, Zimbabwe’s current account deficit is equal to over 17 percent of GDP, while the investment rate is 13 percent and the GDP growth is 1.5 percent; this situation is unsustainable.

Zimbabwe has enormous potential for inclusive growth, but it will be a complex challenge to ensure that recovery is truly broad-based and not regressive. As a country, Zimbabwe's education expenditures relative to GDP are among the highest in Sub-Saharan Africa and the Country has an impressive human capital base. Following the economic disruptions of the 2000s, income distribution is more equitable than at any time in the country’s recent history. But the price of this redistribution, and the new downside risks facing the economy have a disproportionately negative impact on middle and low-income households. The authorities have demonstrated a credible commitment to broad-based growth, but without correcting key imbalances in both private sector and public sector service delivery, the recovery could take place in a way that is regressive and could compromise Zimbabwe’s path toward a fair distribution of the gains from further economic growth.

Clearing external debt arrears is important to Zimbabwe’s medium-term growth trajectory. The total public and publicly guaranteed external debt was estimated to be US$7.1 billion (51 percent of GDP) as at September 2015, with external arrears occupying a large share at US$5.6 billion (79 percent of total external debt). The public debt burden has had a deleterious impact on the cost of capital and the economy. It has limited Zimbabwe’s access to financing for development and raised the cost to the private sector of accessing international capital markets. The authorities have recognized that clearing the arrears would allow for a resumption of longer term and concessional development financing both for investment and for buffering the impact of current shocks on the poor and vulnerable. To this end, the Government has presented a strategy to clear Zimbabwe’s arrears to multilateral institutions in 2016 using own resources and loans, at a meeting with its international creditors during the 2015 annual World Bank – IMF meetings. If successful, this strategy will go a long way to lifting Zimbabwe’s medium-term growth outlook.