On May 2, 2016, the Executive Board of the International Monetary Fund concluded the Article IV consultation with Zimbabwe.

Zimbabwe’s economic difficulties have deepened. Drought, erratic rains, and increasing temperatures, have reduced agricultural output and disrupted hydropower production and water supplies. Economic activity is severely constrained by tight liquidity conditions resulting from limited external inflows and lower commodity prices. Inflation remains in negative territory, because of the appreciating U.S. dollar – the country’s main currency – and lower commodity prices. Zimbabwe remains in debt distress and the level of international reserves is low.

Despite the adverse environment, the authorities have reduced the fiscal deficit in both 2014 and 2015. They have started to rationalize public expenditures by implementing recommendations from the 2015 civil service audit. They are also amending the Public Financial Management and Procurement Acts. The Reserve Bank of Zimbabwe has taken measures to restore confidence in the financial sector. All banks in operations now have capital buffers above the minimum requirements.

Unless the country takes bold reforms, the economic difficulties will continue in medium-term. Given the outlook for the global economy, growth is projected to remain below levels needed to ensure sustainable development and poverty reduction. The current account deficit is expected to narrow, but remain high over the medium term, financed mainly by loans to the private sector.

The authorities have met their commitments under the Staff Monitored Program (SMP) that ended at end-December 2015, despite economic and financial difficulties. The program focused on implementing a limited number of key reforms to show that the country has the capacity to implement the kind of reforms that would be required for a Fund-supported program. The SMP has been a useful anchor in a difficult macroeconomic and political environment.

The authorities are pursuing a gradual, step-by-step approach to reengaging with the international community. Clearing arrears to the International Financial Institutions (IFIs) is seen as a first step in this process. The authorities presented a strategy to clear their external arrears to the IFIs and reforms plans going forward to creditors and development partners in October 2015. The strategy and reform plans received broad support and, once implemented, should provide positive signals to investors and creditors, and help unlock external flows to finance the authorities’ development plans and private sector-led growth.

Going forward, the authorities intend to: (a) reduce the size of the wage bill to re-orient spending towards priority capital and social outlays; (b) improve debt management, develop a comprehensive public financial management strategy, and strengthen VAT policy and key processes in revenue administration; and (c) improve the business environment, including by a transparent and consistent application of their indigenization policy and a new comprehensive land reform program. The latter would include a framework for land compensation.

Risks to the already difficult outlook stem mainly from prolonged adverse weather conditions, and weak commodity prices and policy implementation in a difficult political environment. Timely implementation of measures to curb the wage bill and continued progress in State-Owned Enterprise (SOE) reforms would be needed to lower employments costs.

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Staff Report

Recent Developments, Outlooks and Risks

Zimbabwe’s economic difficulties have deepened. GDP growth slowed significantly to 1.1 percent in 2015, mainly because of the impact of adverse weather conditions on agricultural output, and power generation. The mining sector, which has been hit by low commodity prices, erratic power supply, and policy uncertainties, recovered somewhat because of increased gold production. Meanwhile, significant investment is needed to transition from extracting alluvial diamonds to kimberlitic deposits. Growth is projected to remain subdued in 2016, despite strong performance in mining – which is expected to benefit from increases in gold, platinum, and diamond output – construction, and financial services. Tight liquidity conditions stemming from inadequate external inflows, and lower commodity prices continued to hurt economic activity. Unemployment is rising (Annex II), and employment has been shifting to the informal sector. Inflation remained in negative territory, because of the appreciating U.S. dollar – the country’s currency – and lower commodity prices, but this price adjustment has had only limited impact on competitiveness.

The current account balance improved in 2015, because of lower prices for oil imports, subdued economic activity, and fiscal consolidation efforts. The current account deficit will likely worsen in 2016, despite improving terms of trade, because the drought has raised the need for substantial maize imports. The levels of international reserves remain low, and Zimbabwe remains in debt distress.

Fiscal performance in 2015 was better than programmed, despite the adverse macroeconomic environment. Tax revenue benefitted from strong collection efforts on overdue payments and court decisions at year end in favor of the revenue authority (ZIMRA) that offset the impact of slower-than-anticipated growth, increased unemployment, reduced profitability, and lower commodity prices. On the expenditure side, the authorities kept employment costs well below budgetary projections – for the second year in a row – and saved on capital outlays, while protecting social spending. As a result, the primary cash deficit was lower than programmed.

Despite spending pressures to mitigate the impact of the drought, the authorities remain committed to fiscal discipline, and target a primary cash deficit of 0.2 percent of GDP for 2016. Additional spending to provide maize to the poor and the vulnerable groups of the population (0.5 percent of GDP) is to be offset by lower allocation for non-priority current outlays. To generate additional resources, and restore the financial viability of the public service pension system, the authorities have re-established withholding of social security contributions – resulting in an increase in non-tax revenue, and adopted measures to broaden the tax base.

The authorities have started to implement measures to rationalize public expenditure and reduce public employment costs. In line with the recently completed civil service audit, they have started to eliminate duplications and redundancies, rationalize posts, revise leave policy in the education sector, reduce employment costs to grant-aided institutions, and cuts to government top-ups to teachers in private schools.

Deposit growth in the banking sector continued to slow in 2015, constrained by the weak economy. Domestic credit recorded a marked increase in 2015, driven by higher lending to the central government – the majority being debt issued to recapitalize the Reserve Bank of Zimbabwe (RBZ) and other public institutions, financing the asset management company (ZAMCO) and addressing legacy debt obligations. In addition to direct purchases, financial institutions have increased their holdings of government securities through purchases on the secondary market, particularly from corporates and individuals who acquired them as part of the government’s clean-up of legacy debt obligations. Credit to the private sector declined by 2 percent, reflecting the combined effects of the weak economy, tight liquidity conditions, and banks’ cautious approach to lending to the private sector. Deposit and credit growth is expected to benefit from the financial sectors reforms and implementation of the financial inclusion strategy.

The authorities remain committed to the multi-currency regime. While they acknowledge the costly constraints this regime imposes on macroeconomic policy, they do not see any feasible alternative in the short-to-medium term. To provide credibility to the multicurrency system, and promote consumer and business confidence, the RBZ undertook a three-month demonetization process (June-September 2015), effectively removing the legal status of the Zimbabwe dollar. The process addressed cash held by the public, and non-loan bank accounts as at end-2008. Some US$9 million was converted during the period. There was increased demand for the bond coins as consumers switched from the depreciating rand coins. At end-December 2015, bond coins in circulation stood at US$10 million. The introduction of the coins has helped in correcting the pricing of goods and services.

The economic outlook remains challenging, as El Niño-induced drought is already severely affecting another agricultural harvest season and the energy sector. Given the outlook for the global economy, projections under the baseline scenario are for growth to average 4 percent over the medium term, well below the level that would be needed to ensure sustainable development and reduce poverty.8 Inflation is projected to remain in negative territory in 2016, but pick up over the medium term. The current account deficit is expected to narrow, but remain high over the medium term, financed mainly by offshore loans to the private sector. The persistent large current account deficits, exacerbated by a sharp appreciation of the U.S. dollar, have worsened Zimbabwe’s external position and competitiveness. Zimbabwe will need to improve its competitiveness by facilitating further relative wage and price adjustments while creating fiscal space. In the medium term reforms aimed at removing structural impediments and strengthening institutions to create a supportive business environment will be needed to restore external stability and increase resilience to external shocks (Annex III).

Risks to the already difficult outlook stem mainly from continued adverse weather conditions, fiscal challenges, weak commodity prices, and policy implementation in a difficult political environment. (Annex I, Risk Assessment Matrix). The projections are subject to macroeconomic and policy risks. Should external shocks intensify, macroeconomic conditions would deteriorate further and jeopardize the revenue targets. Timely implementation of the measures to curb the wage bill and continued progress in State-Owned Enterprise (SOE) reforms and wage restraint would be needed to lower employments costs. Failure by the authorities to effectively implement their reform agenda or delays in advancing their arrears clearance strategy could undermine their efforts to attract much-needed foreign investment to transform the economy, and to normalize relations with the international community.

The authorities shared the staffs’ views on the medium-term outlook and risk assessment. They emphasized that the major economic challenges facing Zimbabwe emanate from exogenous shocks – El Niño-induced drought, low commodity prices, and the appreciating U.S. dollar – exacerbated by inadequate external flows and tight liquidity, erratic power supply, and the economic slowdown. In the near-term, they will have to accommodate additional spending to help mitigate the impact of the devastating drought on the vulnerable population. The staff underscored the urgent need to move forward with comprehensive reforms to transform the economy. The authorities concurred with the staff’s macroeconomic outlook and assessment of risks. They noted, however, that the absence of external financial support magnifies risks and their impact, and generates resistance to reforms. They believe that a successful re-engagement with the international financial community would be a necessary condition to reduce the impact of domestic and exogenous risks.