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Report No. 11533-ZIM4
Z'imbabweA Policy Agenda for Private Sector DevelopmentJune 30,1993
Southern Africa DepartmentIndustry and Energy Operations DivisionCorporate Planning Departmentand Africa Regional Department
FOR OFFICIAL USE ONLY
MICROGRAPHICS
Roport No; 11533 ZIMType: SEC
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CURRENCY EOUnIVAIENT(April 1993)
US$1.00 = Z$.361Z$1.00 = US$0.1572
WEIGHT; AND MEASURES
ACRONYMS AND ABBREVIATIONS
AEF African Enterprise FundAPDF African Project Development FacilityCMB Cotton Marketing BoardDLMA Direct local market allocationERS Export retenion schemeESAP Econonic Strucural Adjustment ProgramESW Economic and sector workFDI Foreign direct investmentPER Framework for Economic ReformPIAS Foreign Investment Advisory ServiceGMB Grain Marketing BoardGOZ Government of ZimbabweIDC Industrial Development CorporationIPC Industial Projects CommitteeMMCZ Mineral Marketing Corporation of ZimbabweMSE Micro and small enterprisesNRZ National Railroads of ZimbabweOGIL Open general inport licenseOPIC Overseas Private Investment CorporationPOSB Post Office Savings BankPPF Project Preparation FacilityPrC Post and Telecommunications CorporationRBZ Reserve Bank of ZimbabweSEDCO Small Enterprises Development CorporationSI Statutory instrumentSIA Special initial allowanceSOE State-owned enterpriseUDI Unilateral Declaration of InepedenceZDC Zimbabwe Development CorporationZIC Zimbabwe Investment CenterZISCO Zimbabwe Iron and Steel CompanyZSE Zimbabwe Stock ExchangeZUPCO Zimbabwe Urban Passenger Company
FISCAL YEAR
July 1 - June 30
FOR OMCIAL USE ONLY
ZIMBABWVE
A POLICY AGENDA FOR PRIVATE SECTOR DEVELOPMENT
TABLE OF CONTENTS
INlOD)UCXION ............................................ .... 0404.1
I* BACIKGROUM .......... 1000....
11. PROPILE OF THE PRIVA3T. SECTOR ........................ 3..............*...3
ImportLace and Structure of the Private Sector .3M'icro, SniAl, and Medium-Scale Enterprises .5Agriculture .5Manut~trng.6Minerals .6
P-ublic Ownership .7
III. CONSTRAINTS TO PRIVATE SECTOR DEVELOPIMEWF 8.8
Policy Constraint .8Exchange Rate Policy .8Public Sector Deficit .9Investment Rationing .10Trade Policies .12Capital Movements .13P'rice Controls .15Labor Laws and Practices .16Financial Systm. .17Taxaton .21
State Owned Enterprises and Stattory Monpolies .22Constra1nts to SmaU and Medium-Scale Firms ................................................ 24
Title Deeds ................. 25
This report was prepared by a joint World Bank-IFC team comprising Messrs. Pedro BeUl,Mark Schankerman, Osman Ahmed and David Donaldson. The report draws on preexistgmaterial on Zimbabwe and on two field missions, one by World Bank Staff and one by IFCstaff. IFC's contribution, coordinated by Osman Abmed, beneftted from inputs from theCorporation's Regional Department and FIAS. On the Bank's side, Pedro Belli was the taskmanager and Ms. Minhchau Nguyen was peer review er. Mr. Stephen M. Denning wasDepartment Director and David Cook managing Division Chief.
This document has a ratricted distribution and may be used by recipients only in the performanceof their official duties. Its contents may not otherwise be disclosed without World Dank authoiation.
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Iuicenalg and Zoning ................................................. 25Land R e d sX*o ..................... 0 ............ o........ 26Sumnway Of Constraints X 26
IV. PAST APPROACEMS AND FUTE STRATEGY .................................... 28
lie Bank Group Strategy *... ............................... 30IBank's Rle .... 0....................*.........#............. 30
Pa Approaches by Bank ................................... 30County Asssta ttegy S............................. 30
eaft B Pfogram ....................................................... 31Econoaic and Sector W ork .. . .................. 31
WC's Role ... 32Potential for Expanded Role .............................. 32
INTRODUCTION
1. This repot has three purposes: Q) to make a preliminary assessment of the barriers toprivate sector development in Zimbabwe; (ii) to make recommendations on the changes needed tostiwulate sustaile private sector development; and (ill) to identify areas where the Bank and IFCcan play useNI roles in stimulating private sector development and equitable economic growth.The central conclusion of the report is that persistent excess demand for foreig exchange hassrved as the raison d'etre for an elaborate network of controls whose effect has been to constrainprivate sectoi developmen:. Excess demand for foreign exchange has been the result of twoprimary factors, large fisal deficits and exdhange rate policies. Fiscal deficits have exacerbatedthe excess demand for foreign exchange (at the prevailing exchange rate) and created the need fordiscretionary allocation of foreign exchange, investment sanctioning, controls on internationalcapital flows, and price controls. Accordingly, the primary objective of policy reform should be toeliminate excess demand for foreign exchange and thereby obviate the need for this network ofcontrols. To achieve this objective will require some combination of fiscal restraint, prudentmonetary policy and appropriate exchange rate management. 'Tere are other important issues,unrelated to mam-economic management, that also need to be addressed in order to stimulateprivate sector development. The most important of these issues are related to Governmentmonopolies and other parastatls, inadequate infrastructure, and labor regulations (especiallyretrnchment).
2. The report is divided into six sections. Section I presents a brief description of thezimbabwean economy. Section II contains a profile of the private sector. Section m discusses themain constraints to private sector development. Section IV describes past programs by the Bankgroup and outlines the Bank Group strategy to deal with these constrailts.
L BACKGROUND
3. At the time of independence in 1980, Zimbabwe was the fifth richest Sub-Saharan Africancountry, with a per capita GNP of US$780. Zimbabwe was self-sufficient in food and had a moredeveloped manu ring sector than any other Afican country outside South Africa and Nigeria.The country also had good infastucture, well-developed mining and financial sectors, a fairlyefficient public administration, and virtually no foreign debt.4. The post-independence Government embarked on a program of 'Growth with Equity'which achieved a great deal of success in many social areas. The program increased lifeexpectanc by four years, nearly doubled enrollment in pmary schools, increased enrollment insecondary schools nine-fold, reduced infant mortality by a third, lowered the rate of populationgrowth, and integrated smaluholders inoo the market economy to such an extent hat they nowaccount for the bulk of the maize ad cotton marketed through official channels.
5. The achievements in the social sectors, however, were not matched by progress in theeconomic arena. Per capita income has stagnated since 1980 and the Government's economicpolicy options are severely constrained by heavy debt service obligations acquired after
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independence'. A public sector deficit on the order of 10 percent of GDP has contributed topushing inflation to levels that h. e fluctuated between 15 and 20 percent per year. Finally,Zimbabwe's unemployment problem is growing at an alarming rate. While about 200,OC" peopleleave school every year, the economy creates only 60,000 to 70,000 new job openings and it isestimated that as much as one-quarter of the work force is unemployed.
6. Low investment levels have been the principal cause of Zimbabwe's modest economicgrowth. Total private sector investment as a share of GDP fell from 12.4 percent in 1985 to a lowof 7.7 percent in 1988. It recovered to 10.5 percent of GDP in 1990 and Is estimated to stand atabout 14.7 percent of GDP at present. Gross investment has been barely adequate to replace thecapital stock, and there has been essentially no net investment. Low investment demand has beenthe result of three key factors: (i) risks associated with unsustnable fiscal deficits, (ii) severelylimited X cess to imported capital and intermediate goods, due primarily to excess demand forforeign exchange and the associated foreign exchange allocation system, and (iii) relatively higbcost of doing business in Zimbabwe's heavily regulated business environment.
7. Zimbabwe's highly regulated business environent predates independence and its mostsalient features originated as a response to economic sanctions imposed against Rhodesia in 1965.Sanctions led the country to adopt a tightly controlled resource allocation system (especiallyforeign exchange), price controls, and regulation of private investment. This set of policies led tosubstantial Government inwervention in the economy and to an inward-looking growth path basedon import substitution. The principal features of this system are discussed more extensively inSection m.8. ZANU-PF, which formed the first post-independence Governent, came to powerintending to transform the economic structure into a socialist system. The eonomic policies thatthe Mugabe ad on inheated fitted very well with its socialist orientation. The strictforeigp exchange allocation system, the procedures to vet investment projects, and the wide-ranging price controls were seen as instruments to achieve the equity objectives of the newGovernment. Far from seeking change, the Mugabe Government sought to keep the system inplace. The Government's management task was made easier by the familiarity that both the privatesector and the bureaucracy had with the system, which after fifteen years of refinement ransmoothly. However, the pervasive controls and the distorted incentive structure led to low growth,declining fixed investment, growing formal unemployment, stagnant per capita income, and excessdemand for foreign exchange.
9. In 1991 the Government began implementing a five-year structural adjustment program toincrease investment, growth, and employment. The program, as set in A Frameworkfor EconomicReform 1991-1995 (FER), represents a major policy shift from pervasive direct controls to marketforces. Its central components are: (i) fiscal and monetary prudence; (ii) trade liberalization; (idi)domestic dereglation; and (iv) measures to alleviate the Impact of reforms on vulnerable groups.The program is a blend of strucural reforms and macroeconomic stabilization measures designedto address the key policy constraints that hampered Zimbabwe's development in the 1980s. Othermeasures to stimulate investment by both domestic and foreign private sectors include theGovernment's recent joining of the MIGA and signing bilateral investment guarantee protcols(e.g. OPIC). Unfortumtely, the worst drought in Zimbabwe's history coincided with theimplementation of the structural adjustment program, rendering the adjustment process all the more
Debt srvice payments ros from four percen of exports in 1980 to a peak of 37 percent in 1987. They felto about 22 percent in 1990.
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difficult. While the international response to the drought has been swift, it is an addedcomplication in a situation of rapid change. Pardy as a result of the drought, GDP Is projected tofall In 1992 by about 10 percent and fiscal target, among other things, have had to be revised.
II. PROFILE OF TBE PRIVATE SECTOR
hnportaace and Structure of the Private Sector
10. Ihe private sector is the dominant productive force In the Zimbabwean economy (seeFigures 1 and 2). It owns the vast majority of the productive assets, it accounts for four-fiffts ofthe country's GDP and it employs about seven of every ten Zimbabweans. In manufacturing,which accounts for about one-quarter of GDP, firms that are majority-owned by the private sectoraccount for more than 95 percent of the equity in the sector and an equally large share of industlemployees. Agriculture accouns for approximately 14 percent of GDP, 70 percent ofemployment, and 40 percent of exports. The Gove=nmui owns about 15 percent of forest andaricultural land, but the private sector generates about 99 percent of value added and 95 percentof employment in the sector. The siuation is similar in mining. Eight private firms account forabout 80 percent of total production and 70 percent of total sector employment, while a myriad ofsmall-time private operators account for the remainder. Through its Zimbabwe MiningDevelopment Corporation, the Government owns and runs copper mines and is increasingly activein gold mining, but its share of employment is less than 1 percent and its share of production isabout 3 percent. A similar pattern holds in services: there is some Government ownership ofasets, but the vast majority of services are rendered by privately-owned firms. As in many othercountries, the Government owns the telecommunications facilities, railroads, and other publicutilities.
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. l r .
anebePs
D^tmIu i Emploe .de Betwen the Private
and the Publ Sector
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0% tO1% 20 30% 40% 50% 60% 70% 80% % 100%
U MOli Secto 0 Private Secto
Ddaeitd on Vhe AddedxBetwma tde oPvaoeand *ePu Seco
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ha iiise nrcenyerowg to mao dsnest t sic 198 an th grwt of-
Pdm c firms A t a s
0% 10% 20 30% 40% % 60% 70 80% 9% 100
11. Although litde hard dea exist on the ea-ac magnitude of foreiga ownership, it isconservatively esfimatd tha at the. time of indlependemc about 60-70 percent of thie productiveassets were contolled. by non-resident sbareholders, mainly muldnatiornd corporatlons. 'Ibis sharehas diminished in recen years owing to major disinvestments since 1987 and the growth ofdomestic firn. According to a survey of 516 firms by the Confederation of Zimbabwe Industry,
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In 1991 firms with a majority foreign owntrship accounted for 23 percent of total assets, a lowerfigure than earlier estimates, and about 20 percent of employment
12. There are no precise data on the size ditribution of formal enterpses in Zimbabwe. Animportant characteristic of Zimbabwe's private sector is the predominant role played by thecorporate sector (!arge and medium modern enterprises) and large-scale commercial farms.Smallholder (communial) agriculture, and small-scale and informal non-farming actvities do notplay as important a role in the Zimbabwean economy as they do In most other African countries.Medium and small-scale enterprises also account for a relatively small proportion of output andemployment.
Mcro, SnaU, and Mediumn-Scale Emerprlses2
13. There are about 845,000 micro and small enterprises (MSEs), deflned as those employing50 or fewer people. MSE activity is dominated by manufacing, with 64.6 percent of enterp; -. esengaged in manufcring. Four subsectors dominated manfcrin: grass, cane and bambooprocessing (13.8 percent of aU enterprises), knitting (12.2 percent), crochetig (8.9 percent), andbeer brewing (5.8 perce.n). These subsectors differ substantially in their geographic locus. Forexample, beer brewing and grass/cane/bamboo processing are nonexistent in urbar. areas but aresignificant acdvities in rural areas (occupying 8.5 and 19.8 percent of all enterprises respectively).There are virtually no forward linkages (e.g., subcontracting) and almost no exportig activityamong MSEs. About 97 percent of MSEs sell directly to the final consumer, and 1 percentcurrendy export.
14. The Government's 1986/87 Labor Force Survey estimates that less than 10 percent of thelabor force i engaged in *informal sector* activies, which are defined as 'non-registred'establishment. According to the most recent and extensive survey of MSEs, however, the latteremploy about 1.6 million people, or about 27 percent of the labor force. About two-thirds ofMSEs are headed by women, but enteprises run by men tend to be larger. IThere are no reliableestmates of the exact munber of people employed by micro and small enterprises. Estimates rangefrom as low as 10 percent of the labor force to as high as 27 percent.
Agrcure
15. The sector consists of about 4,500 large-scale commercial farmers (average size 6000acres) employing about 200,000 people, about 800,000 commual farmers providing employmentand livelihood to about 4 mUllon persons, and about 8,500 small-scale commercial farmers. The1980s was a decade of agricultural stagation and declining per capita output. The contribution ofagriculture to GDP during the second half of the decade declined from 16.7 percent in 1985 to12.7 percent in 1989, and fonnal sector employment fell by 17.5 percent.
16. The most important agricuural commodities are maie, which presenty accounts for 17percent of the total value of agricultural output, and tobacco which accounts for 36 percant. Maizeproduction declined by over one-third, and cotton production by 40 percent during 1985-90, whileproduction of flue-cured tobacco and horticulture rose substanially. Beef production also declined
2 SouWces for this secion include Bank Report No. 9006-ZIM, The InfrMal Sector i Zmbabwe: The Roleof Women (1990), Bank Report by Immni DevQommt, Impeimn Conotig Infa SecoEnterprie in Zimbabwe (1991), and Gemini Technical Report 25 (prepared fir USAID), Micro andSmall Scale En ises in Zimbabwe Reslt of a Countiy-Wide Survey (1991).
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arply over the past decade, with commercial herd failing from 3.2 milUon in the 1970s to 1.8million at present. 'he rect unprecedented drought has had a devastating effect on theagricutul sector, with output two of the major crops-cotton and maize-expected to decline byabout 80 percent. The drought has also affected manufactring activities that depend onagrlcultural inputs, especially agro-processing.
Mo,mifaarng
17. Zimbabwe's m ing sector is the second most developed and diversified in Sub-Saaran Africa, after South Africa's. Manufacturing accounts for 25 percent of GDP, 17 percentof formal employment and 17 percent of exports.
18. Zimbabwe has a long industrial tradition. Manufacturing activities began at the turn ofthe century and gained momenum during and ater World War I, helped by favored access to theSouth African market and the creation of the Federation with Northern Rhodesia (Zambia) andNyasaland (Malawi). By the time of the Unilateral Declaration of Independence (ITDI) in 1965,ncturg accuted for 20 percent of GDP, and exports of manufactured goods acounted for
about 20 percent of manufactured outu. During the early part of UDL m a outputexpanded rapidly as a result of import substtlution policies adopted in response to tnionalsanctions. This expansion came to an end in the mid-1970s with the emergence of sucuralinefficiencies that resulted from inward-looking policies, and the inication of the war ofliberatio. The sector grow rapidly during the first two years after independence (15 percent and11 percent, respectively, in 1980 and 1981) but stagnated during 1982-84. Since 1985 thfe sectorhas grown at a more modest rate (4 percent p.a.).
19. Foodstuffs is the most important manufacturing subsector, aunting for 22 percent ofoutput followed by metal products (17 percent), chemicals (17 percent) and textles ad ginning (9percent). Meta products and textiles are the leading export items a ounting for almost three-quarters of manufcn exports. The liberalization policies envisaged under the ongoingstructural adjustment program could potentily undemine the viability of many mactuingactivities that have survived behind protective walls and have long been isaed frominenationl markets and best practices. Given the small domestic market and itenfiedcomption fiom South Africa in regional market, sustaed nufacturing growth would requiregreater penetration of overseas markets.
MAnerals
20. Zimbabwe is richly endowed with minerals. There are currentiy more than 40 mineralsbeing extracted. Gold, nickel, chromite, asbestos, copper and coal together account for 80 percentof total mial production. Gold is by far the most import mineral wkh total production of 17tons in 1990, valued at US$208 miillon, amounting to 38 percent of total mineal production.Nickel s the second most important mine accounting for 18 percent of the sector's outuForeign companies such as Lonwho dominte gold production, whfle Anglo-American dominatesnickel production. There are considerable platinum deposits in the Great Dyke, which is underexploration by a number of foreigl companies such as RB Utah (U.S.). Although mineralsaccount for only 7 perceat of GDP, they accounted for over 40 percent (USS 320 muion) of thecountry's total foreign exchange earnings in 19903. Despite its potential, the pefomanc of the
3 Fancial Times Survey, Augut 30, 1991.
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sector has beean lackluster. In fact, production declined during 1981-91 (US$572 million in 1981vs. US$520 million in 1991). Policy changes under the recendy adopted Economic StrueturalAdjustment Program (ESAP), In particular the sharp dsvaluation of the Zimbabwe dollar, haveimproved the ilcentive structure for private Investors. Exploration activities are reported to be thehighet in 15 years, with nearly half of the exploration work done by new companies. Withfurther improvement in the incentive framework and possible development of platinum reserves,the sector's performance should improve considerably.
Public Ownershp
21. At present the Government owns about 40 parastatals engaged in a wide varlety ofactivities, but its exact equity participation in each firm is unknown. The Industrial DevelopmentCorporation, a statutory body established in 1965 by the Smith regime as a joint-venture betweenthe Govermment (80 percent) and private sector (20 percent), has been the principal instrumentthrough which the state has been involved in the nufacuring, mining, financial, and tourismsectors. IDC's intervention prior to independence was limited to assisting companies in financialdiress. In 1984 the Government acquired all of IDC's shares and changed its role. IDC becamethe Government's principal instrument for national development charged with the responsibility ofInvestigating had implementing strategic investments. Today, it has a number of subsidiary andassociated companies. IDC has always posted a profit and has never been subsidized. It fundsinvestment mainly from dividends received from the shares it owns. It accounts for an estimated 4percent of the total assets in the manufactring sector.
22. Government also owns a majority stake in ZISCO, the only steel manufacturer in thecountry. It has a 42.6 percent stake in Caps, a pharmaceutical company, and 49 percent inOlivine, a joint venture company with H. 1. Heinz Corporation of America. It recentiy acquired a39 percent stake in Delta Corporation, the largest locally quoted company on tfe Harare StockExchange, and the shares are held in the name of Zimbabwe Development Corporation (ZDC), a100 percent public owned enterprise. ZDC also owns shares in a number of other industries,including BestobeW, Metal Box of Zimbabwe Limited, and Astra Holdings. Zimbank and WankieColliery also have Government ownership.
23. The relatively small participation of the public sector in the ownership of assets as well asin the production process stands in stark contrast to the pattern of investment and expenditures.Government investment accounts for more than one-half of total investment and CentralGovernment expenditures account for nearly one-half of GDP. Thus, while the Government ownsonly a minority of the productive assets and produces only about a fifth of value added, it accountsfor one-half of the country's expenditures and one-half of its total investment. This unequaldistribution of investment is pardy explained by the fact that public investment has been channelledto social infrastructure and some highly capital intensive activities, such as public utilities, but alsopartly because private sector investment has been very limited.
24. In short, it is not public ownership as much as public policy and the assodiated constraintsto private sector development that lie at the heart of Zimbabwe's economic stagnation. This is notto say that public ownership of productive enterprises and marketing parastaals has had no impacton the performance of the private sector. -These issues, however, are discussed in paras. 72-81Ihe next section examines these policy-induced constraints and their economic impact in moredetail.
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m. CONSTRAINTS TO PRIVATE SECTOR DEVELPMaT
25. Zimbabwe was well positioned to take off at Independec In terms of its . excellemanageral sdlls, abundant mineal tources, strong commrcWal agricultu, good inftastructureand telecommunicatios, and sophisticated financial sector with effective fincial resourcemobilization. Since independence the Government has made large Investments in power, therailways, urban housing, and roads. The Govenment has also Improved human cpital trougheducation and better health care, and integrated the black population into the maistream ofeconomic activity. Yet, economic performance has fallen far short of expectaons and perceivedpotential. While anmal flucuations may be ascribed to extena fctors, the long run trend Isrooted in the economic policies that the Govenment inherited and embraced. Tbe structurladjustment progrm is desigped to address some of the most important causs of mediocreeconomic performance: excess demand for foreign exchange, the large fiscal deficits, foreignexchange and Investment rationing, and price controls. The following section examines the impactof the main policies that have suppressed private sector development and provides a preliminaryrview of other reguations that have played a lesser role, but that are likely to become moreImportant in the future as the main constaints are relaxed. With the implementation of theGovernment's adjustment program the policy environment in Zimbabwe is in transition and manyof the hiorical barriers to prvate sector development are being removed. Nevertheless, ahistorical perspective is essential to assess the current situation and propose further policy reforms.
Policy Constnts
Exchange Rate Policy
26. BxCtANs RATE MANAGMR. The single most crtical barrier to private sectordevelopment has been the persistent excess demand for foreign exchange and the elaborateregulatory network that has grown up in response to it. Since UDI in 1965 the value of theZimbabwean dollar has been managed by the Reserve Bank of Zimbabwe (RBZ). Although theRBZ has adjusted the exchange rate frequently, there has been persisteat excess demand for foreignexchange. In order to balance the exten accounts, the Government has resorted to discretionaryallocation of foreign xchange, strict controls on capital movements (including repatiation ofprofits), and elaborate procedures for vetting of private investment projects.4 Ibis network ofreglatory constraints, which derives from excess demand for foreign exchange, is the keyimpedient to capital investment and growth in Zimbabwe.
27. ?OwIN ExcuoAN LLoCATtoN Svr&ir The discretionary allocation of foreigl exchangeand controls on capital movements have had pervasive, negative effects on incentives for privatesector development. These devices have (i) constrained imports of current inputs and henceindirectly restricted production; (ii) constrained investment by ratoning the importation of capital
4 Bonowing in foreign curreny has bee unattractive becuse foreign interest rates, adjusd for foreigexchang risk, were much higher than domestic tes. To enage off-sore borrwg and therebyincres the inflow of foreign exchange, the Govement intouced a fomin exchange cover shem.Because there is no evidt market failure (other than the overvaluation of th exchag rate), there is noeconomic justification for public provision of foreign cover for private firms d this policy needs to berevised or eliminad.
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goods Wuding spare parts); (ii) deterred foreign investment by lowering the effective returnsdenominated In foreign currency; (lv) reduced incentives for cost reduction and innovation byinsulating the domestic market from foreign competition; (v) inhibited exports by artificiallyincreasing the profitability of the domestic market and making it difficult for firms to exploreforeign markets and respond to market opportunities; and (v) indirectly determined domesticmarket shares by affecting production for the domestic market. The foreign exchange allocationsystem and its at_tdat regulatory framework are the most serious obstacles to prlvate sectordevelopment and accordingly are the first items on the Govement's agenda for structural change,as discussed in para. 41.
28. MBcuAius oF rm Sysrmu The foreign exchange available to the private sector has beencalculated as a residual, after deducting debt service and priority uses (e.g., fuel) from the supplyof foreign exchange. The allocation of foreign exchange is governed by the Direct Local MarketAllocation mechanism (DLMA) and is triggered by Government approval of the investment project(see pam 32). In practice, the allocation has been largely detemined on the basis of historicalpatters of imports, but Government objectives for the development of particular Industries orgeographical areas, export orders, and export receipts are additional factors in the allocationdecision.
29. TmH IMPAcr OF TIE SYSTm ON THE PR1VAT8 Sucrx.l 'Shortage' of foreign exchange hasbeen identified as the main constraint to growth in every survey undertaken in Zimbabwe. Theshortage of foreign exchange causes private sector finns to suspend operations for lack of importedinputs, and to delay investment plans. This is the most direct Impact of the allocation system, butthe system hinders the development of the private sector in other more subtle ways. First, becausepractically every productive activity requires imported inputs, by controlling access to foreignexchange the Government Cotrai output and, consequently, effectively allocates market shares,conferrig on established firms a secure domestic market with limited domestic and foreigncompedtion. As a result, Zimbabwean firms typically neglect the marketing function (includingquality control and after-sales service). Second, the foreign exchange allocation system serves as aformidable non-tariff barrier to trade that steers production and investment away from Zimbabwe'scomparative advantage, and generally intensifies the anti-export bias. For example, domesticprices for capital goods are about 33 percent higher than border prices, making domestic sales invalue added terms about 24 percent more profitable than exports. The divergence in profitabilitybetween domestic and export sales creates an anti-export bias that induces a misallocation ofresources and a reduction of growth. In addition, exporters find it difficult to cultivate newmarkets because foreign exchange for foreign travel is strictly rationed. Third, by rationingforeign exchange, the Govemment heavily influences the volume and pattern of private investmentand thereby constrains both entry of new fims and expansion of existing ones. Uncertain anddifficult access to foreign exchange also seriously limits the replacement and upgrading of plantand equipment. As a result, the capital stock in Zimbabwe is old and unsuited for production ofhigh quality, internationally competitive goods. In short, the allocation system restricts productionlevels, the volume and composition of investment, and the pattern of diversification. Iheconstraints are perhaps more binding for industrial firms, but mines, farms, and firms in theservice sector are also affected.
Publac Sector Dcit
30. Public sector expenditure in the period 1985-1991 was, on average, equivalent to about49 percent of GDP and the public sector deficit to about 10 percent of GDP. These deficits havebeen parily fnanced with domestic credit from the financial system and as a result nearly 44
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percent of domestic credit expansion went to the public sector In the years 1985-1990.Nevertdeless, there has been no evidence of crowding-out of private sector investament via highIerest rates or credit rationing. Red interest rates have fluctuated between zero and minus 6percent and there has been no significant excess demand for credit from the private sector.Crowding-out, however, has taken place via foreign exchange rationing and other direct controls,as discussed in paras. 32-35.
31. The program of liberalization means that in the future the Government will not be able tofinance large public sector deficits without increasing the cost of credit to an extent that is likely tostifle the response of private sector investors. Reducing the public sector deficit is as important asthe liberalization of controls on foreign exchange. Under the SAP the Government was committedto reducing the budget deficit from 10.8 percent of GDP in 1990/91 to 7.1 in 1991/92, 9.3 percentin 1992193, and 3.2 percent in 1994195. This target was to be achieved mainly through reductionsin expenditures, specifically: (i) virtu elimination of subsidies to public enterprises (equivalent of3.7 percent of GDP in 1990/91); (ii) reduction in the civil service wage bill (from 16.5 percent ofGDP in 1990191 to 12.9 percent in 1994/95) through retrenchment of 25 percent of civil servansand wage adjustms; and (iii) increased cost recovery in public services. The targets for budgetdeficit reduction and parastatal losses were more than met in 1991/92, once extraordinary drought-related expenditures are taken into account. The adjustment program also places ceilings onlending to the public sector. In its FER, the Government stated its intention to reduce the centalgovernment deficit (excluding grants) to 5 percent of GDP by 1995. This streamlining ofGovertnm expenditures will reduce pressure on the financial system, help maintain low realinterest rates, and prevent crowding out.
Investment Rationing
32. The excess demand for foreign exchange, caused primarily by fiscal deficits and exchangerate management of the Government, creates the need for some discretionary allocationmechanism. In Zimbabwe the Government has developed an elaborate investment approvalprocedure and the DLMA to serve this fimction. Hence, although there is no formal, directregulation of private investment (domestic or foreign), the Government exercises extensive idirectcontrol by means of the investment sanctioning process. Ever) company must obtain projectapproval from the industrial Projet Committee (IPC) in order to obtain the foreign currencyallocation required for importation of capital equipment (ncluding spare parts) and raw materials,and the exemption from tariffs on capital goods (currently 38 percent). AU new investments orexpansions that require foreign exchange need Government approval. Investments with no foreignexchange content are not covered, but these are of negligible importance for the corporate sector.Tbus, IPC constitutes a defacto investment regulation system. The principal reported criteria forinvestment approval include net foreign exchange earnings (the most critical one), employment,regional location, and the priority of the proposed investment. In addition to the approval ofresources for importaton of capital goods necessary for the project, approval in effect confers animplicit right (but no guaantee) to share the future foreign exchange allocations for importedworking capital requirements.
33. The investment sanctioning process is cumbersome and protracted, and has served todiscourage investment activity. According to UNIDO, the rejection rate has been as high as 80percent. Moreover, the investment approval process discrmnates defacto against both small andnew investors who do not have the influence of larger, more established companies to expedite theprocess. After the foreign exchange allocation system and the public sector deficit, rationing ofinvestment is probably the next most Important impediment to private sector development.
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34. The Government has attempted recendy to streamline the investment sanctioning process.Until 1990 investors required separate approval from a number of ministries and agencies. In 1990the Zimbabwe Investment Centre (ZIC) was established as a "one-stop' window to expedite theprocess. All investment projects under Z$10 million that require foreign exchange must beapproved by ZIC. This approval makes firms eligible for foreign exchange allotment under theDLMA. Investments larger than Z$10 million require approval at the ministerial level, and ZICserves only in an advisory capacity. There is widespread dissatisfaction among private firms withthe performance of ZIC, especially long delays in the approval process. Despite a statutoryobligation to process project applications within a 90-day period, delays of six months and moreare common. A tourism project sponsored by IFC, for example, took 12 months to go throughZIC. These delays are due both to understaffing and to delays in adminbtrative operations of therespective sectoral ministries and vanous committees to which ZIC must submit the projects.5
Although ZIC was intnded to streamline the investment approval procedures, in practice it doesnot achieve this aim and the process remains cumbersome and time-consuming.
35. Parliament passed the ZIC Act in September 1992, formally establishing the InvestmentCentre as a legal body and specifying its organizational structure and functions. The Actdesignates three functions: sanctioning investment projects, facilitating acquisition of investmentlicenses from line Ministries, and investment promotion. The Act specifies the general criteria forassessing investment projects and 'sets time limits for the approval process, It also grants theCentre's governing board considerable operational and decision-making autonomy.
36. In its PER the Government outlined its strategy with respect to investment sanctioning.First, the Government intends to base investment approvals on detailed project evaluation,including the use of shadow prices. For this purpose it intends for ZIC to acquire the necessaryexpertise and to involve financing agencies in the evaluation of projects. Second, the Governmentintends to remove the sanctioning role by 1995 for all but large' projects.
37. The Act should help shorten the long delays typical of the investment approval processand properly places the emphasis on investment promotion. Nonetheless, it is does not effectivelyremove the obstacle to private sector investment created by investment sanctioning. First the Actgrants the Government power to specify which sectors of the economy are open to privateinvestment (domestic and foreign), and to reserve certain sectors exclusively for domesticinvestment (Section 35). Second, the Act empowers ZIC with approval authority for large projects(currently defined as those over Z$30 million or US$6 million). This feature effectively retainsinvestment sanctioning for many private investment projects and sends mixed signals to the privatesector regarding the Government's commitment to liberalizing the investment environment.Moreover, there is no economic justification for any threshold investment level, once capital goodsand raw materis are filly on OGIL. If the Government wishes to stimulate private investmentand at the same time safeguard public health and the environment, the review of new investmentprojects should be limited to these issues and should be conducted bv the line mistries withexpertise in those areas.
38. Finally, if the Government wishes to influence the sectoral or geographic pattern ofinvestment, it should rely on traditional fiscal instruments (e.g., targeted tax incentives) which donot discourage the overall level of investment. Investment sanctioning is a blunt and inefficient
5 These include the Investment Projects Comittee, the Buildings Project Committe, the Extemal LoansCommittee, and the Exchange Control Review Committee.
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instrument which increases trasaction and administrative costs, and discourages private flrms(especially small and new firms) from investment activity.
Thrde Polickes
39. MPORtT DUr=5 Compared to the foreign exchange allocation system, other trade policieshave been minor impediments to private sector development. Import duties are moderate for acountry at Zimbabwe's stage of development. Most raw materas are subject to a recenty-imposed minimum tariff of 10 percent. Tariffs on other goods vary between 25 and 30 percent,except for luxury goods where the levy is 35 percen. Ih addition, there is a surchage of 20percent levied on the FOB value of all imports except petrol, medical, surgical and other goodslimited by international treaty. Finally, an additional 10 percent tariff Is levied on goods importedunder OGIL. While encouraging private sector activities in the protected sectors, tariffs aise theproduction costs for firms that either import raw mateials or use the products of protectedactivities as inputs. Becaue the Zimbabwean economy has more extensive intersectoral linkagesthan most countries with similar per capita income, the present level of tariffs on imported inputsdamages export competitiveness more severely in Zimbabwe. Available studies indicate that inputsfor the production of capital goods, for example, are, on average, 17 percent more expensive thanunder free trade conditions. Higher input costs contribute to the economy's anti-export bias and tothe sluggish performance of exports. In short, customs duties have been secondary to the foreignexchange allocation system and ivestment controls as sources of protection. As the Governmentphases out the discretionary allocation of foreign exchange, however, tariffs will become theleading source of protection and a more serious impediment to private sector development. In boththe SAP and its PER, the Govermnent has stated its intention to reduce the 20 percent surtax to 10percent in 1993. In addition, by 1995 the Government intends to have an average tariff rate ofabout 14 percent-final consumer goods would have customs duties in the range of 20 to 30percent, iermediate goods would pay a rate of 15 percent, and raw materials and capital goodswould be subject to customs duties of 10 percent.
40. EXPOIT PROMoTION Poucis. There ae three main export promotion instruments, theexport retenton scheme (ERS), export subsides, and duty drawbacks. Under the ERS, frms areallowed to retain up to 25 percent of their export eanings for importation of inputs for their owause or for the use of other firms. This scheme maikes export activities more attractive becauseexport earnings allow firms direct access to foreign exchange, thereby mitigating the problemsassociated with foreign exchange rationing. Firms are also entitled to a 9 percent export subsidyapplicable to all manufactured goods. Finally, to compensate for higher input costs caused byimport duties, industrial firms engaged in exports are entitled to drawbacks for both customs dutiesand surtax levied on imported current inputs. The authorities, however, often delay payment ofduty drawbadks. High levels of inflation (crrenty about 40 percent per year) rapidly erode theirreal value and tie up the firm's working capital. Small and medium-size firms often fail to applyfor drawbacks because the system is too complicated and cumbersome. Another limitation of theduty drawback scheme is that it does apply to inputs imported by one firm but used by anotherfirm in production for export. This limitation encourages excessive vertical integration in exportactivity, discourages importation of inputs which have wide intersectoral use, and generallystrengthens the anti-export bias of Government trade policy. As the range of goods that fall underthe OGIL expands and import duties replace quantitative restrictions, the need for an effective dutydrawback (or other mechasm that allows exporters to obtain imputs at border prices) will becomemore urgent.
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41. The Government of Zimbabwe has introduced reforms designed to alleviate the negativeimpact of the foreign exchange rationing. First, during the mid-1980s the Government establishedan export revolving fund to enable exporters of manufactured goods to by-pass the rationingsystem when iprting inputs needed in the production of exports. Second, the Governmentestablished a 9 percent subsidy to compensate exporters for duties paid on imported inputs. In1991 the RBZ became more aggressive in its exchange rate management and accelerated thenominal depreciation of the Zimbabwean dollar. The real value of the Zimbabwe dollar (againstthe U.S. dollar) is at the lowest level attained since independence, but as of March 1992, it wasstUi ovevalued by at least 50 percent compared to the black market rate. In addition, theGovernment put in place an OGII fcility that bypasses foreign exchange rationing for goods on aspecified list. The Goverment alsc inroduced an export retention scheme (ERS) that allowsexporting firms to retain a portion of their export receipts (carrently 25 percent). Until mid-1992funds under the ERS were tradable in goods, but'not in foreign exdhange itself. This provisionunnecessarily raised tansaction and information costs for firms wishing to trade ERS funds, andmade it more difficult for the available foreign exchange to be allocated efficiendy. TheGoverment recently allowed trade in the rights to use foreign exchange earned under ERS. Thischange improves the allocation of ERS funds Nonetheless, private investment projects whoseforeign exchange requirements are financed entirely from ERS earnings are stil subject to theinvestment sanctioning process. The Government has also relaxed restrictions on the use of ownfunds (no currency involved scheme) for importation of goods for personal use. Presentdy, 45percent of imports are under OGIL and a wide range of goods are available through the ERS. TheGovernment intends to move all goods, excluding a small reserved list, onto OGIL by end-1995.
Capia Movments
42. Foreign Direct Investment (FDI) has an important role to play in private sectordevelopment. I7DI provides not only physical capital, but also technical expertise and access tomarketing and information networks which are crucial for successful export activity. Foreigninvestment can stimulate the growth of domestic firms, technological upgrading, andentrepreneurship through demonstration effects. Zimbabwe has failed to attract foreigninvestment, however. In fact, during 1980-1987 there was net detment by foreign firms in realterms owg in part to severe restrictions placed on capital movements.
43. Zimbabwe has had strict control on capital movements since UDI. Firms establishedbeforv independence can remit up to 25 percent of their after-tax profits, while firms establishedafter independence can remit up to 50 percent. These rules, however, are subject to frequentchanges. Firms whose remitances had been blocked during UDI (primarily British companies)were allowed to remit up to 50 percent of their after-tax profits after independence. In 1984 theworsening externa position led the Goverment to disallow remances for pre-1979 investments.T'his restriction was lifted in 1986 with the restoration of 50 percent remittability, but in 1987 theproportion was again reduced to 25 percent.
44. In addition to restrictions on the proportion of net profts that can be remitted as dividends,dividend remitance is subordinated to other claims in the allocation of foreign exchange. Thisincreases uncertainty about dividends foreign sharbholders can retrieve. If foreign exchange is notavailable, foreign companies are required to hold remittable funds in 6 percent Government bondswhich are subsequently remittable over six years. Such 'blocked' funds can be invested in"approved" projects, but must remain in place for five years after which the same repatriation rightapplies as for post-1979 investments. Net profits above legally remittable levels are considered"surplus funids" and not eligible for expatration. Since 1987 blocked and surplus funds earn 5
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percent if held In commercial bank accounts, 9 percent if hqld in RBZ accounts, or 13.5 percent ifheld with the Post Office Savings Bank (POSB).6 Firms are not allowed to invest blocked orsurplus funds directly in indigenous enterprises. Given negative real interest rates and thedepreciation of the Zimbabwe dollar with respect to foreign currencies, the value of these accountserodes rapidly over time. In an attempt to encourage exports, the Govermnent has recentlyallowed high levels of remittance to export-oriented projects. Export-oriented projects whereinitial foreign exchange outlays can be recovered in three years or less can remit 100 percent of netprofits, subject to foreign exchange availability.
45. In the event of divestment, firms are again treated differently depending on wheninvestment occurred and the degree of localization (i.e., the fraction of divested equity sold toZimbabweans). Pre-1979 investments must become 85 percent Zimbabwean-owned and theproceeds used to purcbase 4 percent, 20-year external bonds. Full localization is given acceleratedremittances. Post-1979 investments are entitled to divest at any time from two to seven years afterthe initial investment and profit remittances, up to the amount of the original investment in localcurrency, are allowed immediately. Any excess, including undistributed profits, may be investedin a six-year Government bond which is remittable upon maturity. Divestment after seven years ison more attractive terms, subject to foreign exchange availability.
46. Difficulties with profit remittances have led to increased uncertainty, erosion of foreignnvestor confidence, tensions between the Government and foreign companies, and divestment.
The losses in asset value that firms have been willing to incur illustrate the dissatisfaction offoreign firms with Zimbabwean conditions. Since about 1985 disinvestment by foreign firms hastaken two main routes: sale at a discount of between 40 and 60 percent of net asset value, withsubsequent repatriation of receipts in six-year Zimbabwe dollar bonds bearing an interest of 4percent, or sale at a discount of 70 percent of net asset value with the sale repatriated over one ortwo years. In early 1989 the terms for the second category were changed to a required discount ofat least 80 percent. Despite these deep discounts, there was considerable disinvestment activityduring 1987-89. In 1987 alone there was net divestment of about US$ 30.5 million, which was3.8 percent of total gross fixed investment in Zimbabwe. A recent survey of the Confederation ofZimbabwean Industries found that firms with a majority foreign ownership only accouted for 23percent of total urnover, compared to 60 to 70 percent immediately after independence.
47. In response to problems with capital and profit repatriation, potenti foreign investorsoften Insist on protective measures. For example, investors (including the IFC) in a majorplatinum mining project, Hardey Platinum Mining, have insisted on mainaining a foreign escrowaccount to meet their foreign exchange needs before participating in the project. Tbis has causedconsiderable delays in project implementation.
48. Although under the structu adjustment program, controls on capital movements are notfully addressed, in Its PER, the Government stated its intention to remove all exchange controlrestrictions on dividends and profit remittances by end-1995. Nevertheless, the Government hasn artiulated a new policy with respect to blocked and surplus fiuxds. Controls on dividendremitces, repatriation of principal, and blocked and surplus funds strongly deter foreign privateinvestment. Foreign direct investment is unlikely to respond to any significant degree until thesecontols are fuly removed. Because controls strongly deter foreign private investment, the
6 is not leg forfoeip comp to deposit blocked or surplus finds wit t POSB, but it i acommon practice. Funds deposited with the POSB, however, cannot exceed Z$200,000 per depositor(rougly US $40,000 at the curret exchdnge rate).
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Govanment may wish to consider a two-stage liberalization: (i) establish clear rules for the freemovement of capital (dividends, profit remittances, and repatration of principal) In line withinteraional standards for all new lnwnsnent; and (ii) apply these rles uniformly to allinvestments upon completion of OGIL. Given the sizeable amounts of fuids held in the form ofblocked and surplus accounts, a phased release of these funds may be advisable to moderate theirpossible impact on foreign exchange fluctuations and overall macroeconomic stability.
Price Comrols
49. Price controls have also inhibited private sector development, but much less so thanprocedures for foreign exchange allocation and investment approvals. Because exchange controlsand investment vetting both insulated the Zimbabwean economy from effective import competitionand controlled domestic entry, they created substantial (artificial) domestic market power. In orderto restrain firms from exercising this market power and pricing monopolistically, the Governmentdeveloped pervasive price controls. Commodities exempted from price controls included exports,goods sold by public auction, second hand goods (except automobiles), food and drink sold forconsumption on the premises (except beer) eggs, flowers, fruits, and vegetables. There are fourcategories of price-controlled goods In Zimbabwe. Schedule 1 commodities reqire formal Cabinetapproval of prices. These include sensitive agricultural commodities, specified building materials,motor fuel, and stock feeds and ferdlizers. Schedule 2 covers most petroleum fuels, and prices arenormally (though not formally) referred to the Cabinet and are priced on a cost-plus basis. Thedetermination of the markup over cost is not formalized and is highly discretionary in practice.For commodities on Schedules 3 and 4, firms are free to adjust prices when the cost of their inputschanges, according to prespecified margins over costs and without prior approval by the Ministerof Industry and Commerce. Though the Minister retains the right to monitor and disallow theseprice adjustments, he rarely exercises it.7
50. Because most price controls are enforced on a cost-plus basis, there has been nothing tokeep domestic prices in line with import parity prces over time. Moreover, the authoties havebeen unable to enforce price controls uniformly. In manufcturing, for example, price controlshave been effectively imposed on homogeneous products like steel, cement, fertilizers, but not fordifferentiated goods such as textiles.8 Overall, price controls have distorted incentives forindustrial expansion and channeled production into areas with ineffective or no price controlsrather than those reflecting underlying cost competitiveness.
51. The Government has undertaken substantial price decontrol under the EconomicStructural Adjustment Program, especially under Schedules 2, 3 and 4. The most importantcommodities in these categories still under price control include imported and local agriculturalmachinery, implements, and spares, building materials, pesticides, salt, flour, soaps, and vegetableoils and fats, and iron and steel from Zisco (under import parity pricing since October 1991). Withthe liberalization of imports and the expansion of goods under OGIL, price controls are becomingredundant. Under the Structural Adjustment Program, the Government is committed to removing
7 Detils about procedur for price detnation are provided i Statutoy Ilsrsument 153B of 1989,Conrol of Goods (Price Control) Regulations, 1989, Cap. 280 laws of Zimbabwe.
In some cases price contols have had adverse effects on foreigh investment. At least one major foreigna-ponsored invesment in a cement factory was cancelled because prices were too low to make the
investment profitable.
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price controls for items put under OGIL. By December 1993, Government intends to free 35percent of all Imports from foreign exchange controls (place them under OGIL) and to allowexporters to retain 35 percent of their export rnings for importing inputs. These two policyactions will effectively free about 90 percent of private sector imports from foreign exchangecontrols by end-1993, rendering most remaning price controls superfluous. There should be noatempt to maintain price controls in order to hold domestic prices below import parity prices forgoods under OGIL. If Government wishes to achieve this objective for highly sensitivecommodities, it should do so with explicit subsidies tt are transparent and do not discourageproduction.
Labor Laws and Practices
52. Zimbabwe has a long history of relying on the private sector for most of its productiveactivities. The legal framework, which evolved togetier with the private sector, is generallyadequate to deal with day to day requirements of business activity. Nevertheless, there are anumber of post-independence reguations that restrict managerial autonomy to adjust their laborforce (imcluding retrenchment). These regulations are serious obstacles to the formation of newfirms, and to the growth of investment and employment in existing fims. They also make firmsless able to take advantage of market opportunities (especially in export activity) and generallymake the economy less supply responsive. Beginning in 1981, every retrenchment decision by aprivate firm (bot the number of workers affected and conditions of severance includingcompensation) required the approval of the Minister of Labor. 'his highly centralized proceduredid not provide opportuniy fr private resolution of disputes, and creaed delays and unceantydue to unclear criteria for approval. Ministerial approval has proved difficult to obtain, and issubject to long and uncetain delays (six months to two year delays are not uncommon). The effectwas to make it extremely difficult for private fuims to be flexible in adjustng to changing marketconditions, to limit their ability to remain competitive, and ultimatey to discourage thedevelopment of new and small fms in the formal sector where such regulations impinge.
53. The Govermment of Zimbabwe has recetdy revised the labor code goverig temporarylayoffs and permanent retrenchment. In 1990 the GOZ decentralized the procedure, limitinggovernment involvement to cases not resolved by individual or collective bargaini (StatutoryInstrument 404). Accoding to SI 404, retrenchment decisions collectively bargained at the workscouncil (shop level) are binding. Notification of the Ministry of Labor is required for informationpurposes. Disputes are appealed to the employment council, comprised of employer and tradeunion reprsaentives. Agreement at this stage is binding. A second level appeal can be made to atripartite Retrenchment Committee which is an advisory body to the Minister of Labor. TheMinister retains full decision-making authority, with essentially the same discretionary powers asunder the pre-1990 regulations.
54. The Government recently introduced Statutory Instrument 25(1992) which, among otherthings, requires that before retrenching workers, firms consult with works councils to consideralternatives to lay-offs (e.g., reducing overtme, deferring compensation, etc.). The Instrumentalso requires formal approval from the Retrenchment Committee, even if agreement on thesemeasures has been reached through collective bargaining. These provisions potentially underminethe reliance on collective bargaining and decentralized decision-making. Statutory Insument 252needs to be amended to restore reliance on collecdve bargaining.
55. In short, the main reforms are the provisions for voluntary resolution by individual andcollective bargaining at earlier stages, and time limitations imposed on the process at the
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retenchment committe and Ministerial stages. The process would be substantially improved ifthe Retrenchment Committee were granted final decision-making authority and direct ministerialreview were eliminated. Ibis reform would reduce the uncertainty involved in the disputeresolution process, and enhance the ability and wilingness of private firms to respond to changingmarket conditions.
56. Historically, the Government of Zimbabwe intervened heavily in the de ion of a(uniform) minimum wage. Since 1989 the Government has progressively reduced its involvementin this process. Beginning in 1991, the employment council for each subsector (members of theumbrela organization, National Employment Council) determines the minimum wage by collectivebargaining.9 There is no statutory minimum wage, and in practice the collectively bargainedminimum wage varies across subsectors. Actual wages are set individually by each enterprise.This arrangement appeas to work well In practice and no reform is needed.
57. In its FER, the Government stated its Intention to devolve power to resolve all labordisputes to the employment councils. 'Te recent labor reforms substandally accomplish this goal.One major concern, however, is that certain provisions in the Labor Relations Act of 1985 appearto undermine, or are inconsistent with, the recent revisions of regulations on retrenchment and theminimum wage. The most important example is Section 17 which grants the Minister of Labor thepower to Omake regulations providing for the development, improvement, protection, regulationand control of employment and conditions of employment" which supersede the provisions of anystatutory instrument or agreement whatsoever. The scope of powers given to the Minister by theLabor Relations Act is very wide, including the power to determine mininm wages (Section 20)and to override or modify collective barining agreements (Section 25 and 84). It would enhancethe credibility and effectiveness of the Government's labor reforms if these discretionary powerswere rescinded.
Finial Systeim
58. Zimbabwe's financal system is one of the more sophisticated in Sub-Saharan Africa. Thesector is unusually developed in terms of the range of financial insttutions and in the highproportion of long term assets and liabilities. There are four commercial banks (with 100 branchestiroughout the country), four merchant banks, five finance houses specializing in leasing and hirepurchase, three discount houses, three building societes, a Post Office Savings Bank, severaldevelopment banks and corporations, and a number of insurance companies and pension funds.There is also an active stock exchange with about 60 listed companies. Non-bank financialinstittions, which are crucial for the mobilization of long-term funds, are also well-developed inZimbabwe.
59. Despite this set of well-developed financial institutions, resource mobilizaion has beenabout average compared to countries at similar levels of per capita income (see Table 1), but itscavacity to supply long term capital, as exemplified by the Important role of insftiutional investorsand the depth of the capital market, places Zimbabwe ahead of many countries, including Chile,
9 Ths procodur does not pply for farm workews and dometic employees, who are not representd by afma workr ormiin. For thes groups the Govemnt intervenes direcdy in sotting dte minimumWIge.
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Korea, India, Singapore, and Greece.10 The institudonal structure of the financial system includesbanks, fiae companies, penson funds, and insurance companis.
Table 1Index of 1nandal Depth In Zimbabwe and other Countries, 1989
Money and quasi-money asCountry percent of GDP
Morocco 50.5
South Africa 45.8
Botswana 36.0
Philippines 34.4
Zimbabwe 31.8
Cote d'Ivoire 29.7
Kenya 24.1Dominican Republic 22.5
60. The commercial banking sector is domiated by the branches or subsidiaries of Britshbanks, and there are important similarities between Zimbabwe and the United Kingdom in thestucture of fhancial mediaries and capital markets. In both countries institdonal investors-notably Insurance companies-are domina players in financial intermediation and in bothcountries the public sector is the only participant in bond markets and the corporate sector isconspicuously absent. There are, of course, Important differences between the two countries inindustial structure, degree of financial In ation, size and role of equity markets, and otherfeatures. Nonetheless, the similarities in the financial structure and pattern of corporate financeprovide a useful reference point and underline the reladve sophistication of the Zimbabweanfiancial system.
61. The financial system has not been a major deterret to overall private sector developmentCommercial banks have generally followed conservative lending policies and as a result have hadstrong portfolios and negligible amounts of bad debt and writeoffs. Ihe four major commercialbanks have been highly profitable, with an average post-tax rate of return on capital of 22.9percent in 1985-89. Despite consistendy negative real interest rates (ranging from near zero tominus 6 percent), there has been no excess demand for credit from the private sector. Thecorporate sector has financed most of its needs from internally generated funds and the financiasystem has mobilized the necessary resources to meet the residual private sector demand for credit.Ihe demand for credit for both long-term investment and working capital has been suppressed bythe restrictions on investments and the rationing of foreign exchange. The supply of loanable
io in 1985 the totl asset of Insure compian in Zimb*we in relat to GDP was 21.5 peren,compard to 9.0 percent in Kota, 6.9 peren in Malaysia, and 5.2 peet in Chile.
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fumds has been artificially inflated by controls on capital movements, Including restrictions onblocked and surplus funds, and by Reserve Bank requirements on the financial sector. TheReserve Bank of Zimbabwe (RBZ) has required financial institutions, insurance companies, andpension plans to maintain a high degree of liquidity by holding a range of "approved assets,"including Govermment bonds. The RBZ's ability in the past to maintain low and stable realinterest rates has been facilitated by these liquidity and approved-asset requirements, which havebeen modifled according to credit conditions and Government borrowing needs.
62. As the foreign exchange allocation system and the procedures for approving investmentsare liberalized, the Government will need to reduce its demand for credit to avoid crowding out theprivate sector through high real interest rates or outright credit rationing. The events of the pastyear illustrate the urgency of these measures. Tight monetary policies adopted in late 1991,liberalization of the exchange control regime, and moves towards market determination of interestrates resulted in a rise in nominal interest rates. Together with the recent drought, these policiesreduced credit availability to the private sector. The liberalization of interest rates, coupled withhigher than normal inflation and scarce liquidity, pushed short-term nominal interest rates tounprecedented levels (35 percent p.a.). Access to credit is now becoming an important barrier toprivate sector investment and growth. The present situation highlights the need to accompanyforeign exchange liberalization with prudent fiscal and monetary policies to attenuate overalldemand and avoid crowding out of the private sector.
63. Clrr ALoCATION. Credit allocation has been influenced both by Government flat andpolicy, RBZ policy, and market forces. The most obvious example of allocation by fiat is credit toparastatal organizations. RBZ policy has also influenced credit allocation, both directly andindirectly. The implementation of its rediscounting policy is an example of direct credit allocation.Rather than relying exclusively on the rediscount rate to allocate credit, the RBZ has effectivelyimposed quantity restrictions on rediscounting, for example, by closing the rediscount window.ITis approach creates a less efficient allocation of the available credit resources."1 The foreignexchange control mechanism, however, has been by far the most important Indirect influence overcredit allocation. Because scarcity of foreign exchange has been a significant constraint on privatesector production and investment, Government decisions regarding the sectoral allocations offoreign exchange have had important effects on sectoral credit allocations.
64. Private sector credit allocation decisions have also been affected by Government policiesdesigned to ease the burden of its own borrowing requirements. The stringent liquidityrequirements on commercial and merchant banks significantly constraint their ability to makemedium term loans. The high levels of long term, fixed rate securities in insurance company andpension plan portfolios, which are subject to approved asset requirements, have exposed theseInstittions to substantial interest rate and inflation risk and provided them with powerfulincentives to seek inflation hedges in land and buildings.
65. While there have been occasional ceilings on interest rates, direct controls on interesrates (other than mortgages) have not been extensively used. Informal Government pressure,however, limited the premia that banks could charge to compensate for higher risks, especially onlong-term loans. Together with limited demand for long-term flnance, this pressure contrbuted toconservative bank lending policies and limited involvement in long-term finance. The highly
A rcat striking example of the effects of this policy was thempoy susPeson Of the tobacco auction,in May 1992 for lack of finacing boca the rediscount window-the trationa source of finacing-wasclosed.
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protected and uncompetitive environment generated high and stable profitability in the bankingsector: average net post-tax income relative to capital was 22.9 percent for the four merchantbanks over the period 1985-89, almost twice as high as U.S. banks. In addition, debts and write-offs for atl Zimbabwean banks were negligible-one bank has not had to make a single provision inthirty years of lending. In a more competitive environment created by liberalization, bank willface higher risk as well as new arlket opportunities. This new situation will call for morediversity in commercial bank activity, adjustment in lending policies, and possibly entry of nDwcompetitors into the sector.
66. IThe structr adjustment program now underway addresses most of the issues discussedin this section. Interest rates are now almost fully market determined. With the elimination ofcaps on interest rates for lending, rates paid to depositors are expected to rise to positive reallevels. As discussed above, the reduction of Govermnent expenditures is critical for alleviatigdemand pressures on the financial system, helping maintain low real interest rates, and preventcrowding out of the private sector. In keeping with its move to market-determined interest rates inorder to improve resource allocaion, the RBZ intends to abandon quantitative controls on creditand use the rediscount rate to exted credit to the financial sector through its rediscount window.In addition, in Its FER the Government announced its intention to increase domestic competitionamong banks and other financial institons by adopting an open door policy with respect to theentry of new baks.
67. STocK ExcNwas. The Zimbabwe stock exchange (ZSE) provides a supplementary sourceof finance for private sector investment. Until recentty, however, there had been little activity inthe stock market. Trading was confined to local shares in March 1984 when all externat dealings,which accounted for 92 percent of market turnover at the time, were suspended. Predictably, thelevel of activity contacted sharply. From 1981 to 1989 there were no new issues. There are anumber of Issues that wormally affect corporate choice of financing vehicles, including diution ofshares, costs of debt relative to equity, etc. In Zimbabwe, the lack of new equity issues probablyreflected the high cost of equity relative to debt and uncertainty about the business emnvironment.During the period 1980-87 the dividend yield was only slightly lower (by about 4 percent) than thecmmeci bank base lending rate. The slight cost disadvantage of debt finance was more thancompated by the tax provisions allowing interest deductibility (see para. 70). Using an effectivecompany tax rate of 28 percent, the afterw- cost of debt finance was roughly 26 percent lowerthan equity finance. In the past three years, however, dividend yields have fallen sharply, to aboutone-half of the commercial bank base lending rate, making the after-tax cost of debt 59 percenthigher than that of equity finance. During the same period, there was a surge in new listings,rights and bonus issues. Approximately Z$314 million were raised during the fiscal year ending inMarch 1991. The flotation of Barclays shares in June 1991, the first listing of bank shares in 18years, was oversubscribed by a factor of five and raised nearly Z$300 million. Ihe attraction ofthe market as an investment vehicle was enhanced by the adoption of the structual adjustmentprogram and ensuing optimism about the economy.
68. Share prices and market volume plummeted during 1992. In contrast to 1991, whentwenty-one rights issues and three new issues were floated, there have been only two rights Issuesand no new listings. Witi nominal interest rates at unprecedented levels and volatile, short-termmoney market instruments have become relatively more attractve tha secrity investmens.Insthiona investors, who traditionally accounted for 70 percent of investment in the market, arefacing severe liquidity constins. Corporations are also reluctant to float shares because of lowshare prices, despite the high cost of credit and the erosion of their equity base owing to the sharpdevaluation of the Zimbabwe dollar.
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69. While large firms have generally been able to utflize the stock market for equity financeand commercial b for debt fiace, small firms have not had comparable access to thesechannels. IFC helped establish the first venture capital company (Venture Capital Company ofZimbabwe) to provide seed money and project development assistance to small and medium-scale,primarily indigenous, enterprises.
Taxadon
70. Thlu Government has rformed the tax laws In recent years, including reductions in thet rates on sales and company profits, and changes in the tax provisions for investment in plantand equipmenL In 1991 the company profit tax was lowered from 50 to 45 percent, and to 42.5percent in 1992. For selected new investments at designated growth points, the tax is only 20perct for a period of five years. The current statutory rate is still quite high, especially incomparison with newly industrialized countries. Deductions for capital investment (Special InitialAllowance, or SIA), however, substantially lower the effective tax rate. Prior to 1991 the SIAprovided for ful expensing of machinery and equipment as well as deduction of interest for taxpurposes. T11ese two features provided a double tax allowance on debt-financed investment,providing a subsunitl investment Incentive but distorting the financing decision. Beginning in1991, full deductibility was replaced with various forms of phased depreciation schedules thatreduce the present value of the tax allowance.12 Branches of foreign companies are normally liablefor a supplementry branch profits tax equivalent to 8.4 percent. This rate is reduced byprovisions in various double taxation agreements between Zimbabwe and other countries (e.g., 2.5percent for United Kingdom companies, 5 percent for German companies). On the whole, thecurrent effective business profits tax is not unduly high by international standards. Ihe personalincome tax remains moderately high by current international standards, despite a series ofreductions in recent ye&s. The rates are sharply graduated with income, with a maximum rate of55 percent for incomes over Z$45,000. There is a personal income exemption of Z$4,800.
71. Overall, the current structure of business taxes Is not a major constraint to private sectordevelopment in Zimbabwe. The tax code does not provide incentives to promote small business.Available investmt incentives typicaUy benefit larger and more capital-intensive firms.Nevertheless, the use of specialized tax incentives for small fims is not advisable because it wouldencourage tax evasion through deliberate "fagmentiona of entpri. Instead, policies shouldbe put in place to encourage frms operating in the informal sector to register in the formal, taxpaying sector. This would require regulatory reform, including streamlining of business licensing,building and health codes, and zoning regulations, as discussed in paras. 35-89. The Governmenthas announced plans to rationalize the tax stucture to improve equity and efficiency. By end-1993it plans to reduce the company basic tax rate, together with existing deductions and allowances,and to remove double deductions on investment. By end-1995 it plans to reduce the top marginaltax rate for individuals and to further reduce the company tax rate to approximate the effectiverate.
12 Under the 1992 tax laWs, fims Can fuly d cate capital expndtr over three years, 50 percent in thefirs year and 25 percent for two yea thereafker. These are genaous capital depreciation provisions byintanal standards.
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State Owned E ntepises and Statutory Monopolles
72. Many of the reVlations Impeding private sector development weie developed beforeIndependence to protect legal monopolies granted to parastatal enterprises engaged in the provlsionof services. ITere are regulations that sharply limit private sector activity in mining, agdculture,and all of the public utilities. In the mining sector, the state retains monopoly control of the saleof all mineral products through a parastatal, the Mineral Marketing Corporation of Zimbabwe(MMCZ). This arrangement makes business transactions cumbersome and detes new entrants.There is no economic rationale for the statutory monopoly of MMCZ and its presence retardsinvestment and economic growth. Already one major mining concern has withdrawn fromZimbabwe because of this requirement. Trying to control the marketing of output in order toectract economic rents is unnecessary, as the Government can capture mining rents through anappropriate system of taxes and royalties.
73. In the agriculral sector there are restrictions on the movement of goods, sourcing, andthe location of mills, and other legal barriers to entry. The effects of these restrictions on privatesector development and the distribution of income are illustrated clearly by the examples of cottonand maize marketing.
74. The gross value of the cotton crop is second only to tobacco. While there is free entryInto cotton growing, entry into marketing and ginning is restricted. The Cotton Marketing Boardhas a statutory monopoly on the purchase of cotton and entry is blocked by law. Small frmerswho are located far from CMB's depots and lack adequate transportation often sell their productsto illegal middlemen at heavily discounted prices. This arrangement both discourages producdonand has highly undesirable equity consequences. It also has detrimental effects on efficiency:quality and consistency of exstg ginning operations is generally considered inadequate.
75. There is a different arrangement for maize. Entry into maize growing is unrestricted, butfarmers can only sell their maize to "approved buyers"-a layer of middlemen with monopsonisticpower protected by legal barriers to entry. Approved buyers must sell their maize to the GrainMarketing Board. To limit the exercise of monopsonistic power by approved buyers, the GMBdictates both the final price and the margins for middlemen. This arrangement prevents smalloperators from becoming middlemen, thus deterring an activity which serves as an importantsource of employment for the private sector in other countries. The Government has recentlyallowed farmers to sell certain crops directly to users (yellow maize, red sorghum, and millet), butmuch more extensive and rapid decontrol is needed.
76. Simlar restrictions on the participation of the private sector exist in other areas. TheCold Storage Commission has a monopoly on cattle sales. The Grain Marketing Board has amonopoly on the distrbution of maize. Shipment of maize between communal areas is prohibited.These statory monopolies in the agricultural sector impede efficient production and distributionof agriculturl output, and restrict the oppormnities for entry and operations by small scaleenterprises. The Government needs to introduce more flexible marketing arrangements inagriculture, in particular to liberalize and eventua1ly eliminate restrictions on entry and operations.Liberalization will promote efficiency and improve equity in agricultre, the most importantemployment generating sector in the economy.
77. Private sector activity is severely restricted in transport and prohibited in the publicutilities, including telecommunications, where the standard of service has seriously deteriorated inrecent years (currenty a five year wait for network access in Harare). In transport, prvatetruckers require Government permits to haul goods and aU petroleum imports are handled by aparastaa organization. There is an urgent need for policy reforms that would allow private sector
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Investment and operations, subject to suitable regulator) arrangements that specify transparent,non-tiscretionary, and stable rules of the game. This is the course that has been adopted by anincreasing number of developing (and developed) countries.
78. Urban transport has suffered from policies supporting monopoly passenger servicedelivery. All urban passenger transport services are provided by a single commercial bus companyoperating under exclusive franchise, the Zimbabwe Urban Passenger Company (ZUPCO). Untilthe mid-1980s ZUPCO was wholly owned by UTG, a British-based company. Since that timeZUPCO is jointly held, with 51 percent Government and 49 percent private (UTG) ownership.Despite rapid urban population growth, there has been very limited investment in new vehicles andspares by the private investors in ZUPCO. The result has been a deterioration in the condition ofthe fleet and operating efficiency, and a precipitous decline in the quality of urban passengertransport services. The extent of the decline is evident in the excessive waiting times, whichaverage nearly three times more than the normally accepted maximum. Recent investment in newbusses has been funded exclusively by donor governments under procurement conditions (Hollandand Sweden). There are two main reasons for the lack of private investment in ZUPCO: (i)restrictions on the repatriation of profits which seriously discourage the British-based partner, and(ii) a highly deficient regulatory arrangement for the determination of bus fares that makes theprofitability of such investment at best highly uncertain. There are no specific criteria and noexplicit mechanism for the determination of fares, so that even basic cost recovery is not ensured.The process is highly discretionary, with every fare adjustment requiring approval at the Cabinetlevel.
79. Telecommunications services are provided exclusively by a parastatal, the Posts andTelecommunications Corporation. At the present time, private sector provision of such services isnot allowed in Zimbabwe. Telephone density is quite high by Sub-Saharan African standards (1.4direct exchange lines per 100 people), but it is inadequate for the level and growth of economicactivity in Zimbabwe. During 1980-1990 direct exchange lines grew at an average annual rate ofless than 2 percent, compared to growth in registered demand of over 6 percent. In addition togrowing excess demand, the quality of the existing network and service is very poor. This is dueto obsolete equipment, and inadequate ma,atenance caused by poor organization and shortages ofmaintenance capital and technicaly skilled manpower. The availability of investment fimds andforeign exchange severely constrain network upgrading. In addition, tariffs are set at artificiallylow levels and are not adjusted regularly to reflect cost changes. More generally, there is noformal regulatory mechanism, independent of company operations, to set tariffs according toclearly specified guidelines and to monitor company performance.
80. The inadequate telecommunicatom network is a serious constraint to sustained privatesector expansion in Zimbabwe, especially for export oriented growth where modemteleconiaons links are critical to identify and exploit market opportunities. In order toimprove telecommunications links, policies need to be designed to promote the operationalefficiency and financial viability of the Post and Telecommunications Corporation (PTC), and tofacilitate private sector investment in this market, subject to appropriate regulatory safeguards
81. Under the SAP, prices for major parastatals (e.g., ZISCO, ZESA, PTC) and producerprices for all major crops (set by agricultural marketing boards) have been increased. Parastatals,including marketing boards, have also been granted greater autonomy to adjust prices. Despite thisgreater pricing flexibility, with the exception of the NRZ, relatively little progress has been madeto enhance cost-efficiency in the provision of parastata services. Several actions are necessary toimprove the delivery of services now provided exclusively by parastatals. Achieving this goalrequires a two-pronged strategy. In the short term, the Government needs to accelerate
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commercializaion of parastatal operations to promote cost-efficient provision of services. In themedium term, the Government needs to articulate a strategy to encourage private sectorparticipation in these sectors both to promote efficiency and sustainable levels of investment.Elements of this strateg indude (i) elimhatlon of the requirement to have state equityparcipation in new private ventures;13 (ii) divestment of minority ownership in many existingcommerial enterprises where there Is no rationale for state participation; (ii) removal of statutorymonopolies, especially the agricultural marketing boards.
82. In implementing this strategy a distinction needs to be drawn between parastatals run forcommerci purposes in competition with private sector firms on the one hand, and public utilitiescurently run as statutory monopolies (e.g., telecommunlcations, electric power) on the other. rTeformer may be privatized expeditiously, whereas liberalization and privatization of public utilitiesrequires the formulation of an appropriate, sector-specific regulatory framework. For parastlsoperating in competition with the private sector, the Government needs to develop a program toliquidate those that are commercially unviable, and either to privatize the rest or ensure that theyoperate autonomously, on a fiuly commercial basis, and without Government subsidies.Otherwise, private sector investment and new entry in these industries will be discouraged.
ConstaInts to Small and Medium-Scale Firms
83. The activities of small and medium scale firms in Zimbabwe are constrained by many ofthe same factors that have affected larger enterprises. Studies and surveys of smaller businesseshave highlighted the following constraints: (i) access to land (for use and for collateral), (ii) accessto credit (fewer than 5 percent of MSEs have received credit from any formal fiancial insttion),(fii) inadeqwe management and technical skills, Ov) lack of means for transportation anddistribution both for labor and products, (v) inadequate infrastructure, and (vi) a history ofGovernment policies that have favored large industry.
84. Untl very recently, the Government of Zimbabwe did not actively support or promote thedevelopment of small and medium scale enterpises. In 1983/4 Government set up the SmallEnterprises Development Corporation (SEDCO) to lend exclusively to small businesses. Despiterecent infs to its capital base (from Z$5 million to Z$32 mfllion) and Improvements in Itsoperational efficiency, SEDCO remains hampered by serious undercapitalization. ManyGovernment policies, now being reviewed under the Structura Adjustment Program, have directlyor indirectly discriminated against small and new businesses. These Government policies include:(i) an allocation scheme for foreign exchange based on historical Import requiements; (ii) wageand labor laws that estabLished minimum wages and made labor adjustment difficult and cosdy, (iii)approval by Government for all new investment requiring foreign exchange; and (Iv) lengthylicensing/r i process. Recenty, Government has become more sensitive to the potentirole of small scale entprise for employment generation and economic development of the country.In its FER, the Goverment has stated Its intention to relax licensing restrictions on hawking andstreet vending and to review and possibly amend the Factories and Works Act, and fially tosimplify the local council by-laws and other regulations. Government has encouraged lending tosmall businesses, although not in the most productive way, through requirement for lending onthe part of commercial banks. Several banks (e.g., Barclays, Zimbank) have set up special unitsfor lending to small enterprises, but the level of loan activity remains very limited.
13DPrvage prvision of cellular telephone semices was abandoned because of Govement demands for-i8 ht
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We Deedi
8S. Access to land tile deeds is a major Issue in the promotion of the growth of Investmentand employment in small scale firms. It is virtually impossible for operational and new small firmsto obtain fmance capital unless they can offer tide deed as collateral. Moreover, without title deed,the firm has no Incenive to invest In capital equipment or buildings on the land or otherwise todevelop the land. Local authorities frequendy require firms to prove their financial ability todevelop the land before issuing tidtle deed, but the loan commitment from a bank is Itselfunavailable without title deed.
86. Despite Government support for the principle of title deeds at growth points targeted foraccelerated development, there remains a major backlog in the issuance of title deeds. Accordingto information %om the Ministry of Local Government, Rural and Urban Development, there wereabout 100,000 idenified stands (plots) lying idle for lack of title deed as of March 1990.Difficulty in securizg title deeds seriously hampers small firm development and security, especiallyat designated growth points. The problem is due largely to a critic, J shortage of certified landsurveyors in Zimbabwe. The University of Zimbabwe only recently introduced a degree programIn land surveying, so that use of expatriate surveyors or other measures will be needed to removethis serious botdeneck expeditiously. The Land Survey Act limits the use of expatriate surveyorsby imposing examinations and apprenticeship requirements, and leaving considerable discretion tothe Surveyor General. The Government recently drafted legislatve amendments designed toreduce obstades to the use of ex-patriate surveyors, but no parliamentary action has been taken.
Liceing and Zoning
87. The central government registration and licensing requirements and the associated fees(imcluding the general trding license and approval under the Factory Act) are not a seriousregulatory burden, according to private sector firms. However, the trading licenses (includinghawking and vending) required by local authorities are burdensome, especially for small firms.These licenses are too narrowly specified, with detailed lists as to which products can be tradedunder the license. This constrains the formation of new, small firms and the growth anddiversification of existing firms. Local authorites should be encouraged to develop more generalpurpose licenses (similar to central government) that allow greater flexibility in the commercialoperations of private firms.
88. Building codes are extensive and detailed in Zimbabwe. The Factories and WorksRegulations (Stattory Instruments 262 and 263 of 1976) specify elaborate standards for factorydesign and operations. Many of the provisions relate to legitimate health and safety issues, butsome simplification of the codes would be desirable. Local authorities treat these codes asminimum standards and frequently impose additional requirements. Yet firms report that thesecodes are not difficult to meat because construction firms are well informed about the national andlocal codes and routinely configure factories to be consistent with them. The codes do raisebuilding and operational costs, of course, and should be streamlined. For very small firms withprimitive fixed premises, however, these codes impose unmanageable compliance costs. This isone reason very small firms (including microenterprises) remain unregistered, but such statusinvolves risks and costs of its own (e.g., harassment by local authorities, penalties, no access toforeign exchange). Reforms to relax or substantially simplify the codes for such firms would helpstimulate the growth of very smal firms in the formal sector. A reassessment of the need for bothcentral and local government jurediction over these codes is also warranted.
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89. There are strict zoning regulations separating residential, commercial, and industial areasin Zimbabwe. While some zoning is desirable and common to all countries, the current sharpseparation has the effect of forcing small firms to pay the much higher rents typical of industrialareas, increases transport costs for the labor force, and generally raises the operational costs forsmall firms. This encourages very small firms to remain unregistered. Some zoning refirmswould prome the fonration, growth, and formal registration of small scale enterprises-forexample, allowing limited commercial activity in residential areas, distinguishing between light andheavy industry, and possibly establishing exclusive zones for microenterprises involved incommercial and light industrial activity.
Land Redistribution
90. At independence the Government inherited glaring inequalities in the distribution of landownership. In a major attempt to redress this inequality, Parliament passed the Land AcquisitionAct of 1992 which empowers Government to designate areas for resettlement. There is amplerecognition in the country that the current distribution of land is inequitable and that theGovernment has the right to acquire agricultural land for resettlement. Nevertheless, this actinevitably engenders insecurity of land tenure and reduces the incentive to invest in landimprovements. Although Parliament incorporated provisions for compensation and arrangements
for appeal in cases of exptopriation, land designated for resettlement cannot be sold, leased or usedfor a different purpose without Government approval. Moreover, concerns remain within thecommercial farming community and donor agencies about the interpretation and implementation ofthe compensation and appeal provisions. The general uncertainty about the eventual ownership ofdesignated and adjacent areas reduces the market value of such land and makes it difficult to useland (desipated or not) as collatera to finance land improvements and related investments.
91. This is not to deny the legitimacy of land redistribution as an objective. Nevertheless,from the perspective of the Zimbabwean private sector, foreign investors, and the Bank and otherdonors, it is critically important that this process be implemented in a manner that (i) minimthe negative impacts on agricultural productivity and incentives for private investment inagriculture and (ii) does not increase uncertainty about private property rights in other sectors ofthe economy.
&mmary of Constraints
92. In summary, the main direct constraints to private sector development are (i) the foreignexchange allocation system, which affects the operations of enterprises in every productive sectorof the economy by making access to foreign exchange a time consuming and costly endeavor; (ii)investment controls, which constrain the expansion of existing firms and the establishment of newones; (ii) state owned enterprises, including marketing boards, which aggravate the public sectordeficit and prevent private sector entry into certain activities now reserved exclusively for thepublic sector; (iv) inadequate infrastructure, which increases the costs of doing business for allenterprises, especially for those engaged in agriculture; (v) controls on capital movements, whichdeter foreign investment by reducing the real returns on investment; (vi) zoning, licensing, andother regulations which also increase the cost of doing business; (vii) labor laws, which reduce theflexibility of private sector firms to respond to market opportunities and changes in businessconditions; (viii) tariffs, which increase the cost of inputs to producers, and the cost of final goodsto consumers; and (ix) credit, which is a serious constraint to the development of small enterprisesnot because it is expensive, but because it is unavailable. Table 2 provides a summary of thesedirect constraints and a ranirng of their importance. It should be emphasized that e table does
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not include the public sector deficit which is the major indirect constaint, as discussed throughoutthis document.
Table 2Summary of Main Direct Constraints to Private Sector Development
.___ Large Enterprises Small Enterprises
Agdc. Indus. Mining Serv. gric. Indus. Mining Serv.
Foreign Exchange ++ +++ + + + + + + +++ + + +++Allocation
Level of Import Duties + + ++ + + + + +
lnvestment Controls + +++ + + + +++ + ++
Price Controls + + + + + + +
LaborLaws + ++ ++ + ++ + +
Company Tax + + + + + ++
InterationalCapital +++ +++ +++ +++Movement
Reguilatlons(zoning, + + + ++ ++ ++ + ++building codes,licensing)
State Owned ++ + ++ + + + ++ ++
including maretingboards.
Access to Title Deeds + ++ + + +
Telecommunications + ++ + ++ + + ++
Infrastrcture + + ++ + + +++ ++ - +
Credit 4 + + ++ + +
Key: + Mild constraint+ + Moderate constraint+ + + Serious constraint
14 B01d a prevailing sidution befo th drought and Xie initiaio of the stuctua adjustment programPrsently, credit is tg and a severn constraint to private sector investmt and on-going operatioL
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IV. PASr APPROACIIES AND FUTURE STRATEGY
93. Zimbabwe's natural resource base and its developed physical and social inf*astructurehold great promise for the fiture. To reaize this potential, the country needs, among other things,appropriate policies to enable the private sector to play a dynamic role in its development. Thisreport has discussed the constraints that have restricted private sector operations In the past, andthe policy changes that are necessary for those constraints to be removed. Many of these arialready programmed in the ESAP. Others stUIl have to be addressed.
94. A strategy for private sector development must begin with the removal of the foreignexchange allocation system, the linchpin that holds together the network of regulatory constraints.Although some devaluation of the Zimbabwe dollar is likely to be needed to remove excess demandfor foreign exchange, sole reliance on foreign exchange management would lead to a spiral ofdevaluation and high inflation. To eliminate excess demand for foreign exchange and mainainprice stability, devaluation must be accompanied by a reduction of the fiscal deficit and prudentmonetary policies. The present situation of high nominal interest rates, high Inflation, and tightcredit ilustrates the problems that arise when devaluation and tight monetary policy are notaccmpanied by fiscal restaint. It is important to adopt an integrated approach that combinesthese three policy instruments.
95. Once the policies to address the excess demand for foreign exchange are in place, thestrategy for private sector development must focus on the removal of the major regulatoryimpediments to private investment. In particular, the Government needs to remove expeditiouslyail procedures for vettng nvestment projects, to transform ZIC into an investment promotioncenter, and to remove current restrictions on international capital movements, including dividendrepaition, and blocked and surplus finds, at a rate consistent with macro-economic stability.With the removal of the foreign exchange allocation mechansm and contols on investment, importduties wil become the main source of protection. To encourage efficiency in production throughcompetWion, it will be necessary to reduce the levels and dispersion of protection.
96. lTese reforms will remove the effective impediments to private investment in Zimbabwe.Higher private ivestment levels would need to be accompanied by increases in the volume of termfinance. Zimbabwe's well-developed financial sector has the capacity to supply the necessaryadditional credit, but in the past it has primarly supplied short-term credit. There are twomeasures that would induce the financial sector to plac greater emphasis on long-erm credit.Pirst, the Goverment needs to continue fte movement towards fully market determied financialactviy, and in particular to rely on interest rates rather than on direct controls as the policyInstument for allocatig credit. Second, the Goverment needs to foster competition among bankand non-bank financial institons by Intoducing universal banking and other measures toencourage freer entry Into the sector. These policies would encourage the introduction of newfinmcial itume and a greater willingness to provide term finance in support of profitableinvestment oppormities.
97. Beyond these central reforms, the Government needs to initate a process privatizationcoupled with entry liberalization in activities that are now exclusive state monopolies, includingagricultural marketing boards, freight and passenger transport, and communications. Compared toother African counies, the mnmber of parastals is small. Nevertheless, entry liberalization andprvazaion are importat for three reasons: (i) to broaden the scope for private sectorparticipation in these crical sectors; (i) to promote efficient operation of existig patals; and(iii) to reduce the fiscal drain of remaining parastatals. In principle, the Government faces a choice
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betweeA privatizing them or placing their operations on a commercial basis, including fullautonomy in pricing and investment decisions. Privatization must be accompaied by thedevelopment of appropriat competition policy and/or formal regulatory mechanisms to curb theexercise of private monopoly power. In order to remove unceanty and stimulate private sectorinvestment in these sectors, it is important for the Government to develop and announce a programfor commercialization and privaiaon of state-owned enterprises. Removal of the statutorymonopoly status of agriculwal marketing boards, and their eventual privatization are critical to thedevelopment of those sectors. In addition, equity participation by the Government in new venturesshould not be a requirement.
98. Laws and regulations impinging on entry, operations, and exit of firms, such as contractlaw, commercial codes, and bankruptcy law, may need to be examined. On the basis of currentinformaion, however, the legad framework does not appear to be a serious constraint to privatesector development. Regulatory reform is needed to promote the growth of small firms, and theirentry into the formal sector (e.g., simplification of licensing and registration, zoning, and issuanceof land titles).
99. The Government has made substantial improvements in labor regulations regardingcollective bargaining and labor retrenchment. Nevertheless, as discussed in paras. 52-57,Government needs to ensure that the Labor Relations Act of 1985 is consistent with recent reformsin labor regulations in order to ensure the effectiveness and credibility of these reforms.
100. Table 4 presents a suggested sequence for implementing these reforms. Ihis sequence isnot intended to define a precise timetable for reform, but rather to indicate their relative degree ofurgency. While some of the reforms are best implemented after suitable reduction of the fiscaldeficit and liberaization of the foreign exchange regime and hence are categorized as less urgent,4a are necessary to generate a significant shift in the climate for private sector activity.
101. Beyond these reforms, if the private sector is to flourish the Government must shift itsperpective fundamentally from economic control to the facilitation of private activity, and createthe economic environment that buttresses and sustains this new approach. Tne Government needsto convmince local and foreign investors that it now views the private sector as a positive force fordevelopment. Experience elsewhere in Africa indicates that private sector investment, especiallyforeign direct investnt, is very cautious in its response to policy changes until it is convincedthat reforms are permanent. In Zimbabwe, reforms under the SAP represents a significantdeparture from earlier Government policy. Recent events suggest that the private sector is not yetconviced of the Government's commitment to reform.1s Ihe uncainty caused by the LadAcquisition Act exacerbates this skepticism. It is therefore, essential for the Govemment toconvince, the private sector of its commitment to sustained economic reform. The establishment ofa forum to consult the private sector before making major changes in the economic environment isone way to increas, private sector confidence in the Government's commitment to the reformprogram.
5 One prclar example occred when, under te adjustment program, 14 percent of imports wereintrduced into the 001L in late 1990. The immediat reaction of the prvate sactor was to sokpilimported inputs. Tbis contibuted to a surge in demand for foreign exchange far in excess of thatanticipated by the authorities. The plunge of the stock maket in 1992 is another indication of privatesector uncertainty.
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The Bank Group Strategy
10X. The Bank Group's strategy for fostering private sector development in Zimbabwe is toaddress the major constaints through Its lending program and to expand and deepen Its knowledgeof the second and third-order constraints through its sector work. The Bank's first priority is toeliminate the most binding constraints to Zimbabwe's development, the foreign exchange allocationsystem and the excessive fiscal deficit. To this end it is supporting the Governmen's structuraladjustment program. In addition, Bank staff are conducting an on-going dialogue to eliminateother batriers to private Investment and improving the economic environment with a view tobringing domestic relative prices closer to international relative prices. The intention is not only toimprove the allocation of resources in the short run, but also to help the Government put in placethe policies that will create sustainable, labor-demanding economic growth. Consequendy, theBank will continue to help finance operations in the sectors that increase both labor productivityand social welfare (e.g., health and education). As for constraints that are more sector-specific,the Bank strategy is to deepen its knowledge through sector work and to build the requiredconditionality into its lending program in future years. IFC intends to invest in and financeprojects where the economic environment is conducive to efficient growth.
Bank's Role
Past Approaches by Bank
103. The Bank has approached the development of the private sector through its lendingprogram and its economic work. On the policy side the Bank has carried out extensive economicand sector work to help the Government develop a sustinale growth strategy. Over the pastseven years the Bank has produced two Country Economic Memoranda [Performnnae, Polkes andProspects (1985) and A Strategy for Sustained Growth (1987)1, several sector reports, including AnIndustral Sector Memorandun (1987) and The Capital Goods Sector. Insmnent and IndusrialIssues (1990) and a special report entitled Priae Invesme and Goe=me Policy (1989) andThe Infomnal Sector in Zmbabwe. The Role of Women (1991).
104. Ihe Bank has approved 20 projects in Zimbabwe that support the private sector directly,such as the M curing Rehabilitation Imports Program, the Manufacturing Export PromotionsProject, and the Small Scale Enteprises Project, or indirectly through the building up of theeconomic inrastructure of the country. The latter include two projects in each of the followingareas: power, railways, highways, and urban rehabilitation.
County Assistance Strategy
105. The Bank's strategic objectives in Zimbabwe are to help the Government to promote: (i)implementation of policy changes to support the process of economic restructuring that will benecessary for growth with internal and extenWal macroeconomic equilibrium; (ii) investment ineconomic inaucte to support longterm growth in the productive sectors; and (iCM) thereduction of poverty and inequality through investment in social and economic infrastructure andeconomic policies that support a labor-intensive growth path. Table 3 presents a summary of thelending program and the constraints that each loan will address.
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Lending Program
106. The medium-term adjustment program includes a series of adjustment loans and credits,starting with the Structura Adjustment Program (SAP) of January 1992. The Bank's SAP is abroad-based macro-economic adjustment operation with emphasis on the foreign trade regime,fiscal management, and deregulation. The operation supports the Government's plan to (i)liberalize the allocation of foreign exchange through the expansion of the OGIL and ERS facilities;(ii) reduce the scope of price controls; (iii) streamline retrenchment procedures; (iv) liberalizeregulations in transport and agricultural marketing; and (v) commercialize parastatal activities.Successful implementation of this operation will create the basis for a series of follow-upadjustment operations as well as expanded investment lending activities. Project lending wouldcomplement the adjustment program, providing needed infrastructure and telecommunications, thusincreasing the efficiency of private sector activities.
107. In future investment lending activities, there wiUl be a broader focus, ranging fromeconomic infrastructure to poverty-alleviating activities. While the underlying strategy is tocontiue to support the efficient expansion of transport, energy, and urban development,investments in communal firming, snall entrepreneurial development, family health care,education, and wildlife conservation will constitute a growing share of Bank lending. Virtually allof these projects will directly or indirectly involve or benefit the private sector.
108. In the productive sectors, continued emphasis will be given to agriculture. The efficientprovision of services to smallholders wiUl be a major focus, while attention will also be given tothe expansion of export-oriented activities for the whole sector.
109. The Bank's program in infrastructure is designed to address both the need for moreefficient infrastructure and to reduce the drain on the Government budget that has resulted frompoor management, inadequate maintenance and the continued support in some cases of significantexcess capacity. To a large extent, the poor performance of the sector can be traced to the rangeof restrictive policies discussed previously, including the reliance on public monopolies,administrative determination of prices and tariffs, <md regulatory constraints. The Bank's lendingprogram in the tranport and urban sectors seeks to change the policy environment to permit thefunctioning of market forces, while simultaneously assisting in the rehabilitation of physicalinfrastructure and restructuring of transport enterprises.
110. The First Telecommunications Project, expected by May 1993, will involve bothinstutional reform and acquisition of hardware. Under a recently initiated PPF, the Governmentwill address the mechanics for splitting the PTC into posts and telecoms entities, the design of anappropriate tariff structure, and the formulation of a policy framework (including regulatoryapparatus) for the telecommunications sector. It is important that this effort at institutional andpolicy reform be expedited, and that a program for entry liberalization be formulated to stimulatethe necessary investment for network upgrading and the introduction of business orientedtelecommunications services.
Economc and Sector Work
111. Future ESW is designed to assist the Government in the implementation of the EconomicReform Program and in the preparation of an action program for the time beyond the five yearsthat the implementation of the Program of Economic Reform is expected to take. Key tasks willinclude a comprehensive public expenditure review that will provide a basis for setting budgetarypriorites and a Country Economic Memorandum that wil help the Government deal withimpl_menta-ion issues and strategies for the latter part of the ESAP program and begin to prepare
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for dealing with the longer term issues, including poverty alleviation. In later years we willinclude work on the finmcial sector and a study on the supply response to the adjustment program.In addition, support for key productive, infrastructure and human resource sectors will be neededto increase productivity in the economy. These include forestry (which also has importantenvironmental aspects), rural water and sanitation and vocational education.
IFC's Role
112. IFC has supported private sector development through loans, equity positions, mobilizingadditional resources, and facilitating the flow of foreign investment and technical expertise. ITeCorporation has more investments in Zimbabwe than in any other country in Sub-Saharan Africa,with gross investments (mcluding syndication) of US$275 million in 20 companies and total projectcosts of U$500 million. IPC's net investment portfolio as of September 30, 1992 was aboutUS$152 million (JS$146.7 million in loans and US$5.2 million in equity). None of thisinvestment involved any new foreign investor participation. The Corporation has three projects inthe high probability pipeline (with an esdmated total cost of U$29 million of which IFC has beenrequested to finance US$11 million). There are also other projects under consideration.113. IFC has also played a role in the development of the domestic capital market. Itsupported the development of UDC, a hire-purchase and leasing company, through equityinvestments and lines of credit. UDC subsequently promoted and now manages leasing companiesin Malawi and Botswana. IFC also assisted the First Merchant Bank of Zimbabwe through equityinvestments.
114. The African Project Development Facility (APDF) which opened a regional office inHarare in FY91 and the Africa Enterprise Fund (AEF) which became opeaional in FY89 havebeen addressing the needs of sm'aller, mainly indigenous, companies. The APDF assists smallcompanies in project development and project documents prepation for outside finning. TheAEi, an IFC subsidiary, provides financing for projects that are too small for direct IFCfinancing. AEF has so far helped financed two projects and there are additional projects in thepipeline.
Potentifor Expanded Role
115. The potential for an expanded IFC role in Zimbabwe is critically linked to the pace andsuccess of the reform program. IFC's exposure in Zimbabwe has been growing rapidly and Is nowrelatively large. There will be more risk in the future, in the short term due to the drought and inthe longer term to the impact the reforms will have on previously sheltered, domestic business. Asagainst this, the new liberalized environment should offer expanded business opportunities andgreater potential for foreign investors to play a role. Investment opportunities are likely to befocussed on mining, tourism, export-oriented manufcuing enterprises, the capital markets andenterprise restructuring, as domestic firms adapt to a more open business environment.
116. Traditionally IFC's operations in Zimbabwe largely involved lending, rather than equityparticipation. They have involved some syndication and mobilization of finance, proportionatelysomewhat less than is usual for IFC as a whole, though possibly more than is usual in the Africancontext. Recently operations have involved the provision of credit and agency lines to theestablished commercial banks, as well as other operations in the financW markets.
117. Depending on the Government's commitment to and the pace of reform, the changedbalance of risk and reward for foreign investos may also offer a changed role for IEC. Eqity
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stakes In venres may become feasible and attractive. IFC may also have an increased role Insyndication and mobilization of finance, if other forelgn lenders and investors are convinced thatthe reforms will stick, especially those relating to controls on capital and dividend flows.
118. Zimbabwe is rich in mineral resources, and possibilities exist for IFC participation. Mostmials are for export, and mineral developments are therefore partly Insulated fromdevelopments in the domestic economy. Provided that the Government establishes an appropriateoperating envionment, with fieedom of dividend and capital remittance flows and non-interferencein marketg arrangements, this sector offers the earliest possibilities for IFC to expand its role,and bring other foreign investors and lenders.
119. The program of interest rate liberalization and the elimination of the subsidized foreignexchange scheme, would mean that IFC and other foreign lenders would also be able to offerincreasing sophistication in the mix of foreign and domestic currency-based financial srumentsthat the private sector could use (currency hedges, convertibles, etc.). IFC could also be involvedin the stimulation of competition in the bankdng sector, and the continuing need to provide forms offinance ta reach small-scale entrepreneurs, through further involvement in establishing newfinancial institutions. Possibilities might include new banks, leasing and factoring, securitesbrokerage firms and collective investment vehicles such as mutual funds. Direct involvement inthe encou of indigenous small-scale business will continue through the Africa EnterpriseFund and the Afiica Project Development Facility. The recent opening of an IFC RegionalMission in Zimbabwe wil help in this regard.
120. If the Government adopts privatization onto the reform agenda IFC could play anadvisory role, through its Corporate Finance Services Department; or, alternatively, may be ableto take investment positions. ITis is also the case if private provision of infrastructural services iscontemplated; IFC's recent reorganization resulted in the creation of a specialist InrastructreDepartment and there has been a sharp increase in both the direct financing being provided by theCorporation for such projects and the non-recourse financing being mobilized for such investments.
121. As far as Economic and Sector Work is concerned, IFC will contnue to provide inputsbased on its direct experience at the enterprise level. It will also promote reforms by encouragingthe Government to adopt and maintain ground nrles that are fair to both private sector andGovernment, and by demonstrating through operations that these rules are workable.
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Table 3Planned Impact of Lending Program on Constraints to Private Sector Development
F .n x lvest- Pdo Labo _ Coay Regu- Sta ccess to Teecom InA- Crdit bueoment Contob Laws Tax lations. Moo. lad nica sre nal
Controls Til. losCapita_oveiTov
SAff '-x ' = x x x x x x
Pow DMd. (Y) x x
U*an Trans. (FY93) x
Cou n nd (FY93) x x
Teeom (FY93) . x x
Ag. Saerie (Y94) x x
S M+) x x x x x x x x
eW I (FY95) x x x
Wldl Corner. (FY95)
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Table 4Matrix of Policy Reforms
Polky Refonn Urgeny InliationaDlon
(1) Foreign Exchange Liberalization Most Urgent Immediately/2 years
Adoption of a market-clearing exchangerate and elimination of the foreignexchange allocation system.
(2) Hscal Defidt Reduction Most Urgent Immediately/2 years
Reduction of fiscal deficit to 5% of GDPby 1995 mainly through elimination ofsubsidies to public enteprises; retrench-ment of civil servants; wage adjustments,and increased cost recovery in public ser-vices.
(3) Reform/Divestiture of State OwnedEntetpris (SOEs)
(a) To reduce fscal drain Most Urgent Immediatelyl2 years
(i) Commercial enterprises: divestGov'ts participation in profitable onesand liquidate unviable ones.
(Hi) Public utts run as statutory mo-nopolies: accelerate commercializationof SOEs to promote cost-efficientprovision of services.
(b) To improve derciency Less Urgent Iminediatelyl2-4 years
Liberalize entry and, after formulatngappropriate sector-specific reguatoryframework, either privatize or run onfully commercial basis.
(4) Investment decontrol Most Urgent Immediately after FOREX
Remove all procedures for vetting invest- liberaliaton/daysment projects and transform ZIC into aninvestment promotion center.
(5) LIbertaliaon of Capital Movements
(a) Dividend Remittances Urgent Imnediately/months
Remove all exchange controlrestrictions on dividends and profitremittances for new investments.
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(b) Bloced & Surplus Fus Less Urgent Contingent on (1) and (2)
Release blocked and surplus funds /one yeargradually to moderate their possibleimapact on exchange rate and overalleconomic stability.
(c) Other Less Urgent Contingent ou (1) and (2)
Remove all exchange controls on /monthsdividends and profit remittances for allinvestments, regardless of vintage.
(6) Rationaliation of Import Tarffs Less Urgent Contingent on FOREX lib-
Reduce the Import surtax to 10%, the eralization/2-3 yearsaverage tariff to 14%, and the dispersion oftariffs.
(7) Finandal Mrkets Less Urgent Within 2 years/1-2 years
Rely on interest rates rather than on directcontrols to allocate credit; encourageuniversal baking and elimine statUtorybarriers to entry of new baks.
(8) Labor Rgulations Less Urgent Within 2 yearslmonAbs
Amend Statutory Instrument 252 to restorereliance on collective bargaining; devolvepower to resolve all labor disputes toemployment councils.
(9) Regultions affecting SSFs Urgent Within one yearl2-3 years
Relax licensing restrictions on hawkdng andstreet vending; review and amend Factoriesand Works Act; simplify local council by-laws and other regulations.
(10) Company Tax Less Urgent Within 3 years/1-2 years
Streamline tax code and reduce bias infavor of larger, more capital-intensivefirms. Reduce company tax and existngdeductions and allowances.