The Impact of the International Economic Crisis on Tanzania

The Impact of the International Economic Crisis on Tanzania Dr. Paolo Zacchia, Lead Economist, World Bank 1 April 2009 THE CONTEXT: ECONOMIC DEVELOPMENTS SINCE 2000 Tanzania has sustained commendable growth of around 7 percent per year since 2000. In 2007, the economy is estimated to have grown by slightly above 7 percent. Notwithstanding the worsening international environment in the second half of 2008, favorable domestic factors such as good rains and continued economic momentum have contributed to underpin robust economic growth. Overall, Tanzania has maintained a good record of macro-economic stability. Fiscal policy, while strongly expansionary since 2000 on the back of a large increase in foreign aid, has remained broadly on a prudent track, sustained by particularly strong domestic revenue performance coupled with large debt relief. The underlying increase in public expenditures has allowed a significant expansion of service delivery in both the infrastructure and social sectors, albeit administrative and miscellaneous expenditures have also been rising fast. Inflation, however, has been above the government target of 5 percent since 2004. It has significantly accelerated in 2007 and 2008 as international commodity inflation added to domestic liquidity pressures, and it hovered at around 13 percent in the last quarter of 2008 and early 2009. The HBS indicated an even higher price increase for households over the 2001-2007 period. The real effective exchange rate, which was overvalued at the beginning of the decade, has converged to a more competitive level. The external position of Tanzania remained strong, with increasing official 1 The paper also benefited from inputs from Josaphat Kweka, Senior Economist, World Bank Tanzania. However, the views expressed in this paper do not reflect an official position of the World Bank, or of its Board of directors. 1

reserves covering around 4-5 months of imports. Underlying this trend was, however, a continued widening of the current account balance (excluding grants), which moved from around 4 percent of GDP to around 11 percent over the last four years, driven mainly by higher imports. The current account deficit is no longer fully covered by the amount of foreign aid, and is more dependent on FDI flows. Table 1. Key Macroeconomic Indicators (percent unless otherwise specified) 2000 2001 2002 2003 2004 2005 2006 2007 2008 Output and Prices GDP growth at constant prices 4.9 6.0 7.2 6.9 7.8 7.4 6.7 7.1 7.0 CPI Annual Inflation 5.9 5.2 4.3 5.4 4.7 5.0 7.2 7.0 10.3 Government Finances (FY) Revenue to GDP 10.5 10.8 10.8 11.1 11.6 11.8 12.5 14.1 16.0 Expenditure to GDP 15.2 15.2 16.5 18.6 20.7 21.7 22.8 23.0 23.0 Overall Deficit to GDP -1.2-0.7-0.9-2.1-3.0-3.6-5.5-4.9-1.6 Deficit before Grants to GDP -4.7-4.4-5.7-7.6-9.1-9.9-10.3-8.9-7.0 Money M2 to GDP 13.0 13.0 14.0 14.0 14.0 16.0 17.0 18.0 19.0 Balance of payments Export to GDP 12.8 17.0 17.6 18.5 20.5 20.8 22.8 21.9 24.1 Current Account Balance to GDP -5.3-4.8-7.1-4.8-3.8-4.3-7.7-10.6-11.2 Net reserves (months of imports) 4.9 5.3 5.9 6.6 5.9 5.1 3.9 3.6 4.7 The most dynamic sectors since 2000 have been mining, construction, and public administration. The manufacturing, transport, tourism, and financial sectors have also shown solid growth (see Table 2). The World Bank 2007 Country Economic Memorandum (CEM) estimated that three quarters of the increase in the GDP growth rate, from less than 4 percent in the late 1990s to around 7 percent in the 2

first half of the 2000s, could be attributed to higher government spending, fueled to a significant extent by larger aid flows. Even so, the private sector still contributes around half of the overall GDP growth rate, and Tanzania s share of world exports has been increasing steadily since the mid-90s, mainly on the back of a large growth in gold exports, although manufacturing exports have also experienced significant dynamism. Table 2. Growth Rates of Real GDP at Market Prices: 2000-2007 2000 2001 2002 2003 2004 2005 2006 2007 Average 2000-2007 Agriculture, Hunting and Forestry 4.5 4.9 4.9 3.1 5.9 4.3 3.8 4.0 4.4 Fishing 2.9 4.8 6.8 6.0 6.7 6.0 5.0 4.5 5.3 Mining and quarrying 14.3 13.9 16.9 17.1 16.0 16.1 15.6 10.7 15.1 Manufacturing 4.8 5.0 7.5 9.0 9.4 9.6 8.5 8.7 7.8 Electricity, gas 6.2 5.9 6.2 7.2 7.5 9.4-1.9 10.9 6.4 Construction 0.8 7.6 11.9 13.8 13.0 10.1 9.5 9.7 9.5 Hotels and restaurants 4.1 4.8 6.4 3.2 3.6 5.6 4.3 4.4 4.6 Transport 4.3 4.9 5.9 5.0 8.6 6.7 5.3 6.5 5.9 Communications 5.6 8.7 10.4 15.6 17.4 18.8 19.2 20.1 14.5 Financial intermediation 3.9 6.9 10.1 10.7 8.3 10.8 11.4 10.2 9.0 Real estate and business services 4.9 4.2 7.1 6.5 6.8 7.5 7.3 7.0 6.4 Public administration 10.7 10.5 9.2 9.6 13.6 11.4 6.5 6.7 9.8 Education 4.0 11.4 7.0 2.8 4.0 4.0 5.0 5.5 5.5 Health 5.1 5.6 8.6 8.7 7.8 8.1 8.5 8.8 7.7 Total GDP at market price 4.9 6.0 7.2 6.9 7.8 7.4 6.7 7.1 6.8 Source: Government of the United Republic of Tanzania, the President s Office, Planning Commission 3

Overall, there are signs of an incipient structural transformation, albeit slow and concentrated in a few urban areas. Key constraints in infrastructure and in the business environment are not being removed sufficiently fast, and in some areas, such as the port operation or licensing and registration regulations, the country has been experiencing a policy reversal in recent years. Accumulation of modern technology and skills is proceeding very gradually, with a large part of the population still employed in low productivity agriculture, requiring sustained efforts to improve education, especially at the secondary and tertiary levels. The growth in public spending may not be sustained at the same level. There is a broad consensus that the country needs a more operational shared-growth strategy, built on the country s comparative and competitive advantages, which could help to consistently prioritize and screen economic policy and public investment. In the near term, sustained high growth will have to rely more on sectors such as transport and logistics, tourism and natural resources, and a more dynamic agriculture sector. Qualified human resources required for such growth will be of critical importance. Although agricultural GDP is reported to have been growing at around 4-5 percent per year, the data on rural income growth and productive assets from the Household Budget Survey suggest that income generation in rural areas has stagnated. Yields of staple crops, a mainstay of the livelihood for the predominantly poor subsistence farmers, appear to have been flat or declining, with agricultural growth primarily driven by extension of cultivated areas, along with shifts in the composition of crop production. In the cash crop sector, the snail-pace reform of Crop Boards appears to have masked a surge of new modalities for complex licensing regulations, heavy taxation, and anti-competitive practices which hinder profitability, especially for the smaller farmers and businesses. The natural resource sector, including tourism, mining, forestry, and fisheries, is a significant supplement to the subsistence for a majority of Tanzanians, and it fosters the environment on which much of the population s health depends, and provides the basis for much of the economic non-farm growth in the formal and informal economy. Natural resources are positively contributing to economic output, and are expected to be a growing source of income, generating exports from traditional activities such as forestry, fisheries, mining, and tourism. However, recent evidence indicates shortfalls in governance and law enforcement leading to unsustainable use of these resources that undermines shared economic growth in this sector. 4

Over the past five to six years, the government has made significant efforts to improve the business environment through several reform programs, including the Business Environment Strengthening Program (BEST), a Tax Modernization Plan (TMP), and the Second Generation Financial Sector Reform. These cover: (i) labor reform; (ii) land reform; (iii) business registration and licensing reform; (iv) tax administration reform; (v) regulatory reform and (vi) financial sector reform. While tax and financial sector reforms have proceeded positively, business environment reforms have lagged in implementation and consistency, and their impact to date has been marginal. Also, some recent government measures with respect to market regulations, foreign direct investment, and the minimum wage, appear at odds with a conducive and reliable environment for the private sector. Tanzania ranks low in terms of its business environment, being ranked 127 in the 2009 Cost of Doing Business (CoDB) indicators. Tanzania actually dropped two places in the CoDB rankings this year, reflecting a slack in PSD reforms, after being one of the world s ten top reformers in 2006. The recent Investment Climate Assessment reveals that while large firms are faring relatively well in terms of productivity, there is a large discrepancy with smaller-sized firms compared to neighboring countries, indicating that excessive regulation might directly favor larger and better connected firms. The World Bank 2009 Investment Climate Assessment report reveals that the major constraint to formal firms is energy. Overall, infrastructure bottlenecks are still a serious constraint to private investment in Tanzania, and while some sectors, such as road and energy, are gradually improving their performance and institutional setup, others, such as the port, railways, and water sectors, are still dysfunctional. The weak capacity of government to handle PPP transactions in an efficient and transparent way has limited the contribution of the private sector to the finance and management of infrastructure in Tanzania. Continued improvement in the sector and the PPP policy framework will be critical to unlock the situation. Tanzania has made considerable progress in the development of its financial sector in recent years, albeit most enterprises - as elsewhere - still finance investment primarily through retained earnings (68 5

percent of new investment). The coverage of banking services is still low, with 10 percent of the population reporting operating a bank account in 2007, against 6.4 percent in 2000. The mainstreaming of micro-credit institutions in the financial sector is a positive development, and the microfinance institutions are expected to play an important role in providing access to credit for the poor. The Government is preparing a rural finance strategy, coordinated by the Financial Sector Deepening Trust. A new mortgage and leasing bill approved this year should contribute to the development of the sector. The macroeconomic policy mix to support growth and poverty reduction has been less than fully successful, as it has supported a growth pattern skewed towards public expenditures and the absorption of large external liquidity flows in capital intensive sectors, such as mining and construction. The fast aggregate demand expansion has had a tendency to overtake the country s supply response, still crippled by infrastructure and regulatory bottlenecks, resulting in higher prices that have curtailed real household consumption and ultimately dimmed the poverty impact of economic growth. IMPACT OF THE INTERNATIONAL CRISIS AND OUTLOOK The country is now facing the impact of the world economic crisis, on top of the just-described medium-term issues. Tanzania is starting to be affected through the export channel - mainly tourism, regional manufacturing exports, cash crops, and natural resources - and by lower capital flows - from private and possibly official assistance sources. However, overall, at the macro-economic level, Tanzania is likely to be on the right side of the commodity price shocks because of the structure of its trade balance, which is heavily influenced by oil on the import side and gold on the export side. The foreign exchange reserves of the Bank of Tanzania remain at a comfortable level (US$2.7 billion, about 5 months of imports). Tanzanian residents have US$1.6 billions of foreign currency deposits and commercial banks have another US$600 million in net foreign. 6

Figure 1. Gold prices: the exception Gold Pr $/Euro 1100 1000 900 800 700 600 500 400 Jan-05 Jan-06 Jan-07 Jan-08 Jan-09 1.60 1.55 1.50 1.45 1.40 1.35 1.30 1.25 1.20 1.15 Except for an ultimate decline in growth, Macroeconomic fundamentals are projected to generally to stay on course. Overall, these shocks are expected to reduce GDP growth to around 4 to 5 percent in 2009.[1] Growth is projected to recover its pre-crisis level in about two years (Table 3). The BOP deficit might be in the order of US$300 million, which would remain relatively manageable given the current level of reserves. On the fiscal side, domestic revenues may still increase slightly in real terms, but compared to post-crisis projections, current forecast points to a revenue shortfall ranging between US$250 and US$450 million. Prudent fiscal policies in recent years provide scope for relaxing the limit of zero net domestic financing and allowing the budget deficit to widen. Table 3: Macroeconomic Projections (in percent) Base case scenario 1 2008 2009 2010 GDP Growth (at 2001 constant prices) 7.0 5.21 6.7 Annual Inflation (CPI ) 10.3 5.9 8.1 Revenue to GDP ratio 16.0 15.2 15.5 Current account to GDP ratio -11.2-8.9-9.7 Extreme case scenario 2008 2009 2010 GDP Growth (at 2001 constant prices) 7.0 3.2 5.8 Annual Inflation (CPI ) 10.3 11.7 9.5 Revenue to GDP ratio 16.0 15.3 15.6 Current account to GDP ratio -11.2-4.7-6.0 1 Projections congruent with IMF s estimates (as of March 31, 2009). Source: Macroeconomic model for Tanzania (Macmod) 7

However, awareness of the problems in rich countries is causing some concern and has led the Central Bank to issue a clear statement regarding the soundness and stability of the financial sector to avoid overly alarmist rhetoric that could distort confidence. However, developments on the ground in different sectors of the economy have indicated Tanzania is already being affected by the crisis. Private capital flows are expected to shrink; even more considerably if one factor in the earlier government's intention to follow Ghana and Gabon in issuing a sovereign bond to finance infrastructure spending. As financial systems in rich countries have weakened the financial sector in Tanzania has become stronger. Tanzania s financial sector is not exposed directly to the assets which have triggered the financial crisis, and its banks are mostly sound. Although the systemic risk in the banking system is low, the fact that the branches of a number of major international banks affected by the crisis operate in Tanzania entails credit getting tighter for the private sector. The Government of Tanzania has limited the issuing of treasury bills to mopping up operations and the return of government backed securities in rich countries has fallen. This has further encouraged Banks in Tanzania to look to local sources for investment opportunities. Similarly, as the credit crunch has hit in rich countries, banks in markets such as Tanzania have to look to borrow from local sources. The result is that competition is forcing up savings rates in Tanzania (increased from less than 5% in 2007 to over 12% in October 2008 in some banks), while at the same time lending rates are falling (from 24% to about 18% respectively). Credit to the private sector has been growing at very high rates, see figure 2 (albeit from an initially low base) and this does not appear to have been perturbed by the credit crunch in rich countries. In the first 9 months of 2008 credit grew at a rate of 48% while in the first 10 months the rate of increase was 52%. 8

Fig. 2: Private domestic credit (net) 4000 3500 3000 2500 Bill TZS 2000 1500 1000 500 0 199819992000200120022003200420052006 2007 J F M A M J J A S O N D 2008 J F M A M J J Little discernible impact on trade as exports has risen favorably in recent years. Part of this reflects the rapid increase in the price of some of the products exported by Tanzania, especially gold. Nevertheless, other exports have also been increasing. This trend has continued in 2008 with exports over the first 10 months of the year 46 per cent higher than in the corresponding period in 2007. 9

Fig.3: Monthly exports of Tanzania (Tsh Bill) 350.00 Total Export 300.00 250.00 200.00 150.00 100.00 50.00 0.00 Total export - gold and precious stones 2004 1 2 3 4 5 6 7 8 9 1011 12 2005 1 2 3 4 5 6 7 8 9 1011 12 2006 1 2 3 4 5 6 7 8 9 1011 12 2007 1 2 3 4 5 6 7 8 9 101112 2008 1 2 3 4 5 6 7 8 9 10 The main linkages from the rich countries to low income countries are through (i) a demand effect that may dampen exports to rich markets (ii) a competitiveness effect if the crisis leads to exchange rate depreciations in the rich countries. However, in recent months the Tanzanian shilling has been depreciating against the Euro and the dollar. Hence, it appears that the income effect will be the principal route through which the recession in rich countries will impact on low income countries such as Tanzania. In this light we look at the structure of Tanzania s exports to crudely assess the vulnerability of Tanzania to a trade shock that results from a recession centered upon rich countries. In terms of the overall structure of exports there have been some significant changes over the short period since 2000. By 2006 the importance of the EU and other OECD markets as a destination for Tanzanian exports had shrunk appreciably from over two-thirds of the total in 2000 to less than 45% in 2006. Hence south-south trade, although not exports to India, have been the main driver of export growth in the early half of this decade. To this extent Tanzania is less vulnerable now to a downturn that is focused on the OECD countries than it was just 6 or so years ago. 10

Fig. 4: Normalized Measure of Exposure to Country Shocks A more sophisticated analysis links the trade structure of exporters such as Tanzania to predicted changes in GDP in overseas markets. Previous work has shown that it is not only the variance of GDP growth in overseas markets that affects an exporters vulnerability to downturns but also extent to which GDP in key overseas markets moves together (the covariance). 2 This analysis suggests that in terms of exposure to shocks in overseas markets Tanzania is somewhat in the middle of the range of developing countries (see figure 4). An important feature of the analysis is that the measure of exposure to country shocks for Tanzania is dominated by the covariance term and only 10% of exposure is explained by the variance. This suggests that Tanzania is unlikely to be greatly affected by a negative shock that is specific to its main export market but is much more vulnerable to a shock that is contagious across its export markets. This provides a strong argument for further diversification of Tanzania s exports across markets. 2 We employ the measure developed by Jansen, Lennon and Piermartini (2008), the ECSS (Country exposure to specific shocks) indicator. The ECSS measures the volatility of the export portfolio by looking at the variance and the covariance of the trade partners GDPs growth rate. Both variance and covariance components of each partner are weighted by their share in the exporter s basket. Mathematically, the volatility of the export portfolio of an exporter i equals: ECSS= (x ij /x i ) 2 VAR (g j ) + (x ij /x i ) (x ik /x k ) COV (g k g k ). Therefore, the exporting country under analysis can reduce its external risk by choosing either partners with less volatile growth rate or partners whose economic cycles are less or negatively correlated. In order to construct a measure of future demand, we use the forecasted GDP growth rate (from 2009 until 2013), and we compare the measure among a set of 60 developing countries. For simplicity of presentation, we normalize the variable, such that the ECSS ranges between 0 and 100. 11

Interviews with a small number of exporters and commercial banks have raised the issue of the vulnerability of Tanzania to a slowdown in demand for basic commodity exports such as coffee and cotton. It appears that falling commodity prices have had a substantial impact with one Bank reporting that the price of cotton has fallen to an extent that some borrowers can no longer service their loans. The breakdown of exports by market and by key commodity in the tables above shows that exports to the OECD markets are indeed dominated by these products. On the other hand, exports to China (with the exception of cotton) and sub-saharan Africa comprise little of these commodity exports. Hence, an important response to the recession in OECD countries is search for alternative markets for these products. Here there is an important role for government institutions such as the Board of External Trade as well as MITM in helping to identify market opportunities and provide information to exporters about these market opportunities (that exporters acting individually may find difficult and expensive to obtain). Table 4: Share of Key Export commodities by Markets: 2000 Fish & Edible fruit Coffee, tea, Precious TOTAL crustacean and nuts spices. Tobacco Cotton. stones Other All 24.61 6.49 17.03 7.89 6.15 11.00 26.83 100 China 4.56 0.00 1.17 0.00 21.96 0.17 72.13 100 India 0.00 65.19 0.91 0.00 7.05 21.97 4.88 100 SSA 3.23 1.00 1.36 0.76 5.21 1.61 86.82 100 EU25 39.84 0.00 20.07 12.51 2.69 9.99 14.90 100 Other OECD 13.37 0.05 27.45 4.70 1.14 18.70 34.59 100 Other 100 Developing 10.98 0.10 15.23 4.28 23.60 4.43 41.38 Source: Computed from TRA Customs data Table 5: Share of Key Export commodities by Markets: 2006 Edible TOTAL Fish & crustacean fruit and nuts Coffee, tea, spices. Tobacco Cotton. precious stone Other All 11.92 3.95 7.25 6.97 6.26 18.75 44.90 100 China 0.36 0.00 0.02 0.00 24.02 0.02 75.58 100 India 0.00 45.43 5.95 0.00 1.37 11.57 35.68 100 SSA 0.51 0.85 2.17 1.04 2.41 9.74 83.28 100 EU25 35.42 1.43 13.07 13.48 2.53 7.32 26.74 100 Other OECD 5.37 3.25 13.43 6.55 3.11 37.01 31.28 100 Other 100 Developing 6.07 0.06 3.09 9.50 10.25 37.53 33.51 Source: Computed from TRA Customs data 12

It is also important to consider services exports, especially tourism. There is some indication that hotel bookings in some tourist areas (about 30%) have been cancelled and that hotels have to adjust to unused capacity. Again, this suggests a need to look for alternative markets for tourists to diversify away from those from the OECD markets. The sub-regional context is more problematic. The countries most affected in Eastern Southern Africa are the Resources dependent economies of Zambia (copper), Angola (oil), DRC (minerals), South Sudan (oil), and the countries that are highly FDI or remittances dependent, such as South Africa (30-40% devaluation of the Rand in six months), and Kenya. The social impact of the slowdown, if uniformly distributed, is estimated at worst to be an additional 1 percent in the number of poor, as well as increased poverty depth. However, the social impact is expected to be much larger as shocks are likely to be concentrated and affect some categories disproportionally. In the cash crop sector, coffee, cotton, and cashews are produced by a large number of small farmers, totaling some 1.2 million households. The processing of these commodities is made by larger firms that employ around 40,000 formal employees. At the same time, while many of the small cash farmers also grow staple foods, estate workers, landless agricultural laborers, and formal employees may have little fallback options if their main livelihood disappears. Tourism employs around 300,000 persons, while non-food-related manufacturing employs another 45,000 persons. These groups are predominantly urban workers, and a reduction in employment would be highly visible. While the poorest subsistence farmers would not be directly affected by the export slump, they might suffer from lower personal transfers and government expenditures. Subsistence farmers are also vulnerable to climatic shocks, and already this year s short rain season, accounting for around 25 percent of maize production, has been erratic. A further rain deficit in the long rain season could create major food shocks for most of the poor. 13

CONCLUDING REMARKS The paper has discussed the impact on Tanzania of the current financial crisis/recession that is gripping rich countries by broadly drawing examining the macroeconomic behavior and medium term economic outlook. The paper noted that the falling commodity prices and the recent depreciation of Tanzanian Shilling against the Euro and the dollar (since October 2008) suggest that the income effect will be the principal route through which the recession in rich countries may impact Tanzania s trade performance. Some further fiscal expansion could be envisaged in the 2009/10 budget under preparation to accommodate revenue shortfall. However, as stressed at the conclusion of the recent IMF review mission under PSI, any planned increased spending, notably in infrastructure or social protection, should be financed on a sustainable basis and geared towards fostering long term growth potential or cushioning the most vulnerable segments of the population from the impact of the crisis. As for many developing countries that have achieved reasonably good economic performance, the priorities in fiscal policy response are to maintain the gains of macroeconomic stabilization, while trying to implement a countercyclical policy in degree proportional to the severity of the shock. In this context, it will be critical to protect longer-term growth and development objectives by protecting core infrastructure and human development spending, while extra expenditures will be needed for protecting the vulnerable through enhanced social safety nets. The Tanzanian government s emerging strategy to deal with the impact of the crisis and of a possible drought year is to: (i) protect public investment - especially in infrastructure - to sustain medium-term prospects for shared-growth; (ii) try to support employment by facilitating credit guarantees by commercial banks to firms in distress; (iii) support food security through an extension and reform of the fertilizer subsidy scheme, and through a more strategic use of the National Grain Reserve stocks. Given that Tanzania is not facing a major macroeconomic slump, but rather a growth slowdown concentrated in selected sub-sectors, a key to the success of a fiscal response will be the targeting, modalities, and costs of the selected interventions. In particular, support to affected economic activity should clearly target employment protection, rather than transferring excessive private sector business 14

risk to the public sector. Protection of public investment should target labor-intensive public works, possibly with a geographic targeting towards the area most severely affected. A good example for countries like Tanzania would be the Korean public works program set up in the wake of the Asian economic crisis in 1997. It was characterized by attention to design and detail. The wage rate in such programs was set below the market wage but slightly above minimum wage, to allow for self-selection of the neediest. Project selection was carefully done assessing labor intensity of each task and prioritizing ones with high labor content. Fifty percent of projects were community-selected (demand-driven) and 50% selected by line departments (supply-driven). Finally, Exceptional attention was paid to maintaining high quality of assets created. [1] See IMF Press Release No. 09/13, March 31, 2009, and government s estimates (Macmod) which project GDP growth in 2009 at 5.2 percent under the base scenario and 3.2 percent under a the lower case scenario. 15