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• Document Type: CREST
• Collection: General CIA Records
• Document Number (FOIA) /ESDN (CREST): CIA-RDP86T01017R000707290001-5
• Release Decision: RIPPUB
• Original Classification: S
• Document Page Count: 12
• Document Creation Date: January 12, 2017
• Document Release Date: March 8, 2011
• Sequence Number: 1
• Publication Date: July 8, 1986
• Content Type: MEMO

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DIRECTORATE OF INTELLIGENCE OCR 3
8 July 1986 P&PD '
Zambia? Tampering With Economic Reform ~~ 25X1
Summary
In our judgment, President Kaunda may be setting the stage
to backslide on economic reform by tampering with Zambia's
foreign exchange auction system. A review of reporting by the
US Embassy, the IMF, and the press indicates that the auction,
which has reduced the rate of exchange, is the centerpiece of a
number of reform measures designed to help the economy adjust
to a long-term deterioration in the country's terms of trade.
The steep devaluation of Zambia's currency and consequent
inflation resulting from the auction have spurred widespread
rkrnact;r neoosition to its continuation
politically threatened at this juncture, the auction's
unpopularity--coupled with Kaunda's fears of violent opposition
and his belief that the auction is contributing to poverty--is
causing him to backtrack somewhat. Recently, Kaunda ousted the
major proponents of the auction as part of a larger cabinet
shuffle. The government also has diverted foreign exchange
from debt service and other foreign payments to support the
exchange rate, according to US Embassy reporting, and has
appointed a tariff commission that will likely recommend ways
during the next few months to limit the demand for foreign
exchange.
This memorandum was requested by Raymond Smith, Deputy Director, Office of
Southern African Affairs, Department of State. The paper was written by
_ _ _ _ .. ~.~ _ r nt__! __.- ..-J
Latin American Analysis. This paper was coordinated with the Directorate
of Operations. Questions and Comments are welcome and may be directed to
the Chief, Africa Division, ALA
ALA M 86-20032
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CF('RET
We believe that any desire by Kaunda to end the auction
probably is tempered by his concern that the IMF and major
Western aid donors that have supported it might cut their
aid. Leaving the auction intact but limiting demand for
foreign exchange
Kaunda's goal of boosting the exchange raze Lo aL ieas~
s.20 per kwacha from the present x.14. We believe, however,
that doing so would undermine prospects for improving the
competitiveness of Zambian products on international markets.
In our judgment, this would reduce long-term prospects for
economic growth, which depend heavily on Zambia's ability to
increase exports.
Centerpiece of Reform
President Kaunda's announcement last October of a foreign exchange
auction--conceived as the centerpiece of an IMF-supported austerity
program--marked a major turning point in the government's effort to come
to terms with Zambia's decade-long economic decline, according to US
Embassy reporting. The auction has cut the dollar value of the kwacha by
about 70 percent, according to the Embassy, reducing the exchange rate of
Zambia's currency be roughly the same amount as the deterioration in
Zambia's trade position. Embassy and IMF reporting indicates that over
time the devaluation should improve the competitive op sition on foreign
markets of agricultural and manufacturing exports.
Zambia's economic decline mainly stems from a sharp deterioration in
its terms of trade and a fall in the production of copper, which
historically has accounted for over 90 percent of exports. Industry data
indicate that Zambian copper production has declined by one-third since it
peaked in 1976. The production decline has been compounded by falling
world copper prices and rising import prices, thereby reducing the foreign
purchasing power of each ton of copper by three-fourths over the same
period. (See A endix I for a fuller discussion of Zambia's copper
problems.l
Zambia's previous system of allocating foreign exchange through
government agencies and of determining the value of the exchange rate by
linking it to a basket of foreign currencies had led to corruption and a
major black market in foreign exchange, according to press and US Embassy
reporting. The government had feared that the steep devaluation that
would follow an auction would cause violent protests by military, labor,
and other groups. Embassy reporting indicates that, aside from the IMF
and major donors, such as the United States, only the head of the Central
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The 1~breign Exchange Auction
The auction {evolves a four stags process:
-- Importsrs?subm{t requests to commerc{ai banks, {saclud{ng
{formation on amounts wanted, purpose, and kwacha/dollar
b{d rate.
-- The commsra{a1 banks set aside the requ{red amounts of
kwacha from the requesters' accounts and send the bids to
the auct{on secrstar{at.
__ Th,e secretar{at arranges the biaLs from h{ghest to lowest anal
at 5:00 P.Y. on 1~}ida?/ .of each week, aLlocatss the available
fora{gn sschange 6e8~nn{ng w{th the h{yhest bidder.
-- The secrstar{at then sets the exchange rats for all succesafuL
b{ddsrs Jor any 9{vsn weak at the rate that exhausts tlw amount
of fora{gn ssahange on offer for that week.
i
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S E C R E T
Bank, David Phiri, and Finance Minister Luke Mwananshiku were in favor of
the auction.
In our judgment, Kaunda's reluctant decision to take their advice and
initiate the foreign exchange auction reflected his tacit recognition that
the decline in copper prices and production was likely to be permanent.
In past years, massive borrowing from foreign suppliers and banks,
including seven loans from the IMF between the initial falloff in copper
production in 1976 and the start of the auction, was intended mainly to
sustain the economy until world copper prices recovered. In our judgment,
the $4 to $5 billion foreign debt that accrued during this period left
Lusaka in a much tougher economic position than it would have faced if the
government had decided early on to make the decline in living standards
keep pace with the deterioration in trade.
Government Backtracking
Opposition to the auction--particularly the lack of government
control over the exchange rate and the rate of inflation in excess of 50
percent--has increased within the regime, and we believe has led to a
softening of President Kaunda's support for it. Less than three weeks
after the first auction,
government officials wanted an immediate halt to the auction ecause o
the sharp devaluation of the currency. US Embassy reporting indicates
that members of Parliament have questioned the wisdom of the auction and
the resulting price increases. They believe the auction has forced the
price of essential goods too high and are worried about the possibility of
serious domestic unrest if prices are not reduced. Aside from the
auction, the parliamentarians believe that the government's decision last
January to reduce the fertilizer subsidy would further increase the costs
of corn production in Zambia. In early February, Parliament passed a
non-binding motion to roll back the price of fertilizer by nearly half to
its 1985 subsidized price. ,(Appendix II explores domestic reaction to the
auction system in detail.)
Much of the criticism of the auction apparently is by individuals in
the party and government who had profitted under the old system by selling
foreign exchange on the black market, according to US Embassy reporting.
In contrast, access to foreign exchange is much more reliable now for the
business and farming communities, which strongly support the auction.
According to our Embassy, Kaunda--despite his continuing public support
for the auction--has sta d rivatel that the exchan e rate for the
kwacha is "unrealistic,"
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SF('RFT
In our view, President Kaunda's announcement on 4 April of dramatic
changes in his top economic leadership signaled the beginning of an effort
to gain more government control over the foreign exchange rate and to slow
down the decontrol of the state-run economy. Among those replaced were
the two pro-Western proponents of the auction and of free-market policies,
Finance Minister Mwananshiku and head of the Central Bank Phiri. US
Embassy reporting indicates that Mwananshiku's replacement has no
experience in economics, while Phiri's successor studied socialist
economics in the Soviet Union and has no administrative background.
Kaunda's appointment of weak administrators who probably favor more
state intervention will put him in a position to push through the changes
he is seeking. Kaunda has been quoted in the press as saying that while
the old economic team had done a commendable job, it had failed to raise
the kwacha to its "real value" against the dollar. According to the US
Embassy, the new head of the Central Bank has echoed this sentiment and
said that several modifications in the auction are being consider
ensure "a more stable and acceptable rate" for the currency.
To boost the exchange rate without interfering directly in the
auction system, in our judgment, the government would have to either
increase the supply or limit demand for foreign exchange. So far, the
regime has done the former. It has diverted foreign exchange from debt
service and other foreign payments and has borrowed foreign exchange from
commercial banks to increase the flow of funds through the auction,
according to Embassy reporting.
The US Embassy reports, however, that Kaunda has appointed a tariff
commission which, we believe, will recommend ways during the next few
months to limit demand for foreign exchange by reducing the number of
importers eligible to bid in the auction. The commission probably will
ban further bids for imports that it designates as "luxury" goods. It may
also erect import barriers for "protected" manufacturing industries, thus
disallowing bids for foreign exchange to import goods that would compete
with the protected industries. In contrast to the fall in the exchange
rate that accompanied an increase in the average number of bidders this
spring, reducing the number of bidders probably would limit demand for
foreign exchange, in our judgment, and put upward pressure on the exchange
rate.
Prospects
Although limiting demand should help slow the rate of decline in the
exchange rate, Kaunda's efforts to regain a rate of $.20 = 1 kwacha may be
frustrated in the second half of this year because of foreign exchange
shortages. Foreign exchange allocations to the auction will fall short of
C F !' R F T
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C F f R F T
Lusaka's goals by $50 to $70 million, according to US Embassy reporting.
Pressures to end the auction will increase if, instead of rising, the rate
falls significantly. Any desire by Kaunda to terminate the auction
system, however, will be tempered by his concern that such a move probably
would induce the IMF and major donors to review aid policy and cut
donations.
In addition to its preoccupation with controlling the auction system,
we believe Lusaka will soon have to co e with the im act of further
subsidy-related reforms on inflation.
a corn price incre sa e o e ween
40 and 45 percent planned for this summer could spark demonstrations or
riots. If major protests should occur, we judge Lusaka probably would
rescind the price increases and call upon the police and paramilitary
forces to restore order. If this failed and the demonstrations worsened,
we believe Kaunda would be tempted to lower the? price of
auction, and set the exchange rate at $.20 per kwatcha.
Despite the present level of auction-related economic grievances
within the government, there does not appear to be significant organized
opposition within the military. Any bid for a takeover from the military
would require the cooperation of several different tribal groups, which we
judge would be difficult to obtain. Moreover, we believe Kaunda's
intelligence service is loyal and effective enough to uncover coup
plotting. With the regime apparently set on a course of easing off
gradually from unpopular austerity measures, we believe grumbling will
subside and that Kaunda's position likely will remain relatively secure
over the next year or so. On the downside, however, any softening of
austerity could undermine already limited prospects for increasing the
competitiveness of Zambian commodities on international markets and
promoting longer term economic growth.
Over the longer term, we judge that substantial political courage
will be required to resist temptations to renege on further devaluations
as copper production declines, or to water down the impact of inflation by
raising wages. In our view, any backsliding by Zambia on economic reform
and efforts to muddle through with half-steps will pose increased risks
for stability. If donor confidence is allowed to flag, Lusaka could lose
access to foreign assistance now used to prop up its sagging economy. In
our judgment, a serious, prolonged decline in the domestic
economy--compounded by a series of grievances accumulated over the
years--could finally pose a significant political threat to Kaunda.
C C !` D C T
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C F (' R F T
Appendix I
Zambian Copper Problems
Zambia is the world's third largest copper exporter after Chile and
Canada. Zambian government statistics indicate that copper production has
declined from a peak of 713,000 tons in 1976 to 479,000 tons in 1985.
According to industry experts, the decline is the result of a number of
factors that make Zambia one of the world's highest cost copper producers
despite an abundance of rich ores. Problems include excess labor and
labor turnover, faulty equipment, spare parts shortages, and difficult
access to some ore deposits:
-- Government pressure to provide jobs has kept Zambian copper
employment at about 60,000 workers. In comparison, Chile
produces almost three times as much copper annually with less
than 35,000 workers.
-- Expatriates dominate critical managerial and skilled positions
in Zambian copper mines and annual turnover among this group
averages nearly one-fourth of the total expatriate labor
force.
Capital expenditures have fallen behind equipment replacement
needs for more than a decade, and production is hampered by
critical shortages of explosives, diesel fuel, lubricants, and
spare parts.
-- Ten of Zambia's 15 copper mines are underground and ma~nr~are
located in mountainous regions with harsh terrain.
Economic and industry journals indicate that, in a vicious circle,
the decline in copper exports has cut foreign exchange earnings that are
crucial to operating and maintaining copper mining machinery and
equipment, thus contributing to further cuts in copper production and
exports. Foreign exchange shortages have:
-- Forced mines to forgo imports to replace aged machinery and
equipment and to postpone development of new ore deposits, thus
reducing productivity and output.
-- Induced the government to siphon off ever larger amounts of
foreign exchange income for non-mining needs such as food
imports, thus reducing foreign exchange allocations for
maintenance and development of mines.
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SECRET
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Extensive minerals surveys have not revealed any large new ore
deposits in the Zambian copperbelt rich enough to offset the depletion of
ores at existing mines, and copper production is expected by mining
experts to decline even more sharply by the mid-1990s. This prospect led
President Kaunda to say in a speech earlier this year that "the mining
industry has now at most only a decao to go before ending its
domination of the Zambian economy."
A review of international commodity statistics shows that world
copper prices peaked in 1974 and 1980 at just under $1.00 a pound, and
subsequently fell in each period to about $.60--roughly the current
price. Two factors account for the price decline:
-- Larger quantities of copper are being delivered to international
markets because major foreign competitors have increased
production and exports, according to industry data. Increases
in copper production and exports by Chile, for example, have
more than offset the decline in Zambian output since 1976.
-- Industry experts report that the development of fiber optics,
satellite transmission, and processes such as multiplexing are
beginning to reduce the consumption of copper in communications
systems in Western countries.
As a result, in a significant break with historical patterns, strong
economic growth since 1982 in the United States and other developed
countries has not resulted in an upsurge in copper prices. For the same
reasons, any significant economic slum in developed countries may lead to
further cuts in copper prices.
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Appendix II
Domestic Reaction
Lusaka's fears of a popular uprising or military revolt following the
introduction of the foreign exchange auction system--and the resulting
inflation and layoffs--have proven to be exaggerated. Nevertheless, the
US Embassy reports that in President Kaunda's eyes the program has created
enough political tension in the government and criticism among consumers,
labor unions, and the military to make him backpedal.
Public demonstrations. Violent public demonstrations in opposition
to price increases an layoffs have been scattered and easily
controlled. Demonstrations occurred one week after the first auction in
October, when taxi drivers demonstrated in downtown Lusaka against.a
doubling in fuel prices. Although this demonstration seemed to be an
ominous sign of increasing public resistance to the economic situation and
had to be broken up by police, further ex ression of opposition had been
confined to widespread public grumbling
The US Embassy has reported that government
officials trying to bus i y economic reforms have met with unfriendly
crowds. In other forms of protest, Zambians have occasionally refused to
sing the national anthem, according to press reports.
Student Unrest. The introduction of boarding fees for primary and
secondary sc ool students as part of larger efforts by the government to
reduce budget expenditures led to demonstrations by university students in
Lusaka and Kitwe last December, according to the US Embassy. These
demonstrations
occurred spontaneously and did not attract
ou si a suppor o ur er outbreaks of economically-motivated student
unrest have been reported. Nevertheless, Kaunda was reminded of the
potential for student militancy in mid-May when the government was forced
to close the Lusaka campus of the University of Zambia due to the violence
that followed the explusion of a student leader for non-attendence of
classes.
Labor Unhappiness. Soon after the auction system went into effect,
the Secretary General of the Zambian Congress of Trade Unions (ZCTU)--the
parent labor organization--stated that labor wanted to maintain a good
industrial climate, but would not cooperate with the government in
allowing prices to skyrocket, according to the US Embassy. Subsequent
Embassy reporting indicated that ZCTU Chairman Chiluba directed member
unions shortly after the first auction to start negotiations for a general
wage and salary increase, arguing the need to ease the impact of inflation
resulting from the currency devaluation. Some unions have won pay
increases, while others are still negotiating.
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mineworkers demonstrated on three
occasions soon after the first auction. These demonstrations were timed
to coincide with a visit to the region by the Prime Minister. Although
the demonstrations were nonviolent and no arrests were made, they added to
Lusaka's fears at the time of a violent backlash due to the auction0
Moreover, according to the Zambian press, at least 53
strikes involving 24,000 workers occurred between January and May of this
year. Kaunda predictably has tried to curb publicity for labor's
opposition to the auction system.
Military Concerns. Military personnel have been hard hit by budget
cuts over the past several months. These measures have led to complaints
about pa and livin conditions from enlisted personnel and some junior
officers Although the military has
had some morale an isc~p ine pro ems or years, Lusaka has becomes
sensitive to the Qrumbling since the beginning of the auction.
Pay increases of 40 percent for enlisted personnel and 17 percent for
senior officers appear to have blunted the worst effects on the military
of inflation resulting from the auctiop'
ve
forestalled more outspoken criticism by appointing officers to government
positions traditionally held by civilians. According to the US Embassy,
the President has made several Army commanders district governors and
promoted General Malimba Masheke from Commander of the Armv to Minister of
Defense, a post previously filled by a civilian.
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S E C R E T
SUBJECT: Zambia: Tampering With Economic Reform
Original--Raymond F. Smith, Deputy Director, Office
of Southern African Affairs, Department of
State
1--Phillip Ringdahl, Director of African
Affairs, NSC
1--Charles Freeman, Deputy Assistant Secretary
of State, Bureau of African Affairs
1--Roy Stacy, Deputy Assistant Secretary of State,
Bureau of African Affairs
1--Robert Cabelly, Special Assistant to the
Assistant Secretary of State, Bureau of
African Affairs
1--Jeffrey S. Davidow, Director, Office
of Southern African Affairs, Department of
State
1--Allen Harris, Deputy Director, Office of
Southern African Affairs, Department of State
1--Douglas Holladay, Working Group on South
Africa and Southern Africa, Department of
State
1--Anthony S. Dalsimer, Director, Office of
Analysis for Africa, INR, Department of State
1--Robin Hinson-Jones, Desk Officer for Zambia,
Department of State
1--William Thom, Acting Defense Intelligence
Officer for Africa, Defense Intelligence
Agency.
1--Walter Barrows, Assistant to the Director,
International Security Agency
1--DDI
1--NIO for Africa
1--NIC
1--DDO/Africa
1--DDO/AF/0
1--PDB Staff
1--ILS
1--C/DDI/PES
1--D/ALA
1--ALA Research Director
2--ALA/PS (one sourced copy; one clean)
4--OCPAS/IMD/CB
4--ALA/AF
4--ALA/C (Analyst)
4--ALA/C (File)
ALA/AF/ (8 July 1986)
S E C R E T
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