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Working Paper No 2009/13 APRIL 2009 The implications of mine ownership for the management of the boom: a comparative analysis of Zambia and Chile Elva Bova* ABSTRACT This paper assesses the relevance of mine ownership for the management of the resource curse. It first indicates how macroeconomic management is paramount to cope with the shocks and the instability induced by commodity prices’ behaviour. Then it underlines that under private ownership the space for fiscal and exchange rate policy is limited. The paper also analyses and compares the experiences of Zambia and Chile in the management of the current copper boom and maintains that the existence of a state-owned enterprise for copper has greatly contributed to the positive economic performance in Chile. Yet, the study concludes that ownership is a necessary, but not sufficient, condition to escape the resource curse. Key word: mining, fiscal policy, commodity boom * Elva Bova is a Doctoral student of the NCCR individual project on “Primary Commodities” and a PhD candidate in the Economics Department of the School of Oriental and African Studies, University of London. NCCR TRADE WORKING PAPERS are preliminary documents posted on the NCCR Trade Regulation website (<www.nccr-trade.org>) and widely circulated to stimulate discussion and critical comment. These papers have not been formally edited. Citations should refer to a “NCCR Trade Working Paper”, with appropriate reference made to the author(s). 1 1. Introduction A framework for the analysis of commodity booms in an era of highly liberalised economies should take into consideration the nature of the ownership and management of the commodity industry. In this paper, we will refer to ownership not as merely the degree of privatisation of the industry, but also as the kind of taxation system, for even the latter provides a measure of the sector’s integration in the rest of the economy. This is because, according to whether the privatised commodity sector is highly or little taxed, the repercussions on the economy are different. The distinction between kinds of ownership and taxation regimes bears its relevance for the way a boom affects the economy, since spending and saving responses may differ according to whom precisely gets the inflow.1 This is also the case when the foreign private sector is considered. This study maintains that the presence of largely privatised commodity industries matters not only for the effects on spending and saving behaviour, but also for the scope of macroeconomic management. For a better understanding of the implications that different kinds of ownership have during a commodity boom, this study compares the experiences of Chile and Zambia. In the two countries, the type of mine ownership differs greatly, with a large public sector in Chile and an almost completely privatised copper industry in Zambia. Although additional differences between the countries ought to be considered, there are valid grounds to believe that the kind of ownership has played a role in the ways the copper boom has influenced the economy. As we shall see, the argument appears supported by the fact that the exchange rate regime is approximately the same in both economies, with very little intervention conducted by Bank of Zambia, and even less by Banco Central de Chile. This similarity in the arrangement rules out, then, that the different outcome is owing to the kind of exchange rate regime. The structure of the paper is as follows. Section 2 provides the analytical framework of the paper and reviews issues surrounding privatisation of state-owned enterprises in developing countries. More particularly, we examine how the literature has treated the effects of the reform on fiscal policy while very little has been written on the way the reform impacts on foreign exchange management, and consequently on the currency. Section 3 provides the contextual framework for the paper and illustrates the privatisation reforms and taxation regimes in the two countries. In section 4, we compare the fiscal responses to the boom, and in section 5 the exchange rate ones. Section 6 concludes. 1 See also the literature on commodity booms edited by Collier and Gunning (1999). 2 2. Privatisation reforms and macroeconomic policy In its broadest conception, privatisation identifies a process by which the state’s role within the economy is reduced, while at the same time the scope for the participation of the private capital is extended (Young 1991). The process entails the transfer “from the public to the private sector of the ownership and/or control of productive assets, their allocation and pricing and the entitlement to the residual profit flows generated by them” (Adam et al. 1992: 6). In line with the neoliberal revival of the 1980s, privatisation started as an initiative propounded and embraced by industrialised countries, mainly the UK and the US, and was subsequently taken on by developing countries. As expressed in Bennel (1997), within the World Bank and IMF structural adjustment program, privatisation became “the super ordinate medium long term objective” everywhere in Africa (1997:1785). There are usually two main motivations advocated for privatisation of state-owned enterprises (Adam et al. 1982, Pinheiro and Schneider 1995.). On the one hand is the need to enhance efficiency in obsolete public companies while promoting the participation of the private sector. On the other hand is the rationalisation of public finance, usually in terms of increasing revenues to alleviate the fiscal deficit, which will result from the inflow of privatisation receipts, from corporate taxes and royalties but also from the elimination of state subsidies (Pinheiro and Schneider 1995, Buchs 2003, KayizziMugerwa 2002, and Adam et al. 1992).2 Empirically, the success of privatisation, both in terms of efficiency and of revenues, is not clear (Bhoubakhri and Cossett 1999, Buchs 2003), probably because privatisation has been embraced within a set of other economic reforms and because, more than the reform as such, one should gauge the procedures adopted, the initial conditions and competition discipline (Fine 2007). Along with a privatisation reform, a government should decide on the taxation regime to impose on the private companies, which to a certain extent regulates the new relationship between the private and the public sector. In the specific case of a foreign private sector, the taxation system becomes also an indication of the degree of integration of the sector into the country’s economy. One of the main assumptions of this study is that the combination of a mild taxation regime and highly privatised commodity industry may limit the scope for macroeconomic management during a commodity boom and this occurs mainly in two ways. 2 Besides these general theoretical issues, literature on privatisation has been also sensitive to the effects on the development of the capital market (Bhoubakhri 1999) or to the implications for the labour market, which usually constitutes the main deterrent to the policy. 3 Firstly, the privatisation regime is relevant for the fiscal budget. As mentioned, the fiscal impact of privatisation identifies changes in government revenues resulting from the one-off increase in the privatisation proceeds, from the elimination of possible subsidies to public owned enterprises and from changes in the mining tax regime (Davis et al. 2001, Barnett 2000, Mansoor 1987). Whether a larger private ownership results in an increase in the fiscal revenues or not depends on the totality of these changes. Generally, the privatisation of the resource industry has occurred at times of low commodity prices, when then the bargaining power of the government was very low. This led to a negotiation of taxation regime very favourable for the mining companies, especially in Sub-Saharan Africa (Nissanke 2008). When a commodity boom strikes the economy, the presence of a large and little taxed privatised industry may have additional implications on fiscal policy. Limiting the amount of export receipts accruing to the government, it limits the government’s possibility to save the inflow and use it to allocate resources to key sectors of the economy. As mentioned in the literature on commodity booms (Collier and Gunning 1999, Hill 1991), the best response to a shock is to stretch investments until the boom is over, which is usually done through saving in foreign assets. The measure also mitigates the impact on the currency. Yet, when the private sector is local, its ability to save in foreign assets may be leveraged by its low credit rating. On the other hand, when the private sector is foreign, it may opt to repatriate profits and little would accrue to the economy as a whole. From this, our implicit conclusion is that, where as saving is the most appropriate response, then a largely privatised regime may limit this option. In principle, whenever the role of fiscal policy during a boom is small, the government can at least rely on exchange rate policy to offset the adverse consequences of the shock. For instance, it can accumulate foreign exchange to avoid a nominal appreciation. However, the impact of accumulation of foreign exchange is different under private and public ownership of the commodity sector. While the issue on the implications on fiscal policy has been widely looked at, there has not been such a broad examination of the implications of a largely private mining industry on the exchange rate management. The second implication of a largely privatised commodity sector is that it poses constraints on exchange rate policy. When the inflow of foreign exchange accrues directly to the government, it can be saved and not spent so as to avoid exchange rate appreciation and possible Dutch disease effects.3 Conversely, when the inflow accrues to the private sector, if the central bank intends to curb the appreciation, it needs to conduct foreign exchange interventions, and this has a cost. Foreign exchange purchases entail issuance of the money supply as a counterpart. While advanced economies 3 On the Dutch disease see Corden 1984, Corden and Neary 1982 and Van Wijnbergen 1984. 4 can easily contain the increase in the money supply resulting from purchases of foreign exchange, developing countries cannot. These economies generally sterilise the money supply through the issue of treasury bills or central bank bonds. Given the shallowness of the financial system, characterised by a very small corporate bond market, any change in the amount of treasury bills and bonds undertaken by the government or the central bank greatly affects the capital market. Hence, the issue of treasury bills to mop up liquidity may dramatically increase the interest rate, and, if the country has a large domestic debt, interest payments will become unsustainable. When purchases of foreign exchange cannot be easily sterilised, they will induce an increase in the money supply, which may be inflationary. Thus, a large private ownership of mines may be of hindrance to exchange rate management, since it exposes the central bank to a trade-off between nominal appreciation and inflation. 3. Ownership and taxation regime in Zambia and Chile The economic and political histories of Chile and Zambia have been long dominated by the countries’ production and export of copper. Both economies are still heavily dependent on copper, which constitutes 40% of total exports in Chile, and more than 70% of total exports in Zambia (IMFDTS). Figure 1: GDP, exports and copper price cycle in Zambia and Chile Chile: GDP, exports & copper price (1970-2005) 250 150 100 50 0 Exports (constant 2000 US$) GDP (constant 2000 US$) Copper price (right scale) Millions 200 100000 90000 80000 70000 60000 50000 40000 30000 20000 10000 0 250 200 150 100 50 0 19 70 19 72 19 74 19 7 19 6 78 19 80 19 82 19 8 19 4 86 19 88 19 90 19 92 19 9 19 4 96 19 98 20 00 20 0 20 2 04 4500 4000 3500 3000 2500 2000 1500 1000 500 0 19 7 19 0 7 19 2 7 19 4 7 19 6 7 19 8 8 19 0 8 19 2 8 19 4 8 19 6 8 19 8 9 19 0 9 19 2 9 19 4 9 19 6 9 20 8 0 20 0 0 20 2 04 Millions Zambia: GDP, exports and copper price (1970-2006) Exports (constant 2000 US$) Copper price (right scale) GDP (constant 2000 US$) Source: IMF-IFS, WB- WDI As a capital-intensive sector, the mining industry employs only 1% of total employment in Chile and around 10% of the Zambian workforce. 5 The history of the copper sector in the two economies moves along similar tracks during the 1960s and early 1970s. They both nationalised the copper industry, which was at that time in the hands of multinational corporations. However, the kind of management and patterns of ownership significantly diverge in the following decades. At present, the ownership structure in the two economies differs widely, with an almost completely privatised industry in Zambia and a largely publicly-owned one in Chile. The nationalisation reforms The nationalisation reform in Zambia was implemented in 1969 as part of the general strategy of import substitution, for which the mining sector was considered the stepping-stone (Andersson et al. 2000). In 1982, the government created the Zambian Consolidated Copper Mines (ZCCM), out of the merger of two state mining companies, in an attempt to rescue the mining sector from the prolonged depression in the international price of copper which dated from the end of the 1970s. ZCCM had, as main shareholders, the Zambian government (60.3%) and Anglo American Corporation which controlled 27.3% of the interests. As stated by law, Anglo American had pre-emptive rights to purchase any shares sold by the government and it had an effective right of veto over the sales of any major assets (Craig 2001). Besides mining exploration and exploitation, ZCCM was deeply interlinked with the rest of the economy, through backward linkages with suppliers and forward linkages with traders and manufacturers (Fraser and Lungu 2007). As expressed in Craig (2001:390) “the strategic and symbolic significance of ZCCM was frequently expressed in terms such as ZCCM is Zambia, Zambia is ZCCM”. In Chile, the nationalisation legislation was enacted in 1971, soon after the election of President Allende, with the passing of law 17540, which stated “...the foreign companies forming the great mining are nationalised and incorporated to the full and exclusive dominion of the Nation….”4. The new regime decreed that the goods and facilities of the companies, at that time the US companies Anaconda and Kennecott5, would become property of the State of Chile, and the operations would be managed by collective societies coordinated by the State Copper Corporation (Cochilco 2007). The government could dispose of the organization, exploitation and administration of the nationalized companies (Ministero de Mineria 2007) and in April 1976 the government created a state-owned mining company, Codelco (the Corporación Nacional del Cobre de Chile) in charge of administrating the nationalized copper mines, these being defined as Gran Mineria (Chuquicamata, El Salvador, Andina and El Tenente). 4 5 From transitory disposition of the Article 10 of the Chilean Constitution. For a full description of the copper industry in Chile in the 20th century until the 1970s see Gedicks 1973. 6 The privatisation reforms In the two countries the privatisation reforms occurred in very different periods. In Zambia, the reform was introduced in the mid 1990s, as in many other African countries where privatisation was considered to be the centre piece of the structural adjustment programs (Appiah-Kubi 2001, Bennel 1997). In Chile, the reform was adopted in 1974 at the onset of the Pinochet regime. Zambia embraced privatisation of state owned enterprises in an attempt to rescue itself from a prolonged economic slowdown, which had degenerated into a fiscal crisis. The reform was backed by the Movement for Multiparty Democracy, whose perception of the role of the public sector was expressed in the following terms: “the government restricts itself to rehabilitate and build economic infrastructure with a small public sector in the midst of a basically private enterprise economy” (Andersson et al. 2000, 6). While the privatisation of major sectors of the economy was introduced in 1992, it was only in 1996 that the government implemented the reform for the copper industry, which is indicative of the importance bestowed to the sector. The reform was deemed necessary to rescue ZCCM from a dramatic crisis, which saw a loss equal to 1 million $ per day in 1998 (Andersson et al. 2000, www.bbc.radio4 ). Between 1997 and 2000, ZCCM was split into seven different units and sold off. The units were initially bought up by seven multinational mining companies, including AngloAmerican (AAC) which chose to exercise its per-emptive rights and took on 65% of Konkola Copper Mines (KCM), the largest operating mine at that time. Yet, in 2002 AAC pulled out from Zambia handing the mine back to the state, and in 2004 the mine was finally sold to Vedanta at a knockdown price. The seven multinational companies in 2000 were Anglo-Vaal from South Africa, Binani from India, Metorex South Africa, Glencore and First Quantum from Canada, International Financing Corporation, Commonwealth Development Corporation (see table 1 and figure 2). 7 Table 1: copper mining companies in Zambia Mines Konkola Copper Mines (KCM) Owner 2000 Anglo American Corporation (US) 65%, IFC (7.5%), CDC (7.5%), ZCCM 20% Kansashi Chambishi Metals Plc Anglo-Vaal (South Africa) Chambishi Mines Plc. Co.-Africa (China) Mopani Copper Mines, Plc Glencore International AG, Switzerland (73,1%), First Quantum Minerals, Ltd, Canada (16,9%), ZCCM (10%) Luanshya RAMCOZ Binani, India (85%), ZCCM (15%) Lumwara Owner 2006 Turnover 2006 Vedanta Resources, India (51%), Zambia Copper Investment (28,4%), ZCCM (20,6%) 200,000t per year First Quantum Minerals Ltd, Canada 145,000t per year China Non-Ferrous Metals Corp (85%), ZCCM (15%) Co.-Africa (China) Glencore International AG, Switzerland (73,1%), First Quantum Minerals, Ltd, Canada (16,9%), ZCCM (10%) 140,000t per year NA 135,000t per year J & W Holding AG, Switzerland (85%), ZCCM (15%) 50,000t per year Equinox Resources, Australia (51%), Phelps Dodge Corp US (49%) 25,000t per year Metorex Ltd, South Africa 15,000t per year Chibuluma Mines Source: AnMbendi 2007, Fraser and Lungu 2007 As illustrated in figure 2, at present (2007) the largest share in the Zambian copper industry is owned by First Quantum, with the other large corporations owning more than 15%, like Co-Africa from China, Vedanta from India and Glencore from Switzerland. As stated in the Mine and Mineral Act, adopted in 1995, the new companies would be registered in Zambia and would be subject to the monitoring of an inter-ministerial group. The Government retains a share in each mine through direct ownership of ZCCM-International Holdings. However, so far, the Government of Zambia has not received any dividend from the company, despite the boom, due to the liabilities they had accumulated in the previous years. 6 ZCCM-IH is a state-owned company; a joint venture 87% owned by the government and 13% in the hands of private shareholders. It is listed in the LUSE and has a separate legal entity from the Government. Actually, the Government owes money to ZCCM-IH (from interview to Ministry of Finance). 6 8 Figure 2: ownership structure in Zambia 2007 E q u in ox Z CCM - IH J&W Hold in g V ed an ta G len core F irst Q u an tu m Co- Af rica Source: AnMbendi 2007, Fraser and Lungu 2007 The Mine and Mineral Act greatly simplified the licensing procedures, placing minimal constraints on exploration and exploitation activities. It established a royalty calculated as 2% of the market value of minerals f.o.b., less the cost of smelting, refining and insurance, handling and transport from the mining area (www.zambiamining.co.zm). According to the Act, copper exporters were levied 35% of taxable income whereas other mineral and non-traditional commodities attract a levy of 15%. Despite the terms of the Act, the rate negotiated by most mining companies was 0.6% of the gross revenue, as stated in the development agreements, secretly signed between the companies and the Government (Fraser and Longu 2007). In addition, the export tax was set at 25% instead of 35% and carrying forward losses was allowed for periods of between 15 and 20 years. 7 The Act also granted to the companies deductions of 100% of capital expenditure in the year in which this incurred and it granted exemptions from paying customs, excise duties or import tax levied on machinery and equipment. The mining sector was authorised to claim back from the Zambian Government all of the VAT paid on goods that it buys locally. The government undertook not to amend any of these tax regimes after the agreement was signed for as long as 20 years. It has been estimated that in 2007 the Government would have received at least 50 millions US$ if the mines had paid a 3% of Royalty 8 (from www.bbc.radio4). In Chile, the privatisation reform was embraced in the 1970s after a long period of debate and discussion, given the concerns on the privatisation of the mines. In contrast to that in Zambia, the 7 This indicates that the companies can subtract from taxable profits losses made in year 1 of operations in subsequent years. 8 The development agreements also dispose that if the global copper price increases significantly and exceeds (US$2700 per tonne) then the Government can actually claim back a percentage of each sale made. However, the impact of this price participation clauses has been minimal because the payment to the government is again deductible by the companies for income tax purposes (Fraser and Lungu 2007). 9 reform did not lead to a large shift in ownership to the private sector. On the contrary, a large share of copper production was indeed retained by the government through Codelco. The new mining code, enacted in 1974, reset constitutional protection for the right of private ownership of mines in terms of full exploration and exploitation, and granted equal treatment of domestic and foreign companies, setting no limits on profits and capital repatriation (Spilimbergo 1999). Despite these concessions to the mining companies, very little foreign capital flew into the industry during the 1980s, probably because of the risk associated with the military regime, and it was only with the return to democracy in the 1990s that the share of foreign companies in copper production (the so-called Mediana Mineria) increased substantially, from 6% in 1980 to 54% in 1996, whereas CODELCO shrank from 84% to 39% in the same years (figure 3). Figure 3: public and private ownership in Chile (1987-2007) 6000 5000 4000 3000 2000 1000 Codelco + Enami 20 05 20 03 20 01 19 99 19 97 19 95 19 93 19 91 19 89 0 19 87 Thousands of Metric Tons Public and private sector ownership Private Companies Source: Cochilco 2007 Figure 4: ownership structure in Chile (2006) others Phelps Dodge Codelco Rio Tinto BHP Falconbridge Source: AnMbendi 2006, Cochilco 2007 10 Anglo American As illustrated in figure 4 and table 2, the structure of ownership in Chile is characterised by a large state ownership through Codelco, which owns almost 40% of the mining production, while the rest is owned by trans-national corporations. Table 2: copper mining companies in Chile Mines Owner 2006 Turnover 1987 Turnover 1996 Chuquicamata Radomiro Tomic Turnover 2006 Codelco 502,9 632,3 634 Codelco - - 306 Division Salvador Codelco 97,1 89,9 80 Division El Tenente Codelco 369 344,7 418 Codelco Division Andina 121,6 154,4 236 Collahuasi Anglo American 44%, Falconbridge 44%, Japanese Consortium 12% - - 440 Mantos Blancos Anglo American 100% 85,7 122,4 149,7 Escondida BHP Billiton Limited (Australia) 57.7%, Rio Tinto (UK) 30% - 841,4 1255 La Candalaria Phelps Dodge (US) 80% - 136,8 169,6 El Abra Phelps Dodge (US) 51% Pequena Mineria9 Enami 218,6 114,1 128,3 107,3 Source: AnMbendi 2007, Cochilco 2007 Until 2006, the taxation system for the mining companies was regulated by the Decree Law 600 enacted in 1974, which established the foreign investment statute. The act granted all investors access to the foreign exchange market, the right to return capital without taxation, a tax invariability for 10 years, in some cases extended to 20 if the capital is greater than 50 million US$. As far as the taxes are concerned, in Chile profits earned from business are subject to the First Category tax and to the Global Complementary tax (for local investors) or the Additional tax (for foreign investors). The First Category tax has a 17% rate which is levied on profit received or accrued by the mining enterprise, while the Global Complementary and the Additional taxes, with rates from 0 to 40% and from 1.75% to 35%, respectively, are levied on the remittances of dividends and other profits received by the shareholders or partners. When the base for the Global or Additional tax is calculated the First Category tax is deducted. Companies benefit from deductions to apply when 9 The mining code of 1974 also contemplated the existence of small private owned mines (Pequena Mineria), which produce 10% of the total copper and sell their output to the public enterprise ENAMI (Spilimbergo 1998). 11 calculating the First Category tax, related to organization and start up expenses, interest expenses, technical assistance, tax losses and asset depreciation. 10 Since January 2006, the taxation system is regulated by the law 20.026, article 64bis, which establishes a specific tax on mining activities. The tax will be levied on the taxable operational income of the mine operator in accordance with the following schedule: Table 3: taxes on mining activities in Chile SALES (in MT) TAX RATE <12,000 no tax 12,000-15,000 0.5% 15,000-20,000 1.0% 20,000-25,000 1.5% 25,000-30,000 2.0% 30,000-35,000 2.5% 35,000-40,000 3.0% 40,000-50,000 4.5% >50,000 5.0% Source: www.cinver.cl/ (2007) The reform also imposes a royalty equal to 2%. It appears that prior to the reform, the actual mining taxes paid by Codelco represent 28.7% of the final price; while taxes paid by private mining amounted to only 5.3%. This meant that while Codelco paid 10,659 millions US$ in the years 19902001, the private companies paid only 1,638 million US$ in spite of their product being 25% higher. It is, therefore, estimated that the total of lost tax revenue during that period amounts to more than 10,000 million US$ (www.cinver.cl). 10 Tax losses definition: if net operation losses exceed the taxpayer’s undistributed or accumulated after tax-retained earnings, the excess can be used to offset the taxpayer’s profits of the subsequent tax year. Asset depreciation definition: a tax deduction is allowed for fixed asset depreciation, corresponding to the annual instalment of depreciation of movable and immovable property tax payers may opt for an accelerated method of depreciation with respect to new fixed tangible assets when acquired locally or new or used fixed tangible assets when imported. 12 Table 4: Mining taxation in Zambia and Chile Zambia: Mine and Mineral Act (1995) Royalty 2.5%, but effective 0.6% Chile: Mining Code (1974) 2%; specific mining tax since 2006* Tax on profits 17% Tax Deductions Tax losses Carry-forward Exemptions Tax on exports 35%, but effective 25% 100% of capital expenditure Losses made in year 1 can be subtracted in subsequent years for 15 - 20 years Tax on dividends 35%, less 15% of tax on profits From tax on profits: organization and start up expenses, interest expenses, technical assistance It applies indefinitely Customs or excise duties, import tax on machinery and equipment Other mechanisms Asset depreciation Source: Fraser and Lungu 2007, anMbendi 2006, Cochilco 2007 As shown, the degree of integration of the commodity sector in the two economies is quite different. This distinction partly explains why the outcome of the boom in Zambia and in Chile has differed. 4. Fiscal responses to the copper boom As far as fiscal policy is concerned, a largely privatised regime results in a reduction in export receipts accruing to the public sector. In turn, the low appropriation of commodity revenues may then limit the scope for policy intervention during a boom. In the case of Zambia and Chile, the evidence illustrates how the sum of export receipts accruing to the fiscal budget differs, as expected, given the differences in the privatisation regimes. During the years of the boom, the two economies indeed experienced an increase in fiscal revenues, in absolute terms, excluding rents. Yet, while in Chile the timing of the increase coincides with the one of the boom indicating that export receipts may have positively contributed to the budget, in Zambia the increase in government revenues seems to date from the years before the boom. Looking at the origin of revenues, in both countries the bulk of government revenues come from taxes. However, while in Chile the contribution from the copper sector has reached almost 30% of taxes and 20% of total revenues in 2006, in Zambia the contribution of the mining sector to the total revenues has been roughly of 10% in 2006, and almost non-existent in the previous years. From this 13 evidence, one can infer that the increase in government revenues in Zambia is mainly due to a general increase in taxes, such as VAT and income tax, probably associated with an improvement in tax collection procedure (Cali and Te Velde 2007) (figure 5). Figure 5: Revenues excluded grants Revenues in Chile (pesos) Revenues in Zambia (in ZMK) 25000 20000 6000 Billions Billions 8000 7000 5000 4000 3000 2000 15000 10000 5000 1000 0 0 2001 2002 2003 2004 2005 2006 2000 Mines taxes Revenues Taxes 2001 2002 Codelco's contribution 2003 Revenues 2004 2005 2006 Taxes *mining taxes in Zambia do not include PAYE for workers Source: WB-WDI, Zambian Revenue Authority Figure 6: Zambian taxes Kwacha Billions Tax payed by mining companies (Kwacha) 1,000 800 600 400 200 0 2001 2002 2003 2004 Compay Tax Withholding Tax PAYE 2005 2006 2007 Mineral Royalty Source: Zambian Revenue Authority An interesting point, regarding Zambia, is that the highest contribution to the Zambian budget from the mining companies is in the form of taxes paid for the workers (PAYE), and not from royalties or any other form of tax.11 11 Fraser and Longu (2007) confirm this datum. 14 An additional element to consider is that, although revenues have increased in both economies, in Zambia revenues as a percentage of GDP have not increased. As illustrated in figure 7, revenues as a share of GDP in the country have sharply declined since 2001 and fluctuated without any rising trend in the years of the boom. This is indicative of the fact that GDP growth in Zambia, mainly driven by the copper boom, has not contributed to an expansion of government revenues. On the other hand, in Chile revenues as a share of GDP have increased, indicating that the budget has been benefiting from the country’s economic growth more than proportionately. Figure 7: Revenues in local currency and as % of GDP 25000 Revenues as % of GDP in Zambia 30 25 20 20000 15000 15 10 5 0 10000 5000 0 20 20 19 19 18 18 17 17 16 2000 2001 2002 2003 2004 2005 2006 Revenues Revenues (%GDP) 8000 7000 6000 5000 4000 3000 2000 1000 0 Billions of Kwacha Billions of pesos Revenues as % GDP in Chile 2001 2002 2003 2004 2005 2006 Revenues as % of GDP Revenues Source: World Bank- World Development Indicators In considering the fiscal response to a commodity boom, one should look first at the amount of export receipts appropriated by the government, and then examine how these receipts have been used. Probably the most relevant information is whether revenues have been saved or spent, since this has implications on the way the boom can be continued into the future without incurring Dutch disease kind of effects. When very little accrues to the government, then fiscal policy will be conducted according to the ordinary budget management. However, given that in Zambia revenues have increased in absolute terms, though not because of the boom, it may be interesting to understand how the government has responded to this increase. This is because an increase or reduction in government spending during a commodity boom can still amplify or mitigate the effects on aggregate demand and domestic currency. As illustrated from the first graph in figure 8, the spending response in Zambia has been clearly to increase expenditure registering budget deficits for al the years of the boom. On the other 15 hand Chilean fiscal policy has been rather cautious and the economy has been registering consistent fiscal surpluses since 2003. Figure 8: Spending and saving behaviour Chilean budget Zambian budget 30 25 25 20 20 15 15 10 10 5 5 0 0 1998 1999 2000 2001 Expenditures (% of GDP) 2002 2003 2004 2005 2006 Revenues excl. grants (% of GDP) 2000 2001 2002 Expenditures (% of GDP) 2003 2004 2005 2006 Revenues excl. grants (% of GDP) Note: due to data availability the two graphs have different starting dates Source: WB-WDI The prudent fiscal policy in Chile is regulated by the structural budget rule enacted in 2000. According to the rule, every year a structural government income is calculated based on the medium term price of copper and the economy’s output gap. Fiscal expenditure is the, set so that structural revenue minus fiscal expenditure is equal to 1% of GDP (since 2007 this has been lowered to 0.5%), to maintain a surplus12. Since 2006 part of this surplus, a maximum of 0.5% of GDP is channelled to the Pension Reserve Fund and the remaining part net of capital contributions to the central bank is channelled to the Economic and Social Stabilisation Fund. The two funds are sovereign wealth funds, with assets wholly invested abroad. The funds are managed by the central bank that can then recapitalise the assets every five years (Ministry of Finance 2007, Pedersen 2008). The rule has valid countercyclical properties since it allows for higher conventional surpluses during expansions and it registers lower surpluses or moderate deficits during recessions. In addition, it provides a sort of fiscal anchor for economic agents. As expressed in Marcel et al. (2001:3) “…considering the indicator’s public nature and wide broadcast, this rule provides an anchor of credibility on fiscal policy which Marcel et al. (2001) and Pedersen (2008) illustrate the rule as follows. Bst = Bt – Tt + [Tt (Yt*/Yt)E] – Ct + Cst; where Bst is the structural balance, Bt is the actual balance, Tt are the net tax revenues, Tt (Yt*/Yt)E is the actual tax revenue with Yt* as the potential output and E the output elasticity of tax revenues, Ct are the taxes from Codelco at time t, and Cst are the taxes from Codelco under a medium term level of the copper price. 12 16 means that the economic agents will know how fiscal policy will react when changes in the macroeconomic environment occur”. As indicated, while the boom has probably positively contributed to both countries’ GDP, only in Chile this has lead to a substantial increase in government revenues, since Zambia revenues in relative terms have not increased. Revenues in Zambia do increase in absolute terms, but there is not enough evidence that this increase originates from the copper boom. As far as expenditure is concerned, the fiscal choice has been to save and accumulate surplus in Chile, as regulated by the structural budget rule; whereas in Zambia, it appears that the government has spent the additional revenues. 5. Exchange rate policy responses to the copper boom A specific kind of privatisation regime may influence the impact a commodity boom has on the currency and relative prices not only through fiscal responses, i.e. through the option to spend the inflow as opposed to save, but also through complication of foreign exchange management. In this last case, the problem is identified by the fact that foreign exchange accrues directly to the market and any accumulation of reserves by the central bank can be done only through foreign exchange interventions, which need to be sterilised. To understand how, and to what extent, the privatisation regime may indirectly affect exchange rate policy responses we look here at the effect of the boom on the domestic currency. For this analysis, one should bear in mind that clearly exchange rate responses depend on the kind of exchange rate regime. Notwithstanding the differences in the commodity industry, and in the fiscal responses, the regimes adopted in the two countries are relatively similar. They have a de jure floating exchange rate with a fully-fledged inflation targeting in Chile and a monetary targeting in Zambia. Both monetary frameworks maintain price stability as the primary objective for monetary policy, and postulate no foreign exchange intervention to determine the trend of the exchange rate, no “leaning against the wind”. Although Bank of Zambia tends to conduct foreign exchange intervention, evidence illustrates (see Weeks et al. 2007) that in the years of the boom this management has been negligible. All in all, we consider that the two countries conducted no relevant interventions in the foreign exchange market in the years of the boom, implying the currency has been mainly market determined. Despite these similarities, the impact of the boom on the domestic currency has been rather different, indicating that the combination of inflation stabilising policies with different degrees of private ownership may engender opposite effects. 17 Figure 9: The Zambian Kwacha and Chilean Peso. Nominal exchange rate for Zambia Nominal exchange for Chile 1200 6000 1000 4000 800 CLP 2000 600 400 200 ZKw to SDR ZKw to US$ CLP to SDR 2008m07 2008m01 2007m07 2007m01 2006m07 2006m01 2005m07 2005m01 2004m07 2004m01 2003m07 2003m01 2002m07 2002m01 2001m07 2001m01 0 2000m07 2008m07 2008m01 2007m07 2007m01 2006m07 2006m01 2005m07 2005m01 2004m07 2004m01 2003m07 2003m01 2002m07 2002m01 2001m07 2001m01 2000m07 2000m01 0 2000m01 ZKw 8000 CLP to US$ Source: IFS-IMF At a first glance, the extent and duration of the exchange rate appreciation in the two economies are quite different. The graphs in figure 9 illustrate how the Zambian Kwacha sharply appreciated at the end of 2005 and, after a depreciation, it appreciated again from the end of 2006 to the beginning of 2008. The magnitude of the appreciation appears to be more intense if we account for the value of the currency with respect to the Special Drawing Rights, as opposed to the US$. On the other hand, the Chilean peso has indeed steadily appreciated since 2003, but while the appreciation has continued up to 2008 if we consider pesos to US$, the currency with respect to the Special Drawing Rights has remained relatively stable, at least since 2005. Thus, it seems that the US$ depreciation may somehow account for the peso’s appreciation starting from 2005. When considering the effective exchange rate, thus taking into account the trading partners, the distinction in the two currencies’ behaviour is even more striking. As illustrated in the graph below (figure 10), while the Zambian nominal effective rate has appreciated sharply mainly on two different occasions: at the end of 2005 and end of 2007, in Chile the currency has been rather stable with respect to the other trading partners,13 appreciating only slightly between 2003 and 2005 and at the end of 2007. Chilean trading partners are US, Japan, China, South Korea and the UK. In Zambia these are Switzerland, the EU, the UK, China and the US. 13 18 Figure 10: Nominal and real effective exchange rates14 Real effective exchange rate Nominal effective exchange rate 200 160 140 120 100 80 60 40 20 0 180 160 140 120 100 80 60 Chile Zambia 20 Zambia 2007m12 2007m07 2007m02 2006m09 2006m04 2005m11 2005m06 2005m01 2004m08 2004m03 2003m10 2003m05 2002m12 2002m07 2002m02 2001m09 2001m04 2000m11 2000m06 0 2000m01 20 00 20 m01 00 20 m08 01 20 m03 01 20 m10 02 20 m05 02 20 m12 03 20 m07 04 20 m02 04 20 m09 05 20 m04 05 20 m11 06 20 m06 07 20 m01 07 20 m08 08 20 m03 08 m1 0 40 Chile Source: IMF-IFS As far as the real effective exchange rate is concerned, this is calculated as a traded average of the currencies of the countries’ trading partners each deflated by the partner’s CPI. The second graph in figure 10 shows a very sharp appreciation and subsequent depreciation for the Zambian rate, while the Chilean rate appears to be more stable with a slight appreciation from 2003 to 2005 and then depreciation up to 2007. The limited volatility of the Chilean peso suggests that the economy has been shielded from the price shock, and has been able to mitigate the pressure on domestic prices and on the currency. According to De Mello (2008), the reasons for such behaviour in the exchange rate can be explained by the low pass-through of the exchange rate to domestic prices, and by the existence of the sovereign wealth funds. The author illustrates how the low pass-through from exchange rate to prices is mainly a result of the fact that locally produced goods are invoiced in local currency and not in foreign currency, which buffers these products from currency risk. Then, clearly, the ability to save the inflow into funds abroad has mitigated the pressure on the currency since the foreign exchange is largely kept abroad. On the other hand, in Zambia, the performance of the Zambian Kwacha indicates how the absence of a stabilisation fund together with a higher degree of pass-through has contributed to large fluctuations in the currency and a dramatic appreciation in 2003-2005. Had foreign exchange flown into a separate fund the pressure on the exchange rate would have been much less, and the Bank could have directly accumulated reserves without the need to issue money base as the counterpart. 14 Contrary to bilateral rates, the effective rates appreciate when the value increases and vice versa. 19 6. Conclusion This paper analyses to what extent private ownership of mines may matter for the affects a commodity shock has on the economy, looking at fiscal and exchange rate policy responses. In support of the hypothesis that a large private ownership of the mining sector with a little degree of taxation may complicate the management of a boom exacerbating its effects, we compare the responses in Chile and Zambia, which have very different ownership structures. The comparison first illustrates how the combination of large trans-national corporations in the Zambian copper sector and the mild taxation demanded of them has limited the resources that accrued to the government from the boom. On the other hand, the share of revenues from mines in Chile has been much larger and it appears to have contributed substantially to an increase in government revenues, both in absolute terms, and as a share of GDP. Secondly, the fiscal response to the boom in Chile has been cautiously regulated by the structural budget rule under which the bulk of the inflow has been saved in sovereign wealth funds. In Zambia fiscal policy has indeed been pro-cyclical, as long as revenues net of grants are considered. Thirdly, as far as the exchange rate policy response is concerned, little can be said with respect to Chile. This is because due to the cautions saving behaviour, the impact on the currency has been limited, so no major challenges have faced to the inflation-targeting regime and, consistently, with the framework no foreign exchange intervention has been conducted. As for Zambia, the situation is very different, since the currency has fluctuated quite substantially, which has posed the central bank to a difficult situation, since, to avoid to mitigate the volatility it would have breached the monetary framework. Overall, the impact on the currency seems to suggest that given the same exchange rate arrangement, economic outcomes on the currency may substantially differ owing to the kind of privatisation regime. 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