CHAPTER ONE

BACKGROUND TO THE STUDY

1.0.0 INTRODUCTION
This chapter briefly highlights the topic at hand and gives an insight into Zambia’s
economic overview between the early 1990s to two decades afterwards. It also
highlights the problem statement, the objectives, and hypotheses, significance of the
study and the scope of the study.

1.0.1 ZAMBIA’S ECONOMIC OVERVIEW

For any nation to grow its economy, it will inevitably incur fiscal deficits in the
process. But are fiscal deficits a bad thing? Carbaugh (2005) argues that when correctly
used, deficits can lead to increase in a nation’s stock of capital and expand the
economy’s capacity to produce goods and services. Elekdag et al. (2006) argues that
highly indebted emerging market countries that exercise prudent fiscal policies tend to
reduce vulnerabilities such as solvency risk and have the ability to conduct counter-
cyclical fiscal policy in the face of burden debt service, thus enhancing their ability to
cope with external shocks. According to the economic theory, a country with current
account deficit is borrowing resources from the rest of the world that it will have to pay
back in the future. Fiscal deficits are not without their own short comings, as deficits
grow governments start borrowing from foreign capital markets to finance their budgets
which may lead to the loss of political autonomy (Fleeger, 2006).

From the time Zambia got her independence in 1964 up to the mid 1970s,
Zambia’s economy was doing well running both a current and budget account surplus.
Prior to 1975, exports of goods and services comfortably exceeded imports leading to
the accumulation of foreign-exchange reserves. Between 1975 and 1990, however,
Zambia’s current account deficit averaged some 8% of GDP, accumulating external
debts of $5.8 billion during the same period (Fagernäs and Roberts, 2004). Between
the 1970s and 1990s the Zambian economy was one of the most badly mismanaged in
Africa, at both the macro- and micro-economic levels. At the macro level this is
perhaps best illustrated by the scale of fiscal deficits, which averaged 12.3% of GDP
during the 1970s, 13.8% in the 1980s and 6.0% in the 1990s. One of Africa’s richest
countries, classified as ‘lower middle income’ at Independence, had become a ‘least
developed’ country by the 1990s. It was only after the turn of the 21 st century that the
both the current and fiscal balances started to improve with fiscal deficit reaching an
exceptionally low level of 0.9% of GDP in 2008 (Whitworth, 2012).

Since Zambia became an independent state, it had rapidly accumulated a big

foreign debt until the first years of the new millennia when much of it was cancelled.
During the whole period almost no improvement in the production capacities occurred,
institutional reforms did not progress much and there has been a steady decline in the
country’s gross domestic product hitting -2 % in 1998 (N’gona and Dube, 2012). The
current account deficit in Zambia is likely to have been a consequence of excessive
consumption and unproductive spending of the government sector of the economy. As
is the case, the situation that existed is important to investigate whether government
budget deficit causes current account to deteriorate in Zambia. And the issue of
government budget deficit reduction becomes very crucial for Zambia in case the direct
causality between the two deficits exists.

1.0.2 PROBLEM STATEMENT

This study as earlier indicated, links the current account to fiscal deficit in
Zambia. The study is derived by an apparent disparity concerning Zambia’s economic
experiences in the period between 1991 and 2011. During this period, the country
experienced mixed results of economic growth especially during the 1990s when
extensive macroeconomic and market liberalisation programme occurred. After 1990
determined efforts were made to stabilise, reform, liberalise and diversify the still
declining economy, and to restructure and reduce Zambia’s unsustainable external
debt. The copper sector, much diminished as a source of revenue, became a fiscal
burden in the later 1990s (Fagernäs and Roberts, 2004). GDP growth has been uneven
during the reform period (Bigsten and Kayizzi-Mugerwa, 2000).
 Between 1992 and 2000, the economy performed poorly with the country’s GDP
hitting -2 percent. But the situation started to improve from the turn of 21 st century with a
real GDP per capita average annual growth rate of 2.8 percent from 2000 till 2005
followed by a stable growth rate of about 4.1 percent GDP per capita average annual
growth experienced between 2006 and 2010(CUTS, 2010). This suggests, prima facie,
that the fiscal deficits improvement created after the adoption of the economic reforms
in the 1990s was accompanied by mixed current account balances. The question then
is does an improvement in fiscal deficit causes current account to deteriorate or improve
in Zambia?

1.0.3 OBJECTIVES

In light of the debate that has been ensuing across the great economic divided as
to whether to fiscal and current deficits are twins. This study aims to investigating the
short and long term effects of fiscal on the current account in Zambia.

Specific objectives made are;

1. To assess the effects of the fiscal deficit on the current account

1.0.4 HYPOTHESES

RESEARCH HYPOTHESIS

A hypothesis is a guess or an assumption. It is a tentative explanation for certain

behaviour patterns, phenomena, or events that have occurred or will occur (Gay, 1996).
According to Van der Westhuizen (1993:16), the purpose of the hypothesis, among
others, is to direct and structure the study and to serve as a link between the literature
study (theory) and the research (empirical research) and will eventually result in
expansion of knowledge.

Research Hypothesis

Null hypothesis (Ho): There is no relationship between fiscal deficit and current
account.
Alternative (H1): There is a relationship between fiscal and current account deficit.

It should be emphasised that the aim of the research is to specifically accept or

reject Ho. Should Ho; be rejected, then there is a relationship between fiscal and current
account deficit and appropriate policies will be suggested on how to improve the effects
on the current account which ultimately economic growth. If Ho; is accepted then there
is no relationship between fiscal and current account deficit. However, explanations and
suggestions probably recommendations will be made.

The purpose of the study is therefore to make available empirical information on the
effects of the fiscal deficit on the current account in Zambia.

1.0.4 STUDY CONTRIBUTION

The persistent existence of budget and current deficit has been an important
issue for policy makers in Zambia. Moreover, given the emphasis on free trade,
decentralization and growth, there is need to understand the connection of fiscal and
current account imbalances in Zambia’s economy. The purported theoretical link
between fiscal deficit and current deficit has not been explored from empirical
perspective in Zambia. Various studies have, however, been conducted in countries
outside Zambia particularly in developed nations. Linking current account deficit directly
to budget deficit does not prove a clear consensus of the effect of fiscal policy on
current account hence the need for the topic to be investigated further. The study will
make link fiscal policy to the current account balance. By so doing will make a modest
contribution to the stock of knowledge that is currently available on the subject matter
and will raise the level of enlightenment from a policy making perspective.

1.0.5 SCOPE OF STUDY

This study focuses on a 1991-201- a period reflecting an advanced stage of

economic reforms in Zambia. This period is chosen because it’s a period during which
the Zambian government implemented major economic reforms. The period also
highlights a period during which the country completed the Heavily Indebted Poor
Countries (HIPC) Initiative. This obviously affected the budget formulation policy the
ensuing years which this study wishes to capture.