US embassy cable - 05HARARE1239

C O N F I D E N T I A L SECTION 01 OF 04 HARARE 001239 
 
SIPDIS 
 
AF/S FOR B. NEULING 
STATE PASS USAID FOR M. COPSON 
NSC FOR SENIOR AFRICA DIRECTOR C. COURVILLE 
TREASURY FOR J. RALYEA AND B. CUSHMAN 
TREASURY FOR JOANN CHIN 
USDOC FOR ROBERT TELCHIN 
 
E.O. 12958: DECL: 12/31/2010 
TAGS: ECON, EFIN, ETRD, PGOV, ZI, Economic Policy 
SUBJECT: IMF MISSION FINDS MODEST REFORM MEASURES, HEARS 
MORE PROMISES 
 
Classified By: Ambassador Christopher Dell for reasons 1.4 (b) and (d) 
 
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SUMMARY 
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1. (C) Summary.  An IMF mission was in country from August 
22-September 1 to give advice, assess economic policies, and 
review the strength of the GOZ,s commitment to economic 
reform prior to the September 9 meeting of the Fund's 
Executive Board.  The team acknowledged recent modest 
progress by the Reserve Bank of Zimbabwe (RBZ) in tightening 
monetary policy, but saw little prospect of an improved 
fiscal situation in 2006.  Massive overspending in the first 
half of 2005 plus high wage and interest bills had led to 
considerable fiscal expansion and were feeding inflation. 
The team reduced its forecast of the fiscal deficit to 11.3 
percent from 14.2 percent in May, as a result of measures the 
GOZ took in the July supplemental budget, but projected an 
annualized rate of inflation of 400%, or higher, by end-2005. 
 The team relayed Reserve Bank Governor Gono,s claim that 
the recent arrears payment of US$120 was funded by working 
capital repatriated as a result of devaluation and higher 
interest rates, and a short-term borrowing facility, but 
expressed some skepticism about Gono's explanation of the 
source of the payment.  The GOZ continues to blame its 
economic woes on two forces out of its control: drought and 
U.S./EU sanctions.  The IMF team said that the adjustment 
measures of the last weeks were modest and did not constitute 
a comprehensive reform package. 
 
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Some Reforms, More Promises from Gono 
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2. (C)  Mission Chief Coorey said the GOZ had initiated some 
reforms since the June Article IV mission, which concluded 
that economic and social conditions had deteriorated sharply 
over 2004.  Since June, Reserve Bank Governor Gono has 
tightened monetary policy by devaluing the currency (from 
Z$8,500 to the US$ at end-May, to Z$24,500 at end-August) and 
raising interest rates.  The spread in the parallel market 
premium had narrowed to some 100 percent, down from about two 
and a half times the official rate in early August.  The pace 
of the Reserve Bank of Zimbabwe,s (RBZ) foreign exchange 
losses from subsidies to importers and persons with 
preferential access to foreign exchange has fallen.  The 
picture is nevertheless mixed, with some producer subsidies, 
such as the tobacco subsidy, having been cancelled, while 
others, on cotton, for example, have increased.  Losses 
accumulating from quasi-fiscal measures, in particular the 
high cost of interest payments resulting from liquidity 
support in 2004 to insolvent commercial banks, amount to a 
staggering 20 percent of GDP, according to Coorey.  The 
mission advised the GOZ to terminate quasi-fiscal activity 
(not simply move it to the budget); otherwise, the RBZ would 
have to continue to print money.  The team further urged the 
GOZ to liberalize the exchange rate and limit the role of the 
RBZ to maintaining exchange rate stability.  Coorey commented 
that the RBZ had lost considerable staff in the last months. 
Reserve Bank expertise, except in the area of bank 
supervision, had thinned.   Gono had expressed interest in 
getting technical assistance on exchange rate liberalization. 
 
3. (C)  Coorey reported that Gono is not averse to moving 
toward further liberalization of monetary policy.  On 
September 1 he announced withdrawal of the gold support price 
with immediate effect, with the result that gold will trade 
at the auction exchange rate.  He also announced an end to 
the cotton support price in January.  Coorey said Gono is 
willing to carry out further monetary measures such as 
dropping the surrender requirement on exporters, or ending 
the daily sweep of commercial bank liquidity.  The sweep 
locks funds in for two years at 17 percent interest. 
However, he intended to postpone the announcement of further 
reforms until the October monetary statement, and made no 
commitment on what reforms would be adopted. 
 
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Mr. Fix-It,s Credibility at Stake 
--------------------------------- 
 
4. (C)  Gono is worried about inflation, more so than 
Minister of Finance Murerwa is, according to Coorey.  She 
estimates inflation will end the year at an annualized rate 
of 400 percent against Gono,s earlier double-digit 
projections.  If he cannot deliver on inflation, he has 
failed, by his own admission.  She opined that Gono was not 
in a strong position to ring the alarm bell on the budget, as 
10-20 percent of the deficit arises from RBZ activities.  As 
&Mr. Fix-it8, he has taken on too many tasks and is now 
coming under fire from the Cabinet for having orchestrated 
devaluation without bringing down inflation, as he promised. 
Coorey noted that terminating quasi-fiscal support would end 
profitable rent-seeking activities for favored persons, and 
was thus politically hard for Gono to force.  She 
complimented him for successfully fighting the battle in 2004 
to end liquidity support to insolvent commercial banks, but 
noted that, soon after, an amendment was passed requiring the 
Reserve Bank Governor to consult with the Minister of Finance 
before canceling banking licenses.  She commented that Gono 
goes to Mugabe for approval on the smallest of issues.  He 
could not sign, for example, a public letter or make a 
commitment on capping the PLAP (Parastatals and Local 
Authorities Re-Orientation Programme Facility) without 
consulting first with Mugabe. 
 
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Bleak Fiscal Outlook 
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5. (C)  The mission reduced its fiscal deficit projection 
from 14.2 percent in May to 11.3 percent, based on tax 
measures and spending cuts introduced in the GOZ,s July 
supplemental budget.  The hangover from a massive spending 
binge in the first half of 2005 and high wage and interest 
bills are the major impediments to narrowing the deficit 
further.  Murerwa recognizes the seriousness of the wage bill 
problem ) wages amount to 20 percent of GDP - but is 
noncommittal as to what action to take.  He told the mission 
team that pension and civil service reform would be fleshed 
out in the 2006 budget.  He noted it would be &very 
difficult8 to reduce expenditure in the 2006 budget.  Coorey 
pointed out that the high cost of maintaining the state,s 
security apparatus was also contributing to inflation.  She 
anticipated that the fiscal position would remain unchanged 
in 2006.  Measures such as taxation of the transportation and 
housing allowances, plus medical aid insurance, could 
generate a further one percent of GDP in revenue, but the 
social cost would be high.  She doubted the GOZ would follow 
through in this fiscal environment and spend the Z$300 
billion earmarked in the supplemental budget for &Operation 
Garikai8, the GOZ,s reconstruction program in the wake of 
Operation Restore Order. 
 
6. (C)  Kevin Fletcher, the IMF team fiscal expert, commented 
that his interlocutors were shocked at the magnitude of the 
fiscal problem once the IMF team exposed it to them. The RBZ 
did not realize the cost of its quasi-fiscal activities, in 
particular forex subsidies, gold price support, the cost of 
liquidity support to commercial banks, and the high cost of 
interest.  Against GOZ instinct to hide the numbers and their 
effects, the mission advised shedding light on the fiscal and 
political cost of policy decisions by making provisions in 
the budget.  Coorey advised Gono to make a point of showing 
the politicians the real cost of policies. 
 
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Sources of the Arrears Payment ) According to Gono 
--------------------------------------------- ----- 
 
7. (C)  Gono explained to Coorey that 70 percent of the 
recent arrears payment to the IMF was sourced, at the auction 
rate, from the return of working capital that had fled the 
country, but was attracted back as a result of devaluations 
and rising interest rates.  The remaining 30 percent was from 
a short-term financing facility (source unstated) repayable 
in 2006.  She expressed some skepticism about Gono's 
explanation of the source of the payment, noting there were 
inconsistencies in his public and private explanations.  She 
said Gono believed he had had to deliver to the IMF fast, as 
expectations were rising, the press had focused on repayment 
and the impending September 9 IMF Board vote, the publicity 
was damaging to Zimbabwe,s image, and internal politics had 
become particularly difficult.  The GOZ was not giving up on 
negotiating a loan from South Africa, but had not expected 
negotiations to conclude in time to pay the IMF before 
September 9, given the complications caused by the extensive 
press coverage.  Gono expressed the desire for a &program 
relationship8 with the IMF and said he expected to clear 
remaining arrears by the end of 2006. 
 
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The IMF Mission Assessment ) Balancing GOZ Actions and 
Promises 
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8. (C)  Coorey dodged the Ambassador,s direct question of 
staff,s recommendation to the Executive Board.  She insisted 
the IMF,s decision whether to recommend compulsory expulsion 
to the Board would be made at a much higher level than hers. 
&It,s anybody,s guess8, she said.  She agreed that the 
GOZ,s recent measures were modest and did not constitute a 
comprehensive reform package.  While Gono may have a sense of 
urgency, Murerwa and politicians appeared less concerned. 
Her assessment to headquarters would attempt to balance the 
recent adjustment policies and promises of further policy 
reform with past performance and political realities.  Coorey 
also ruefully agreed with the Ambassador's observation that 
the GOZ was once again hoping to squeak past an Executive 
Board review of its overdue obligations by adopting a minimum 
package of reforms (and a large payment on arrears), and 
promising further improvements at a future date, all designed 
to string us along and avoid tough decisions. 
 
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Drought and Sanctions ) &The Causes of all Zimbabwe,s 
Economic Woes8 
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9.  (C)  Coorey related that the GOZ took every opportunity 
to blamed its economic woes on two forces out of its control: 
drought and US/EU sanctions.  She pointed out to GOZ 
officials that FAO rainfall charts showed a range of normal 
rainfall in the peak growing season of October through 
December 2004, but they insisted the rains hadn,t fallen at 
the crucial time in the right places.  Regarding sanctions, 
GOZ officials would not accept that U.S. and EU sanctions 
were targeted solely against specifically identified 
individuals and their business activities, and not Zimbabwe 
itself.  She said her interlocutors were convinced that the 
U.S. is warning private companies not to do business in 
Zimbabwe. 
 
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Comment and Recommendation 
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9. (C)  GOZ posture toward the IMF delegation follows a 
familiar pattern of privately acknowledging mistakes and 
undertaking modest measures - to be implemented largely at 
unspecified times in the future.  In fact, the government's 
rhetoric with domestic audiences has not strayed at all from 
its extreme command and control approaches of the past five 
years.  As with so many of its economic challenges, the GOZ's 
strategy is just to make it to the next day, in this instance 
to forestall IMF expulsion, with no credible and 
comprehensive long-term recovery plan.  While Zimbabwe's 
surprisingly large payment may impress some, we see no 
evidence that Gono and his crew will be any more able to 
deliver reforms than they have in the past.  Indeed, Gono is 
skating on increasingly thin ice politically.  Depending 
entirely on the impulsive President's favor and not lacking 
in enemies, he is a prime scapegoat candidate to take the 
fall for the country's deepening economic distress. For their 
part, Mugabe and his cohorts betray little or no 
understanding of the underlying causes of the country's 
accelerating collapse nor their own responsibility for it 
through gross mismanagement. 
 
10. (C)  In view of the GOZ's large payment of arrears, we 
understand it is unlikely that we can muster the votes 
necessary for the Executive Board to recommend compulsory 
withdrawal to the Board of Governors.  Coorey also continues 
to frustrate by her unwillingness to draw a bottom line under 
the GOZ's performance, and we have little expectation that 
she or IMF senior management will advocate forcefully for a 
tough position.  While it may not be feasible under these 
circumstances to achieve a vote for compulsory withdrawal, we 
nonethless believe the GOZ should not be let off the hook. 
We recommend pushing as hard as possible for compulsory 
withdrawal while working behind the scenes to obtain a Board 
vote of censure against the GOZ.  To let Mugabe, Gono and 
company get away with nothing more than another six month 
reprieve will only encourage more of the same from them and 
undermine the IMF's credibility. 
 
 
DELL