Fiscal reforms and infrastructure investment in Tanzania

The second-largest economy in the EAC, with an estimated population of 53m, Tanzania is one of the biggest consumer markets in the region. A stable democracy combined with extractive wealth, a favourable climate for agriculture, and natural assets such as Mount Kilimanjaro and the Serengeti National Park have helped it build a relatively high rate of growth over the last decade, averaging 6-7% per year. In 2017 the government of President John Magufuli formulated its second budget, which forms part of a longer-term strategy of attaining middle-income status by the middle of the next decade. This transformation is to be brought about through industrialisation and human development.

Big Picture

The ongoing process of economic reform presents challenges to some sectors, and weak budget execution and policy uncertainty have dampened investment, but the overall macroeconomic picture remains favourable. In June 2017 the IMF projected GDP growth of 6.2% in 2017 and 6.8% in 2018, while headline inflation is expected to remain at 5-7% over the year – broadly in line with the 5% medium-term target.

The implementation of Tanzania’s bold development plan is expected to result in the current account deficit rising from 4.9% of GDP in 2016/17 to 6.8% in 2017/18, but an anticipated increase in project loans and external borrowing means international reserves are expected to expand to $5bn in 2017/18, which represents approximately four months of import cover.

Key Sectors

The economy is already fairly diversified. In 2015, the year of President Magufuli’s election, the services sector contributed the biggest share of mainland Tanzania’s GDP, accounting for 43% of the total. This sector is composed of an array of subsegments, of which the most important contributor is wholesale and retail trade, which represented 11.6% of total economic activity in 2015. Tanzania’s major air and seaports – in Dar es Salaam, Tanga, Mtwara and Zanzibar – all serve to ferry goods to domestic and neighbouring markets. This activity has driven growth in transport and storage, which is the second-largest subsegment, accounting for 4.6% of GDP. Tourism also plays a key role within the services sector. Since 2012 tourism has been the leader in terms of foreign exchange earnings and is the third-largest recipient of foreign direct investment (FDI) after mining and manufacturing.

Agriculture, forestry and fishing make up the second-largest sector, accounting for 31% of GDP. Crop production is the largest agricultural segment and one of the fastest growing in recent years, expanding by 44% between 2008 and 2013, according to the World Bank’s crop production index, comfortably ahead of the sub-Saharan Africa average of 18% over the same period. Tanzania’s main exported cash crops are tobacco, cashew nuts, coffee, tea, cloves, cotton and sisal (an agave cultivated for fibre production). Livestock production grew at a rate of 33% between 2008 and 2013, again outperforming the sub-Saharan average of 11%. The sector continues to be an important provider of jobs, employing 66% of the workforce, according to the Ministry of Finance and Planning (MoFP).

Industry and construction contribute 26% of GDP. The industrial segment is made up of manufacturing (53%), processing (43%) and assembling industries (4%), with the processing of local agricultural goods playing a key role. Important exported goods include processed coffee and tobacco, yarn and twine, wheat flour, plastic items, textiles and cement. This sector also includes the mining industry, which is based on the extraction of metals (such as gold, silver and iron ore), industrial minerals (including diamond, tanzanite, ruby, salt and phosphate) and fuel minerals (coal and uranium).

Tanzania’s construction industry experienced double-digit growth in every year but one between 2010 and 2014, and is being driven by demand for housing and infrastructure, with support coming from development finance institutions and public funds.

Towards Open Markets

The economy has developed rapidly since the country gained independence in 1961. At that time Tanzania had only eight qualified medical doctors, two engineers, a life expectancy of 38 years, per capita GDP of $48 and no universities.

By the time Tanzania celebrated the 55th anniversary of its independence in 2016, life expectancy at birth was 61 years, per capita GDP exceeded $1000, and there were 30,000 engineers, 2190 doctors and 50 universities and colleges, according to official figures.

The path between these two points, however, has not been a straight one. Just a few years after independence, Tanzania’s new leader, Julius Nyerere, rolled out a range of socialist policies – an act which continues to influence economic policy-making. The following years saw the nationalisation of a number of Tanzania’s financial, industrial and commercial companies, and a diminishing role for the private sector.

The increased local ownership of key segments and large influence of the state led to market distortions and inefficiency. The economy suffered, and by the 1970s Tanzania was fighting a chronic currency crisis and soaring inflation. In the early 1990s the country began to transition towards an open economy based on free markets – a process that began with the reversal of the nationalisation process. By 2013 around 300 parastatals had been privatised through the Presidential Parastatal Sector Reform Commission, with assistance from the Tanzania Investment Centre (TIC). In 1995 Tanzania joined the Word Trade Organisation, and the following year the Dar es Salaam Stock Exchange opened for business, establishing a new financial channel by which the nation’s development might be funded.

Improved Outcomes

Underinvestment in previous decades had left a legacy of poor infrastructure, intermittent power and an undeveloped business segment, but since the turn of the century the nation has been on a track of expanding GDP. This gradual liberalisation has had a beneficial effect on the lives of its citizens.

According to the UN Development Programme (UNDP), between 1990 and 2015 the country’s human development index score climbed from 0.37 to 0.531, an increase of 44%. Tanzanians have experienced more favourable outcomes across a wide range of criteria, including health, education, gender parity, income and human security. However, there is considerable room for further improvement; Tanzania’s human development index score for 2015 put the country in the low human development category, ranked 151st out of the 188 countries and territories surveyed.

Strategy

Since the turn of the century government policy-making has focused on how best to respond to these developmental challenges.

The preparation of Tanzania’s main strategic plan began in 1994, and it was launched in 1999 as the Tanzania Development Vision (TDV) 2025. This document still forms the framework within which the government formulates more detailed policy. In broad terms it aims to transform the country into a middle-income, semi-industrialised nation by 2025, characterised by high-quality and sustainable livelihoods; peace, stability and unity; good governance and the rule of law; an educated society; and a strong and competitive economy.

A review of TDV 2025 conducted in 2009 and 2010 resulted in the introduction of the Long-Term Perspective Plan 2011/12-2025/26 aimed at more effectively steering Tanzania towards meeting the vision’s objectives. Three five-year development plans (FYDPs) were established within this framework, each with a different theme, starting with the FYDP I (2011/12-2015/16) and its focus on “Unleashing Tanzania’s Latent Growth Potentials”. The designated themes for the FYDP II (2016/17-2020/21) and the FYDP III (2021/22-2025/26) are “Nurturing an Industrial Economy” and “Realising Competitiveness-Led Export Growth”, respectively.

FYDP II: The current FYDP II established a number of bold targets. These include real GDP growth of 10% (up from 7% in 2015), per capita income of $1500 (from $1043 in 2014) and a reduction in the poverty rate to 16.7% (down from 28.2% in 2011/12). The plan also envisages raising FDI flows from $2.14bn in 2014 to over $9bn, as well as improving electricity connections and access to clean water, and reducing mortality rates.

Manufacturing features prominently in the FYDP II, which foresees the sector growing by over 10% per year, with its share of total exports increasing from 24% in 2014/15 to 30% in 2020 (see analysis). Other sectors that receive particular attention include construction, agriculture, trade, natural resource management, tourism, science and technology, creative industries, education and skills, and health care.

Business Environment

To help meet these objectives, the authorities are in the process of overhauling the wider business environment, with mixed results. In the FYDP II, President Magufuli underlines the government’s determination to “improv[e] the business environment and in so doing, provid[e] a wide range of appropriate incentives and support to unleash [the] creativity of [the] private sector and other stakeholders in harnessing Tanzania’s comparative advantages”.

Since its turn towards free-market economics, Tanzania has introduced a number of laws and signed various treaties that underpin the fundamental rights of investors. The most important of these are the guarantees against nationalisation and expropriation, derived from the country’s membership in the Multilateral Investment Guarantee Agency and the International Centre for Settlement of Investment Disputes.

The TIC acts as a gateway for foreign investors, including those engaging in start-up activity. Companies that meet the requirements necessary to obtain a TIC certificate of incentives benefit from value-added tax (VAT) and import duty exemptions, the right to repatriate dividends and profits, and other advantages.

Similar incentives are on offer to investors in Zanzibar through the Zanzibar Investment Promotion Authority. In addition, Tanzania has established a competitive fiscal regime for foreign investors by signing double taxation agreements with 10 countries, including Canada, Italy, South Africa and India.

Location, Location, Location

Tanzania’s infrastructure provides a comparative advantage. Its location halfway between the Horn of Africa and the Cape of Good Hope makes it an important gateway to neighbours Uganda, Burundi, Rwanda, Zambia, Malawi and the Democratic Republic of the Congo.

Reaching these markets has become easier in recent years thanks to sustained investment in the nation’s infrastructure. A road-building programme has resulted in a high-quality network linking its major cities, while two railway networks connect 14 out of 20 cities and neighbouring Zambia. International and domestic airports provide expanding air freight linkages, and three major ports – Dar es Salaam, Tanga and Mtwara – are emerging as important commercial hubs.

Challenges

There are, however, numerous challenges to conducting business. Land ownership, for example, remains restrictive, with all land held by the state and vested to the president as Trustee of the Land for Tanzanians. Moreover, while Tanzania has improved its business conditions, it ranked a modest 137th out of 190 countries in the World Bank’s “Doing Business 2018” report. Placing the country in the top 100 of this influential index was an ambition of the FYDP I, and the government has reaffirmed its commitment to this aim in the FYDP II (see analysis).

Some reform efforts have also received mixed reviews by affected sectors. For example, in July 2017 several new mining bills were signed into law, requiring that the government hold a minimum 16% stake in mining projects, raising royalties for several metals and granting the government the right to renegotiate contracts for natural resources (see Energy & Mining chapter). This follows the 2016 ban on the export of copper concentrates. The move was intended to boost the value-added component of the industry by compelling mining companies to develop smelting operations domestically. While some economists were pleased with the development, the ban – as well as the government’s reassessment of taxes owed by some mining companies – has not been welcomed by all stakeholders in the industry. By mid-2017 a number of related arbitration cases had been initiated against Tanzania.

The government’s broader review of taxation has succeeded in boosting much-needed revenue over the past year, but the tighter application of tax regulations and the extension of VAT to tourism and financial services have had a disruptive effect on some of Tanzania’s most important sectors (see analysis).

Investment

Improving Tanzania’s business environment is central to the government’s attempt to reverse a decline in FDI as a percentage of GDP, which has persisted since 2010/11. In absolute terms FDI inflows decreased from nearly $1.7bn in 2014 to just under $1.4bn in 2016, a trend witnessed in a number of other large markets in Africa. Nevertheless, Tanzania remains one of the most popular FDI destinations on the continent. As of 2016 FDI stock in the country totalled approximately $19.8bn, equivalent to 42% of GDP, according to estimates from the UN Conference on Trade and Development. The 2016 “African Economic Outlook”, authored by the African Development Bank (AfDB), the UNDP and the OECD, ranked Tanzania among the top-10 African recipients of FDI for that year, attributing this success to the government’s new drive to attract investments in line with its medium-term development plan and industrial ambitions.

Much of this investment comes as a result of Tanzania’s promotion of large-scale development projects, particularly a number of port facility, energy and gas liquefaction projects initiated in 2013, which attracted significant capital from China, among others. Historically, the oil and gas industry and the agriculture sector – especially the primary production of coffee, cashew nuts and tobacco – have attracted the biggest volumes of FDI. The UK, China, South Africa, the EU and Canada are the country’s primary investors.

Decentralised Growth

The geographic spread of Tanzania’s resources makes for a wide distribution of investment flows, though the government has also established a number of special zones in an effort to attract targeted domestic and foreign investment.

In 2002 Tanzania launched the export processing zone (EPZ) scheme, designed to nurture export-orientated investment activity by establishing competitive conditions in designated areas. The scheme’s policies are centred on adding value in segments such as textiles and garments, leather goods, agro-processing and gemstones. In 2006 the special economic zones (SEZs) scheme was introduced with the aim of attracting domestic and foreign investment to a wider range of activities. The tax incentives on offer in the EPZs and SEZs have become a source of debate in recent years, in terms of concerns over lost potential government revenue. However, a 2015 analysis by the Export Processing Zones Authority showed the net benefit provided by the EPZ/SEZ framework. Focusing on a Chinese-owned clothing manufacturer operating in the EPZ scheme, the study demonstrated that between 2012 and 2014 the government forfeited TSh4.6bn ($2.1m) due to tax exemptions, but received TSh9.5bn ($4.3m) in the form of import taxes from the company.

Trade

Despite these attempts to boost exports, Tanzania has run a persistent trade deficit over the past decade. The scenario is far from unique to Tanzania, with other African economies facing similar situations.

MoFP data show that the ratio of exports to GDP was 31% in 2011, dropping to 29% in 2012 before continuing along a broadly downward trajectory to 25%, 18% and 20% in 2013, 2014 and 2015, respectively. The MoFP has identified a number of impediments to trade growth, including a narrow production and export base dominated by low-value, low-tech products such as raw materials and primary commodities; high trading costs; tariff and non-tariff barriers to intra-regional trade; and limited access to international markets.

However, Tanzania’s trade position is more robust than it might at first appear. In absolute terms, exports grew at an average annual rate of 9.5% from 2011 to 2016. Moreover, while the significant investment-related imports required by the infrastructure development programme means that the negative trade balance is likely to persist over the medium term, the country has a number of preferential trade windows it can exploit. These include the US’ African Growth and Opportunity Act, the EU’s Everything But Arms initiative and bilateral agreements with several countries, including Germany, Switzerland and the Netherlands.

The majority of Tanzania’s manufactured exports, however, are destined for African markets, which accounted for 72.4% of the total in 2014. Of that, exports to the EAC region accounted for 46%, while goods shipped to the Southern African Development Community (SADC) comprised 47%. Under the EAC, Tanzania has duty-free access to more than 70m consumers in Kenya, Uganda, Rwanda and South Sudan. Tanzania is also part of the negotiations on an economic partnership agreement between the EU and the EAC, although ratification of the agreement has been stalled due to disagreements among EAC members. However, in February 2018 Kenya and Tanzania agreed to resolve their trade dispute, which may put the signing of the EU-EAC agreement back on track. Tanzania is also a signatory to the Tripartite Free Trade Area, a proposed free trade agreement encompassing the EAC, the SADC and the Common Market for Eastern and Southern Africa, although – like most of the other signatories – the country has yet to ratify the agreement.

Fiscal Scenario

Developing the full potential of the most promising economic sectors, improving the domestic business environment and boosting exports are top among the government’s long-term objectives.

In the short term, however, the state faces a fiscal hurdle: a rising budget deficit and expanding public debt. The fiscal deficit – which stood at 3.3% of GDP in 2013/14 – deepened to 4.2% in 2015/16, while gross national debt grew from 31.4% to 38.8% of GDP. The key challenge for the current government is making good on its commitment to address a range of issues – including reducing inequality, and improving infrastructure and social services – which would necessitate increased spending, while at the same time addressing its structural budget shortfall. “The government is now trying to generate revenue from different sources to try to pay for the line items in the budget,” Samuel Gyan, regional managing director for East Africa at SGS Tanzania Superintendence Company, told OBG.

Capital Expenditure

The budget reform process has included the streamlining of government spending – such as cutbacks in procurement budgets and the removal of foreign travel perks traditionally enjoyed by government employees – and a reorientation of the budget towards capital expenditure. Running parallel to this is an attempt to improve revenue collection by minimising tax exemptions, increasing the use of electronic systems in collection and widening the tax base.

The 2016/17 budget was welcomed for its large allocation to capital expenditure (around 40%, or $5.4bn), with funds earmarked for a wide array of projects in transport, communications, water, irrigation and agriculture. However, by April 2017 only 38% of this sum had been spent, mostly on road construction, electricity projects, advance payments for the Dar es Salaam-Morogoro railway and the acquisition of aircraft. Recurrent expenditure remained above the budget target for the year. This discrepancy between budgetary ambitions and real spending remains a barrier to economic growth. More specifically, the government’s pruning of expenditure has not been adequately offset by capital spending, resulting in slower-than-expected expansion of GDP in 2016 of 7%, although this is still four times higher than the continental average.

New Budget

The 2017/18 budget – which sets headline spending at TSh31.7trn ($14.4bn), up 7% on the previous year – aims to narrow the fiscal gap to 3.8% of GDP, part of a set of objectives that seeks to maintain inflation between 5% and 8%, and increase tax revenue to 14.2% of GDP, up from the 13% estimated by the IMF for 2016/17. Nearly TSh12trn ($5.5bn), or 38%, of the budget has been earmarked for development spending, which is within the 30-40% target range established by the FYDP II. Some 62% of the budget, or TSh19.7trn ($9bn), is directed to recurrent expenditure, which includes TSh9.4trn ($4.3bn) for public debt and general services, and TSh7.2trn ($3.3bn) for wages and salaries.

Development partners are expected to contribute nearly TSh4trn ($1.8bn) in the form of grants and concessional loans, of which TSh2.5trn ($1.1bn) will go directly to development projects. The government intends to secure its targeted revenue expansion by increasing the use of electronic monitoring to reduce leakage, raising the contribution of property taxes, extending the tax net over the informal sector and formalising land ownership to further facilitate taxation.

The fiscal gap is forecast to persist into the medium term, however, so Tanzania remains dependent on external aid in order to meet its spending commitments. Foreign grants accounted for 14.8% of the budget in 2014/15, although much of it was withheld by donors due to governance concerns.

The government has since sought to reduce dependence on aid by borrowing, primarily on concessionary terms, from multilateral financial institutions such as the AfDB and the World Bank.

Taxation

Tax reform represents an early success for the government. Tax revenue in the second half of 2016 showed a 13% rise year-on-year. In the two budgets since President Magufuli took office, the government has made several major alterations to the taxation system, which is based on VAT, income tax, import duties and excise taxes. In broad terms these have sought to widen the tax base while protecting vulnerable segments of the population. In FY 2016/17, therefore, a reduction was implemented in the lowest tax rate applicable to individuals and employees from 11% to 9%. Tax exemptions were also removed, however, from the final gratuity paid to members of Parliament and dividends earned from certain classes of shares.

The changes to income tax for FY 2017/18 are relatively minor, such as greater tax relief for non-commercial motor vehicles, the introduction of a 5% withholding tax for small-scale miners, and a reduction of corporate tax for new assemblers of vehicles, tractors and fishing boats. The latter measure chimes with Tanzania’s efforts to promote the industrial sector, embodied in the government’s slogan Tanzania ya viwanda (Industrialising Tanzania).

VAT

The country has attempted to broaden its tax base by adjusting the schedule of its VAT framework, which first came into effect in July 2015. The most significant VAT changes were made at the start of FY 2016/17, and extended the 18% VAT levy to financial transactions and tourism services.

The short notice given for the changes resulted in a number of administrative challenges, and tourism sector stakeholders have been particularly vocal about the new expense, which they see as setting the sector at a disadvantage to its regional competitors.

In FY 2017/18 the government has taken a more accommodative stance towards its VAT revisions, re-establishing the zero rate on ancillary transport services. The introduction of VAT to this segment negatively affected shipping volumes though Tanzanian ports, as maritime traffic was routed to other ports in order to avoid increased transport costs.

FY 2017/18 also saw the introduction of a VAT exemption on the procurement and importation of capital goods used in production of edible oil, textiles, leather and pharmaceuticals (including veterinary) products. As with the change to income tax made the previous year, this alteration is intended to support the government’s bid to boost the industrial sector.

Monetary Policy

The task of ensuring the government’s process of economic reform does not adversely affect inflation falls to the Bank of Tanzania (BoT). The primary objective of the central bank is to formulate and implement monetary policy in order to deliver domestic price stability, defined as low and stable inflation.

The BoT has a medium-term inflation target of 5%, which it strives to reach by managing the growth of the money supply through open-market operations. These include the standard array of policy tools, such as the sale and purchase of securities by the BoT to withdraw or inject liquidity, selling and buying foreign exchange in the interbank market, repurchase agreements and standby facilities (Lombard and discount windows).

A loosening of monetary policy in late 2014 was partly responsible for a depreciation of the Tanzanian shilling. However, headline inflation remained in the single digits throughout 2015, due largely to a tightening of monetary policy in May 2015 and a general decline in global commodity prices. During 2015/16 monetary policy was geared towards aligning inflation with the medium-term target of 5%, an effort which broadly succeeded; the last quarter of 2016 showed an inflation rate of 4.8%, according to the BoT. Inflation reached a 12-month high in March 2017, hitting 6.4%, a rise that was largely attributable to a weather-related contraction in the food supply. However, it has moderated since then, with annual headline inflation averaging 4.5% in the quarter ending December 2017.

How the BoT addresses inflation is also scheduled to change, with plans to transition from an open market operations approach to a fully fledged interest ratebased framework. According to a blueprint that was approved by the BoT, this will involve establishing a policy rate and interest rate corridor, which could be formed by existing lending and deposit facilities.

While open market operations remain the principal means by which the BoT implements its monetary policy until this framework is established, in March 2017 the BoT reacted to a slowdown in private sector credit growth by cutting its discount rate from 16% to 12%, and lowered it again in August to 9% – marking the first time it had lowered borrowing costs since 2013.

Outlook

While the current administration’s ongoing fiscal reform efforts – including revisions to VAT, and the push to boost local content and revenue in the mining sector – will take some time to work through company balance sheets and the broader economy, Tanzania’s growth outlook in both the near and medium term remains largely positive.

The IMF projects a real GDP growth rate of 6.2% in 2017 and 6.8% in 2018, with significant investment in rail, port and road development likely to drive GDP expansion well into the next decade.

The presence of abundant natural resources, a reform-oriented government and a 53m-strong population that is growing at an annual rate of 3% are just some of the key growth drivers that will help Tanzania remain an interesting prospect for investors.