# DETERMINANTS OF MINING INVESTMENT: A CASE STUDY OF THE ZIMBABWE MINING SECTOR Lyman Mlambo, Institute of Mining Research, University of Zimbabwe. Presentation.

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DETERMINANTS OF MINING INVESTMENT: A CASE STUDY OF THE ZIMBABWE MINING SECTOR Lyman Mlambo, Institute of Mining Research, University of Zimbabwe. Presentation at the UNCTAD Workshop on the Teaching, Research and Policy Design of Natural Resources and Economic Development, July 12-16, 2010, Dar-es-Salaam, Tanzania Presented on 13 July, 2010.

ORGANIZATION OF PRESENTATION  Background – brief reference to theory to shape thoughts  Overview of the mining sector in Zimbabwe  Discussion on determinants of mining investment in Zimbabwe  Results of an estimation model

 The Keynesian investment function (Pentecost 2000; NEPC) can be summarised as given below : Where i= market rate of interest β 0 = captures exogenous shifts in business expectations, which affect the firm’s rate of return Thus, the rate of return and the rate of interest are determinants of mining investment.

The Accelerator theory of investment (Gujarati 1988; Dzawanda 1994; Pentecost 2000)  This theory assumes that there is a desired stock of capital to produce a given output for a given technology, rate of interest and so on.  The theory makes three assumptions: where t indicates period t, K* t is desired mining capital stock, Q t is current mining output, K t is current capital stock, I g t is gross investment, α is the depreciation rate and δ is the coefficient of adjustment.

 By a series of mathematical derivation and manipulations it can be shown that:  This function can then be estimated and coefficients of the above variables be tested for statistical significance.

 Theoretical Determinants of Investment, as suggested by the foregoing discussion Project rates of return/internal rate of return Project rates of return/internal rate of return Interest rate Interest rate Current level of output Current level of output Previous year’s output Previous year’s output Previous year’s investment Previous year’s investment When one looks at the peculiarities of the mining sector (Gentry & O’Neil 1984; Pearce 1986; Driver & Moreton 1992; Gocht et al 1988), the following factors can be added: When one looks at the peculiarities of the mining sector (Gentry & O’Neil 1984; Pearce 1986; Driver & Moreton 1992; Gocht et al 1988), the following factors can be added: Risks - market risks and political risks Risks - market risks and political risks Uncertainty. Uncertainty.

Poindexter (1976), also suggests the following: Credit rationing or availability Credit rationing or availability Cash flow – empirical evidence exists that investment is positively related to cash flow. Cash flow – empirical evidence exists that investment is positively related to cash flow. This list is certainly not exhaustive, but we can use it for analysis. This list is certainly not exhaustive, but we can use it for analysis.

AN OVERVIEW OF THE MINING SECTOR IN ZIMBABWE Introduction  Currently there are more than forty different types of minerals mined in the country. Major among them, in terms of production value, are: gold, asbestos, nickel, coal, copper, chrome, tin, iron, silver and cobalt (Central Statistical Office, CSO).  In 1980 Zimbabwe’s proven reserves of chrome were more than half that of the world (Mining in Zimbabwe Pamphlet). See the table below for some reserve estimates for ten minerals mined in Zimbabwe (Source: IMR database).  Most of these estimates are based on operating mines

MineralReserve estimates (tons) Year of estimate Gold84m1990s Asbestos560m1993 Nickel114m1980 Coal2 billion1992 Copper350m1988 Chrome608m2001 Iron ore1 billion1973 Cobalt8,0001987 Platinum136m1988 Aluminium2m1983

 Exploration for coal bed methane gas has recently been carried out and there are huge estimates of reserves being given going to billions of cubic metres of gas. But detailed exploration to prove these reserves are yet to be done.  The mining industry in Zimbabwe has generally remained a primary producer and exporter. We have exported to the region, the continent and internationally (Source: Ministry of Mines).

 Contribution of mining to the economy (CSO, etc (?).): 4.5% of Gross Domestic Product (GDP) in the 1990s, 4.5% of Gross Domestic Product (GDP) in the 1990s, 4.5% of employment in the same period, 4.5% of employment in the same period, 10.2% of Gross National Investment from 1992 to 1997, and, currently, about 10.2% of Gross National Investment from 1992 to 1997, and, currently, about 40-45% of foreign exchange earnings. 40-45% of foreign exchange earnings.

FISCAL REGIME The schedule of royalties are as follows (Mining in Zimbabwe, 2002/2003, p.9.): Precious stones10%, precious metals 3%, base metals 2%, industrial minerals 2%, coal bed methane gas 2% and coal 1%.   Capital goods imported for purposes of mining are exempt from import restrictions in the first five years of development and all capital expenditure is tax deductible at 100%.   Right to market directly subject to reporting requirements (to report to Minerals Marketing Corporation).

Mining Investment in Zimbabwe[1] [1]  From 1968 to 2009 the ratio of investment to gross- output was estimated at between 10 and 12 percent.  Vigorous mining industry expansion was recorded for 1968-1971 period, the period during which nickel and ferrochrome experienced expansion. During this period investment averaged 21.5% of gross output.  Another period of vigorous expansion was the mid 1990s.  From 1973-1996 mining investment averaged 25 percent of output (at current prices).  Since the late 1990s there was steep decline in mining investment (besides 1995 and 1996). [1][1] Based on Hawkins (2009) [1]

 During the period 1983-1993 there was negative net investment and a backlog in replacement investment.  After 1997, except in the platinum and diamond sectors, exploration and new capacity investments have been minimal. According to the President of the Chamber of Mines at the Chamber of Mines Annual Congress in 2007, since 2003 no new (major) exploration licences had been issued despite that applications for new EPOs had been made.  A lot of the equipment being used has also aged or become obsolete.  The post-crisis recovery of the mining industry requires more than normal investment levels in both exploration and capacity, since the industry had effectively retrogressed to an ‘immature’ status. Recovery requires large foreign injections.i.e. foreign direct investment (FDI), the achievement of which will depend on the new mining sector policy and private sector response to it.

DISCUSSION ON DETERMINANTS OF MINING INVESTMENT IN ZIMBABWE Cash flow problems and Credit constraints [Based on Chamber of Mines, 2010]  Cash flow problems for the mining sector have been caused by a number of factors, which include: Stiff surrender requirements – for the gold sector mines were required to surrender 100% of their proceeds since 1997 (up to 2009 at the advent of dollarization) by being forced to sell their produce to the Reserve Bank of Zimbabwe in return for Z\$ at the rate of Z\$55/US\$1. Stiff surrender requirements – for the gold sector mines were required to surrender 100% of their proceeds since 1997 (up to 2009 at the advent of dollarization) by being forced to sell their produce to the Reserve Bank of Zimbabwe in return for Z\$ at the rate of Z\$55/US\$1.

The RBZ also owed mining companies substantial amounts of money in foreign currency. This debt emanated either from the raids the Bank did on mines private accounts to fund critical areas of need during the crisis, or unpaid mineral deliveries. Later the RBZ converted this debt into gold bonds which could not be redeemed unless they were steeply discounted. The RBZ also owed mining companies substantial amounts of money in foreign currency. This debt emanated either from the raids the Bank did on mines private accounts to fund critical areas of need during the crisis, or unpaid mineral deliveries. Later the RBZ converted this debt into gold bonds which could not be redeemed unless they were steeply discounted.  With respect to credit, this was and is simply not available due to low savings in the domestic market. For example, in December 2009, total deposits amounted to US\$1.3 billion, an insignificant figure considering the country’s requirements.  With such restrained cash flows and credit it was very difficult for mines to meet operational requirements let alone to achieve net investments.

Interest rates  There have not been any significant lines of credit to the mining sector for fixed capital investment from the local credit market.  Studies have also concluded that a negative relationship between investment and interest cannot be supported in Zimbabwe (Mlambo, 2010; Dzawanda, 1994), while others which have obtained results consistent with the theory have found them to be insignificant (Dailami & Walton, 1989). This is also true of mining investment.  However, the local banking sector is sometimes an important source of working capital. In this case, interest rate becomes an important factor that affects the operation of mines hence affects the general business outlook. Interest rates (on borrowing) are more than 30% per annum currently (with dollarization) (Chamber of Mines, 2010).

Country risk profile and uncertainty Political risk is the single most significant damaging factor on mining investment.  There is great uncertainty with respect to property rights. This is due to (Based on Chamber of Mines 2010): The fear of expropriation which is real among miners. This is especially due to the recent land reform programme that dispossessed many white farmers of their land for redistribution to the majority of Zimbabweans. Some of these farmers have not been compensated and are not sure of ever being compensated.The fear of expropriation which is real among miners. This is especially due to the recent land reform programme that dispossessed many white farmers of their land for redistribution to the majority of Zimbabweans. Some of these farmers have not been compensated and are not sure of ever being compensated. There are also concerns of the rule of law emanating from cases whereby court orders have been disregarded.There are also concerns of the rule of law emanating from cases whereby court orders have been disregarded. There have been long disputes in the courts over farmland (and some of these disputes have gone to the regional SADC court), and these are yet to be resolved.There have been long disputes in the courts over farmland (and some of these disputes have gone to the regional SADC court), and these are yet to be resolved.

 The Mines and Mineral Act is in the process of being amended. Originally, the amendment sought to transfer 51% of the stake in the mining sector to the indigenous people (meaning basically black Zimbabweans), 26% of which was not to be paid for immediately. The bill, in its original form, faced stiff resistance from the mining industry, and was withdrawn for further review. This bill has taken too long to be finalized, and during this time, many big investors have been sitting on the fence.  There is also the Indigenization and Empowerment Bill which has been on the cards for quite some time. This looks at all the sectors of the economy.  Risk profile is also compounded by large foreign debt arrears, which have meant that Zimbabwe could not access critical support from international creditors like IMF and the World Bank (Chamber of Mines, 2010).

Project internal rate of return and adverse operational environment (Based on Chamber of Mines, 1989, 2010; Roussos, 1988; Mining in Zimbabwe 2002/2003; and Hawkins, 2009) The business environment has also been affected by the following:  Lack of foreign currency especially for non-exporting mines. Companies had to apply for forex at the RBZ and most of the times would not get it, and would end up in the black market. Forex allocation to the mining sector (in the 1980s) was so minimal that it only covered minimal maintenance (Chamber of Mines Journal, 1989). It could only be expected to have worsened after that.  Rising cost of imported spares due to the parallel market exchange rates.  General inflationary environment which has caused an escalation of operating costs including rises in wage bill.

Inadequate rail service due to old National Railways of Zimbabwe equipment. Inadequate rail service due to old National Railways of Zimbabwe equipment. Rising electricity tariffs and frequent power outages. Power outages have been so significant that mines had to buy generators. Rising electricity tariffs and frequent power outages. Power outages have been so significant that mines had to buy generators. Skills flight - mining skills are scarce worldwide and Zimbabwe has lost geologists, engineers, technicians and managers to the world labour market during the recent crisis. Skills flight - mining skills are scarce worldwide and Zimbabwe has lost geologists, engineers, technicians and managers to the world labour market during the recent crisis.

ESTIMATED RESULTS FROM A FLEXIBLE ACCELERATOR MODEL FOR ZIMBABWE  This study estimates the flexible accelerator model using the data for Zimbabwe Mining sector from 1977 to 1997.  The data were obtained from Reserve Bank of Zimbabwe (1998) and CSO(2001).

 The model estimated is both an autoregressive model and a distributed lag model. To take care of autoregressiveness we use the instrumental variable technique, and the ad hoc method is used to deal with the problem of distributed lags.

 Model without lagged output variable  Model with lagged output variable  The second model is unstable and produces meaningless results we use the first model.

Results  Autonomous investment The results show that autonomous investment is negative at –Z\$131 million. This coefficient is, however, insignificant at 0.05. This means that autonomous investment is statistically equal to zero. This indicates that when there is no production in the current period and has been no investment the previous year, there will be zero investment this year. The results show that autonomous investment is negative at –Z\$131 million. This coefficient is, however, insignificant at 0.05. This means that autonomous investment is statistically equal to zero. This indicates that when there is no production in the current period and has been no investment the previous year, there will be zero investment this year. However, considering the negative sign, this result means that when mines are not producing and have not invested in the previous year, there will be disinvestment in the current year. This indicates a move towards liquidation. For some mines in Zimbabwe we have had consecutive years of non-production and non-investment and many have actually degraded beyond care-and- maintenance to liquidation or just closing down, suffering natural depreciation of capital. However, considering the negative sign, this result means that when mines are not producing and have not invested in the previous year, there will be disinvestment in the current year. This indicates a move towards liquidation. For some mines in Zimbabwe we have had consecutive years of non-production and non-investment and many have actually degraded beyond care-and- maintenance to liquidation or just closing down, suffering natural depreciation of capital.

 Current output The results show that investment in the current period is positively affected by current output. The positive coefficient is significant at 0.05. The sign of the coefficient of current output is consistent with theoretical expectations, that is, an increase in current output would cause an increase in investment. The results show that investment in the current period is positively affected by current output. The positive coefficient is significant at 0.05. The sign of the coefficient of current output is consistent with theoretical expectations, that is, an increase in current output would cause an increase in investment.  Lagged dependent variable The coefficient of the lagged dependent is negative and insignificant at 0.05. The following possibilities may be drawn from the negative sign: The coefficient of the lagged dependent is negative and insignificant at 0.05. The following possibilities may be drawn from the negative sign:

This result may indicate that capital expansion is very discrete – which may reflect the attitude of miners to try to take advantage of short-term or once-off investment incentives, for example, investment credits. Once they are no longer there the investment drive stops or falls. This result may indicate that capital expansion is very discrete – which may reflect the attitude of miners to try to take advantage of short-term or once-off investment incentives, for example, investment credits. Once they are no longer there the investment drive stops or falls. The result also seems to reflect the small-scale nature of mining in Zimbabwe, which, therefore, may shorten lead- time to one year for a project. The mining industry in Zimbabwe is characteristically small-scale (especially the gold sector, which is the main contributor to mining output value), and the view of most mines is short-term. Few miners are prepared to undertake new projects or expansion projects that take more than one year of waiting before they come into operation. So when investment is undertaken this year, it may mean no investment for some years to come in the particular project or by that particular miner. The result also seems to reflect the small-scale nature of mining in Zimbabwe, which, therefore, may shorten lead- time to one year for a project. The mining industry in Zimbabwe is characteristically small-scale (especially the gold sector, which is the main contributor to mining output value), and the view of most mines is short-term. Few miners are prepared to undertake new projects or expansion projects that take more than one year of waiting before they come into operation. So when investment is undertaken this year, it may mean no investment for some years to come in the particular project or by that particular miner.  Whole model The explanatory power of the model as a whole is high at 88%. The explanatory power of the model as a whole is high at 88%.

Conclusion and policy recommendations based on the model and the foregoing discussion  It has been shown that the most significant factor that drives investment is current output.  A negative relationship between successive investment levels is also shown to exist, and it has been shown that possible factors to explain this include the discrete or once-off nature of investment, and the small-scale nature of mines in Zimbabwe.  The influence of interest rate is insignificant in Zimbabwe because of the non-existence of local credit. However, interest rate has affected the cost of working capital hence general business outlook.  Cash flow problems have also limited internal sources of funds for investment. These cash flow problems are linked to the Reserve Bank  Political risk and uncertainty have significantly held back big investment, and created a series of short-term/small investments. Risk is related to Mines Act, Empowerment Bill, and the recent land reform programme.  Rates of return have also been affected by various operational constraints and problems including lack of forex, parallel markets for forex, general domestic inflation, dilapidation of transport infrastructure, rise in energy costs and loss of skills to other countries.

 Some of the policy recommendations: Need to reduce risks and uncertainties in the mining sector. Need to reduce risks and uncertainties in the mining sector. This can be done through provision of market information, including the development of a comprehensive database on mining, mineral processing, geology, mineral economics and general economic environment in Zimbabwe (indicative planning).This can be done through provision of market information, including the development of a comprehensive database on mining, mineral processing, geology, mineral economics and general economic environment in Zimbabwe (indicative planning). Finalization of laws on mining and empowerment.Finalization of laws on mining and empowerment. Enhance respect of private property rights among citizens.Enhance respect of private property rights among citizens. Improve rule of law (especially the implementation of court orders)Improve rule of law (especially the implementation of court orders) Need to espouse macroeconomic policies that further stabilize the economy (stabilization policies)[1]. Need to espouse macroeconomic policies that further stabilize the economy (stabilization policies)[1].[1] Need to relook at the fiscal regime that impacts upon the mining sector in order to have a long-term rather than a short-term view (make long term investment incentives). Need to relook at the fiscal regime that impacts upon the mining sector in order to have a long-term rather than a short-term view (make long term investment incentives). Need for Government to prioritise mining in the allocation of forex. Need for Government to prioritise mining in the allocation of forex. Need for Government to directly promote current production through enhancing mining sector services such as geosurveys, analytical services (for export or exploration) and so on. Need for Government to directly promote current production through enhancing mining sector services such as geosurveys, analytical services (for export or exploration) and so on. [1][1] On indicative planning and stabilization policy refer to Driver & Moreton (1992, p.157-158). [1]

REFERENCES & BIBLIOGRAPHY  Chamber of Mines of Zimbabwe (2010a), “Mining Perspective”, Chamber of Mines Journal May- July 2010, Harare  Central Statistical Office (2001), Compendium of Statistics 2000, Harare  Dornbusch, R. & Fischer, S. (1981), Macroeconomics, Second Edition, McGraw-Hill Book Company, New York.  Driver C. & Moreton D. (1992), Investment, Expectations and Uncertainty, Blackwell Publishers, Oxford UK and Cambridge USA  Dzawanda, B. (1994), The effect of national income and the cost of capital on aggregate private investment in Zimbabwe (1970-1990). Unpublished Masters Dissertation, Department of Economics, University of Zimbabwe.  Gentry, W.D. & O’Neil, T.J. (1984), Mine Investment Analysis. Society of Mining Engineers of American Institute of Mining, Metallurgical, and Petroleum Engineers, New York.  Gocht, W.R., Zantop, H. & Eggert, R.G. (1988), International Mineral Economics: Mineral Exploration, Mine Valuation, Mineral Markets, International Mineral Policies; Springer-Veralg, Berlin.  Government of Zimbabwe (a), Various statistical publications, Central Statistical Office, Harare.  Government of Zimbabwe (b), Annual Reports of the Chief Government Mining Engineer and the Chief Inspector of Explosives (various issues from 1990 – 2000), Harare.  Gujarati, N.D. (1988), Basic Econometrics, Second Edition, McGraw-Hill Company, New York  Hawkins, T. (2009), The Mining Sector in Zimbabwe and its Potential Contribution to Recovery. UNDP Zimbabwe Comprehensive Economic Recovery in Zimbabwe Working Paper Series, Working Paper 1. Retrieved December 22, 2009, from UNDP website: http://www.undp.org.zw. http://www.undp.org.zw

 Mining in Zimbabwe Magazine 2002/2003  Mining in Zimbabwe, Prize of Africa Pamphlet  Mlambo, L. (2010), An ISLM Model for Zimbabwe and Macroeconomic Policy Implications, Global Conference on Business and Finance Proceedings, San Jose, Costa Rica, 2010, Vol.5, No.2, ISSN 1941-9589 Online & ISSN 1931-0285 CD, pp.370-382.  Pearce, D. (General Editor) (1986), The Dictionary of Modern Economics, Third Edition, English Language Book Society/Macmillan, London and Basingstoke.  Pentecost, J.E. (2000), Macroeconomics: An Open Economy Approach, Macmillan Press Ltd., Houndhills.  Poindexter, Carl, J. (1976), Macroeconomics, The Dryden Press, Hinsdale, Illinois.  Reserve Bank of Zimbabwe (1998), Quarterly Economic and Statistical Review, Vol.19, No. ½, March/June Issue, Harare  Romer, D. (2001), Advanced Macroeconomics, Second Edition, McGraw-Hill/Irwin, Boston  Roussos, P. (1988), Zimbabwe: An Introduction to the Economics of Transformation, Baobab Books, Harare  Shapiro, E.(1974), Macroeconomic Analysis, Third Edition, Harcourt Brace Jovanovich, Inc., New York.

 ACKNOWLEDGEMENTS The author wishes to acknowledge God Almighty for suggesting this topic and for taking me through the writing of it.  BIOGRAPHY Lyman Mlambo is a mineral economist at the Institute of Mining Research, University of Zimbabwe, and can be conducted at: Institute of Mining Research, University of Zimbabwe, P.O.Box MP167, Mount Pleasant, Harare, Zimbabwe. Email: lymlambo@science.uz.ac.zw.

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