Zambia downgraded on liquidity pressures

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Zambia’s long-term foreign-currency issuer default rating (IDR) has been downgraded to CCC from B- by Fitch Ratings, as the country struggles with liquidity pressures.  This comes just after Moody’s downgraded Zambia’s long-term issuer rating to Caa2 from Caa1, with the outlook changed to negative from stable.

Fitch’s downgrade reflects the government’s high external financing requirements.  This is coupled with a continued fall in official foreign exchange reserves, constrained access to domestic and external financing, and a further rise in government debt.

Zambia faces total external debt service repayments of $1.9 billion in 2019, which is 7.8% of GDP, of which $1.1 billion is external public debt service, according to Fitch. This is coupled with a current account deficit of $700 million.

Liquidity will also be further squeezed by Zambia’s obligation to repay the $750 million Eurobond due in September 2022.  The country is also under pressure to repay another $1 billion Eurobond in April 2024.

Zambia’s official gross international reserves were $1.4 billion at the end of March 2019, down from $1.6 billion, in December 2018.

Fitch is also concerned that the country remains a net external creditor, but its external asset position does not give the true position of the sovereign. This is because the large majority of foreign assets belong to the private sector and are held outside the country.

Given that yields on Zambia’s current Eurobonds have reached 16.6% and above, additional issuance is not viable. The Zambian government has held repeated discussions with the International Monetary Fund (IMF) in recent years on a support programme that could also unlock other sources of financing. However, given the current fiscal framework the likelihood of any programme is low.

The government is yet to show progress on measures to put public finances on a sustainable path and the current fiscal framework foretells several more years of high deficits, according to the ratings agency.

In 2018 and in May 2019, the Ministry of Finance announced its intention to postpone or cancel some contracted but undisbursed loans and undertake efforts to re-profile existing debt. However, so far evidence of progress on this is limited, with the key challenge remaining that the government has been slow to scale down its ambitious capital spending programme.

Zambia’s capital budget was 8.4% of GDP in 2018, up from an average of 5.3% in 2013 to 2017. The most recent Medium-Term Expenditure Framework (MTEF), published in August 2018, envisaged approximately 7% of GDP annual capital spending over 2019 to 2021.

The capital budget will be funded by external debt flows tied directly to project lending, which will mean the continued accumulation of non-concessionary external debt, according to Fitch. The government may begin to scale back on infrastructure spending, but expenditure through the first quarter of 2019 is in line with the most recent fiscal framework.

A history of significant and sustained fiscal deficits has led to a rapid increase in Zambia’s government debt. Fitch forecasts Zambia’s general government debt to rise to 81.3% of GDP in 2019 from 60.2% in 2017, including domestic payment arrears. This is well above the current median for the ‘B’ category of 59.4%. The general government (GG) deficit narrowed only slightly to 7.6% of GDP in 2018, from 7.9% in 2017 on a cash basis. The build-up of additional domestic payment arrears brought the 2019 deficit on a commitment basis to 9.2%.

On the upside, Fitch forecasts the GG cash deficit to narrow to 7.2% of GDP in 2019 and 6.8% in 2020. This will partly reflect assumptions about the impact of planned changes to the mining tax regime and the introduction of a sales tax to replace value-added tax (VAT). These measures could shift government revenue upwards over the medium term.

However, the rating agency is concerned about the impact of falling production, in the current year, in the context of strained relations between the government and the mining sector. This may blunt the impact of higher royalty rates and the implementation of the sales tax has been postponed.

Fitch expects GDP growth to decrease to 2.0% in 2019, from 3.7% in 2018, when strong growth in the mining sector helped to counter a fall in agricultural output. Copper production increased by 8.6% in 2018, but the sector has since been hit by stagnating copper prices, new mining taxes and uncertainty regarding electricity supply in the Copperbelt. Fitch’s GDP growth forecast for 2019 assumes that these issues will continue and that copper production for full year 2019 will fall by approximately 10%.

On the bright side, Zambia’s banking sector remains well capitalised relative to regional peers and the authorities report that stress tests indicate resilience to potential shocks. Non-performing loans remain high, at 11% of total loans at end-2018. Credit to the private sector returned to positive real growth in 2018 after two years of negative growth. This has further accelerated in early 2019, but the small size of the sector means that the risk to the sovereign is limited.

Zambia’s sovereign ratings remain constrained by weak development indicators, with GDP per capita remaining well below the current ‘B’ category median. Zambia has historically exhibited political stability, but governance indicators have recently deteriorated. Furthermore, the run-up to the next election in 2021 is likely to further reduce the government’s willingness to contain public spending.

Implementation of a fiscal consolidation plan sufficient to regain creditor confidence and increase re-financing options would lead to an improvement in the country’s rating. Fitch’s rating could also consider lifting the rating in the event of a rise in international reserve coverage, thereby raising Zambia’s ability to ensure smooth servicing of its liabilities.

An inability to access external or domestic sources of financing or increased signs of probable default could lead to a further downgrade in the rating.

Fitch’s rating comes just after Moody’s downgraded Zambia’s long-term issuer rating in early 2019. The rating agency downgraded Zambia’s rating to Caa2 from Caa1, with the outlook changed to negative from stable, over the country’s default concerns.