Zambia Battles Downside Risks over Inability to Repay Debts
Zambia’s economy still remains messed up with worsening macroeconomic data except that Kwacha, the country’s local currency has gained moderately against the United States in the recent times.
Burdened by heavy debt load amidst large fiscal slippage worsened by global supply chain disruption that followed covid-19 pandemic and then Russia-Ukraine war, Zambia bond has been downgraded to junk after default.
Now, the country runs the risk of re-defaulting amidst debt restructuring plan which authorities say exclude borrowing from the local debt market.
Moody’s Investors Service affirmed the Government of Zambia’s Ca foreign-currency and local-currency long-term issuer ratings while outlook remains stable, according to the rating action released.
The global rating agency said the decision to affirm the Ca ratings balances Zambia’s limited external financing sources, very weak governance; exposure to environmental and social risks.
These include ongoing debt default against recent improvements to the economic outlook and efforts to improve fiscal management in the context of the IMF programme approved earlier this year.
At this rating level, Moody’s said the stable outlook implies that the government’s credit profile is unlikely to improve materially until after the current debt restructuring exercise is completed and expected losses to creditors remain aligned with those associated with a Ca rating.
“The government is not currently servicing external private sector debt and, while it continues to meet local currency debt service obligations, risks remain elevated that some or all local currency instruments may be included in the upcoming restructuring exercise.”
Moody’s expects Zambia will also remain subject to elevated risk of re-default in future.
In the rating action, the global rating agency started that Zambia’s local-currency and foreign-currency country ceilings remain unchanged at Caa1 and Caa3, respectively.
It noted that the three-notch gap between the local-currency ceiling and the sovereign rating reflects the government’s small role in the economy relative to peers and moderate domestic and geopolitical risk, notwithstanding relatively high external imbalances and heavy reliance on a single common revenue source in copper.
The two-notch gap between the foreign-currency ceiling and the local-currency ceiling reflects Zambia’s high external indebtedness and very low policy effectiveness that generate a degree of transfer and convertibility risk, notwithstanding its open capital account and track record of limited intervention, the ratings said.
RATINGS RATIONALE
Moody’s explained that after Zambia borrowed heavily from a range of external creditors to finance domestic infrastructure projects, the pandemic-induced shock led Zambia to default on its Eurobonds in October 2020.
Since then, the country has ceased servicing of its commercial external debt and is seeking a debt restructuring under the auspices of the G20 Common Framework for debt relief beyond the DSSI (Common Framework).
Given Zambia’s unsustainable debt level and the size of the debt reduction outlined in the International Monetary Fund’s (IMF) Debt Sustainability Analysis, Moody’s expects bondholder losses will exceed 35% net present value at the time of the original default, consistent with a Ca rating.
To-date, Zambia has continued to service local currency debt obligations, including those to non-resident holders.
It noted that authorities are seeking to exclude all local currency debt instruments from the restructuring, citing concerns regarding domestic financial market stability and the need to preserve domestic debt market financing post-restructuring, as well as practical and legal considerations regarding the ability to isolate non-resident holders.
However, the eventual parameters of Zambia’s debt restructuring will be subject to negotiations between Zambian authorities and its creditors, it said.
Risks that some local currency creditors will be included in the restructuring perimeter remain elevated, while Zambia’s weak governance, high exposure to environmental and social risks, and vulnerability to external shocks given its heavy reliance on a single commodity export base leave all creditors exposed to risk of re-default in the future following the restructuring.
Moody’s expects more clarity on the details of the restructuring, including its overall size, interest reductions, maturity extensions, and treatment of local currency creditors to be outlined in a Memorandum of Understanding between the official creditor committee and Zambian authorities, which will serve as the basis for the next stage of the restructuring process: bilateral negotiations between Zambia and its individual creditors.
Zambia’s macro outlook has improved in recent quarters but remains vulnerable to external shocks. Real GDP growth recovered to 4.1% in 2021 but is projected to decelerate to 3% in 2022 partially due to a slowdown in mining output after heavy rainfall in the north of Zambia, where most of the mining industry is located, led to difficult operating conditions and lower production from the industry.
Moving forward, while Moody’s expects investment and output in the mining sector to increase from current levels, the sector will remain vulnerable to similar environmental shocks as well as global metal price fluctuations, most notably copper.
Copper exports accounted for around three quarters of Zambia’s good exports in 2021 and mining extraction royalties are around 8% of the government’s revenue, meaning Zambia’s credit profile will remain vulnerable to fluctuations in copper prices.
The Zambia kwacha has staged a rapid recovery since depreciating versus the US dollar in the first half of 2021, helping to bring inflation back to single digit levels since June 2022.
Confidence in the kwacha improved following an injection of international reserves from the IMF in 2021 and the rally was sustained by improvements in copper prices in early 2022, supporting a positive current account balance despite the shock to food and fuel import prices, which Moody’s expects to remain slightly positive in 2023.
Large portfolio inflows from foreign investors into local currency government debt has also supported currency demand as well as the government’s access to local currency financing. READ:“Zambia is experiencing debt distress”
However, continuing appetite from non-resident investors in Zambia’s local currency debt is not assured as global financing conditions tighten, with potential implications for the value of the kwacha and, by extension, inflation.
Zambia faces significant institutional challenges in the areas of government effectiveness, rule of law and control of corruption. Frequent changes to the government’s mining tax regime have perpetuated the perception of unpredictability in policymaking.
In addition, the government’s missed fiscal targets have complicated the implementation of monetary policy and hindered macroeconomic management.
Zambia’s recent default and track record of accumulating domestic and external payments arrears to contractors, suppliers, pensioners, and other non-creditors are also indicative very weak fiscal management and payment culture.
The government has begun efforts to improve the institutional framework supported by its current IMF programme but very high social risks may constrain the government’s policy effectiveness and limit the government’s ability to implement unpopular reforms to meet fiscal consolidation objectives.
#Zambia Battles Downside Risks over Inability to Repay Debts#
