“Zambia is experiencing debt distress”
The International Institute of Finance, IIF, stated in a review that Zambia is experiencing debt distress after years of external borrowing.
According to the institute, the distress followed the end of the commodity super cycle in mid-2014, which hit the country’s main export, copper.
Though, the goods balance surplus has returned, but it has not recovered to pre-2015 levels, and copper exports are unlikely to recover meaningfully in the near term.
It noted that at the same time, foreign borrowing, used to cover large fiscal deficits, has resulted in a substantial income balance deficit, further worsening the current account balance.
“While Eurobonds will not mature until 2022, interest on these bonds, as well as Chinese loans, will require substantial financing over 2019-20.
However, reserves are deteriorating rapidly, and non-resident capital flows have declined. As pressure on the kwacha continues, both monetary and fiscal policy will need to tighten substantially to avoid debt distress.
Zambia’s government has already been forced to run arrears, including large unpaid VAT refunds, which is hurting growth.
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Thus, given the scale of policy contraction needed, Zambia would be an obvious candidate for an IMF program.
However, it is doubtful that the country will be able to meet the necessary criteria to receive IMF assistance.
Zambia’s current account shifted to a persistent deficit in 2015 ranging from 1.5 to 4.5% of gross domestic products following the copper-led cyclical decline as the government turned to foreign borrowing to plug fiscal deficits.
This is reflected in the income deficit, which has grown considerably. The most recent deterioration differs from previous episodes, which were funded by large FDI inflows, the institute stated.
As FDI inflows fell dramatically (in line with declining copper production) and portfolio flows dried up, reserves and other investment plugged the hole.
Specifically, resident capital outflows from the private sector declined substantially. Despite long maturities, income payments resulting from government external borrowing will continue to weigh on the current account.
Thus, Zambia’s current debt distress stems from high borrowing costs rather than principal repayments. At the same time, the goods surplus will likely remain depressed as copper production continues to decline, partially a result of VAT refunds owed to the mining sector.
Furthermore, price pressures continue. When combined with a growing services deficit, these factors point to a persistent external imbalance going forward.
“This is not sustainable, as debt will have to be repaid and reserves will eventually run out. After peaking at around $4 billion in early-2015, reserves have been on a steady decline following a period of excessively loose monetary policy”, IIF reckoned.
As of May 2019, reserves stood at around 2 months of imports. Reserve losses were not enough to offset depreciation pressures on the kwacha, which has continued to lose value since July 2017.
Recently, the Bank of Zambia raised its policy rate 50 bps from 9.75% to 10.25%, the first time since late-2015.
However, net capital flows continue to be weak, with the kwacha remaining above 12 ZMK/$, due to concerns about investor protections and debt sustainability.
“Further rate hikes and fiscal contraction are needed to depress demand for imports and the need for fresh capital inflow.
“Otherwise, reserves will continue to decline and the exchange rate will keep depreciating, further worsening debt sustainability.
“In a future piece, we will further examine Zambia’s fiscal picture through a public debt sustainability analysis”, the Institute noted.
