6 Mar 2020

Talking Point | Zambia

Fitch paints sombre picture, but reality even bleaker

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In a report dated March 5, Fitch Ratings cautioned that the “significant overshooting” of
Irmgard Erasmus the fiscal deficit target in 2019 highlighted the difficulties in slowing debt accumulation.
Senior Financial Economist While the rating agency projects that debt will peak in 2020, “already high debt levels”
present a “key vulnerability” even under a scenario where fiscal measures are effective in
irmgard@nkc.co.za
reining in debt accumulation. The rating agency considers Zambia’s sovereign credit
worthiness to rank within the CCC category, which captures the copper producer’s
“heightened probability of default”. The ambitious capital expenditure programme – aimed
at closing the road, rail, and energy infrastructural gap – forms the root of Zambia’s rapid
pace of debt accumulation over the past decade. Faced with a high recurrent expenditure
bill, Fitch warned that while debt is forecast to stabilise this year, public external financing
requirements will remain “relatively high” to official reserves. Consequently, either an
increase in reserve coverage or fiscal adjustment that will increase refinancing options
may lead to a positive rating action.

Preliminary data released by the ministry of finance places the cash deficit at 8.2% of
GDP in 2019, well above the deficit target of 6.5% of GDP, while the shortfall on a
commitment basis is estimated to be close to 9% of GDP due to the high stock of
domestic arrears. While government revenues surprised to the upside – supported by
improved revenue collection – expenditures (9% higher than target) ballooned due to
higher debt servicing costs (exceeding target by the equivalent of 1% of GDP). This was
partially due to negative balance sheet effects, following the sharp depreciation in the
kwacha. Government spending on capital investment and subsidies exceeded the budget
by a substantial margin as well.

Fitch estimates that the successful implementation of the fiscal measures approved in
December 2019 – which outlined a slowdown in new external project accumulation and
the cancellation or reduction in undisbursed external loans already contracted – may
reduce the stock of undisbursed outstanding loans by $5bn (the equivalent of 21.5% of
GDP). Fitch estimates that general government debt stood at 88% of GDP by 2019, up
from 32% of GDP in 2014, with the rapid increase driven by “persistent” fiscal deficits.
Fitch places the external public debt burden at 54% of GDP, which implies that
approximately $1.5bn is due in external debt servicing costs this year. This translates to
105% of current international reserves and reflects the dire external liquidity position. Fitch
believes the government is “likely to manage its 2020 debt servicing requirements”, but
warned that the Eurobond repayments due September 2022 ($750m) and April 2024
($1bn) “will lead to a surge in external debt servicing in these years”.

We retain a decidedly more pessimistic estimation of the real debt burden than official
figures, while maintaining a below-consensus growth forecast of 1.8% for 2020 (with risks
tilted to the downside). In our estimation, Zambia’s gross government debt burden (PPG)
is forecast to equate to 98.4% of GDP by end-2020, rising steadily throughout the medium

Page 1 Contact: NKC Research | research@nkc.co.za

 term to reach 102.3% of GDP by 2022. In our assessment of the debt burden we included
Deepening terms of
contingent risks from non-financial public enterprises, primarily related to Zesco, which is
trade shock
estimated to exceed 10% of GDP. We believe this metric is a more accurate reflection of
threatens fragile
Zambia’s indebtedness than the net government debt estimation. A critical component in
growth recovery
the PPG debt projection is our assumption that emergency power imports will persist
longer than envisioned by government. The large portion of government debt held by non-
residents exposes Zambia to sudden stops and capital flight brought about by external
and domestic shocks, in particular a prolonged global risk-off mood due to the Chinese
demand shock.

WHY DO WE CARE? While we concur with Fitch’s assessment on most metrics, a

notable point of divergence relates to the debt forecast trajectory. Negative balance sheet
effects, along with our assumption that Zambia will opt to disburse a larger portion of
previously contracted loans (in contravention of the announced measures), result in a
decidedly worse outcome than Fitch’s baseline projection. In addition, we estimate that
the outbreak of the novel coronavirus (Covid-19) will shave off at least 0.1 ppt off Zambian
growth this year to deepen a terms of trade shock. The spillover effects of the outbreak
will likely eclipse a modest recovery from a multi-decade-worst drought, while private
consumption growth will be undermined by unreliable power supply, weakening
institutional strength, and rapid erosion of domestic purchasing power. Furthermore,
delayed payments by government to goods and services providers created a liquidity gap,
which could further nip the fledgling recovery in the bud and weigh on business sentiment.
As the new debt cycle is set to commence in 2022, the hourglass is running out on
refinancing negotiations, especially as a downgrade action by S&P Global Ratings in
February further narrowed the potential investor pool.

Contact NKC Research | research@nkc.co.za

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