Fitch Ratings has downgraded Zambia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CC’ from ‘CCC’.
Fitch typically does not assign Outlooks or apply modifiers for sovereigns with a rating of ‘CCC’ or below. A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The downgrade reflects Fitch’s view that the shock from the coronavirus pandemic has exacerbated Zambia’s already constrained external liquidity, increasing the likelihood of a default event. We see a default as probable, as evidenced by the government’s tender of a request for proposals from advisors on a potential liability management exercise. We also see the liability management exercise as a probable precursor to a support programme from the IMF or other international financial institution.
The government is unlikely to be able to fully meet its external debt obligations in 2020 and 2021 in the absence of new external financing sources. The government faces external debt service payments, including principal and interest, totalling USD1.5 billion in 2020; this is approximately 115% of official gross international reserves at end-January 2020. A combination of already programmed external borrowing and mineral royalties will add to reserves. However, much of the external borrowing is directly tied to project financing and will not be readily available for debt servicing. We also expect copper export receipts to fall on lower production and copper prices. As a result, the Bank of Zambia (BOZ) will struggle to maintain the necessary external liquidity to allow for uninterrupted debt servicing, in our view.
The maintenance of reserves in 2020 will be further challenged by a current account deficit and currency depreciation pressure. Reserve levels were supported by a current account surplus of 1% of GDP in 2019, but Fitch forecasts the current account will swing to a deficit of 2% of GDP this year. The BOZ was able to bolster reserves in 2019 by opportunistically purchasing hard currency from the foreign-currency market. However, as of 11 April, the kwacha had depreciated by 24% year-to-date, which will make dollar purchases costlier. Reserve accumulation could also exacerbate downward pressure on the foreign-currency rate.
The sovereign’s medium-term solvency has deteriorated, along with its liquidity. This will limit the government’s refinancing options and is likely to see conditions imposed on new lending. We forecast the general government deficit to expand to close to 10% of GDP in 2020, although the running of domestic payment arrears may keep the deficit lower on a cash basis. We also forecast general government debt to reach 113% of GDP and to continue rising over the long term.
Zambia’s public finances will be further affected by slowing growth. Fitch forecasts GDP growth to contract by 0.7% in 2020, and to experience a slight recovery to 1.0% in 2021. Zambia’s growth was already slowing due to a combination of lower copper production, power shortages caused by seasonal droughts, and spotty agricultural production due to poor rain. Zambia’s economy could return to trend growth of approximately 3.0% by 2023, but this is well below the 5.6% average that Zambia experienced in the decade to 2018.
The shock to the domestic economy will also further stress Zambia’s banks, which have struggled with poor asset quality and low levels of credit provision. Extra stress will inhibit banks’ ability to finance the government. The government’s domestic debt issuance is already routinely undersubscribed at longer maturities, while yields across the curve have risen steadily. The BOZ has set up a ZMW10 billion liquidity facility, which aims to enable banks to restructure or refinance qualifying facilities or on-lend to eligible clients. The facility will provide some support to the banks and the domestic economy, but will not significantly enhance banks’ ability to provide funding to the governmen