June 2019: Fitch Ratings has downgraded Zambia’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to ‘CCC’ from ‘B-‘.
The downgrade of Zambia’s IDRs reflects the government’s high external financing requirements, combined with a continued fall in official foreign exchange reserves, constrained access to domestic and external financing, and a further rise in government debt in the context of an ambitious capital expenditure programme.
Fitch estimates that Zambia faces total external debt service repayments of USD1.9 billion (7.8% of GDP) in 2019, of which USD1.1 billion is external public debt service, combined with a current account deficit of USD700 million. The government will also have to prepare to meet the principal repayment on its USD750 million Eurobond due in September 2022, followed by another Eurobond repayment of USD1 billion in April 2024. Zambia’s official gross international reserves were USD1.4 billion as of end-March 2019, down from USD1.6 billion at end-December 2018.
Zambia remains a net external creditor, but its external asset position belies the fragile external position of the sovereign, as 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 authorities have held repeated discussions with the IMF in recent years on a support programme that could also unlock other sources of financing, but given the current fiscal framework the likelihood of any programme is low.
The government has yet to show material progress on measures to put public finances on a sustainable path and the current fiscal framework envisages several more years of high fiscal deficits. In 2018 and again 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, but so far evidence of progress on this is limited. A key challenge remains that the government has been slow to scale down its ambitious capital spending programme.
The 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. The government may begin to scale back on infrastructure spending, but expenditure through 1Q19 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. Including domestic payment arrears, Fitch forecasts Zambia’s general government debt to rise to 81.3% of GDP in 2019 from 60.2% in 2017, 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%.
Fitch forecasts the GG cash deficit to narrow to 7.2% of GDP in 2019 and 6.8% in 2020. This will partly reflects conservative assumptions about the impact of planned changes to the mining tax regime and the introduction of a sales tax to replace VAT. Over the medium term, these measures could shift government revenue upwards, but in the current year, the impact of falling production in the context of strained relations between the government and the mining sector will blunt the impact of higher royalty rates and the implementation of the sales tax has been postponed.
Zambia’s ratings also reflect the following key rating drivers:
Fitch expects GDP growth to decelerate to 2.0% in 2019 after growing by 3.7% in 2018, when strong growth in the mining sector helped to counter a steep fall in agricultural output. Copper production increased by 8.6% in 2018. However, the sector has since been hit by a combination of 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%.
The Zambian 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 and 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. GDP per capita remains well below the current ‘B’ category median. Zambia has historically exhibited political stability, but governance indicators have recently deteriorated. There were brief episodes of political instability following the 2016 election, which President Edgar Lungu won by a narrow margin. The run-up to the next election in 2021 is likely to further reduce the government’s willingness to