It might get worse before it gets better, Bank of America warns Zambia

ZAMBIA will likely need to turn to the IMF before 2022, says the Bank of America.

In a report titled ‘Worse before it gets better’, the

BofA Merrill Lynch, Zambia Viewpoint of 26 April 2019 states that upcoming Eurobond maturities, falling reserves and the conclusion of elections in August 2021 would force Zambian authorities to the International Monetary Fund by early 2022.

“We will be watching for any signals in on-going IMF article IV discussions, but ultimately Zambia might need to get much worse before it gets better,” states the Bank of America.


This is the report in part:


“Our March visit to Zambia confirmed three things: continued reliance on Chinese borrowing, no imminent fiscal adjustment and no real talks of an IMF programme. Since then, the macro picture has deteriorated further given the slow progress on Chinese negotiations, sales tax uncertainty and declining FX reserves. We see external financing needs of at least US$1.5bn p.a. out to 2021 with FX [foreign exchange] reserves at US$0.8bn by early- 2020. This still assumes a delay on half of the external amortization schedule out to 2022. Without concessions, reserves could be depleted sooner. Either way, a muddle through to 2021/22 seems increasingly difficult. This is likely to keep Eurobonds under pressure despite current low cash prices.


IMF is at the end of the tunnel


“Even if Zambia faces a more imminent liquidity crisis, we still see an IMF programme at the end of the tunnel. With capital expenditure and arrears at 5-7 per cent of GDP each, we think adjustments would be feasible. Reductions on these two areas could yield a primary surplus on a 3-5 year view with debt falling to more sustainable levels. Under an IMF programme, we estimate public debt closer to 70 per cent of GDP from 83 per cent in 2021. This, of course, requires proactive actions from authorities, which we do not see forthcoming ahead of the August 2021 elections. We will be watching for any signals in on-going IMF article IV discussions, but ultimately Zambia might need to get much worse before it gets better. Looking at reserves in previously debt-distressed countries, this could mean less than a month in import cover vs. c.2 months currently.

Maturity extensions are our base case

“Instead of haircuts, we think authorities will most likely need to extend maturities to solve liquidity pressures nearer 2022. We find Mongolia’s 2016/17 case a useful comparison given similarly large Chinese borrowing and pending bond maturities at the time. With Zambian bonds trading around 70 currently, there would be substantial upside from current levels with maturity extensions, or even haircuts of 20 per cent for example. The tail-risk to our view is that Zambia is not willing to adjust and does not undertake an IMF programme. We see this as the least likely outcome.”

No adjustments till 2021 +IMF in 2022:

“If Zambia continues to rely on Chinese loans for infrastructure spending with no cutback in disbursements, we forecast a primary deficit of 2.3 per cent of GDP p.a. with debt reaching 83 per cent by 2021 from 64 per cent at end-2018. We believe upcoming Eurobond maturities, falling reserves and the conclusion of elections in August 2021 would then force authorities to the IMF by early 2022. We emphasise that the underlying (ex-capex) deficit in Zambia is relatively contained, which should make an IMF programme easier to achieve. Here, we would expect more aggressive adjustment with the primary deficit of -2.3 per cent of GDP improving to a surplus of two per cent of GDP by 2025. Debt to GDP would decline from 83 per cent in 2021 to 72 per cent by 2025. Interest rates and debt servicing ratios would also improve.

Looking at Ghana, Ecuador and Ukraine and the initial conditions under their recent IMF programmes, we believe significant fiscal adjustments can be achieved. For example, Ecuador and Ghana were expected to attain 4-5 per cent of GDP in primary consolidation over the course of their programmes. They were also expected to cut capex spending by 1.7 per cent and 0.9 per cent of GDP, respectively. With 1-2 per cent of capex cuts, we think Zambia would be able to make further adjustments by clearing arrears and reducing subsidies – the two other key issues that have been the focus of IMF discussions.”


Partial adjustment + IMF in 2022

“In this scenario, we assume Chinese loan disbursements would slow to 1.0bn p.a (per annum) due to ongoing debt servicing challenges. Infrastructure spending would fall and the primary deficit would narrow by 0.5 per cent p.a. from 2.3 per cent of GDP to a small surplus of 0.2 per cent by 2025. Interest rates would gradually decline. Reserves would, however, continue to deteriorate and authorities would turn to the IMF by 2022. Debt to GDP would fall to 65 per cent of GDP by 2025. Under such a scenario, bond refinancing would be easier than the above.

Adjustment now, IMF in 2019/20

“A China stalemate and FX reserve pressure (under our bearish scenarios) would lead authorities to cut back borrowing and spending. The IMF would step in this year or early 2020. Primary surplus would reach by 2021 with debt to GDP just under 60 per cent of GDP by 2025.

No adjustment

“Zambia maintains a primary deficit of 2.3 per cent of GDP with debt to GDP increasing toward 90 per cent of GDP by 2022. Interest rates remain elevated with debt to GDP breaching 100 per cent by 2025. We believe this is ultimately unsustainable; sizeable haircuts would be likely by 2022 in this case.

“With sentiment towards EM strong in recent months and a continued bid for high-yield bonds, it is tempting to buy Zambia here, particularly with prices around 70, levels where bonds have historically bounced. This is particularly true given that we do not see a nominal haircut under our baseline. However, the main reason why we would not buy at this stage is that this China lending/debt extension that Zambia both wants and needs may disappoint. Should this scenario materialise and FX reserves stay under pressure, we think Zambia would eventually turn to the IMF. We emphasise that a reduction in Chinese lending would itself lead to a reduction in capital spending, improving the country’s fiscal profile, and allowing for an IMF programme.

“However, our biggest fear is that fundamentals (namely FX reserves) will need to fall further before authorities change their strategy. Despite the cheapness of bonds currently and our longer-term positive view, we are concerned further declines in reserves will lead to even lower bond prices. Looking at reserves in previously debt-distressed countries, this could mean import cover of less than a month. At around two months of cover at present, we think Zambia’s reserves may need to fall further before authorities change their strategy. We do not think they will take proactive steps towards a programme now given elections are in August 2021 – unless Chinese spending slows more meaningfully.”

Disbursements from China would allow ongoing Eurobond servicing pre-2022

“If Zambia is able to muddle through (even as the country’s credit profile deteriorates), investors could enjoy the very high yields available currently since Zambia should be able to service its debt (emphasising the lack of maturities before 2022). However, the lack of fundamental improvement catalysts would mean the bonds would likely stay range- bound in price terms. If Chinese disbursements continue, but are insufficient to keep reserves steady, we would still expect debt servicing to continue, but increased fears could see bonds drop further. Our largest concern currently from a strategy perspective is that the authorities will only turn to the IMF when the situation reaches a critical point with bonds likely to face even heavier pressure before that time. As seen in other countries, reserves can reach levels well below three months of import coverage before authorities take action.”

However, Zambia will likely need to turn to the IMF before 2022.

Despite Zambia’s reliance on future Chinese lending, there are concerns about ongoing disbursements as discussed above. We think it is very likely Zambia would need to turn to the IMF in 2021/22 (post-elections) in order to refinance the 2022 US$750mn Eurobond. However, this point could come much earlier depending on the relationship between China and Zambia. Should reserves reach a critical level, Zambia would likely have little choice but to turn to the IMF. As written previously, a reduction in capex (which would accompany a reduction in Chinese funding) would itself enable fiscal improvement, allowing for an IMF programme.

Chinese negotiations opaque, could be insufficient

“Our gross external financing framework is still premised on sizeable Chinese disbursements in the coming years to 2022. We estimate US$5bn in disbursements over the next 2-3 years based on previously contracted loans. We think the political and diplomatic repercussions of a sudden stop in Chinese funding now would be costly for both countries. Bilateral trade was up 35 per cent last year and between 2014 and 2017, FDI inflows from China averaged US$2.1bn per annum. We acknowledge, however, that negotiations have been opaque and slow, with funding shortfalls now looking more likely relative to authorities’ external financing targets of US$2.5bn p.a. Discussions for the swap deal, for example, have been on-going since Q3 last year but still seem to be at preliminary stages. Data from the Global Investment Tracker/American Enterprise Institute also shows a peak in Chinese contracts in 2016 but slowing to just US$1.3bn in 2018. This was led by declining transport projects and could signal slowing inflows in the medium term, particularly as debt servicing remains challenging. We have assumed that rollover of upcoming debt maturities would be easier to negotiate and still see only half of external principal payments being met out to 2022. Current delays, increasing debt servicing costs and the strain on reserves, however, suggest negotiations may not be going smoothly.

“Little to no feedback has emerged regarding debt restructurings despite official visits to China in late 2018 and at end-March this year. Without concessions and FX pressures, we estimate debt servicing costs could accelerate towards 60 per cent of revenue.”

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