Zambia Outlook Revised To Negative On Rising External Debt Service; 'B-/B' Ratings Affirmed

Foreign and Local Currency: B-/Negative/B

For further details see ratings list.



  • We expect sizable fiscal deficits, fueling current account deficits, and a depreciating exchange rate to further increase the Zambian government's external indebtedness.
  • We are therefore revising our outlook on Zambia to negative from stable, and affirming the 'B-/B' ratings.
  • The negative outlook reflects the risks associated with Zambia's rising external financing needs and low levels of foreign currency reserves.
RATING ACTION
On Feb. 22, 2019, S&P Global Ratings revised its outlook on Zambia to negative 
from stable. At the same time, we affirmed our 'B-' long-term and 'B' 
short-term foreign and local currency sovereign credit ratings.

We have also maintained our transfer and convertibility (T&C) assessment on 
Zambia at 'B-'.


OUTLOOK
The negative outlook reflects the risks associated with Zambia's rising 
external financing needs and low levels of foreign currency reserves over the 
next six to 12 months. 

We could lower the ratings if the central bank reserve levels were to fall 
further or external indebtedness were to rise beyond our expectations, perhaps 
due to a material deterioration in the government's fiscal position. We would 
also consider a downgrade in the event of a sustained and material decline in 
copper prices that hurt Zambia's external and fiscal accounts. 

We could revise the outlook to stable if Zambia's fiscal and external 
imbalances were to improve. 


RATIONALE
In our view, Zambia's increasing debt and declining foreign currency reserves, 
alongside exchange rate depreciation of around 20% in 2018, has accentuated 
the country's external debt vulnerabilities. We estimate that Zambia's 
external debt service (amortization and interest payments) will average 42% of 
current account receipts (CARs) over 2019-2022, compared with an average 35% 
over 2016-2018. We estimate central bank's usable foreign currency reserves at 
only 1.6x coverage of monthly current account payments in 2019, down from a 
still relatively low 2.1x in 2018. 

A number of structural factors constrain Zambia's credit quality, including 
its low wealth levels, high fiscal deficits, and debt burden. Zambia's 
external indebtedness net of liquid assets is high and we expect a meaningful 
increase to around 130% of CARs in 2019-2022 from about 87% in 2014-2018. We 
view external risks as high, due to the country's dependence on copper exports 
to generate CARs. Our external analysis is also hampered by the lack of 
comprehensive external data, including the publication of an international 
investment position.

Zambia has a relatively stable political environment for the region, but we 
believe that future policy responses are difficult to predict because of the 
highly polarized political landscape, with tensions both within the governing 
Patriotic Front and with the opposition.

Flexibility and Performance Profile: Ongoing external and fiscal deficits are 
increasing Zambia's indebtedness further 
  • Rising external debt and falling foreign currency reserves resulted in a pronounced swelling in gross external financing needs in 2018.
  • Fiscal deficits and debt burden remain sizable.
Higher government external debt is intrinsically fueling public sector 
external debt service. We estimate that, as of December 2018, government 
external debt stock is about US$10 billion, or 40% of the forecast 2019 GDP. 
The external debt includes Zambia's US$3 billion in outstanding Eurobonds, 
US$2 billion in private bank loans. The remainder of approximately $5 billion 
is largely $2 billion from export credit agencies and supplier credits and 
concessional debt from bilateral and multilateral sources. 

Foreign currency reserves at Bank of Zambia, the central bank, are declining. 
Our estimate of usable foreign currency reserves fell from $1.8 billion at 
end-2017 to about $1.4 billion at end-2018, which represents less than two 
months of current account payments. In the event of an external shock, 
Zambia's thin reserves may not insulate the economy. 

Zambia is exposed to volatility in terms of trade, in our opinion, due to its 
dependence on copper export receipts (about 70% of total exports). Higher 
copper production volumes and prices (relative to the past two years) boosted 
CARs and a surplus in trade account emerged in 2017, which we expect to remain 
in place through 2022. However, the current account should remain in a deficit 
of about 3.3% of GDP over 2019-2022, due to continued outflows of primary 
income, mostly profits realized by multinational mining companies and interest 
payments abroad. Public sector investment projects will continue to weigh on 
capital goods imports, while copper's contribution will remain vital to export 
receipts. Spot copper prices have dipped to about $6,200 per ton (/ton) from 
$6,500 in 2018. 

Zambia's external debt (including private sector and financial enterprises) 
has increased over the past two years. We estimate Zambia's external 
indebtedness net of liquid external assets at over 130% of CARs on average 
over 2019-2022. The increase in external indebtedness owes primarily to higher 
central government borrowing to finance public investments in transport and 
energy, which are expected to ultimately boost economic activity. We estimate 
total external debt coming due this year (the long-term amortizing debt and 
short-term debt of all sectors in the economy in 2019) to be about $3.9 
billion. Only about $1 billion is short-term debt, primarily borrowed by 
private-sector companies and banks through parent loans, commercial credit 
lines, and trade finance facilities. We also note the nearing 2022 maturity of 
the first government Eurobond. Our external analysis is hampered by a lack of 
comprehensive external data, considering that a full international investment 
position has not been published since 2013. The Zambian authorities are 
working with the International Monetary Fund (IMF) on technical assistance to 
improve the quality of external accounts.

While our headline fiscal deficit assumptions are unchanged from six months 
ago, our debt accumulation projection has weakened due to substantial exchange 
rate depreciation in 2018 (close to 20%). We estimate that Zambia's 2018 
revenue performance was slightly above projections thanks to sound value-added 
tax (VAT) contributions, despite the underperformance of customs duties and 
income tax collections. However, total expenditures are exceeding budget 
targets because of overruns in externally financed public investment projects 
and interest payments, which have led to increased expenditures constraining 
revenue gains. As such, the 2018 fiscal deficit likely remained above 7% of 
GDP. 

Over 2019-2022, we estimate that fiscal deficits will gradually decline to 
about an average 6%, as the government works toward consolidating both 
revenues and expenditures. On the revenue side, the government plans to 
introduce a goods and services tax from April 1, 2019, that will replace the 
VAT and thereby eliminate the process of VAT refunds. For the mining sector, 
the government will roll out a sliding scale for royalties to 6% from the flat 
4% and an additional 10% tax when the price of copper exceeds $7,500/ton. More 
broadly, the government is implementing multiple administrative measures to 
increase its collection capacity. It has adopted various measures to control 
expenditures, including stopping domestically funded capital projects that are 
less than 80% complete, minimizing contraction of further external debt, and 
curtailing expenditures on the public sector wage bill and other goods and 
services expenditure items. We think the country's shortfall of basic services 
to the population and infrastructure will likely create persisting spending 
pressures.

Government supplier arrears are still large and increasing due to the 
completion of capital projects. The government estimates supplier arears have 
increased to nearly Zambian kwacha (ZMW) 15 billion (about $1.3 billion, 5% of 
GDP) as of December 2018 from ZMW12.7 billion a year before. Some of the 
arrears relate to supplier payments to contractors involved in the 
construction of new roads and to ZESCO, the state electricity company, and VAT 
refunds still to be processed. Owing to a combination of fiscal deficits and 
exchange rate depreciation, we now forecast that the change in the 
government's net debt to GDP will average close to 7% in 2019-2022 compared 
with our previous estimate of below 6% over the same period. Nearly 60% of the 
government's debt burden is denominated in foreign currency, leaving the debt 
structure vulnerable to sharp currency depreciations or a reversal in investor 
sentiment.

We anticipate that Zambia's net government debt burden will increase further 
this year to 64% of GDP, before climbing to 68% of GDP by 2022. The increasing 
debt burden fuels rising debt service payments. We estimate interest payments 
will average 27% of revenues over 2019-2022. Apart from direct government 
debt, we believe contingent risks to the government from nonfinancial public 
enterprises comprise close to 10% of GDP, dominated by ZESCO's debt 
liabilities until the electricity utility company is able to charge and 
collect tariffs that ensure financial sustainability.

We estimate that 60% of the government's commercial debt is held by 
nonresidents, which we think could expose government financing to changes in 
foreign investor sentiment. We also view the large exposure of the domestic 
banks to the government (26% of banking sector assets) as a potential risk for 
the government's debt profile. This could leave banks with a limited ability 
to lend more to the government without further crowding out private-sector 
borrowing. We understand that the government may engage with bilateral 
creditors in a liability management exercise, likely intended to smooth the 
foreign currency debt redemption profile and reduce the associated financing 
risk.

We assess the exchange rate regime as a managed float exchange, with 
interventions by the central bank to smooth volatility. However, the extent of 
its intervention is limited by weak foreign currency reserves. We expect the 
kwacha to depreciate by about 5% by end-2022, partly because of limited 
investor confidence due to the government's weak fiscal and external 
positions. With lower rainfall and crop production, some mild pressures could 
spark inflation, which we expect will likely average about 8%, landing in the 
upper end of the central bank's 6%-8% inflation target. 

Institutional and Economic Profile: Economic growth rates will average 3.8% 
over 2019-2022, but will be susceptible to changes in commodity prices
  • Compared regionally, Zambia's political situation has been generally stable, but an increasingly polarized political landscape, with tensions between the government and the opposition, has put it to the test.
  • Improving copper production volumes and increased government capital expenditures support Zambia's modest economic growth outlook.
In our opinion, tensions between the government and opposition threaten 
Zambia's political stability and policymaking predictability, particularly 
since the August 2016 elections. The Supreme Court has cleared President Edgar 
Lungu to run for another term in 2021, should he wish to do so or be elected 
by his party, the ruling Patriotic Front. Although negotiations with the IMF 
for a funded program are still on the agenda, we think that the current fiscal 
and debt challenges will reduce the possibilities of a near-term agreement. 
However, the IMF's Article 4 surveillance consultations and technical support 
programs continue to function as normal. In our view, the adoption of an 
IMF-funded program could support Zambia's creditworthiness, since it would 
provide a policy anchor and support central bank reserves, which are gradually 
declining. 

Zambia has low economic wealth. We estimate GDP per capita at $1,400 in 2019. 
For 2013-2022, we estimate real per capita GDP growth at less than 1% as a 
weighted average--a rate below peers' at similar income levels.

Data indicates that the economy grew at 2.8% in the first quarter of 2018, 
3.9% in the second, and 5.0% in the third (3.9% on average). We estimate that 
economic expansion over 2019-2022 is likely to average 3.8% in real terms. We 
have slightly lowered our GDP growth forecasts by about 0.2% compared with our 
estimate six months ago. This is partly due to the impact of currently 
relatively low copper prices on the mining sector (see "Metal Price 
Assumptions: S&P Global Ratings Expects Mixed Outlook Amid Trade Tensions and 
Slowing Economic Expansion," published Dec. 13, 2018, on RatingsDirect). 
Furthermore, Zambia's southern provinces received lower rainfall than in 
previous years, resulting in lower crop yields and, in turn, smaller 
contributions from agriculture to GDP growth performance. The Zambian kwacha 
depreciated by almost 20% in 2018, but we expect a lower magnitude of 
depreciation averaging 5% over 2020-2022. 

In addition, domestic tax policy changes could strain output in the medium 
term. For example, higher tax revenue extraction from the mining sector may 
interfere with investment decisions and production volume growth, as we have 
observed in Zambia in the past. The government has amended regulations 
requiring a portion of royalties to be paid in U.S. dollars instead of local 
currency, as well as its planned introduction of a general sales tax in place 
of the VAT. 

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