Editor's note: Fitch today affirmed Zambia's credit rating at 'B', suggesting the outlook remains stable despite significant deterioration in public finances. It appears slightly dated with respect to the rapid monetary developments taking place and other issues (e.g. GDP rebasing has not been mentioned). Full assessment below.
Fitch Ratings affirmed Zambia's Long-term foreign and local currency Issuer Default Ratings (IDRs) at 'B'. The issue ratings on Zambia's senior unsecured foreign and local currency bonds are also affirmed at 'B'. The Outlooks on the Long-term IDRs are Stable. The Country Ceiling is affirmed at 'B+' and the Short-term foreign currency IDR at 'B'.
KEY RATING DRIVERS
The affirmation of the ratings reflects Zambia's continued strong macroeconomic performance, with robust growth and low inflation. However, vulnerabilities have increased as fiscal policy has turned more expansionary and the exchange rate has come under pressure, partly due to weaker copper prices but also due to policy announcements, which have undermined private sector confidence.
Fitch forecasts robust GDP growth of 7.2% in 2014 and 7% in 2015, supported by strong infrastructure spending, especially on energy and roads, and continued growth in copper production. Risks to growth come from a growing budget deficit, which risks crowding out private credit growth, poor management of government spending, low agricultural productivity, as well as infrastructure and energy constraints. Inflation is forecast to remain around 7%, but currency and wage pressures present upside risks.
Government finances have deteriorated sharply in the last two years, from an average deficit of just 2.3% of GDP between 2005 and 2012, to 6.8% in 2013. In July last year, the government announced a sudden revision in the planned 2013 budget deficit to 8.6% of GDP from 4.7%. Although the outturn now seems likely to be better than earlier expected, and partly reflects one-off factors, the underlying deterioration is clear. Public sector wages increased by an average 45% after a decision to implement pay reforms immediately rather than over several years. And although fuel subsidies were scrapped last year, delays in the decision meant that subsidies were under-budgeted. Other one-offs include arrears payments and the taking on of contingent liabilities of the Food Reserve Agency.
In addition, almost every category of revenues under-performed against budget plans except VAT - where the government is in dispute with the mining sector over refunds. Moreover, the government's cash treatment of the deficit (versus the IMF accruals basis), does not fully account for arrears payments in 2013, nor loan payments to the Food Reserve Agency, which will therefore continue to affect the 2014 deficit.
Fitch expects the deficit outturn to be worse than government projections in 2014 at 7.2% of GDP, against a government target of 6.6%. This reflects our expectation that wage costs will continue to put pressure on spending and revenues will underperform again. Fitch forecasts a decline in the deficit to 5.2% of GDP in 2015. The IMF has recommended a front-loading of fiscal consolidation but Fitch regards this as unlikely ahead of the 2016 election.
Nevertheless, despite the expansionary fiscal stance, strong GDP growth is forecast to mitigate any increase in the debt burden. We expect consolidated general government debt to remain at 31%-33% of GDP until 2015 and believe the debt trajectory is sustainable while growth remains robust. However, debt service costs are rising, as an increasing share of public sector debt is now on non-concessional terms, and the weaker kwacha is raising the burden of external debt.
Zambia's external position is stable with a small, albeit reduced, current account surplus in 2013 and robust foreign direct investment flows. However, reserves fell in 2013 and are a low 2.3 months of current account payments. Any external shocks from capital flows or copper prices could put further pressure on the currency, which has fallen by over 13% so far this year.
The ratings are constrained by weak structural indicators including low per capita income, in purchasing power parity terms, of USD1,620 compared with the 'B' category median of USD5,100, as well as poor levels of human development. Physical infrastructure is also underdeveloped. There are weaknesses in data coverage in the national accounts and the wider public sector.
The Stable Outlook means Fitch's sensitivity analysis does not currently anticipate developments with a high likelihood of leading to a rating change. However, future developments that could, individually or collectively, result in negative rating action include:
- A further deterioration in public and external finances that puts debt on an unsustainable path and jeopardises Zambia's external financing capacity
- External shocks from commodity prices (particularly copper), or capital markets, that put the currency under pressure and reduces net FDI inflows
- A deterioration in the policy environment, making business more difficult for the private sector
Conversely, the main factors that individually, or collectively, could result in positive rating action include:
- A faster-than-expected fiscal consolidation that reduces the debt burden
- A significant improvement in international reserves to reduce Zambia's vulnerability to external shocks
- Well-implemented infrastructure investments, which improve growth potential and increase market access for traditional and non-traditional exports.
Fitch assumes that GDP growth will remain robust, averaging 7%, based on the assumption that copper production will increase significantly by 2020, with strong net FDI inflows.
Fitch assumes that some fiscal consolidation will take place, albeit at a slower pace than the authorities' projections.
New power stations are not delayed and that constraints on growth from electricity shortages do not intensify.
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