Editor's note: Fitch today affirmed Zambia's credit rating at 'B', and revised the outlook to positive owing largely to the rebased GDP figures, government revoking BoP regulations and promises to consolidate fiscal spending as part of the ongoing discussion with the IMF on a new austerity programme. The Fitch assessment does not appear to reflect current information on some issues so some the risks it flags requires deeper consideration.
Fitch Ratings has revised the Outlook on Zambia's Long-term foreign and local currency Issuer Default Ratings (IDR) to Positive from Stable and affirmed the IDRs at 'B'. The issue ratings on Zambia's senior unsecured foreign and local currency bonds have also been affirmed at 'B'. The Country Ceiling has been affirmed at 'B+' and the Short-term foreign currency IDR at 'B'.
The revision of the Outlook on Zambia's IDRs reflects the following key rating drivers and their relative weights:
The outlook for Zambia's public finances is more positive compared with October 2013, when we downgraded the Long-term IDR to 'B'. The fiscal outturn for 2013 (5.7% of GDP or 6.6% prior to GDP rebasing) came out significantly below the budget figure of 8.6% of GDP announced in August 2013. Furthermore, fiscal data for the first six months of 2014 suggest that the deficit was well contained at 2% of GDP (against a target of 2.5% of GDP). Although this partly reflects higher-than-expected VAT receipts due to the build-up in VAT refund arrears (2.5% of GDP) to exporters, Fitch acknowledges the commitment to expenditure restraint over 1H14.
The authorities' decision to approach the IMF, combined with the latest medium-term expenditure framework, which shows the budget deficit falling to 3.2% of GDP by 2017, suggests renewed commitment to fiscal prudence by the government. However, possible pre-election spending ahead of the 2016 presidential contest, failure to agree on an IMF programme as well as the repayment of VAT arrears to mining companies once a final agreement is reached, all add to fiscal risks.
The government has revised down the expected budget deficit for 2014 from 6.6% to 5.2% (6.2% on old GDP base), reflecting the rebased GDP as well as the lower-than-expected deficit in the first six months of the year. However, the risk remains that the government will overrun the deficit in 2014, due to the better than expected maize harvest and consequent spending pressure from the Food Reserve Agency, higher wages, as well as the payment of VAT refunds. Fitch therefore forecasts a deficit of 5.8% of GDP.
An improved fiscal outlook as well as strong GDP growth is forecast to contain the debt burden. Fitch expects consolidated general government debt to peak at 33% of GDP in 2016, well below 'B' peers.
Tight domestic liquidity conditions have seen yields on 182- and 364-day treasury bills rise to 17.5% and 23% in mid-August, up from 13.2% and 13.3%, respectively, a year ago. Treasury auctions in the first six months of the year were significantly under subscribed.
The policy environment has improved, following the uncertainty initially created after the election of President Michael Sata. Early pronouncements from the new administration led Fitch to revise the Outlook to Negative in February 2012. However, the decision to revoke regulations that were adversely impacting the foreign exchange market is credit supportive. Although risks persist, particularly ahead of the elections, the business environment has not deteriorated as much as previously expected and the likelihood of significant and adverse policy shifts has significantly reduced.
Zambia's 'B' IDRs also reflect the following key rating drivers:
The recent rebasing of GDP has revised upwards Zambia's already robust average growth rate over the past five years, to 7.3% from 6.8%, well above the 'B' median of 4.3%. Fitch forecasts growth to remain at a robust 6%-7% in 2014-2016, benefiting from the government's ambitious infrastructure investment programme, rising copper production and continued foreign direct investment (FDI). The rebased GDP shows that the economy was 20% larger in 2013 than previously measured, with services and mining now the two largest sectors in the economy. Inflation remains above the Bank of Zambia's 6.5% year-end inflation target.
The current account is expected to remain in surplus over the medium term, supported by rising copper production and broadly stable copper prices. Foreign companies' repatriation of profits abroad is more than offset by strong inflows of FDI (5% of GDP). The recent Eurobond issue has boosted reserves above three months of current external payments (CXP). The decision to revoke exchange rate regulations as well as the announcement that the government intends to approach the IMF has seen the local currency appreciate 12.9% since May, after a sharp sell-off in 1H. Nevertheless, the kwacha remains sensitive to external shocks from capital flows or copper prices.
A decade of growth above 6% has resulted in an improvement in social indicators, but per capita income (at 60% of the 'B' median) and measures of human development still compare weakly with 'B' category peers. Health and education outcomes are especially weak, with average life expectancy of 49 years. The lack of skills adversely affects the employability of the workforce, with only 10% employed in the formal sector. The average adult has less than seven years of schooling.
The main factors that could lead to an upgrade are:
- Continued progress on narrowing the budget deficit.
- A further improvement in the macroeconomic policy framework.
- An 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.
The current rating Outlook is Positive. Consequently, Fitch's sensitivity analysis does not currently anticipate developments with a material likelihood of leading to a downgrade. However, any sustained deterioration in fiscal discipline, or external balances as well as a marked deterioration in the policy environment ahead of the 2016 elections would result in the rating Outlook being revised to Stable.
Fitch assumes that GDP growth will remain robust, averaging between 6%-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.
We assume new power stations come on-stream as scheduled and help alleviate electricity shortages.
Fitch does not assume any material volatility in copper prices over the forecast horizon.
© Zambian Economist 2014