Editor's note: Fitch Ratings yesterday affirmed Zambia's credit rating at 'B', and revised the outlook down from 'positive' to 'stable' owing largely to poor policy coherence and credibility. It also notes a growing fiscal deficit and possibility of slower growth. The Fitch message is that we are doing OK but there are risks which need to be handled or things may get out of hand quickly.
Fitch Ratings has revised the Outlook on Zambia's Long-term foreign and local currency Issuer Default Ratings (IDR) to Stable from Positive 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:
Policy coherence and credibility are weak and a growing constraint on the rating. Numerous policy decisions since 2012 - most recently changes to the VAT regime and mining taxes - appear to have been legislated without widespread private sector consultation and have contributed to weakening the business environment.
In the 2015 budget, the government changed the tax regime for copper mining companies, introducing a mineral royalty tax - a tax on production rather than profit. The new tax could undermine the viability of certain mines at current low copper prices. Although the government has committed to negotiate with mining companies, changing the tax regime without adequate consultation has resulted in significant uncertainty in the sector and contributed towards a delay in foreign investment. Zambia's ranking in the World Bank's Doing Business Survey fell below the 'B' median for the first time in 2015.
Growth in Zambia is expected to moderate in 2015. The extent will depend on whether a solution can be reached to challenges facing the copper mining sector. Fitch expects growth to slow to 5.3% in 2015, down from 6% in 2014 and 6.7% in 2013, but still above the 'B' median of 4.2%. Growth could slow further if copper mines are forced to close, due to the new mineral royalty tax and lower copper prices, aggravated by high operating costs. A faltering mining sector would have negative spill-over effects on the broader economy. An IMF Mission is expected in March 2015. Fitch does not expect that a deal will be reached ahead of the elections in September 2016.
Zambia's vulnerability to external shocks has increased, due to lower copper prices pushing the current account further into deficit and declining reserves, which Fitch expects to fall below three months of import cover in 2015. Fitch forecasts a deficit of 3.5% of GDP in 2015, up from 2.6% in the previous year. In the past, the current account surplus funded the deficit on the financial account. With the current account recording a deficit for the second consecutive year in 2015, Fitch expects the authorities to seek between USD600m and USD1bn in external concessional funding to finance the balance of payments deficit or risk a sharper fall in reserves.
Downward pressure on the kwacha, which abated in the second half of last year following the prospects of an IMF programme and tighter liquidity, appears to have regained momentum. The currency has fallen by 9% against the dollar since the start of the year, following a 13% depreciation in 2014. The weakening currency reflects a deterioration in the trade balance, increased risk aversion and a shortage of dollar liquidity in the market.
Zambia's 'B' IDRs also reflect the following key rating drivers:
Government debt is low at 30.5% of GDP, against 46.8% of 'B' rated peers and is a key support for the rating. However, failure to contain the budget deficit, which is expected to average 5.3% between 2015 and 2016, up from an average of 2.2% over the previous five years, remains a risk.
The 2015 budget was passed in December 2014 and forecasts a deficit of 4.6% of GDP, down from an estimated 5.2% in 2014. Fitch forecasts a deficit of 5.3% of GDP. Fiscal risks arise from potentially repaying VAT arrears, revenue underperformance due to low copper prices and unforeseen consequences of the new mineral royalty tax, ongoing subsidies and increased spending ahead of the 2016 elections.
Tight liquidity and the government's increased domestic borrowing requirement, has pushed up domestic financings costs. Yields on 365-day T-bills rose to 21.4% in February, up from 15.75% in January 2014. Domestic debt accounts for nearly 50% of the governments total debt stock. Fitch views the increase in domestic borrowing announced in the 2015 budget as a risk. Combined with increased risk aversion, this could see domestic bond yields rise further.
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.
Rating Sensitivities :
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently well-balanced. The main factors that could, individually, or collectively, trigger positive rating action include:
- Improved policy predictability that supports investment and growth.
- An improvement in international reserves to reduce Zambia's vulnerability to external shocks.
- Continued progress on narrowing the budget deficit.
- Well-implemented infrastructure investments, which improve growth potential and increase market access for traditional and non-traditional exports.
The main factors that could, individually, or collectively, trigger negative rating action include:
- A sustained deterioration in fiscal discipline.
- A sharp deterioration in external balances, for example through a sharp and sustained fall in copper prices.
Fitch assumes that GDP growth will remain robust, 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 expects the elections in 2016 to proceed smoothly, with limited risk of political instability.
(Source : Fitch Ratings)