Editor's note: Moody's recently affirmed Zambia's credit rating at 'B1', but has revised its outlook to negative based on rising debt levels, poor track record of fiscal management and worsening trade deficit. Details below.
Moody's recently affirmed Zambia's B1 government bond rating and changed the outlook to negative. The key drivers for the negative outlook are:
» Deteriorating debt metrics, as evidenced by a rapidly rising debt burden and increasing debt servicing costs;
» A trend of missed fiscal targets that points to high execution risks in current deficit reduction plan to arrest the upward debt trajectory, particularly amid spending pressures in the lead up to next year's presidential election; and
» The shift of the current account into deficit, removing a key credit support that has historically suppressed external vulnerability.
The affirming of B1 rating acknowledges Zambia's credit profile will remain in line with peers at the B1 level should these credit-negative trends dissipate or reverse in the next 12-18 months. Key credit supports include: a track record of growth above the B1 median, lower growth volatility, better conditions relating to the rule of law and control of corruption, and one of Africa's most stable political environments.
Moody's has left the local-currency bond and deposit ceilings unchanged at Baa3 and left the foreign-currency bond ceiling unchanged at Ba2 as well as the foreign-currency deposit ceiling at B2.
RATIONALE FOR THE NEGATIVE OUTLOOK
The first driver of the negative outlook is the deteriorating trend evident in Zambia's debt metrics. The debt burden, as measured by the debt-to-GDP ratio, has risen more than 10 percentage points of GDP since 2010 (to an estimated 31.1% of GDP in 2014). Domestic interest rates, meanwhile, have risen sharply: yields on 365-day T-bills rose to 23.5% in May 2015, up from 15.75% in January 2014.
The 2015 fiscal deficit will be considerably higher than originally budgeted as a result of lower revenues due to the policy reversal regarding the mining tax regime, the deceleration of growth associated with postponed mining sector investment impacting government revenues, and currency depreciation impacting foreign-currency denominated debt servicing costs. The IMF recently published its revised deficit and debt projections indicating that, on a no policy change basis, the fiscal deficit would increase to 7.7 this year and debt will increase to 39.6% of GDP due to the large fiscal deficit and a sharp weakening of the exchange rate inflating the size of foreign currency-denominated debt.
We expect a number of additional revenue-generating and cost-reduction measures to be announced in the mid-year budget update aimed at compensating for this year's deterioration in the fiscal position, meaning the deficit and debt outcomes should ultimately be lower than these projections. However, economic headwinds and political dynamics point to high implementation risk and the likelihood of further budgetary slippage.
The second driver supporting the negative outlook is the trend over the past few years of missed fiscal targets. Despite some success in implementing politically difficult measures in the past two years (for example, the two-year public sector wage freeze, fuel subsidy reduction, etc.) following the 2013 budget "blowout", three consecutive years where the deficit has exceeded 5% of GDP and the outcome has been materially worse than originally budgeted, point to high execution risks in the current deficit reduction plan to arrest the upward debt trajectory, particularly amid weaker revenue growth and spending pressures in the lead up to next year's presidential election.
The constrained growth outlook for the next two years, where GDP growth will undershoot the 7%+ average of the past decade, will further complicate fiscal consolidation efforts and delay upward debt trajectory stabilisation. Growth in 2014 dipped below 6% for the first time in a decade. We expect growth of 5.8% in 2015 as a result of the slowdown in the mining sector and flow on effects to related sectors of construction, transport and mining community services, as well as tighter domestic liquidity conditions constraining private sector activity.
The third driver of the negative outlook is the recent shift of the current account into deficit as a result of the decline in the trade surplus and fiscal imbalance, removing one of Zambia's key credit supports that suppressed external vulnerability. The Kwacha hit a record low against the US dollar in March, reflecting the decline in copper prices and the fiscal imbalance transmission through lower foreign exchange reserves and weaker investor sentiment.
The surplus in previous years helped fund the deficit on the financial account. While the deficit is still relatively small compared to a number of peers in the region, the deficit on the current account in the vicinity of 2% of GDP in 2015 potentially increases Zambia's vulnerability to external shocks relative to the country's position when it ran current account surpluses. At around $2.2 billion in March, foreign exchange reserves are below the IMF's recommended minimum of three months of imports cover for emerging markets.
RATIONALE FOR AFFIRMING THE B1 RATING
Despite the persistence of credit-negative pressures in recent years, for the time being most of Zambia's key credit metrics remain in line with those of similar rated sovereigns. Zambia's average real GDP growth is above the B1 median and the volatility of its growth is lower than the B1 median. Zambia scores better than the B1 median in governance indicators such as rule of law and control of corruption.
Although Zambia's fiscal deficit is larger than the B1 median, the government debt burden (an estimated 31.1% of GDP) is still lower than the B1 median. And while policy coherence is not always evident, half a century of political stability since independence and a history of fair and peaceful elections and no ethnic violence underscores Zambia's comparatively stable domestic political situation.
(Source : Moody Investors Service)
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