As a risk-adverse but seemingly isolated development, yields on Zambia's USD750 million 2024 bond spiked last week, peaking at 22%, a 20-percentage point spread over US Treasuries. This is more than double its margin in early 2019. Such levels imply that investors assume a significant degree of capital write-off. Some outstanding Zambian issues traded at prices around the low to mid-60% area of nominal value.

The yield spike followed an announcement on 29 May by Finance Minister Margaret Mwanakatwe that Zambia had made progress in efforts to renegotiate some existing dollar liabilities and to convert them into CNY-denominated obligations. While noting that the Zambian and Chinese central banks were working on a memorandum of understanding, no further detail was provided.

Our Take

Zambia's government has denied that it plans to default on its international Eurobond debt.

Likelihood of default within 2019 is reduced by Zambia already having paid half of the USD237 million due in interest on its bonds this year.

However, there are multiple adverse indicators regarding its future debt sustainability in the absence of external support.

• The IMF has forecast that Zambia will enjoy only 2.3% economic growth in 2019, described as its lowest level in two decades.
• Foreign exchange reserves have fallen by some 50% over the last three years to just USD1.4 billion when last reported.
• According to Standard Bank research, this overstates the actual position: it claims that after meeting debt service payments reserves are likely to have fallen to USD1.1-1.2 billion by end March and could reach USD1 billion by end-June.
• Our Zambian economist, Thea Fourie, shares these concerns. In early May, she noted that Zambia's import cover ratio ended 2018 well below the desired three months of imports of goods and services threshold, at an estimated 1.8 months of imports of goods and services.
• Overall, IHS Markit expects Zambia's import cover ratio to end 2019 at around 1.4 months of imports of goods and services. The weaker foreign reserve position leaves Zambia's short-term debt holdings at 40.6% of total foreign reserve holdings, up from 20.9% in 2015.

Zambia also has hindered new investment by a high-profile tax dispute with Vedanta Resources. While IHS Markit does not expect this to trigger actual expropriation, such threats increase uncertainty for companies selecting investment destinations, and could delay capital commitments to existing projects.

IHS Markit lowered its debt rating for Zambia in early May. Moody's also has lowered its rating twice over the last year (to Caa2, only two notches above actual default) and forecast in late April that Zambia's debt to GDP ratio will exceed 75% this year, versus 62% in 2017. Moody's suggested at the time that "debt affordability is weak relative to peers and fiscal policy credibility is limited", with ongoing fiscal slippages and continued government spending on favored projects indicating a lack of fiscal discipline.

Our assessment is that while Zambia is on a trajectory towards potential debt default, this could be avoided. While many local commentators suggest that the government is driven primarily by domestic considerations, we project that - citing Thea Fourie once again:

"The Zambian government will have little option but to approach the IMF for financial assistance under an IMF support program in the near term. Fiscal consolidation, lower domestic subsidies, and aligning a greater share of spending towards well-targeted public investment projects could be key conditions stipulated under an IMF support program".

Zambia's problems fall within a wider issue of concern regarding African debt sustainability. Growing indebtedness benefitting from historically-favorable demand conditions, combined with often ineffective application of past proceeds, is leading to rising debt burdens affecting the wider region. These adverse trends are being covered in a series of Special Reports prepared by our African economists. A further report in the next few weeks will consider factors that could alter the strong demand that the region has enjoyed in recent years.

Posted 03 June 2019 by Brian Lawson, Senior Economic and Financial Consultant, Country Risk, S&P Global Market Intelligence