We recently completed a Zambian research trip, researching economic policy, politics, IMF programmes and debt sustainability. I had gone into the trip with a marginally positive view on fiscal progress made under the then Finance minister Felix Mutati, but unfortunately came away with serious concerns. The deterioration in local politics means that an IMF programme is unlikely as authorities remain reluctant to deal with the issues of external debt and public financial management that endanger debt sustainability. A cabinet reshuffle announced on the first day of our trip raised further alarm bells given the reform minded Finance Minister Mutati was effectively demoted to minister of supply and works. We now have little exposure to Zambian assets within our emerging market debt portfolios, believing the risk/reward opportunity is much more attractive in other parts of Africa and around the globe.
Short term political gains a higher priority than necessary reforms
Since the economic crisis of 2015, the economy’s recovery has been painfully slow despite the tailwinds from higher copper prices, rising electricity and agricultural production. The partial revival in economic growth has done little to help correct bloated external debt levels.
The government had made some progress on fiscal reform, reducing subsidies and pushing a public financial management act which would require all contracted debt to have Ministry of Finance sign-off. Unfortunately scratching beneath the surface uncovered a different reality, with the government continuing to contract debts outside of the view of the ministry of finance. In light of President Lungu’s focus on securing support for a second term there may not be enough top down support to help correct this issue. An unexpected ministerial reshuffle over the last few days emphasises this point, as does the arrest of a key opposition leader last year (he was released, but charges remain on the book). Zambia does not enjoy the same freedom of the press as neighbouring South Africa.
Scandals delays IMF deal
After 18 months of back and forth with the IMF, authorities failed to secure an IMF programme at the final minute in September 2017 due to issues around debt transparency. Upon further investigation it became clear Chinese loans were granted at a ministerial level without Ministry of Finance sign-off. The government are still unable to provide guidance on the size, tenor and terms of these loans. Estimates from our trip put the Chinese debt number at almost 30% of GDP (US$6 billion), with disbursements over the next five years. This would mean that without any additional debt contraction Zambia would need to growth at least 6% annually to just keep the debt load stable, which is a situation we feel is unlikely and puts longer term debt sustainability into question.
The financial cliff is approaching at a steady pace
While imbalances in the country have improved and remain manageable over the short term with the current account and fiscal deficits 3% and 6% respectively (as a % of GDP), risks are rising. Zambian authorities continue to bleed reserves due to high external interest payments and a lack of mining flows given the accumulation of VAT arrears. In our view, this scenario is not sustainable in the long-run and without any additional external funding or assistance from the IMF the country will become more vulnerable to an external shock. Zambia could avoid some of these funding shortfalls by issuing local currency debt, although in the current environment we believe the government will struggle to attract foreign inflows.
We have now cut our modest Zambian exposure to zero across all emerging market debt portfolios and will closely follow the current situation before we consider reengaging any long positions.