Fitch Ratings-Hong Kong-11 October 2018: Fitch Ratings has downgraded Zambia's Long-Term Foreign-Currency Issuer Default Rating (IDR) to 'B-' from 'B', with a Negative Outlook.
A full list of rating actions is at the end of this rating action commentary.
KEY RATING DRIVERS
The downgrade and Negative Outlook on Zambia's Long-Term IDRs reflects the substantial upward revision in the government budget deficit targets.
The Minister of Finance presented the 2019 Budget to the National Assembly on 28 September. This followed the release of the 2019-2021 Medium-Term Expenditure Framework (MTEF) earlier in September. Both documents lay out the government's fiscal framework, which envisages a reduction in the fiscal deficit to 5.1% of GDP by 2021, down from 7.9% in 2017. The new fiscal framework represents a significantly less ambitious fiscal consolidation effort than the previous MTEF, which had set out the objective of reducing the fiscal deficit to no more than 3% of GDP by 2020.
Upward revisions to fiscal deficits and government debt have weakened the credibility of the government's fiscal targets. The government revised the 2018 fiscal deficit target to 7.4% of GDP from the 6.1% contained in the 2018 budget. Earlier in the year, the government revised its 2017 fiscal deficit to 7.9% of GDP from the provisional figure of 7%, and also revised its external debt stock up to USD8.7 billion from USD7.9 billion. The deficit revisions have been the result of the reconciliation of previous disbursements to externally financed projects and of higher debt-servicing costs, both of which reflect broad deficiencies in public financial management and a rapid accumulation of new external debt. The government has taken some steps to keep future disbursements in line with the budget, but this is likely to remain a problem over the medium term.
The 2019 Budget envisages an increase in revenue from a number of tax reform measures. These measures include reducing tax expenditures by updating the rules on tax deductions and transfer pricing, and increasing the withholding tax. The budget also proposes changes to the mining tax regime, which would increase royalty rates by 1.5pp across all brackets and add a new top bracket. These measures could help to marginally increase government revenue, but not by enough to counter the expected increase in capital expenditure. The government's budget targets a reduction in the 2019 fiscal deficit to 6.5% of GDP, from 7.4% in 2018. Fitch believes that the budget targets are optimistic, and forecasts a deficit of 7.5% of GDP in 2018 and 6.9% in 2019. The agency also believes that the risks are tilted to the downside.
The Ministry of Finance released a statement in June, noting the need for fiscal consolidation and highlighting the high risk of debt distress. The statement indicated the government's intention to curtail the contraction of new debt and to cancel some of the contracted but undisbursed loans. Despite the statement, the current MTEF contains a total of USD3.4 billion in new external financing in the years 2019 to 2021, which equates to approximately 4.3% of GDP each year. The government has reduced some domestically financed project spending, but capital expenditure remains at around 7% of GDP per year through 2021. Over the same period, debt servicing will consume approximately 24% of government revenue.
Fitch now forecasts Zambia's general government debt to reach 69% of GDP by end-2018, up from 60% at end-2017, and to rise again in 2019. This represents an increase from our previous forecast of a rise to 64% of GDP in 2018 and for government debt to begin falling in 2019. The further expected increase in foreign-currency debt will make Zambia's debt stock more vulnerable to FX volatility and to a rising global interest-rate environment.
Increased external borrowing will also weaken the external position. Reserves were USD 1.7 billion in August 2018, which is down from the USD2.1 billion (or 2.4 months of current external payments (CXP)) at end-2017, as the Bank of Zambia has sought to contain currency depreciation. Fitch forecasts reserves to remain below three months of CXP through 2018 and 2019.
Zambia's 'B-' IDRs also reflect the following key rating drivers:
Fitch forecasts GDP growth at 4.5% in 2018 and 2019, but emphasises that risks are tilted to the downside. Copper output will increase to around 830,000 metric tonnes (mt) in 2018, and to grow at approximately 5% per annum in the following years. However, Fitch expects that copper prices will plateau, which, along with increasing mining taxes and questions about the business environment, may reduce investment in the sector. Beyond the mining sector, increased government capital expenditure will support growth in the construction and services sector.
Delayed fiscal consolidation and high debt will weigh on macroeconomic stability. In a sign of stress, the Zambian kwacha depreciated by almost 20% in September 2018, after a period of relative stability beginning in 2H16. The kwacha may recover some ground, but FX volatility raises risks to debt/GDP projections. CPI growth has increased to 8% yoy in August 2018, having fallen to 6.1% at end-2017. Inflation will accelerate further if the recent weakness of the kwacha is not reversed. The ability of the Bank of Zambia to tighten monetary policy in response will be constrained by the impact on the government's interest expenditure which is already high, while currency depreciation will increase the government debt/GDP ratio.
Zambia's sovereign ratings remain constrained by weak development indicators. Both GDP per capita and per capita income remain below half the historical 'B' median, and measures of human development compare weakly with rated peers. Furthermore, deterioration in performance on governance indicators has put downward pressure on the ratings.
SOVEREIGN RATING MODEL (SRM) and QUALITATIVE OVERLAY (QO)
Fitch's proprietary SRM assigns Zambia a score equivalent to a rating of 'B-' on the Long-Term Foreign-Currency (LT FC) IDR scale.
Fitch's sovereign rating committee did not adjust the output from the SRM to arrive at the final LT FC IDR
Fitch's SRM is the agency's proprietary multiple regression rating model that employs 18 variables based on three-year centred averages, including one year of forecasts, to produce a score equivalent to a LT FC IDR. Fitch's QO is a forward-looking qualitative framework designed to allow for adjustment to the SRM output to assign the final rating, reflecting factors within our criteria that are not fully quantifiable and/or not fully reflected in the SRM.
RATING SENSITIVITIES
The main factors that could, individually, or collectively, lead to negative rating action include:
- An inability to access external or domestic sources of financing or evidence of heightened risks in meeting debt-service payments;
- A failure to narrow the budget deficit and stabilise the government debt/GDP ratio; and
- Deterioration in the external reserves position.
The main factors that could, individually, or collectively, lead to positive rating action include:
- Narrowing of the fiscal deficit and stabilisation of the general government debt/GDP ratio; and
- A rise in international reserve coverage, thereby reducing Zambia's vulnerability to external shocks
KEY ASSUMPTIONS
Fitch assumes that copper prices will not experience a sustained fall from current levels.
The full list of rating actions is as follows:
Long-Term Foreign-Currency IDR downgraded to 'B-' from 'B'; Outlook Negative
Long-Term Local-Currency IDR downgraded to 'B-' from 'B'; Outlook Negative
Short-Term Foreign-Currency IDR affirmed at 'B'
Short-Term Local-Currency IDR affirmed at 'B'
Country Ceiling downgraded to 'B' from 'B+'
Issue ratings on long-term senior unsecured foreign-currency bonds downgraded to 'B-' from 'B'
Issue ratings on long-term senior unsecured local-currency bonds downgraded to 'B-' from 'B'
Issue ratings on short-term senior unsecured local-currency bonds affirmed at 'B'
