Moody's Investors Service has today downgraded Zambia's government issuer rating to B2 from B1 . The outlook on the rating has been changed to stable from negative.
The key driver for the downgrade is our expectation of a sustained deterioration in fiscal and debt metrics that is unlikely to reverse over the course of the 3-5 year rating horizon given the challenges stemming from a lower growth environment amid an extended period of weak commodity prices, constrained copper production, and domestic electricity shortages constraining business activity.
The stable outlook reflects our expectation that, despite the continuing deterioration in the country's key fiscal and debt indicators, Zambia's credit metrics will remain aligned with B2-rated peers. The stable outlook also balances the downside risk of a more pronounced weakening of the country's public finances and international balance of payments position, against credit supports such as a track record of political stability, responsive monetary policy, and banking system stability.
Concurrently, Moody's has lowered Zambia's foreign currency bond ceiling to Ba3 from Ba2, its foreign currency deposit ceiling to B3 from B2, and its local currency bond and deposit ceilings to Ba1 from Baa3.
RATINGS RATIONALE
RATIONALE FOR THE DOWNGRADE -- PERSISTENT FISCAL DEFICITS AND UPWARD DEBT TRAJECTORY UNLIKELY TO REVERSE
The key driver for the downgrade is our expectation that the trend of persistent fiscal deficits and deterioration in debt metrics witnessed over the past few years is likely to continue, warranting repositioning Zambia's rating at the B2 level to reflect higher credit risk. We expect fiscal deficits to remain elevated in the 5%-7% of GDP range for the next several years amid lower growth, subdued mining sector revenues, expenditure pressures, and higher debt servicing costs following significant currency depreciation. Meanwhile, the upward debt trajectory that has seen an increase in debt to GDP of more than 20-percentage-points in the past five years is unlikely to reverse over the course of the 3-5 year rating horizon.
Since 2011, Zambia's debt-to-GDP ratio has grown from 20% of GDP to more than 41% of GDP in 2015, while its interest-to-revenues ratio has tripled from roughly 5% to almost 15% over the same period, owing to strong increases in spending, weaker revenues associated with lower commodity prices, and adverse currency movements inflating the stock of foreign currency-denominated debt relative to GDP and increasing the local currency equivalent of US dollar-denominated Eurobond coupon payments. Such a debt burden brings Zambia closer to peers at the B2 rating level; we expect debt to GDP to peak above the current B2 median of 45% within the next few years.
The subdued growth outlook will exacerbate the government's fiscal consolidation challenge. We expect to see growth this year to fall below 5% for the first time since 2002, in contrast to the country's average growth rate of 7% over the past decade. Copper production will likely decline for a second successive year (with the new FQM Sentinel mine production insufficient to compensate for the announced suspension of Glencore's Mopani mining operations), while we expect copper export values will remain weak reflecting our projections of 'lower for longer' copper prices as global commodity demand wanes. Moreover, the rapid depreciation of the kwacha against the US dollar in the past 5 months--more than any other currency in the region--is unlikely to quickly restore balance in the current account, given the low demand elasticity of important export partners, such as China. Meanwhile, the acute drought-induced electricity crisis threatens to persist for a protracted period with concomitant downside risk to growth expectations.
RATIONALE FOR THE STABLE OUTLOOK -- CREDIT METRICS TO REMAIN CONSISTENT WITH B2 PEERS
The stable outlook reflects our expectation that, while the deterioration in Zambia's credit metrics is set to continue, the deterioration in the next 12-18 months is unlikely to be of sufficient magnitude to warrant considering positioning the rating at B3—a cohort characterised by much lower fiscal and institutional strength and higher susceptibility to event risk. Zambia's creditworthiness is supported by a monetary policy framework that to date has been successful in preserving macroeconomic stability, a track record of democratic stability that limits political event risk, and a stable banking system that supports growth and represents minimal contingent liability risk to the sovereign.
Nevertheless, downside risks are present, such as the potential for further deceleration in growth due to copper price weakness and drought-induced electricity shortages, the risk of a higher-than-expected fiscal deficit due to spending pressures in the lead up to next year's Presidential election, and the cyclical and structural deterioration in the current account position (including the emergence of trade deficit) that reduces a key credit support that has historically suppressed external vulnerability associated with relatively low levels of foreign exchange reserves. With regards to the latter point, however, our external vulnerability indicator, which measures the volume of the country's external obligations due within a year against foreign exchange reserves, remains relatively low at around 30% and thus does not suggest imminent acute pressures on the country's external position.
WHAT COULD CHANGE THE RATING UP
Upward rating pressure is unlikely in the current context. However, several conditions could provide for a positive outlook and, eventually, an upgrade, including (1) demonstrated fiscal consolidation that significantly reduces the budget deficit, leading to a meaningful reversal in the debt burden; (2) a reduction of the current account deficit towards balance and an eventual return to surplus, or sizable strengthening of foreign exchange reserves, or both, that reduce external vulnerability; or (3) material improvement in the growth outlook that paves the way for stronger government revenues and foreign exchange earnings.
WHAT COULD CHANGE THE RATING DOWN
Downward pressure would be exerted on the rating in the event of (1) persistent, worse-than-anticipated fiscal deficits that accelerate the pace of the upward trajectory in the government's debt burden; (2) further widening of the current account deficit that increases external vulnerability; or (3) a secular slowdown in economic growth on account of persistent power shortages or even lower global copper prices than currently projected.
GDP per capita (PPP basis, US$): $4,064 (2014 Actual) (also known as Per Capita Income)
Real GDP growth (% change): 5.4% (2014 Estimate) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 8.2% (2014 Estimate)
Gen. Gov. Financial Balance/GDP: -5.6% (2014 Estimate) (also known as Fiscal Balance)
Current Account Balance/GDP: -1.5% (2014 Actual) (also known as External Balance)
External debt/GDP: 28.1% (2014 Estimate)
Level of economic development: Low level of economic resilience
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
