Fitch Affirms Zambia at 'B'; Outlook Stable
KEY RATING DRIVERS
The affirmation reflects the following factors:
Zambia's 'B' ratings balance strong growth, macroeconomic stability and moderate government debt, against deteriorating public finances and weak policy coherence and credibility. High levels of foreign direct investment, which more than offset the current account deficit, as well as the country's strong net external creditor position, also support the ratings.
Policy coherence and credibility remain relatively weak. Since 2012, there has been the introduction and subsequent reversal of growth-negative changes in the fiscal treatment of the highly important mining sector. Fitch believes the initial policy shock and U-turn have had an overall negative impact on business and investor confidence. It also indicates weaknesses in the policy formulation process. Zambia's ranking in the World Bank's Doing Business Survey remains in line with the 'B' median.
Fitch expects GDP growth to slow to 4.9% (previously 5.3%) in 2015, down from 6.1% in 2014 and 6.7% in 2013, but still above the 'B' median of 4.6%. Falling copper production, combined with electricity challenges and policy uncertainty has contributed towards growth slowing.
Public finances have deteriorated since 2012, with planned fiscal consolidation falling off track in 2015. The budget deficit is expected to average 6.3% of GDP between 2013 and 2016, up from an average of 2.1% over the previous five years and above the 'B' median of -4.8%. Although lower revenue (falling copper prices and changes to the mining tax regime) is partly responsible, expenditure has been revised upwards due to higher interest payments and subsidies as well as repaying arrears built up during 2014.
The Ministry of Finance forecasts a cash deficit of 6.9% of GDP, up from the October 2014 budget (4.6%) and wider than the deficit of 5.9% in 2014. On a commitment basis, the deficit is expected to fall to 5.8% of GDP from 10.4% in 2014, as arrears are paid down. Fitch expects the cash deficit to increase to 8.1% of GDP in 2015, due to expected revenue underperformance and likely challenges containing expenditure. Zambia has never had a history of spending ahead of elections, but risks remain given the narrow gap between the two parties.
Zambia's previous track record of fiscal prudence and low debt has led to moderate public indebtedness. Gross general government debt remains below the 'B' median (37.1% of GDP, versus 51.3% in 2015). However, the build-up in arrears and recent fiscal laxity will push government debt-to-GDP beyond Fitch's previous peak of 34.2% of GDP in 2017, to above 40% by 2018. A rising debt burden will see interest costs increase, taking up 18% of government revenue in 2015 from 6% in 2011. This reduces fiscal flexibility and will complicate consolidation efforts.
Zambia has tapped the Eurobond market three times since 2012, most recently with an 11-year, USD1.25bn bond issued in July 2015, taking the total value of outstanding Eurobonds to USD3bn. Eurobond issuances have led to Zambia's external debt profile deteriorating, with commercial debt now making up 50% of the total external debt stock, up from 0% in 2011,
Falling export revenue, adverse sentiment towards emerging markets and growing risks from Zambia's fiscal position have led to the exchange rate falling by 20% since the start of the year. To limit exchange rate volatility the Bank of Zambia has dipped into reserves, which have fallen by USD300m to USD2.2bn (2.4 months of CXP) in 1H15. The recent Eurobond issue will boost reserves, which are expected to end the year at 3.5 months of CXP, and help close the gap on the balance of payments. Zambia is expected to run a small current account deficit for a third consecutive year in 2015, although this is more than financed by FDI. Increased copper production in 2016 will push the current account back into surplus, despite Fitch's base case that copper prices will remain flat over the forecast period.
A decade of growth above 7.5% has resulted in an improvement in social indicators, but per capita income (at 60% of the 'B' median) and measures of human development still compare weakly with 'B' category peers. Health and education outcomes are especially weak, with average life expectancy of 57 years. The lack of skills adversely affects the employability of the workforce, with only 10% employed in the formal sector.
The Stable Outlook reflects Fitch's assessment that upside and downside risks to the ratings are currently well-balanced. The main factors that could, individually, or collectively, trigger positive rating action include:
- Progress on narrowing the budget deficit.
- Greater clarity over the medium term fiscal framework.
- A rise in international reserve coverage to reduce Zambia's vulnerability to external shocks.
- Improved policy predictability that supports investment and growth.
The main factors that could, individually, or collectively, trigger negative rating action include:
- A sustained deterioration in fiscal discipline.
- A sharp deterioration in external balances, for example through a sharp and sustained fall in copper prices, relative to Fitch's forecast.
- Fitch assumes that GDP growth will remain robust, based on the assumption that copper production will increase significantly by 2020, with strong net FDI inflows.
- We assume new power stations come on-stream as scheduled and help alleviate electricity shortages.
- Fitch expects the elections in 2016 to proceed smoothly, with limited risk of political instability.