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Fitch Affirms Zambia at 'B'; Outlook Negative
November 27, 2017 / 4:39 PM / 17 days ago

Fitch Affirms Zambia at 'B'; Outlook Negative

(The following statement was released by the rating agency) HONG KONG, November 27 (Fitch) Fitch Ratings has affirmed Zambia's Long-Term Foreign-Currency Issuer Default Rating (IDR) at 'B' with a Negative Outlook. A full list of rating actions is at the end of this rating action commentary. KEY RATING DRIVERS Zambia's 'B' rating reflects the sovereign's elevated public debt burden, weak fiscal management, high commodity dependence, and low income and human development indicators. The weaknesses are balanced against a credible monetary policy, strengthening economic growth, a net external creditor status, and the potential for the government's reform agenda to successfully ameliorate structural constraints in the economy while continuing fiscal consolidation. The Negative Outlook reflects the continuing downside risks from persistent fiscal deficits and increased external debt servicing costs. Zambia's public finances continue to present a downside risk to the sovereign credit profile. The government has begun to take steps towards fiscal consolidation, which have shrunk the fiscal deficit by close to 5pp of GDP on a commitment basis since 2015. However, Fitch forecasts the general government fiscal deficit to widen to 7.8% of GDP in 2017 on a cash basis, from 5.8% in 2016, reflecting a combination of current year budgeted spending and the payment of accumulated arrears to contractors. The authorities have managed to keep expenditure broadly in line with the budget through 1H17, but revenue had underperformed, although Fitch believes that revenue performance in 2H17 has been stronger. Fitch expects that efforts to move farm subsidies to a new e-voucher system and to increase VAT compliance will lead to smaller fiscal deficits in the coming years. However, a number of weaknesses in the government's fiscal framework and public financial management increase the likelihood of new arrear accruals and off-budget spending in the short-term. Also, plans for large infrastructure projects pose a threat to consolidation efforts and to the debt trajectory. Disagreements over the sustainable level of new private commercial borrowing have so far prevented the authorities from coming to an agreement with the IMF on a support programme. An IMF programme would provide a policy anchor for the government's reform agenda and would also secure other sources of long-term external financing. The Zambian authorities have signalled their desire to enter a programme, but progress towards an agreement has been slow and negotiations have stalled. Persistent fiscal deficits and FX depreciation have led to a doubling of general government debt over the past five years, but the debt trajectory is likely to plateau by 2019. Fitch forecasts gross general government debt to increase to 56% of GDP at end-2017, from 55% at end-2016. However, a failure to implement the fiscal consolidation programme outlined in the Medium Term Expenditure Framework 2018-2020 could result in the debt/GDP ratio continuing to rise to 65% through 2026. The growing stock of foreign currency-denominated debt, much of it non-concessional, brings added vulnerability given the recent history of FX shocks and Zambia's dependence on copper exports for foreign currency. Additionally, at 326%, the ratio of government debt to government revenue is well above the 'B' median of 235%. An increase in private sector external borrowing has matched the increase in public sector debt leading to overall deterioration in the external debt position, increasing vulnerability to short-term financing flows. Zambia remains a net external creditor and much of the external private debt is inter-company and is matched with high levels of private external assets. Fitch forecasts Zambia's liquidity ratio, a measure of liquid external assets to short term external liabilities, to fall to 125% in 2017, from 223% in 2016, materially below the 'B' median of 171%. Fitch expects gross international reserves to fall to USD2.2 billion by end-2017, from USD2.4 billion at end-2016. Additionally, recovery in imports means that reserves will fall to 2.6 months of current external payments (CXP) by end-2017, from 3.3 months in 2016. In 2018, the narrowing current account deficit, which Fitch expects to shrink below 3% of GDP from 4.5% in 2016, will support FX reserve accumulation. Fitch forecasts the reserve position to increase to USD2.5 billion, or 2.7 months of CXP, at end-2018. Economic growth indicators have been mixed in 2017, but most point to a continuation in recovery from 2016, following the cyclical downturn brought on by falling copper prices and poor rains in 2015. Fitch forecasts real GDP growth to accelerate to 4% in 2017, from 3.6% in 2016, and to increase further to 4.7% in 2018. Fitch expects that the easing of drought conditions will improve both crop harvests and the supply of electricity, which along with higher copper prices, will drive growth in the agricultural, mining and manufacturing sectors. Inflation decelerated sharply in 2017, with CPI falling to 6.5% in 2017, from an annual average of 18% in 2016. Inflation peaked in 1Q16, following a year in which the kwacha lost over 60% of its value in dollar terms. In response, the Bank of Zambia (BOZ) increased its main policy rate by 300 bps in 4Q15 and held it at that level through 2016; this, along with a combination of base effects and higher food supplies, was responsible for the fall in CPI. Some administrative price increases in fuel and power will put upward pressure on CPI, but inflation expectations are anchored in the single-digits. This has allowed the BOZ to aggressively ease monetary policy beginning in 1H17, lowering the policy rate by a total of 525 bps and the statutory reserve ratio by 1,000 bps. As a result, credit to the private sector has resumed growth in 2017, after contracting 9% yoy in December 2016, but it will continue to face crowding out from government borrowing in the domestic market. Tight monetary policy and economic challenges have had a negative impact on Zambian banks, but the banking sector remains well-capitalised relative to regional peers and stress tests indicate resilience to potential shocks. Tight domestic liquidity has contributed to asset quality deterioration, with non-performing loans (NPLs) increasing to 12% of total loans at end-September 2017, from 10% at end-2016. However, NPLs peaked in 2Q17 and have improved slightly during 3Q17 following monetary easing. Zambia's sovereign ratings remain constrained by weak development indicators. Both GDP per capita and per capita income remain below half the 'B' median and measures of human development compare poorly with rated peers. Health and education outcomes are especially weak, with an average life expectancy of 60 years. 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 (LTFC) IDR scale. Fitch's sovereign rating committee adjusted the output from the SRM to arrive at the final LT FC IDR by applying its QO, relative to rated peers, as follows: - Macro: +1 notch, to reflect the authorities' credible, counter-cyclical monetary policy, which has helped to stabilise the kwacha and bring down inflation and will be supportive of growth; and the government's fiscal and structural reform agenda. 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 the ratings being downgraded include: - A failure to improve public finance management, reverse fiscal deterioration and stabilise the government debt/GDP ratio; - A sustained inability to access external sources of financing, as might occur with the failure to successfully negotiate an IMF programme, and which could lead to liquidity and funding shortfalls; and - Further deterioration in external balances, for example through a sharp and sustained fall in copper prices. The main factors that could, individually, or collectively, lead to the Outlook being revised to Stable include: - Improved public finance management and effective fiscal consolidation that leads to a sustained 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- and Local-Currency IDRs affirmed at 'B'; Outlook Negative Short-Term Foreign- and Local-Currency IDRs affirmed at 'B' Country Ceiling affirmed at 'B+' Issue ratings on long-term senior unsecured foreign- and local-currency bonds affirmed at 'B' Issue ratings on short-term senior unsecured local-currency bonds affirmed at 'B' Contact: Primary Analyst Jermaine Leonard Director +852 2263 9830 Fitch (Hong Kong) Limited 68 Des Voeux Road Central Hong Kong Secondary Analyst Jan Friederich Senior Director +852 2263 9910 Committee Chairperson Tony Stringer Managing Director +44 20 3530 1219 Media Relations: Peter Fitzpatrick, London, Tel: +44 20 3530 1103, Email: peter.fitzpatrick@fitchratings.com; Wai-Lun Wan, Hong Kong, Tel: +852 2263 9935, Email: wailun.wan@fitchratings.com. 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