Zambia’s Midyear Budget Deficit Is Double Original Projection, a Credit Negative

Lusaka, Zambia (Capital Markets in Africa) — On 16 June, Zambia (B1 negative) Finance Minister Alexander Chikwanda released the midyear budget update, which revealed a deficit of ZMW20 billion (roughly $2.7 billion, or around 10% of GDP) for the first six months of this year, more than double the original projection. He also sought parliamentary approval to nearly double the external borrowing limit to access international capital markets to plug the deficit. The credit-negative larger-than-expected half-year budget deficit amplifies pressure on the country’s already deteriorating debt metrics, while additional external borrowing would increase Zambia’s foreign currency risk.

This is the third consecutive year in which the deficit is materially worse than originally budgeted, and has contributed to debt rising by more than 10 percentage points, a key driver behind our change to Zambia’s rating outlook to negative on 29 May. Debt/GDP was around 31.1% of GDP in 2014. Although this remains below the B1 sovereign median, the International Monetary Fund’s (IMF) recently revised debt projections indicate that, on a no-policy-change basis, the debt burden would increase to 39.6% of GDP by year-end* owing to the large fiscal deficit and a sharp weakening of the exchange rate inflating the size of foreign currency-denominated debt.

Zambia’s debt servicing costs have risen sharply to more than 12% of revenues, reflecting sharply higher domestic interest rates and currency depreciation inflating foreign-currency-denominated debt service obligations. Moreover, Tuesday’s request to parliament to increase the external borrowing ceiling to ZMW60 billion from ZMW35 billion comes amid the IMF warning of “moderate risk of external debt distress and heightened public debt vulnerabilities,” and calling for “prudence” in borrowing on commercial terms**.

Tax receipts associated with the revised mining regime will pick up in the second half of the year, while Mr. Chikwanda spoke of scope to rationalize capital expenditure. The more favourable budgetary trends that the government expects in the second half should help contain the full-year budget deficit, but we still expect the government to post a much larger deficit overall than it originally targeted. Moreover, a subdued growth outlook for the next two years, where GDP growth will fall short of the 7%-plus average of the past decade, and spending pressures in the run-up to a presidential election next year point to the challenge the government will have implementing its deficit-reduction plan and the likelihood of further budgetary slippage.

Concurrent with the midyear budget update and request to raise the debt ceiling, Mr. Chikwanda announced the establishment of a sinking fund for the repayment of Zambia’s two outstanding 10-year Eurobonds maturing in 2022 and 2024. Although dedicating current revenues to future debt repayments demonstrates the government’s commitment to reducing future rollover risk, it will add to the government’s funding challenges by increasing its borrowing needs at a time of reduced investor appetite and rising yields. Moreover, there is a low likelihood of Zambia’s new sinking funds accumulating sufficient reserves in the context of elevated budget deficits expected over the next few years. Accordingly, rollover risks are likely to remain at maturity.

Reference

*  IMF Press Release: IMF Executive Board Concludes 2015 Article IV Consultation with Zambia, 22 May 2015.
** IMF 2015 Article IV consultation—Press Release, Staff Report, and Statement by the Executive Director for Zambia, 16 June 2015.

Source: Moody’s Credit Outlook Report, 25 June 2015