London, October 21, 2022 -- Moody's Investors Service ("Moody's") has today affirmed the Government of Zambia's Ca foreign-currency and local-currency long-term issuer ratings. The outlook remains stable.
The decision to affirm the Ca ratings balances Zambia's limited external financing sources, very weak governance, exposure to environmental and social risks, and ongoing debt default against recent improvements to the economic outlook and efforts to improve fiscal management in the context of the IMF programme approved earlier this year.
At this rating level, the stable outlook implies that the government's credit profile is unlikely to improve materially until after the current debt restructuring exercise is completed and expected losses to creditors remain aligned with those associated with a Ca rating. The government is not currently servicing external private sector debt and, while it continues to meet local currency debt service obligations, risks remain elevated that some or all local currency instruments may be included in the upcoming restructuring exercise. Moody's expects Zambia will also remain subject to elevated risk of redefault in future.
Zambia's local-currency and foreign-currency country ceilings remain unchanged at Caa1 and Caa3, respectively. The three-notch gap between the local-currency ceiling and the sovereign rating reflects the government's small role in the economy relative to peers and moderate domestic and geopolitical risk, notwithstanding relatively high external imbalances and heavy reliance on a single common revenue source in copper. The two-notch gap between the foreign-currency ceiling and the local-currency ceiling reflects Zambia's high external indebtedness and very low policy effectiveness that generate a degree of transfer and convertibility risk, notwithstanding its open capital account and track record of limited intervention.
RATINGS RATIONALE
RATIONALE FOR AFFIRMING THE Ca RATING
ONGOING RESTRUCTURING EXERCISE LIKELY TO RESULT IN SIZEABLE LOSSES FOR PRIVATE CREDITORS, NOTWITHSTANDING IMPROVING ECONOMIC CONDITIONS
After borrowing heavily from a range of external creditors to finance domestic infrastructure projects, the pandemic-induced shock led Zambia to default on its eurobonds in October 2020. Since then, Zambia has ceased servicing of its commercial external debt and is seeking a debt restructuring under the auspices of the G20 Common Framework for debt relief beyond the DSSI (Common Framework). Given Zambia's unsustainable debt level and the size of the debt reduction outlined in the International Monetary Fund's (IMF) Debt Sustainability Analysis, Moody's expects bondholder losses will exceed 35% net present value at the time of the original default, consistent with a Ca rating.
To-date, Zambia has continued to service local currency debt obligations, including those to non-resident holders. Authorities are seeking to exclude all local currency debt instruments from the restructuring, citing concerns regarding domestic financial market stability and the need to preserve domestic debt market financing post-restructuring, as well as practical and legal considerations regarding the ability to isolate non-resident holders. However, the eventual parameters of Zambia's debt restructuring will be subject to negotiations between Zambian authorities and its creditors. Risks that some local currency creditors will be included in the restructuring perimeter remain elevated, while Zambia's weak governance, high exposure to environmental and social risks, and vulnerability to external shocks given its heavy reliance on a single commodity export base leave all creditors exposed to risk of redefault in the future following the restructuring. Moody's expects more clarity on the details of the restructuring, including its overall size, interest reductions, maturity extensions, and treatment of local currency creditors to be outlined in a Memorandum of Understanding between the official creditor committee and Zambian authorities, which will serve as the basis for the next stage of the restructuring process: bilateral negotiations between Zambia and its individual creditors.
Zambia's macro outlook has improved in recent quarters but remains vulnerable to external shocks. Real GDP growth recovered to 4.1% in 2021 but is projected to decelerate to 3% in 2022 partially due to a slowdown in mining output after heavy rainfall in the north of Zambia, where most of the mining industry is located, led to difficult operating conditions and lower production from the industry. Moving forward, while Moody's expects investment and output in the mining sector to increase from current levels, the sector will remain vulnerable to similar environmental shocks as well as global metal price fluctuations, most notably copper. Copper exports accounted for around three quarters of Zambia's good exports in 2021 and mining extraction royalties are around 8% of the government's revenue, meaning Zambia's credit profile will remain vulnerable to fluctuations in copper prices.
The Zambia kwacha has staged a rapid recovery since depreciating versus the US dollar in the first half of 2021, helping to bring inflation back to single digit levels since June 2022. Confidence in the kwacha improved following an injection of international reserves from the IMF in 2021 and the rally was sustained by improvements in copper prices in early 2022, supporting a positive current account balance despite the shock to food and fuel import prices, which Moody's expects to remain slightly positive in 2023. Large portfolio inflows from foreign investors into local currency government debt has also supported currency demand as well as the government's access to local currency financing. However, continuing appetite from non-resident investors in Zambia's local currency debt is not assured as global financing conditions tighten, with potential implications for the value of the kwacha and, by extension, inflation.
Zambia faces significant institutional challenges in the areas of government effectiveness, rule of law and control of corruption. Frequent changes to the government's mining tax regime have perpetuated the perception of unpredictability in policymaking. In addition, the government's missed fiscal targets have complicated the implementation of monetary policy and hindered macroeconomic management. Zambia's recent default and track record of accumulating domestic and external payments arrears to contractors, suppliers, pensioners, and other non-creditors are also indicative very weak fiscal management and payment culture. The government has begun efforts to improve the institutional framework supported by its current IMF programme but very high social risks may constrain the government's policy effectiveness and limit the government's ability to implement unpopular reforms to meet fiscal consolidation objectives.
RATIONALE FOR STABLE OUTLOOK
The stable outlook indicates that the government's credit profile is unlikely to improve materially until after the current debt restructuring exercise is completed. Zambia's application for debt treatment under the Common Framework obliges the government to seek comparable treatment from all commercial creditors, including private sector bondholders. A reprofiling of some noncommercial and local currency debt could limit losses for external bondholders. Conversely, without a reprofiling of some of the government's noncommercial and local currency debt, the losses for private sector creditors could be larger than implied by the Ca rating.
ESG CONSIDERATIONS
Zambia's ESG Credit Impact score is very highly negative (CIS-5), reflecting high exposure to environmental risk, very high social risk and very low resilience, driven by weak governance, low wealth levels, weak fiscal metrics and exhausted fiscal space that exacerbate the exposure to environmental and social considerations.
Zambia's credit profile is highly exposed to environmental risks, as reflected in its E-4 Issuer Profile score. Environmental considerations are material to Zambia's rating and weigh on its economic strength as weather conditions affect the agricultural sector and electricity generation, given the country's high reliance on hydropower, as well as production from open pit mines. Persistently low rainfall and a pest outbreak in some parts of the country led to a substantial contraction in the agricultural sector while heavy rainfall in other parts led to a decrease in copper production in the first half of 2022. Water risk is high because a high share of the population is exposed to unsafe drinking water. In addition, Zambia is facing one of the highest deforestation rates in the world, driven by demand for charcoal across the country. Prolonged damage caused by deforestation will lead to both environmental and economic costs in the longer term.
Exposure to social risks is very highly negative (S-5 Issuer Profile score), driven by low access to basic services, including unequal access to electricity, high levels of poverty and inequality, with Zambia ranking among the countries with the highest level of inequality globally. Zambia also ranks weakly in terms of health indicators and, to a lesser extent, education outcomes.
Zambia has a very highly negative governance profile score (G-5 Issuer Profile score). Zambia receives low scores on the Worldwide Governance Indicators, revealing institutional challenges in the areas of government effectiveness, rule of law and control of corruption. Fiscal policy has been ineffective in addressing the mounting challenge stemming from rapidly increasing debt, leading to a default on its eurobonds, and the government has a history of generating large stocks of fiscal arrears.
GDP per capita (PPP basis, US$): 3,559 (2021) (also known as Per Capita Income)
Real GDP growth (% change): 4.1% (2021) (also known as GDP Growth)
Inflation Rate (CPI, % change Dec/Dec): 16.4% (2021)
Gen. Gov. Financial Balance/GDP: -8.5% (2021) (also known as Fiscal Balance)
Current Account Balance/GDP: 11.9% (2021) (also known as External Balance)
External debt/GDP: 60.7% (2021)
Economic resiliency: caa1
Default history: At least one default event (on bonds and/or loans) has been recorded since 1983.
On 18 October 2022, a rating committee was called to discuss the rating of the Zambia, Government of. Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed. The issuer's institutions and governance strength, have not materially changed. The issuer's governance and/or management, have not materially changed. The issuer's fiscal or financial strength, including its debt profile, has not materially changed. The issuer's susceptibility to event risks has not materially changed.
FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATINGS
WHAT COULD CHANGE THE RATINGS UP
Zambia's credit profile will likely remain very weak until after the debt restructuring exercise has been completed. Albeit unlikely, an expectation of smaller losses for private sector creditors than currently implied by the Ca rating as part of the debt restructuring could prompt an upward revision to the rating. Assurances from official creditors that local currency debt will be excluded from the restructuring could lead to an upgrade of the local currency rating, if Moody's is confident that a future restructuring would not affect local currency debt. Tangible evidence of the government's reforms improving governance, institutional strength, and economic and export diversity would lower future redefault risk and support the rating after the restructuring has been resolved.
WHAT COULD CHANGE THE RATINGS DOWN
Conversely, a lower rating would result from an increased likelihood that investors will face larger losses than implied by the current Ca rating as part of the current debt restructuring. A protracted restructuring period could also increase the net present value losses for bondholders below the level implied by the Ca rating. A deterioration in external conditions, such as a prolonged period of depressed copper prices, would increase the existing risk of a redefault following the debt restructuring with larger losses for bondholders, potentially resulting in a lower rating.
The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://ratings.moodys.com/api/rmc-documents/63168. Alternatively, please see the Rating Methodologies page on https://ratings.moodys.com for a copy of this methodology.
The weighting of all rating factors is described in the methodology used in this credit rating action, if applicable.
REGULATORY DISCLOSURES
For further specification of Moody's key rating assumptions and sensitivity analysis, see the sections Methodology Assumptions and Sensitivity to Assumptions in the disclosure form. Moody's Rating Symbols and Definitions can be found on https://ratings.moodys.com/rating-definitions.
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a.With Rated Entity or Related Third Party Participation: YES
b.With Access to Internal Documents: YES
c.With Access to Management: YES
For additional information, please refer to Moody's Policy for Designating and Assigning Unsolicited Credit Ratings available on its website https://ratings.moodys.com.
Regulatory disclosures contained in this press release apply to the credit rating and, if applicable, the related rating outlook or rating review.
Moody's general principles for assessing environmental, social and governance (ESG) risks in our credit analysis can be found at https://ratings.moodys.com/documents/PBC_1288235.
The Global Scale Credit Rating on this Credit Rating Announcement was issued by one of Moody's affiliates outside the EU and is endorsed by Moody's Deutschland GmbH, An der Welle 5, Frankfurt am Main 60322, Germany, in accordance with Art.4 paragraph 3 of the Regulation (EC) No 1060/2009 on Credit Rating Agencies. Further information on the EU endorsement status and on the Moody's office that issued the credit rating is available on https://ratings.moodys.com.
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John Walsh
Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
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London, E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Marie Diron
MD - Sovereign Risk
Sovereign Risk Group
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454
Releasing Office:
Moody's Investors Service Ltd.
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