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Rating Action:

Moody's downgrades Zambia's ratings to Ca, outlook changed to stable

03 Apr 2020

London, 03 April 2020 -- Moody's Investors Service, ("Moody's") has today downgraded the Government of Zambia's long-term issuer ratings to Ca from Caa2 and changed the outlook to stable from negative.

The downgrade to Ca reflects Moody's view that Zambia's capacity to service its debt has further weakened over the past year as weak governance has prevented rapid and decisive policy actions, leading to a substantial deterioration of fiscal metrics. In addition, external and liquidity pressures are rising rapidly amid exceptionally challenging global conditions, also increasing the probability of default. In Moody's view, a restructuring of Zambia's government debt that constitutes a default under Moody's definition has become increasingly likely in order to address debt sustainability issues. Should a default occur, the losses expected to be experienced by investors will likely be larger than Moody's previously estimated.

The coronavirus and oil price shock are creating severe and extensive credit shocks across many sectors, regions and markets. The combined credit effects of these developments are unprecedented and expose sovereigns' vulnerabilities through several channels, including lower economic growth, fiscal costs to contain the virus, greater exposure to shifts in investor sentiment and institutional weaknesses. Most sovereigns are relatively less exposed than other sectors to the crisis, provided the crisis remains short-lived and growth resumes in the second half of 2020. However, the weaknesses in Zambia's credit profile have left it extremely vulnerable to acute risk aversion and to a prolonged period of low commodity prices related to the global economic impact of the coronavirus.

While under these challenging conditions a debt restructuring exercise has become highly likely, the stable outlook reflects potential contrasted outcomes for private sector creditors. A reprofiling of some non-commercial debt could limit losses for private bondholders. Conversely, without a reprofiling of some of the government's non-commercial debt, the losses for private sector investors in case of a default could be larger than implied by a Ca rating.

Concurrently, Moody's has lowered Zambia's long-term foreign-currency bond ceiling to Caa3 from B3, its long-term foreign-currency deposit ceiling to Ca from Caa3, and its long-term local-currency bond and deposit ceilings to Caa1 from B2.

RATINGS RATIONALE

RATIONALE FOR THE DOWNGRADE TO Ca

DEBT RESTRUCTURING INCREASINGLY LIKELY AMID DETERIORATING FISCAL METRICS AND INCREASING LIQUIDITY AND EXTERNAL RISKS

The further deterioration in Zambia's fiscal, liquidity and external metrics, from very weak levels, as weak governance impedes decisive policy action points to an increasingly likely debt restructuring. Moody's estimates the fiscal deficit on a cash basis at 8.2% of GDP in 2019 which was higher than the budget target of 6.5% and than Moody's previous expectations. While total revenue (including grants) overperformed the budget target, the fiscal slippage was largely driven by pressures on the expenditure side due to higher interest payments and significantly higher than planned capital spending and outlays on the Farmer Input Support Program. The stock of arrears excluding VAT refunds also increased during the year, to an estimated 6.6% of GDP as of December 2019 from about 5.5% of GDP at end-2018. Debt affordability continued to weaken, with interest payments absorbing almost 30% of government revenue in 2019 from 24.3% in 2018. The track record of fiscal slippage and arrears accumulation underscores Zambia's weak government effectiveness that has translated in the absence of rapid and decisive policy responses to reestablish debt sustainability.

Government debt has continued to increase to very high levels, also beyond previous expectations, due to persistently large fiscal deficits and exchange rate depreciation. Total general government debt (including guarantees and arrears) is now estimated at around 90% of GDP in 2019, up from 76.5% in 2018.

GDP growth was very weak last year and Moody's projects a 1% contraction in 2020, as a gradual improvement in agriculture will be more than offset by continuing challenges in the electricity sector and the decline of the mining sector. The balance of risks to the growth outlook is tilted to the downside given the difficult prospects for the mining sector, also reflecting the risk for the copper sector related to a prolonged fall in demand as a result of the pandemic.

In this environment, Moody's projects the fiscal deficit to remain above 7.5% of GDP in 2020 exceeding the budget target of 5.5% of GDP as revenue underperforms given the challenging economic conditions and spending pressures persist in particular from interest payments due to the very high and rising cost of debt and exchange rate depreciation, resulting in an additional fiscal slippage. As a result, the government's debt burden will rise yet further, approaching 100% of GDP in 2020, with the debt trajectory remaining particularly vulnerable to a growth shock and further pressure on the exchange rate, especially in the absence of credible policies to rebuild the foreign exchange reserves buffer.

While foreign exchange reserves have stabilized in the second half of 2019, supported by net purchases of foreign exchange by the Central Bank, and continued payments of mineral royalties in US dollars, external vulnerability risk and liquidity challenges are increasing amid the currently financial market turmoil. Pressure on the exchange rate has recently resumed, with the kwacha depreciating by more than 20% since the start of the year.

As of January 2020, foreign exchange reserves (excluding gold and IMF SDR holdings) stood at $1.1 billion (equivalent to 1.7 months of imports), remained well below adequate levels to cover imports and external debt service. Moody's expects the current account to move into deficit in 2020 on the back of lower copper exports and despite lower oil prices. Foreign exchange reserves are projected to continue to decline, impairing the government's ability to service its external debt obligations and further weakening the country's external position.

The liquidity conditions are extremely challenging. Domestic yields have remained very high, reflecting weak demand for domestic securities, with auctions regularly undersubscribed. The limited absorption capacity of the banking system due to its relatively small size compared to the government's financing needs and already high exposure to government securities, amplifies the risk. Meanwhile, Eurobond yields have spiked to extraordinarily high levels, signaling Zambia's debt distress. In addition, the gradual withdrawal of foreign investors from the domestic markets has continued over the past year. In this context, recent overdue debt payments to some Multilateral Development Banks, some of which have since been addressed, illustrate Zambia's liquidity constraints and the challenges in meeting obligations, especially denominated in foreign currency. Large Eurobond maturities fall due from 2022 onward, with no clear strategy to address the repayment. In recent years, the government has consistently indicated its intention to implement a market-based liability management exercise to improve the external debt profile. While the outcome of this exercise is highly uncertain, Moody's expects that it could involve significant losses for private creditors. In particular, a liability management exercise that would be considered a distressed exchange by Moody's would represent a default.

RATIONALE FOR THE STABLE OUTLOOK

While a debt restructuring exercise has become highly likely, the stable outlook reflects potential contrasted outcomes for private sector creditors. A reprofiling of some of non-commercial debt could limit losses for private bondholders. Conversely, without a reprofiling of some of the government's non-commercial debt, the losses for private sector investors in case of a default could be larger than implied by a Ca rating.

ENVIRONMENTAL, SOCIAL, GOVERNANCE CONSIDERATIONS

Environmental considerations are material to Zambia's rating and weigh on its economic strength as weather conditions significantly impact agricultural sector and electricity generation, given the country's high reliance on hydropower.

Social considerations inform our assessment of Zambia's credit profile, given very low wealth levels, with a low GDP per capita in our sovereign rated universe, high levels of poverty and inequality. The UN's Human Development Index 2019 ranking is also relatively low, while high unemployment rate, especially among the youth, remains a key challenge, exacerbating the risk of social discontent.

Governance considerations are material to Zambia's rating. They are a driver of today's rating actions and have driven previous rating actions. Zambia faces significant 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.

FACTORS THAT COULD LEAD TO AN UPGRADE OR DOWNGRADE OF THE RATING

WHAT COULD CHANGE THE RATING UP

Zambia's credit fundamentals will likely remain very weak for the foreseeable future. Smaller losses for private sector creditors than currently implied by the Ca rating as part of a debt restructuring could lead to a higher rating.

WHAT COULD CHANGE THE RATING 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 a debt restructuring that would be considered a default under Moody's definition.

GDP per capita (PPP basis, US$): 4,118 (2018 Actual) (also known as Per Capita Income)

Real GDP growth (% change): 4% (2018 Actual) (also known as GDP Growth)

Inflation Rate (CPI, % change Dec/Dec): 7.9% (2018 Actual)

Gen. Gov. Financial Balance/GDP: -7.5% (2018 Actual) (also known as Fiscal Balance)

Current Account Balance/GDP: -1.3% (2018 Actual) (also known as External Balance)

External debt/GDP: [not available]

Economic resiliency: b3

Default history: No default events (on bonds or loans) have been recorded since 1983.

On 31 March 2020, a rating committee was called to discuss the rating of the Zambia, Government of. The main points raised during the discussion were: The issuer's institutions and governance strength, have materially decreased. The issuer's fiscal or financial strength, including its debt profile, has materially decreased. The issuer has become increasingly susceptible to event risks. Other views raised included: The issuer's economic fundamentals, including its economic strength, have not materially changed.

The principal methodology used in these ratings was Sovereign Ratings Methodology published in November 2019 and available at https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1158631. Alternatively, please see the Rating Methodologies page on www.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 at: https://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_79004.

For ratings issued on a program, series, category/class of debt or security this announcement provides certain regulatory disclosures in relation to each rating of a subsequently issued bond or note of the same series, category/class of debt, security or pursuant to a program for which the ratings are derived exclusively from existing ratings in accordance with Moody's rating practices. For ratings issued on a support provider, this announcement provides certain regulatory disclosures in relation to the credit rating action on the support provider and in relation to each particular credit rating action for securities that derive their credit ratings from the support provider's credit rating. For provisional ratings, this announcement provides certain regulatory disclosures in relation to the provisional rating assigned, and in relation to a definitive rating that may be assigned subsequent to the final issuance of the debt, in each case where the transaction structure and terms have not changed prior to the assignment of the definitive rating in a manner that would have affected the rating. For further information please see the ratings tab on the issuer/entity page for the respective issuer on www.moodys.com.

The ratings have been disclosed to the rated entity or its designated agent(s) and issued with no amendment resulting from that disclosure.

For any affected securities or rated entities receiving direct credit support from the primary entity(ies) of this credit rating action, and whose ratings may change as a result of this credit rating action, the associated regulatory disclosures will be those of the guarantor entity. Exceptions to this approach exist for the following disclosures, if applicable to jurisdiction: Ancillary Services, Disclosure to rated entity, Disclosure from rated entity.

These ratings are unsolicited.

a. With Rated Entity or Related Third Party Participation:YES

b. With Access to Internal Documents:YES

c. With Access to Management:YES

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://www.moodys.com/researchdocumentcontentpage.aspx?docid=PBC_1133569.

At least one ESG consideration was material to the credit rating outcome announced and described above.

Please see www.moodys.com for any updates on changes to the lead rating analyst and to the Moody's legal entity that has issued the rating.

Please see the ratings tab on the issuer/entity page on www.moodys.com for additional regulatory disclosures for each credit rating.

Daniela Re Fraschini
Asst Vice President - Analyst
Sovereign Risk Group
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
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: 852 3758 1350
Client Service: 852 3551 3077

Releasing Office:
Moody's Investors Service Ltd.
One Canada Square
Canary Wharf
London E14 5FA
United Kingdom
JOURNALISTS: 44 20 7772 5456
Client Service: 44 20 7772 5454

No Related Data.
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