Africa’s second largest copper producer Zambia currently grapples with a rising debt and energy crisis that has caused deterioration in its credit posture. All top three rating agencies have lowered their assessments for the copper producer to CCC+/CCC/Caa2 (S&P/Fitch/Moody’s) citing balance sheet vulnerabilities and risks to growth. These risks continue to heighten as drought effects thicken causing an inflation spiral that pushed August CPI to a 3-year high of 9.3%. Power rationing hours have since doubled to (8) adversely impacting manufacturing pulse as the copper producer slides deeper into contraction as Purchasing Managers Index (PMI) readings headline below 50 for 10 straight months. Lack of liquidity and an elevated cost environment have been persistent drivers of anemic growth in the manufacturing sector.
Ballooning debt has been a consequence of an infrastructure boom given the deficit Zambia has. Infact the infrastructure deficit is actually continental whose gap most African nations have been relentlessly trying to plug. Economists blame politics and or political decisions as the key cause for rising debt. This debt is not only infrastructure driven but is a consequence of some borrowings whose proceeds cannot be vividly traced to self sustaining projects. The argument has been that borrowing should be for capital expenditure that generates proceeds of a self liquidating nature. That way there would be no burden of repayment. Most dollar debt issuance proceeds have been questioned for corresponding projects financed because no returns seem to be covering debt burden obligations. This is the source of pain in the fiscals whose autopsy effects can be seen in the money and foreign exchange markets today.
Political spillages can not be mopped using monetary policy tools
At the annual Jackson Hole meeting of global central bankers, US Federal Reserve Chair Jerome Powell and the Bank of England Governor Mark Carney told the meeting that the world currently suffers from heightened political risks which has fueled a misconception that political risk effects on the markets and macroeconomy can be fixed by monetary policy tools.
This follows Donald Trumps attacks on Powell following his stance on the US economy. Trump has rattled the market mood with spontaneous rhetorics that have escalated a trade impasse that has thrown the whole world into uncertainty. He has attempted to clean up this mess through influencing US Federal Reserve FOMC to swing the interest rate pendulum in his favor.
In Africa the expectations aren’t any different just as in Zambia expansionary fiscal policy has led to the dislocation between monetary and fiscal policy. It is evident that monetary policy has bottomed despite calls for stimulus which analysts believe should now come from the fiscal side through potential tax cuts for specific sectors if the authorities are thinking long term. It is easier for a camel to pass through the eye of a needle than to attempt to use monetary policy tools to cure political malaise.
Power deficits and falling currency reserves
Zambia’s foreign exchange reserves have plummeted to record levels of less than 1.6 months Import cover at $1.4billion (deviating from the targeted 3 months), so has energy generation ebbed lower due to low dam levels at the Kariba costing the nation (8) hours of rolling black outs daily. The central bank and the power utility firm are major off-takers of foreign currency and power (from IPPs) respectively. The power utilities capacity is inadequate to absorb the rising demand hence the need to supplement excess industry appetite through independent power purchase agreements such as from Naval Bharat owned Maamba thermal and Lunsemfwa hydro power plants etc. The central bank on the other hand has found itself in competition for dollars with commercial banks as it targets to shore up falling foreign currency reserves and readies dollar stock buffer to meet external debt obligations. The August MPC communique revealed that the central bank was in the market for dollars to fund crude imports.
Pricing underwater across the board
Pricing for both underlyings has been either non reflective of current fundamentals or underwater causing asset valuation concerns. Ideally the power utility has arguably charged tariffs not reflective of the cost structure of the entity. In steering the utility to cost reflectivity, the first cost of service study commissioned was discontinued with the Energy Regulation Board (ERB) recently commissioning a second study. All this occurs in an environment were energy reforms have been delayed. There is need for reforms to be expedited if the requisite efficiency is to be achieved in the sector. It is vivid that there exists dysfunction in the tariff structure given that the power utility does not have a sufficient resource pool to either import power or plug the deficit it persistently runs. In retrospect there has been lack of investment in power generation over the years. Never in the history of Africa has investment in renewable sources such as solar spiraled to records.
On the monetary side, a similar observation is made, though the only difference is attributed to the cost of political decisions that many believe can be cured by central bank policy. This misconception must be over come. If it were entirely up to the bank of zambia to fix the autopsy effects of political decisions, monetary policy would have by now tightened sharply at the cost of private sector pulse that would be choked with stunted growth. Two point six (2.6%) is the quantum by which Zambia expanded in 1Q:19 compared to 2.7% a year ago. The economy is expected to grow 2%-2.2% in 2019 (IMF/World Bank estimates). Treasury bill and bond yields are elevated to records with 1 year paying 27.5% while the 5 year is pegged at 32% in an inflation rising environment. The true reflection of sovereign risk would be evidenced by the cheeky bids that the central banks continues to see at the fortnight auctions which the secondary market price discovery mechanism can attest to. Bonds continue to trade at spreads above the current primary curve by at-least 300 basis points. Traders have seen appetite for 2 year paper at between 33%-35% in the secondary market. Both ZESCO and BOZ are not pricing reflective rates given the economic landscape. If the real sovereign risks were priced into the currency and interest rate curves, asset valuation would deteriorate. The cost burden on consumers for energy would be so stressful worsening consumers livelihoods through elevated cost of living.
*About being the largest off-taker..*
With a decline in reserves, the central bank is one of the largest players for dollars and this overcrowding effect is affecting the foreign currency markets. Suffice to say dollars offloaded onto the market by the mines are sanguinely absorbed by central bank in its quest to shore falling import cover. This partly explains why the kwacha has recently been under pressure. Counter efforts to manage the falling foreign currency ammunition by paying mineral royalty taxes directly to the central bank in dollars has still been negated by the insatiable dollar demand to fund suspect sectors such as energy and this time agriculture given the fertilizer input season is open. The power utility on the other hand being the largest off-taker of independent power generated will surely have the task of ensuring that it pays the IPPs or risk being cut off. We speak about these credit risks because ZESCO owes EDM of Mozambique around $50million for the energy imports of 2015/2016 period.
It is about a dry point of construction that the energy crisis looming over Africa’s copper hotspot reveals very similar effects of the fiscal posture effects on market variables such as foreign exchange reserves or import cover. There is urgent need to radically act to aid realignment.
The writer whose identity has been withheld is an Economics and Finance Expert.