Africa’s second largest copper producer Zambia, is celebrating a key mile stone attained after the International Monetary Fund (IMF) Staff Mission team announced that consensus with the MinFin over an Extended Credit Facility (ECF) for $1.4billion had been reached. This was contained in a note dated December 03 on the lenders website. This will be 22 months after the Zambian authorities formally requested for a funded program after economic conditions started to deteriorate faster arguably. This outcome is also happening on a new leadership clock, dubbed the new dawn with Hakainde Hichilema at the helm, though the request for a fully funded program was made in the former political regime led by Edgar Lungu. By March of this year, a macroeconomic framework had been agreed but could not be implemented before parliament dissolution in May which some schools of thought believe some of the areas agreed would have eroded a political populist view of the current government whose implementation they opted to defer especially that the polls where on the horizon. These concerned subsidy adjustments in the power and petroleum sectors.
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However Zambia’s leadership change did give a positive political cue that has seen stronger will from a new regime that then improved sentiment resulting in greater confident in the copper producer by the Washington based lender the IMF leading to the staff mission teams position on Zambia.
Zambia is currently in the labyrinth of a debt restructure following multiple defaults on its coupon payments on its outstanding dollar debt stock of $3 billion maturing in 2022 ($750 million), 2024 ($1 billion) and 2027 ($1.25 billion) respectively. The copper producer was the first and only nation to default in an acute pandemic era 2020 which saw epidemiological risks exacerbate fiscal vulnerabilities. The copper producer also grappled with currency depreciation pressures and feeble reserves (<$3 billion), a weak import cover position. With increased dollar demand for debt service purposes the major driver of foreign currency at the time, various interventions such as dollarization of mining taxes were implemented to address the demand side. This nonetheless created supply concerns for the foreign exchange market that decreased over 55% (of conversion activity) leading to rapid depreciation which thereof transmitted higher costs momentum for inputs and generally retail prices manifesting in inflation currently in the double digits with the highest levels flirting within the 23’s in percentage terms. Inflation has nonetheless started to ebb though upside risks remain eminent from global supply chain autopsies such as soaring food prices and above all logistics inflationary pressure.
DEBUT DEFAULT LEADERS IN PANDEMIC ERA
Default ratings by the international agencies Standards and Poor’s/Fitch/Moody’s narrowed the red metal producers credit lines with the widest Credit Default Swap (CDS) levels seen in history of between 2,500 – 6,000 basis points (bps) on its dollar debt signaling shriveled sentiment. Zambia’s MinFin opted to seal debt accumulation, which scaled to $12.97 billion (external) pushing the Debt to Gross Domestic Product (GDP) ratio to above 115%. Realization of this led to restricting borrowing to the domestic market but overcrowded it to a large extent leading to a steeper yield curve with 1 year treasury bills priced as high as 25.75% while the 5 year tenor peaked 33.5%. However post August, the Kwacha demand curve has aggressively flattened with yields climbing down an average of 825bps on the long end and between 500 – 1,250bps on the short end spelling the genesis of the ‘margin squeeze’ era.
US Fed Chair Jerome Powell. With record high inflation the Fed is looking to taper money market to curb the consumer price index.
US FEDS POWEL WILL DETERMINE HOW LONG YIELDS CONTINUE EBBING
Evidently the steam with which yields are climbing down is phasing but worth mentioning is that the extent to which or the latitude with which the Kwacha yield curve has to further compress is highly dependent on global inflation versus current ultra thin treasury yields in the west and the effectiveness of US Federal Reserve tapering to curate the anomaly in international markets. As long as inflation persists, global liquidity will seek to find a home in Emerging and Frontier Market (EMF) assets for which Zambia’s subsiding political risk posture and positive sentient keeps making its government securities attractive to offshores.
Copper smelting in the red metal producer on the Copperbelt of Africa.
A COCKTAIL OF RISKS LINKED TO SOVEREIGN POSTURE THAT WEIGHED THE RED METAL PRODUCER
Risk appetite has somewhat eluded the Zambian market for a long time with most commercial banks reflecting default rating in their credit models evidenced by not only the provisioning implications according to International Financial Reporting Standard – IFRS9 for holding highly risk weighted sovereign assets but in general cautious extension of balance sheet in the hedge to manage concentration, and hedging against transfer and convertibility (T&C) risk concerns. (These link to foreign exchange liquidity and above all sovereign posture). Fiscal fragilities have impacted the SME sector that has been owed sums in ballooning arrears now in excess of K46 billion depriving the ecosystem of the requisite liquidity to grow. Other sectors such as mining were marred by political risk pressures such as the takeover of Vedanta’s Konkola Copper Mine which saw a business restructure into a smelting and mineral resource business all on an arbitration clock while Statutory Instruments such as No.57 on common carrier paradox were clearly adverse to development of the energy sector growth. This matter is still in court for which an injunction was granted in favor of Copperbelt Energy Corporation (CEC Plc) that had to raise provisions to the tune of $95 million for political and policy related risks. For over 46 months Zambia’s manufacturing pulse was in the doldrums (<50 as measured by Markit Economics Purchasing Managers Index – PMI) reflecting currency woes, feeble demand and acute pandemic effects). The Southern African nation has however levitated to expansionary territory supported by a post election bond rally effect on the exchange rate transmitting lower costs to importers on a relative basis. Growth is forecast to be more bullish inferring from an 8.1% expansion for 2Q21 from 0.7% in 1Q21.
WHAT THE IMF STAFF MISSION TEAM AGREEMENT WITH ZAMBIA MEANS FOR RISK APPETITE
It was clear at inception that creditors would require more assurance than just words to restore fiscal fitness and guarantee obligation absorption but that IMF bailout would provide greater comfort at such a time. Suffice to say an IMF package is a precursor to debt restructure which the authorities have earmarked for completion by end of 1Q22. Zambia has for years suffered sever lack of flows in the veins of the economy due to vagueness around policy and prudent fiscal will. Markets did however already start to price in a package especially when the Republican Head Hakainde Hichilema courted multilateral chiefs namely Kristalina Georgeiva and David Malpas of the IMF and World Bank respectively in Washington on the sidelines of the United Nations General Assembly New York sessions. Never has this happened in the history of Zambia that a sitting head of state deliberately courted a multilateral chief, but this sent the strongest signal around political will, accountability and appreciation of foreign policy as a tool for effective economic diplomacy.
Zambia’s delegation led by President Hakainde Hichilema meets the IMF delegation led by Kristalina Georgieva the Managing Director.
Other exceptional developments adding to credibility of the process include the head of state courting dollar bond creditors in London in November on the sidelines of the COP26 climate session.
READ ALSO: Zambia’s Chief Investment Officer, Hichilema Courts Dollar Bond Holders in London
Attainment of the key milestone with the IMF Staff Mission team signals the biggest hurdle the copper producer faced and the next stage is to present the findings before a board for approval after which the extended credit facility line will be granted for draw down. The agreement is for $1.4 billion which various schools of thought question if it will be enough to solve Zambia’s hurdles. Balance of payment support must be viewed from a positive externality standpoint because the flood of flows Zambia will get by the IMF’s vote of confidence, will be the biggest drivers of economic activity to spur growth. These will will by far exceed the size of the ECF and that sets the pros of getting onto an IMF package. Other policy changes to be expected linked to the agreement could border on the stance on subsidies in the energy sector covering electricity and petroleum products. The mines got a fair share of pronouncements in the 2022 budget after Dr. Musokotwane announced that mineral royalties are now tax deductible. This sets the tone for exploration propensity to back the 3 million metric ton production target in the next 5-10 years. Other tax incentives vividly signal the private sector skew to driving growth in Zambia going forward.
Power transmission lines on the Copperbelt in Nkana East. Zambia awaits results of an EMRC cost of service study to complete long overdue reforms in the sector.
The biggest outcome of the IMF agreement is that it signals positivity around an accelerated debt restructure process which will also if successful signal credit rating adjustments upwards for the sovereign to provide an opportunity for international credit lines for Zambia to open once again. Banks whose risk appetite was constrained by sovereign posture could start to ready for greater latitude in 2022 thereafter.
With copper reverberating on either side of $9,500/MT as a bell wether for global pulse supported by a very strong global decarbonization push Zambia’s recovery prospects remain bullish.
The Kwacha Arbitrageur