Africa’s second largest copper producer Zambia is on the verge of a successful Eurobond restructure after its authorities reached a landmark consensus concerning its $3 billion worth of outstanding dollar bonds. Zambia’s finance ministry reported in a note that the three outstanding bonds will be reorganized into two fixed income assets of size $2 billion and $1.135 billion maturing 2035 and 2053 respectively.
This development does brighten the Southern African nations prospects through shifting its production possibility frontier in addition to plethora of positives. Hamstrung by debt distress over the years, accumulated by international capital market fixed income issuances purportedly meant for infrastructure development which arguably has not generated cashflow cover to meet obligations. The land linked nation has grappled with fiscal vulnerabilities which its nation’s seventh head of state Hakainde Hichilema seeks to address in his economic policy. Under his clock, economic policy diplomacy and ‘face on’ stakeholder engagement with creditors and multilateral chiefs has earned the nation an array of dividends key of which has been the surge of confidence that has allowed Zambia to reclaim its position in the champions league as he told the European Union in a key address.
Zambia’s dollar debt proposal will be subjected to a vote in the third week of November which if nodded by bondholders could see the reissuance of two assets under a base case ‘economic’ scenario. The restructure mechanics are very similar to the bilateral deal especially in area of the economic performance as a driver for how long it could take to repay the obligations. Favorable bond pricing in the proposal is tied to Zambia being on a program.
The coupons at which debt is to be reissued are very close to the initial issuances (5.75% vs 5.25% when the celebrated $750 million was issued) and will hold at these levels for as long as Zambia is on an IMF deal, an indirect guarantee that then makes it critical for adherence to fiscal restoration commitments. The coupons do have an element of concession in them.
The clinched deal spells a list of upside and downsides for Zambia. The are explained in detail below.
GREATER ECONOMIC POSSIBILITIES
The proposed deal will offer $2.5 billion in debt repayment deferment that will allow the Zambian authorities to re-route funds to accelerate production possibilities. The reprieve will offer budget support for a stronger growth agenda to support its medium term expenditure framework. Zambia has a 5% growth target to 2026 outlined in its fiscal road map presented by its finance minister Situmbeko Musokotwane.
LIKELY CREDIT RATING UPGRADE
The copper producers dollar bonds are currently graded ‘RD’ & ‘SD’ with Standards & Poor’s and Fitch on its foreign currency long term issuer rating. Restructure will reclassify levitate these assets from default status to junk as fundamentals dictate their onward trajectory. The current international ratings posture has been the biggest driver of high premiums driving higher pricing costs making foreign capital sourcing pricey. Further, international commercial banks has borne the brunt of ratings on the back of higher transfer and convertibility risk. The default cost the red metal producer its place on the JP Morgan bond index chart and above all shut capital access lines for the sovereign a move that pushed the authorities to rely more on the domestic money markets for funding explaining why these local cash markets are overcrowded. Much as a rating upgrade is on the verge, it may take years to reclaim the ‘B+’ rating. Support from the Washington based lender the International Monetary Fund through the extended credit facility does allow for bondholders to charge a favorable coupon of 5.75% on the $2 billion (2035) to 2031 and raising it to 8% to maturity. As for the $1.135 billion, amortization of 3 equal installments paid in 2051, 2052 and 2053 with 0.5% coupon in the economic base case scenario which on the upside (should economic conditions improve faster) could see acceleration of maturity to 2035 with amortization from 2032 onwards. This step up bond is the first ever in sovereign restructures.
A STANDARD FOR DEBT DISTRESSED NATIONS
The agreement in principle sets a standard for other distressed nations under the G20 Common framework. Being the first African nation defaulter in pandemic times Zambia will be the first nation to set the bailout benchmark for the distressed. This is one hand believed to be a testament of resilient political leadership, correct use of economic policy diplomacy and prudent use of fiscal resources which has persuaded creditors that they will have their dues settled. Above all the new face of the IMF and World Bank has been another important enabler the of copper producers successful strides.
FAIRLY PRICED CAPITAL ON THE VERGE
Cost of capital has been a persistent inhibitor of sustainable growth across the continent. Interest rates have remained fairly high because of elevated yield curves whose shape continues to depict fiscal posture and government borrowing. Zambia’s agreement in principle spells greater fortunes that are likely making it an investment destination that could see offshore seek to lock in liquidity at the current high yields that are on the verge of falling. The last two auctions have seen yields collapse marginally whose pace is forecast to accelerate in the next local debt sales as sovereign risk subsides steadily.
KWACHA COULD SEE MORE PRESSURE IN INTERIM
Successful restructure will entail coupon payment cycle commencement as early as late November to early December which could add on to already existing currency pressure. The copper currency has been on a losing streak with constrained supply not fully matching the demand side. A check in the Lusaka the capital revealed that the kwacha was on the backfoot trading north of 21.8, just below the 22 psychological barrier.
Commenting on the matter, Onyambu Dean Executive Head at Global Opportunik Fund said in a weekly note that the agreement, in principle, with Bondholders signals a step in the right direction. However, the foreign exchange market’s underwhelming response starkly contrasts the positive reaction to the nation’s dollar bond prices. Interestingly, the currency market has shrugged off this development, highlighting the lingering uncertainties and potential roadblocks that still lie ahead.
This skepticism arises because of the intricacies of the debt restructuring negotiations. While there is an agreement in principle, a crucial concern looms in the background as to the possibility that bilateral creditors may oppose one of the key terms agreed upon with commercial creditors, as it questions one of the International Monetary Fund’s (IMF) critical principles of comparability of treatment, a paramount concern underpinning the debt treatment process. This divergence in interests could protract negotiations and, in turn, cast a bearish shadow over the Kwacha’s immediate prospects.
Onyambu highlights furthermore that even if bilateral creditors find the terms agreeable, the government faces the obligation to make early amortization payments totaling $500 million, scheduled to begin as soon as December 2023. This substantial financial commitment is poised to draw down on the already precarious foreign exchange reserves, which currently stand at a meagre $2.8 billion or 3.0 months of import cover, as of July 2023.
First National Bank Zambia Economist Chileshe Moono said the agreement is timely and sets Zambia in good stead to finally complete the protracted external debt restructure program. It is worth noting that even though the agreement only covers a portion of Eurobond holders, the 1.5% consent fee will be attractive for the remainder of the bondholders to participate in the debt exchange. The reduction in coupon, upfront haircut on claims, and the extension in maturity profile appear to be consistent with the Comparability of Treatment (CoT) principle of the G-20 common framework.
Moono said the market can now expect an agreement with the non-dollar bond creditors before the end of this year. Market reaction has been positive in the fixed income space as evidenced by the 70 bps average drop in yields across the curve. However the Kwacha has not responded to the positive change in risk posture as domestic demand and supply conditions remain skewed towards a weaker Kwacha. The current trend could see the currency test its historical peak of 22.60 in July 2022. The agreement with Eurobond holders will add an additional US$500 million to the foreign exchange demand pipeline over the next 24 months.
The market awaits the results of the ongoing IMF review (second review of the year) which could unlock another c.US$188 million funding under the extended credit facility. This funding, coupled with the improvement in sentiment, could moderate the current pressure on the Kwacha, he said.
Overall Zambia’s restructure sprint is said to have more upsides than downsides and will accord the copper producer levitate from a frail fiscal position to resilient growth. This is contingent on the actualization of the business agreements inked in the year with private players across the world that will seek to unlock commercial potential. Musokotwane will now seek to win over parliamentarians for the full execution of the K177.8 billion budget themed unlocking economic potential.
The red metal producer currently faces rising price pressures headlining 12.6% for October in the wake of cost push effects from currency pressure and rising crude prices which could trigger another rate hike in the central banks rate decision meeting this November. Zambia anticipates El Niño induced drought and power generation hurdles as key headwinds this year into next year.
The Kwacha Arbitrageur