When driving through Lusaka, Zambia’s capital, newly paved roads make it easy to forget that the country’s bonds are stressed. I came here in September to find out whether the new finance minister could turn—or at least arrest—the country’s dangerous debt trajectory.
I visited Zambia at the start of the year but decided to return after the appointment of a new minister of finance and amid signs of increased interaction with the International Monetary Fund (IMF). Not much had changed on the ground: the shiny new airport terminal remains unused, road works continue and the mining industry is under pressure. Rain has been scarce and extended power outages weigh on economic activity.
Yet the improved road infrastructure makes a difference. Even local market commentators who criticize the country’s accumulation of external debt admit that their daily commute is a pleasure because of the government’s infrastructure drive.
This tension between rising debt and infrastructure spending reflects the conundrum facing Zambia today—and potential investors. Can Zambia continue to press ahead with development spending and service its mounting debt? Our analysis suggests that the market-implied probability of default through the life of the three outstanding Eurobonds is well above 50%.
Externally financed infrastructure spending has been the hallmark of President Edgar Lungu, who took office in 2015. Today, the country has external debt in excess of US$11 billion—with about a third coming from Chinese loans—which represents the lion’s share of total public debt of around 80% of GDP. In Africa, only Angola’s exposure to Chinese loans is larger than that of Zambia when measured against the size of the economy. And both economies depend almost exclusively on one commodity: copper for Zambia and oil for Angola. But even though Angola has a higher level of debt at about 90% of GDP, investors are more concerned about Zambia’s ability to repay its debt for two main reasons.
First, Zambia is facing significant fiscal risks which will be sustained by the high-stakes presidential election in 2021. Second, Zambia doesn’t have financial backing from the IMF. If the country moves toward fiscal consolidation, the IMF and investors may jump in (in that order). But Zambia is running out of time.
Bwalya Ng’andu, the new finance minister, knows he needs to act—and appears to have received some leeway from the president to rebuild policy credibility. Just two months after his appointment, at the end of September, Ng’andu presented the 2020 budget and pledged to create fiscal space, ensure debt sustainability and dismantle domestic arrears. The budget deficit for 2019 seems to be broadly on target (6.5% of GDP) and the plan is to reduce the deficit to 5.5% of GDP in 2020. Despite some encouraging proposals in the budget, tax and policy uncertainty continues to undermine investor confidence.
But external debt, which is financing the government’s ambitious infrastructure drive, represents a growing share of the budget. Although the absolute economic growth dividend from these externally financed investments remains ambiguous, the deceleration in GDP growth suggests diminishing returns. And while the drought has exposed some of Zambia’s macroeconomic vulnerabilities, policy uncertainty remains the biggest challenge for economic growth, particularly for the mining sector.
There have certainly been more indications of engagement with the IMF since Ng’andu took over, but we are not convinced that it will lead to a funded program in the foreseeable future. Zambian bonds might not deteriorate meaningfully from current depressed levels. But upside price movements seem limited, as a muddle-through on the political and fiscal fronts still looks like the most likely scenario, in our view, even if the newly paved roads greet investors and visitors with a shinier veneer.
