Investors Eye Zambian Reforms as Lungu Faces Crucial Test
Bonds & Loans
Published: 5 May 2017 03:32
Rising tensions between the Zambian government, led by President Edgar Lungu, and opposition leader Hakainde Hichilema, have done little to deter investors who are closely watching the country as it looks to clinch a critical IMF funding programme. They should not be so quick to dismiss the recent escalation that led to Hichilema's arrest and its implications for governance in the Sub-Saharan African country.
Tensions between the government and HH’s United Party for National Development (UPND) have run high since the August last year, when Lungu narrowly beat the opposition leader in a closely contested presidential race – the results of which HH has refused to recognise.
HH’s concerns about the election largely echoed observations by independent election monitors: Lungu’s Patriotic Front (PF) party used state resources to support its cause, drown out alternative media outlets, and antagonise the opposition campaign, alongside broader concerns about vote tampering (Lungu won by a margin of about 16,000 votes). The result was challenges in the country’s Constitutional Court, but the case was not heard after it was first postponed and then eclipsed the allowed period for the Court’s consideration.
HH, along with UPND Vice President and former Defence Minister Geoffrey Mwamba, was also arrested in October last year for unlawful assembly; the two were accused of blocking roads as they greeted party supporters.
Things took a turn for the worse in April when HH along with five other UPND employees were arrested on suspicion of treason for allegedly obstructing Lungu’s motorcade en route to a ceremony in the Western Province. HH, whose property was raided by police in early April, is currently being held by authorities on charges of attempting to overthrow the government. At their maximum, a charge of treason carries the death penalty.
“One of the most interesting things about this is how little the markets moved in response to the growing tensions,” said Joe Delvaux, a senior fund manager at Duet Asset Management, which invests in local and hard currency in Africa. “Spreads on Zambian local currency debt widened by about 50 basis points at the top end, but quickly recovered – which is surprising both because of how illiquid this market is, and the size of the swing relative to typical shifts seen on this and comparable Sub-Saharan African credits.”
To put this in perspective, local currency credits in Ghana – which most investors see as a comparable credit given the relative size of the market and common dislocations on the fiscal front – regularly see spreads shift by 25-35bp in intra-day trading. In that sense, 50bp means investors barely flinched following HH’s arrest – which has some observers worried.
“I am actually quite surprised by the extent to which this hasn’t fazed the markets. Growth prospects and fundamentals aside, this kind of antagonization has the potential to galvanise the opposition and cause political unrest, particularly given the scale of opposition support in Zambia,” explained Edwin Chui, an investment analyst and Dyer & Blair Investment Bank.
Fiscal Reforms are Needed
The recent inflection point in the spat between HH and Lungu could not have come at a worse time for Zambia, which is currently looking to clinch a critical IMF funding programme in the range of US$1-1.5bn alongside further concessional funding linked to the programme, which is needed to help get the country’s finances out of the dumps.
Beyond subdued growth, economists tend to point to three troubling trends that have shown few signs of easing. First, the country’s twin deficit is worsening. The current account balance is forecast to run at about -2.6% of GDP, while the fiscal balance is pegged to reach around -8.5% of GDP. The country’s current account balance may improve as the price of copper, which accounts for 5% of its GDP, rises, but it is hard to tell just how fast the commodity will appreciate; prices have stagnated over the past six months.
Second, the country’s stock of debt has increased significantly over the past four years, and ever more as yield-hungry investors ploughed into the local currency market in search of high double-digit returns over the past year and a half. Aggregate government debt stood at 55% of GDP at the end of December, and foreign portfolio investors own about a quarter of the country’s credit stock – just over US$6.7bn, raising further concerns about hot money.
At the same time, interest expenditures have more than trebled since 2013, and could reach up to 21% of fiscal revenue by the end of the year according to a recent report from Standard & Poor’s.
“The country’s debt level has more than doubled in the last four years, and continuing at that pace is clearly unsustainable. There is a clear need to rein in borrowing requirements and address the rapid pace at which debt is accumulating vis-à-vis revenues,” explained Yvette Babb, a Sub-Saharan Africa economist within the EMEA EM Research team at JP Morgan.
Third, the country’s borrowing costs have soared since 2012 – when it started ramping up its international borrowing activities. The country issued a US$750mn Eurobond in 2012, followed by a US$1bn issue in 2014 and another US$1.25bn in 2015, with maturities falling in 2022, 2024, and 2025. Late last year, it was cautioned by the IMF against refinancing its existing maturities in part due to the high cost of funding.
“On the hard currency side, spreads are still below their 2016 peaks but much higher than they were in 2014 when the sovereign started issuing more frequently. The weighted average cost of domestic debt is still in the high teens – between 17-19%, so the average cost of debt is fairly elevated.”
Zambia is looking to restore GDP growth, which currently stands at 3%, to the 6-7% levels it is wants to achieve in a bid to help further reduce poverty in the country and reverse a slump that has been exacerbated by the low price of copper, Zambia’s chief export, and more recently, severe drought – which has caused hydroelectricity power prices to skyrocket, weighing on domestic production.
The IMF programme, in the works since late last year, is crucial to relieving some of Zambia’s fiscal constraints. Sources who spoke with Bonds & Loans on the condition of anonymity suggest progress on the programme was held up by due to the ambivalence of a number of high-ranking officials and cabinet ministers, some of which were concerned that an IMF programme could be seen by citizens as something that is being imposed on the country.
“The region has a legacy with large multilateral agencies imposing stringent and often difficult terms on certain countries in the region, which are still feeling the pain today. [Politicians and Ministers] were concerned about how this would be perceived by the man on the street,” one source said.
In a bid to pre-emptively overcome any perception of foreign imposition, Minister of Finance Felix Mutati launched the “Zambia Plus” economic recovery programme in October last year, which includes a series of reforms and strategic initiatives marketed as ‘home grown’ and largely designed as a crucial stepping stone for an IMF programme.
These include the removal of fuel subsidies; reduction of the farming input subsidy programme and diversifying the types of crops that qualify, as well as reducing the number of recipients and migrating from a direct procurement to voucher-based farming system; moving towards cost recovery tariffs in the electricity market; creating a debt management office; implementing spending controls; reforming the public sector wage bill; and, implementing a single treasury account.
But, with the exception of the fuel subsidies reforms, which were implemented late last year, the government has made painfully little progress on most of the initiatives outlined in its plans – which, in addition to higher-than-anticipated spending, has irked the IMF.
“In the first two months of the year, expenditures outpaced revenues substantially, with the deficit financed mostly by domestic borrowing,” explained Tsidi Tsikata, who led the IMF consultation with Zambia in March this year. “Further engagement is needed on details of measures and reforms to achieve fiscal consolidation targets while protecting social spending and clearing the large stock of arrears without accumulating new ones.”
Lungu’s Crucial Test in the Short Term: How to Handle the Opposition
Both Zambian authorities and the market seem resolutely upbeat about the country’s prospects in securing an IMF programme. That said, the dominant risk from the perspective of investors is the degree to which the country’s authorities feel they can continue without an IMF programme, should they fail to secure one. It would be detrimental because the market has limited confidence in the government’s ability to carry through with fiscal consolidation reforms without external pressure.
Others have signalled growing concerns over governance, which could influence its standing with rating agencies, the donor community, and other concessional lenders - if the situation deteriorates further. International leaders in the EU and the US have already weighed in on the spat, urging Lungu to exercise restraint. But many within the country are already nervous that the ruling PF is working to stymie opposing views.
“Zambia today is being said to be worse than the worst countries in this part of the world in terms of governance,” explained Biemba Maliti, professor of business strategy and management at Copperbelt University in a recent op-ed in the Zambian Observer. “The other unfortunate development in Zambia is the silencing of all dissenting views including those of intellectuals through various threats and intimidations and replacing them with those of party cadres.”
Some also see HH’s recent arrest as a crucial test for Lungu and the country’s institutions.
“Zambia was on track to become a model for good governance in Africa in the early to mid-2000s, but there have been growing concerns over delegitimating the opposition, a perennial theme on the continent, in addition to broader concerns around government corruption and the independence of key institutions like the judiciary,” one analyst explained.
“The recent HH arrest borders on the absurd and will undoubtedly be written off by many observers and investors… but, it raises serious questions about the health of country’s institutions and their willingness to play by international norms.”
Lungu’s challenges in the long-term are well-understood. The government needs to keep fiscal consolidation top of mind and stick to the reform plan laid out last year in order to help put the country back on the path to growth – not an insignificant task, to be sure.
But in the short-term, Lungu needs to swallow his pride and resolve his dispute with HH amicably, a move that would surely help stem sliding confidence in the health of governance in the country.
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