Sovereign Analysis /

Zambia: Bleak reform prospects but potential upside for Eurobonds

  • Material reform and IMF program unlikely before August 2021 elections, but capex cuts can stabilise the debt burden

  • Short-term external debt service exceeds reserves, with cashflow relief necessary to ease liquidity constraints

  • Haircuts likely to be limited, though restructuring complicated by Chinese involvement. We initiate ‘Buy’ on Zambia 24s

Zambia: Bleak reform prospects but potential upside for Eurobonds
Stuart Culverhouse
Stuart Culverhouse

Chief Economist & Head of Fixed Income Research

Tellimer Research
13 August 2020
Published byTellimer Research

Zambia announced its intention to restructure on 31 March, but details are still sparse (see our research here). The government has hired advisers, and bondholders have organised, but it is still current on its bonds. Its decision was probably prompted by the impact of Covid, but in reality a debt crisis has been brewing for a number of years now and the sense of urgency will grow as the 2022 maturity approaches.

In response, Zambian Eurobonds sold off to cUS$30 at the beginning of April after hovering around US$70 at the end of 2019. They have since rebounded by c80%, but are still c15-20% below their already distressed pre-Covid levels.

Covid and currency depreciation (down c23% ytd, among the worst in EM) have exacerbated an already worsening debt outlook, with the IMF’s August 2019 DSA saying that “Public debt under current policies is on an unsustainable path”. This prompted the government to take the step towards restructuring.

The government has since hired Lazard on 27 May to advise on “liability management” and the Ministry of Finance has stated that Lusaka “has no intention of unilaterally restructuring debt without consulting creditors” and “will respect agreements and diligently use market-based instruments in our debt management”.

While the perimeter of the restructuring has not yet been defined, a group of 10 US and Europe-based bondholders that hold c35% of outstanding Eurobonds – enough to comfortably block a deal – formed a creditor group on 23 June. The group, advised by Newstate Partners, says it is “in close contact” with other bondholders representing an additional c30% of outstanding Eurobonds and that many of the holders are also significant holders of domestic government debt (with foreign holdings of cUS$700m in May, or 14.8% of the total stock).

This note will take a comprehensive look at Zambia’s macro backdrop, restructuring considerations and recovery analysis. While we are not optimistic about Zambia’s reform prospects before August 2021 elections, we think the composition of the budget will make consolidation feasible in the near-term and that there is a strong argument for a relatively light restructuring based on cashflow relief. However, the involvement of China and the IMF will be crucial in determining how this plays out.

We see potential upside for Zambia 24s at current prices, and initiate with a ‘Buy’ recommendation.

Robust growth gives way to stagflation

Zambia has enjoyed robust GDP growth over the past decade, averaging 4.9% yoy (albeit from a low base, with GDP per capita of only US$1,300). However, in recent years growth has begun to run out of steam, falling from 6.6% from 2010-14 to 3.5% from 2015-18 and 1.5% in 2019 (half of its 3% population growth). The IMF projects a 5.1% contraction in 2020 followed by a tepid rebound to 0.6% growth in 2021.

The downtrend reflects a growing sense of economic crisis, a deteriorating business environment and governance, and growing authoritarian and nationalistic tendencies (notably on mining policy), with the IMF successively revising down previously strong growth estimates as the outlook deteriorated.

These trends can be seen by a systematic deterioration across a number of international benchmarks since President Lungu took over in 2015. Zambia has dropped 27 places in the WEF’s Global Competitiveness Indicator, 28 places in Transparency International’s Corruption Perceptions Index, and 59 places in the Heritage Index of Economic Freedom since 2014.

While Zambia ranks above SSA peers in the World Bank’s Ease of Doing Business ranking and improved 13 positions to 85th globally in 2017, progress has been nil since then and major constraints remain in the areas of access to electricity, trading across borders, registering property, and enforcing contracts, among others.

Zambia’s economy is also particularly vulnerable to cyclical shocks related to weather and commodity prices, with drought leading to a 16.3% yoy drop in maize production (Zambia’s staple crop) in the 2018/19 season and prompting a 7.6% drop in electricity production (85% of electricity is hydro based).

This led to blackouts, exacerbating power constraints (capacity is only 2,800 MW and access is 31%, with an estimated demand gap of c800 MW) and leading to a 4.8% contraction in the mining sector (which makes up 13% of GDP but consumes 51% of power).

It also exacerbated inflationary pressures and pushed food inflation to a peak of 17.4% yoy in May 2020, which alongside currency passthrough and increased regulated prices (with fuel and electricity prices hiked 10.3% and 113%, respectively, in December) pushed headline inflation to 16.5%. While CPI has since moderated to 15.9% yoy in June, it is still far above the Bank of Zambia’s 6-8% target.

After hiking the policy rate by 175bps to 11.5% over the course of 2019, the BoZ cut by 225bps in May in response to Covid, pushing the policy rate into deeply negative territory. Interest rates on government and private sector borrowing nonetheless remain elevated, with ballooning public sector debt crowding out private sector investment (which grew at a tepid 10.4% yoy in June, or -5.5% in real terms).

Zambia, therefore, finds itself in a worsening stagflationary bind, and requires concerted policy efforts to boost growth while bringing inflation under control.

A look back at Zambia’s slow-motion economic train wreck

Zambia’s current economic collapse has been brewing for the past five years, due mainly to excessively loose fiscal policy. Zambia first tried to get an IMF programme in 2014 at the beginning of the 2014-16 commodity price crash but failed to do so, and after a series of false dawns continued its policy of heavy non-concessional external borrowing.

They nearly had a programme in September 2017, but at the last minute the government wanted to include additional borrowing and the IMF put talks on hold, citing a high risk of debt distress and saying it wanted more clarity on fiscal policy and borrowing plans compatible with restoring debt sustainability.

Nothing has really changed since, except the customary noises from the government on how they want a programme accompanied by some superficial announcements to slow the pace of borrowing but seemingly without any real political commitment (more on this later).

The result of the above phenomenon has been a near quadrupling of government debt. In 2012 gross public debt totalled a moderate 25.4% of GDP, with the budget deficit averaging just 2% of GDP in the five years following the GFC. However, by 2019 the debt stock had risen to a monstrous 89.5% of GDP, with the budget deficit averaging 7.8% of GDP in the five years to 2019.

The deterioration has been driven by a massive ramp up in capital expenditure (capex), which has been financed mainly by external non-concessional borrowing (c75% by IMF estimates). With a Eurobond last being issued in 2015, much of this has taken the form of bilateral Chinese project funding. With c2/3 of public debt now denominated in FX and the ZMW losing c55% of its value over the past five years, currency depreciation has massively inflated the debt stock relative to output and revenue.

While increased capex should, in theory, raise future growth and tax revenue to service the associated debt, weak project management has led to an estimated efficiency loss of 45% for Zambia’s public investments vs 36% across SSA, per IMF estimates. Growth has continued to decline despite the government’s aggressive capex program, with the debt burden consequently spiralling out of control.

These factors have interacted with Zambia’s weak public financial management (PFM) framework to create significant budget overruns in four out of five years since 2015. While revenue has generally performed in line with (or above) targets and current spending has been contained, capex and interest spending has consistently overshot the target and pushed up the deficit.

Weak PFM has also given rise to significant arrears. The government reports its budget on a cash basis but the BoZ has recently begun documenting arrears, showing a 3% of GDP accumulation in 2019 and bringing the total stock to 9.8% of GDP. By effectively financing much of the deficit via arrears accumulation, private sector growth and investment has been increasingly crowded out.

In response to Covid, Zambia has reduced mineral import and export duties to support the mining sector, waived tax penalties and fees on outstanding tax liabilities resulting from Covid, and suspended customs duties and VAT on key medical supplies and some other items. The government has also issued a ZMW8bn bond (2.4% of GDP) to finance Covid-related expenses, including health spending, arrears clearance, and grain purchases, as well as a recapitalisation of the development bank.

Luckily, capex is easier to rein in than recurring spending like wages or service provision, so the government can offset some of the Covid-induced slippage by turning off the capex taps. This is exactly what it has done so far this year, cutting capex in half relative to the budget baseline.

Alongside revenue that is somehow performing broadly in line with the budgetary target, the budget deficit through May is 56% below the initial nominal target. Despite remarks by the BoZ in May that the deficit would likely exceed its 5.5% of GDP target in 2020, it may actually be attainable.

However, the government may find it difficult to keep capex in check. Zambia had a pipeline of US$9.7bn (c40% of GDP) of contracted but undisbursed debt as of April 2019 which, at the time of the IMF’s August 2019 review, was projected to be fully disbursed within the next five years. Of that total, c45% was for projects that had not yet begun disbursing.

Cabinet approved measures in December to cancel some undisbursed loans and slow the contraction of new loans, which Fitch says could reduce the external financing pipeline by US$5bn (21.5% of GDP). That said, similar commitments were made in 2018, with government failing outright to adhere to them.

In fact, a more rapid than expected drawdown of these facilities was largely responsible for the capex-induced spending binge of 2018-19. Slower drawdown moving forward must be a key part of Zambia’s reform program, but since c55% of the pipeline is related to projects already underway, government may find it difficult to limit their drawdown once the initial Covid shock begins to fade.

As of end-2019, we calculate Zambia’s public debt to be 89.5% of GDP (slightly below the IMF estimate of 91.7% of GDP). This includes domestic debt of 27% of GDP, external debt of 53.3% of GDP (at the end-2019 exchange rate of ZMW14.15/US$), and arrears of 9.3% of GDP. It does not include contingent liabilities of 8.6% of GDP (5.7% guaranteed and 2.9% non-guaranteed, largely relating to state utility Zesco), which would bring the total stock to 98.1% of GDP at the end of 2019.

As of May 2020, domestic debt has risen to between 27.3% and 29.6% of GDP (depending on the GDP figure used). Adding in net external financing of cUS$60m and factoring in currency depreciation of c23% ytd, the external debt stock has increased to between 63.8% and 69.1% of GDP. Assuming arrears and contingent liabilities are constant, we estimate total debt stands between 109% and 116.5% of GDP.

Reserve buffers approaching zero

The debt situation looks even more desperate when compared to Zambia’s limited reserve buffers, with reserves falling steadily from a peak of US$3.94bn in July 2015 to US$1.34bn by May 2020 (c2.2 months of trailing goods and service imports).

With the IMF estimating public external debt service of US$1.49bn in 2020 and US$1.53bn in 2021 (excluding interest on the US$1.4bn of loans contracted in 2019), the reserves are now less than a year of external debt payments.

The two main drivers of Zambia’s balance of payments are copper prices/production and government spending, with copper making up c75% of exports and capital equipment (driven mainly by public capex) comprising 40% of imports.

After averaging a current account surplus of 3.7% of GDP from 2011-15, Zambia has averaged a deficit of 1.6% of GDP from 2015-19. However, the deficit swung from a 1.3% of GDP deficit in 2018 to a 1% of GDP surplus in 2019 as declining exports from lower copper production and prices were offset by lower imports due to subdued local demand.

Through the first six months of the year, the trade balance has swung back into surplus with a 17% yoy drop in exports (with a 5.8% rise in copper production offset by a 12.3% decline in prices) more than offset by a 29.9% drop in imports (with capital imports down 27% amid lower government spending).

Assuming a 20% contraction of both imports and exports in 2020, we forecast a 3.2% of GDP current account deficit this year from a 1% of GDP surplus in 2019. This would push reserves to US$1.25bn by year-end and US$370m by 2024 (vs the IMF’s August 2019 forecast of cUS$1bn and cUS$475bn, respectively), highlighting the urgent need for reform.

IMF support unlikely with government likely to remain resistant to reforms

To avoid a balance of payments (BOP) crisis, Zambia has requested emergency RFI financing from the IMF as well as a funded program. The IMF held a virtual mission from 22 June to 10 July to discuss the emergency financing request, which comes with no strings attached. However, the IMF is unable to lend – including via emergency disbursements – to countries with an unsustainable debt burden. They were quite explicit about this in the 21 May press briefing, saying that “any IMF financial support [to Zambia], including emergency financing, is contingent on steps to restore debt sustainability”.

Even before Covid the IMF said in its August 2019 staff report that Zambia’s debt was “on an unsustainable path”, and we calculate that Zambia is currently in breach of all five of the IMF’s debt sustainability thresholds for countries (like Zambia) defined as having a weak carrying capacity.

Even if Zambia is able to unlock RFI funding (cUS$1.375bn maximum based on Zambia’s quota), requests for a full-blown program are unlikely to be met with much sympathy. Government/IMF relations have deteriorated under President Lungu, with Zambia promising investors a program three times from 2014-17, only to suspend negotiations each time due to lack of cooperation.

The most recent round of negotiations ended in October 2017 after the government failed to provide clarity on borrowing plans that were seen to be inconsistent with debt sustainability. While a June 2018 statement by the finance ministry subsequently cleared up some of the data gaps on Zambia’s debt stock and borrowing pipeline, further clarity on fiscal policy never followed. Instead, Lusaka appeared to use the prospect of IMF support to shore up investor support without any real reform intent.

This time around the situation is likely no different, with President Lungu gearing up for August 2021 elections where he will seek a third term following a December 2018 court ruling that his first term (which lasted 20 months after he took the helm following the death of then-President Sata) did not count towards the two-term limit.

Lungu narrowly defeated opposition UPND leader Hakainde Hichilema in 2016 elections that were marred by election-related violence, restrictions on opposition-aligned media, and misuse of public resources by the ruling PF, according to Freedom House. Since then, Lungu’s authoritarian tendencies have reportedly increased, eroding the quality of institutions and governance for a country once seen as a beacon of democracy in Africa.

Like today, Zambia was in IMF negotiations leading up to the 2016 elections, but resisted austerity measures (such as reducing costly fuel, electricity and food subsidies) to boost popular support. That said, Lungu is unlikely to agree to externally imposed austerity measures ahead of 2021 elections, and in any case the window is rapidly closing with the IMF rarely approving a program close to elections. We think if there is no agreement by January, that window will have shut until after the election. This makes a prolonged muddle through for at least the next 12 months the most likely policy scenario.

In the post-Covid environment, some may argue that the IMF has a moral obligation to help countries in crisis, due at least in part to such an unprecedented external shock rather than adhering strictly to historical lending policy and conditionality. However, even in the case of Lebanon – which has by far the strongest “moral” argument after last week’s explosion in Beirut – the IMF has remained steadfast in its insistence on reforms before funding (see here). In our mind, that should effectively squash any hope for countries like Zambia to play the crisis card and receive funding without good faith attempts at reform.

In its August 2019 staff report the IMF outlined several key measures to consolidate the deficit by 4.4% of GDP and attain a primary surplus of 2-3% over the medium term. A larger than expected deficit in 2019 may have increased needed consolidation closer to c5.0-5.5% of GDP, but the general prescriptions remain unchanged. Key measures include:

  • Increase revenue by 0.6% of GDP by broadening the base and simplifying the tax regime (regular changes to mining taxes in recent years have created uncertainty and deterred investment);

  • Capex cuts totalling 3.5% to bring them back in line with historical norms of <5% of GDP and introducing a moratorium on new non-concessional external borrowing and guarantees (the government has already implemented major capex cuts this year); and

  • Halting the accumulation of domestic arrears and clearing the existing stock (thus removing a key barrier to growth).

Previous IMF recommendations had also focused on containing subsidies, which peaked at 3.6% of GDP in 2016 (mainly to the Farmer Input Supply Programme and Food Reserve Agency). The IMF recently estimated that these had fallen to 0.6% of GDP in 2019, but FISP spending actually exceeded target by c300% in 2019 and reached 2.3% of GDP. Subsidies will thus be back on the chopping block, which will serve as a further obstacle given Lungu’s propensity to use them as a carrot for voters before elections.

Restructuring a necessary pre-condition for debt sustainability, but the extent may be limited

We think Zambia is in the unique situation of being able to potentially stabilise debt by simply cutting capex closer to historical levels. We estimate a debt stabilising primary balance of -0.2% to +0.2% of GDP, meaning the primary deficit needs to fall by c2.5-3.0% of GDP to stabilise debt (and c5.0-5.5% of GDP to set it on a sustainable downward path).

This is more ambitious than at least 75% of IMF reform programs, but achievable given the capex-heavy composition. In fact, cutting the deficit by 5.5% of GDP via capex cuts would leave it at 4% of GDP, still high relative to Zambia’s own history and its peers.

We forecast Zambia’s debt stock under three scenarios, with our base case assuming limited meaningful reforms in the near-term but a balanced primary budget over the medium-term via capex cuts. Our adjustment case assumes a primary surplus of 2.5% of GDP over the medium-term (roughly in line with previous IMF targets), and the unchanged policy case assumes no changes to the 2019 fiscal stance.

Under the base case, public debt rises to 102% of GDP by 2025. To reach the IMF’s indicative debt threshold of 70% of GDP by 2025 this would require haircuts of c30% on all public debt (excluding arrears and contingent liabilities). If instead the adjustment scenario obtains and Zambia sticks to IMF-sponsored targets, then the required haircut would be only c10% on all public debt.

These numbers rise to 50% and 15%, respectively, if domestic debt is excluded, which is altogether possible given that c2/3 of debt is external and a domestic restructuring will not address external liquidity constraints. Without adopting a firm view on this front, we conservatively estimate that a 30% haircut would likely be required to restore debt sustainability.

A heavier adjustment is required from the BOP perspective, as Zambia’s liquidity constraints are more dire. We estimate that the IMF would want to return reserves to between US$2.4bn (roughly four months of imports) and US$3bn (our estimate of the IMF’s reserve adequacy metric – calculated as 30% of short term debt + 20% of other liabilities + 5% of exports + 5% of broad money for countries with a floating exchange rate) by the end of 2022/2023 if Zambia were to enter into a 2-year program (and depending on when it does so).

Using the midpoint of US$2.75bn as the target, this would require haircuts of c15% if Zambia is able to roll over 100% of public and private amortizations. However, this number rises to 60% if rollover drops to 80%, highlighting the sensitivity of this calculation to rollover assumptions.

As such, we think it is more straightforward to take a cashflow approach (i.e. maturity extensions, grace periods or coupon cuts) to address Zambia’s liquidity constraints. External public debt service is estimated at cUS$1.5bn annually from 2020-21, rising to US$2.1bn in 2022 due to the US$750m Eurobond maturity. If only 50% of external amortizations are rolled over, it would require a 3-year maturity extension and 3-year interest grace period to reach US$2.75bn of reserves by the end of 2022.

In all, we view a 30% haircut as sufficient to restore debt sustainability from the solvency perspective and a 3-year maturity extension and grace period as sufficient to deal with Zambia’s liquidity constraints, with the government able to choose a mix of the two solutions in its final restructuring deal.

Encouragingly, initial statements from the government seem to imply an intention to treat creditors fairly and it may very well be that external creditors won’t have to do that much heavy lifting to restore debt sustainability, possibly suggesting a more cashflow-heavy restructuring that limits nominal haircuts (or claws back some of the loss in NPV terms via coupon step-ups down the road).

However, the composition of Zambia’s external debt stock will create complications. Out of Zambia’s US$11.2bn external debt stock (as of end-2019, including guarantees), Zambia owes roughly US$2bn to commercial banks, cUS$2.1bn to multilaterals, US$3bn to Eurobond holders, and US$3.1bn to China’s main public lenders (China Exim, CDB and CATIC).

Further, the Chinese debt stock could be much higher (either due to debt caught up in the “other” categories below or not yet on the books). Data from the Johns Hopkins University SAIS China-Africa Research Initiative estimate that China extended US$7.4bn of loans to the Zambian government and Zesco from 2000 to 2018. While some of the loans listed have since been paid off, this represents a reasonable upper-bound estimate for the potential amount of Chinese debt outstanding.

As such, any restructuring will necessarily require Chinese involvement and we think investors are unlikely to agree to a restructuring without further clarity on the size and conditions of Chinese debt. This will be difficult, as Zambia itself may not have exact figures since some of the debt was likely contracted directly by spending ministries.

President Lungu has reportedly asked Xi Jinping for some "debt relief and cancellation" to help Zambia stave off crisis, but it is unclear if China is willing to play ball. While China has previously been willing to extend debt relief to low-income development partners (it announced generous terms for Angola recently – see here – although details are still sparse), Zambia may not be strategically important enough – or a big enough exposure – to warrant similar treatment.

Even if China does agree to debt relief it does not tend to disclose the specific terms. This could also complicate efforts to agree to a commercial restructuring or negotiate IMF support, as neither party will be willing to make any commitments without clarity on the new stock of debt and terms thereof.

Debt relief from China is therefore a necessary precondition to IMF support (since the IMF is unlikely to commit to a program unless China promises to share some of the burden), but is not in itself sufficient to reach an agreement on restructuring (i.e. IMF involvement will likely be required either way).

So, we find ourselves in a bit of a game, with investors waiting on the IMF and the IMF waiting on China. A similar game was played out in the Republic of the Congo, but Zambia is arguably a bigger test for all parties. Zambia also differs from Angola in that, with a roughly equal stock of debt held by China and bondholders, a restructuring of one without the other is unlikely to restore sustainability.

Beyond Chinese debt relief, Zambia became the latest country to benefit from the G20’s Debt Service Suspension Initiative (DSSI) on 10 August. This will halt debt service to Paris Club creditors through year-end, which was estimated at US$139m (0.6% of GDP) from May to December but is probably lower now that some time has elapsed. While this will provide welcome relief, it will not be transformative.

However, could this potentially be a signal of progress towards an IMF program, or relaxation of the IMF’s stance? Per the G20’s 15 April communique, DSSI relief will be limited to countries which “are benefiting from, or have made a request to IMF Management for, IMF financing including emergency facilities (RFI/RCF)”. We think it seems unusual for the Paris Club to have jumped the gun ahead of IMF agreement on emergency financing. Reading the tea leaves, could it be that G20 partners have reason to believe that Zambia is close to securing IMF support, or was their outstanding request enough to catalyse DSSI relief?

Restructuring scenarios are wide-ranging, with some potential upside

With all this in mind, what does it mean for the price of Zambia’s Eurobonds? Firstly, it is unclear whether this “restructuring” will look more like a “reprofiling” (i.e. coupon cuts, grace periods and/or maturity extensions) or go the extra step to include substantial haircuts.

As we mentioned previously (see here) initial reports indicated that Zambia is seeking a "reorganisation" of its foreign debt, which may imply a relatively mild treatment on the bonds, which amount to a total outstanding of US$3bn. Since announcing the restructuring, Zambia has made coupon payments on 20 April and 30 July totalling cUS$155m, an initial show of good faith by the government. The next payment is on 20 September, totalling a mere US$20m.

Zambian Eurobonds are currently pricing in a nominal haircut of 40% on average. As this is greater than the 10-30% haircut we think would be required to bring Zambia’s debt below 70% of GDP over the medium-term, there could be some upside from the solvency perspective.

That said, if domestic debt is excluded from the restructuring (which would not be surprising) it could require 20-50% haircuts on the rest of the debt to bring debt down to the same level. Likewise, if Chinese debt is excluded then the haircuts required would rise to 15-40% (though we don’t see that as being acceptable to bondholders).

With public debt surpassing 100% of GDP, declining growth prospects and little fiscal reform, Zambia may look like a solvency problem. However, with stronger policies a cut in capex is all Zambia really needs to help restore fiscal balance, which may help bolster the argument of creditors that it is really a liquidity crisis requiring credible policy efforts and cashflow relief rather than nominal haircuts.

From this perspective, we also don’t think the IMF will require substantial haircuts as a funding condition, but they may insist on PSI to at least deal with the 2022 maturity which would likely fall within the timeframe of a potential programme. Indeed, c60% of the bonds’ outstanding matures in the next four years. We think the most likely scenario, therefore, is a small nominal haircut coupled with a maturity extension and grace period on coupons to achieve needed cashflow relief. Lower coupons may also be required given relatively high coupons on the 24s and 27s.

Given Zambia’s liquidity constraints (with short-term external debt service exceeding reserves), we think that a 3-year maturity extension and 3-year grace period on interest are likely required to restore reserves to minimum benchmark levels.

Any maturity extension applied to the 22s would probably have to be applied to the 24s and 27s as well, both because bondholders will likely expect treatment pari passu and because a heavy maturity profile from 2024-27 will make for a crowded amortization profile over that period if the 22s are rescheduled without touching the later maturities.

Below, we present an array of potential restructuring scenarios and weight by probability to arrive at our estimated fair bond price. We present several basic scenarios for each of three categories, including reforms and IMF program (either no reforms and no program, marginal reforms and program post-election, or material reforms and program by year-end, with corresponding exit yields of 15%, 12% or 10%, respectively); nominal haircuts (either 30% or none at all); and cashflow relief (heavy relief with 5-year maturity extension and interest grace period and 50% coupon cuts, or limited relief with 3-year maturity extension and grace period and unchanged coupons). Interest is assumed to be capitalised:

In expected value terms, we think the 22s and 24s appear to be fairly valued given current pricing of cUS$57 for each, with the 24s showing more potential for upside. Meanwhile, the 27s do not look attractive assuming that maturity extensions are applied evenly (if not then this could change the relative outlook).

In our base case (i.e. slight reforms, late 2021 program, no haircut and limited cashflow relief), the 24s have an expected value of cUS$83. Below, we show the sensitivity of the 24s to various exit yields and nominal haircuts, assuming a 3-year maturity extension and 3-year grace period:

That said, with existing CACs, what appears to be a well-organised and robust creditor committee, and a so far collaborative approach from the government (see here for our initial thoughts), there is a chance that bondholders will be able to negotiate relatively favourable terms. The bondholder committee as constituted already holds a blocking stake (representing 35% of bondholders vs a per series CAC threshold of 75% in each of the bonds), throwing added weight behind their stance.

Argentina’s creditors closed negotiations last week with a recovery value of cUS$55 vs an initial offer of cUS$40 (see here), and Ecuador’s creditors similarly received a recovery value in the high US$50s (here). We think Zambia’s restructuring needs are potentially less onerous, so if these represent a floor then there could be little downside based on current pricing.

While bonds have rallied c80% since their April low of US$31.50, they are still roughly 15-20% below pre-Covid levels (with the 24s having a mid z-spread close to 5,000bps vs c1,000 for B-rated peers). As such, we think that the risks are still skewed to the upside.

It is worth noting, though, that we are not optimistic on Zambia’s reform prospects. President Lungu will likely remain intransigent in his resistance to reforms until at least after elections in August 2021. With limited runway for reforms between elections and the US$750m eurobond maturity in September 2022, reserves dwindling from already low levels, and limited ability to roll over debt without an IMF program in place, Zambia could eventually be forced into a more onerous restructuring if they delay too long.

That said, we think that given the likely continuation of the global reach for yield and potential upside in the event of a soft restructuring based mainly on cashflow relief, Zambian bonds remain attractive on a relative basis. We initiate a ‘Buy’ recommendation on Zambia 24s.