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Zambia

Zambia: Opposition landslide boosts prospects, but upside now priced in

  • Hakainde Hichilema (HH) defeated incumbent President Lungu by over 1 million votes amid surge in voter turnout

  • Economic outlook vastly better under HH, boosting chance for timely IMF programme and restructuring

  • Zambia 24s have surged by c8.3pts (c12.5%) to cUS$75.6, with upside now largely priced in; downgrade to Sell from Hold

Zambia: Opposition landslide boosts prospects, but upside now priced in
Tellimer Research
16 August 2021
Published byTellimer Research

Hakainde Hichilema (HH) of the United Party for National Development (UPND) has been declared winner of Zambia’s presidential election, defeating incumbent Edgar Lungu of the Patriotic Front (PF) by a margin of nearly 1 million votes. With 155 of 156 constituencies reporting, official results on Monday showed HH had secured 2,810,757 (59.8%) of the vote versus Lungu’s 1,814,201 (38.6%). In a televised address, electoral commission chairman Justice Esau Chulu officially declared HH as the winner.

Turnout was high, with many voters waiting hours to cast their ballots and some polling stations forced to stay open late to accommodate the influx of voters.  With one constituency still left to be counted, turnout reached 71% from just 56.5% in 2016 and 32.4% in 2015, with 4.98mn Zambians casting their ballots. With 1.2mn more votes cast than in 2016, it is clear that the scale of the economic collapse under Lungu was a call to action for Zambia’s youthful electorate, which has felt the brunt of the economic crisis and was increasingly dissatisfied with Lungu's handling of the economy.

Over the weekend there were signs that Lungu may not accept the results, with Lungu releasing a statement on Saturday that the elections were "not free and fair" in some provinces due to alleged incidents of violence against PF supporters and polling agents in HH strongholds, thus "rendering the whole exercise a nullity". The statement is certainly ironic, with local and international observers flagging concerns ahead of the election that the playing field was tilted unfairly against the UPND amid campaign restrictions, skewed media coverage, and intimidation of opposition voters and officials.  

Many observers worried that Lungu would use his incumbency to manipulate the vote, and these concerns were exacerbated by a ban on WhatsApp and social media platforms over the weekend. However, in a televised address to the nation today he said "I will comply with the constitutional provisions for a peaceful transition of power, I would therefore like to congratulate my brother, the president-elect, His Excellency Mr Hakainde Hichilema," reducing the risk of post-election unrest and beginning to repair Zambia's battered reputation as a functioning democracy after several years of rising authoritarianism under Lungu. Lungu still has seven days to lodge a complaint with the Constitutional Court if he changes his mind, barring which HH will be sworn into office next Tuesday, 24 August.

Markets have welcomed the news, with the Zambia 24s jumping by c8.3pts (c12.5%) to cUS$75.6 at the time of writing, and the ZMW rising by 1% versus the US$. As we highlighted recently, economic management under HH is sure to be a vast improvement over Lungu. HH’s market-friendly credentials will enable him to secure an IMF programme and conclude restructuring negotiations more quickly than Lungu could have, and he will likely be more willing to implement the tough reforms required to set Zambia's economy and debt on a sustainable path.

Bonds

However, the outlook under HH may not be as smooth as markets seem to think. IMF negotiations could be delayed while HH forms a government and takes over talks from the previous administration, and there is also a risk that the new administration finds the fiscal situation to be worse than previously thought once they lift the hood (as we saw in Ghana in 2016 due to rampant pre-election spending). Some of the more contentious reforms, such as reducing farming subsidies under the FRA and FISP programmes, could also prove hard to implement even under a more reform-friendly HH, who may be hesitant to use so much political capital upfront.

That said, clearly HH has a strong mandate for reform, and if he can capitalise on post-election momentum to quickly secure an agreement with the IMF and conclude restructuring talks with official creditors and bondholders, then Zambia's economic outlook could quickly improve. But, as we highlighted in our previous note, the reality of Zambia's debt situation is that significant fiscal consolidation, alongside material debt relief (via haircuts, and potentially also cashflow relief), will still be required to set debt on a sustainable path (and thus unlock IMF funding).

HH's landslide victory is positive for bonds in several ways: 1) it will likely speed up IMF and creditor negotiations, resulting in a better starting point for the restructuring and reforms; 2) it will result in a more favourable reform and growth outlook post-restructuring, reducing the amount of relief needed to make debt sustainable; and 3) the reform programme will be more credible, reducing the exit yield and maximising the chance reforms will be sustained. However, with the Zambia 24s now trading above US$75, it is hard to imagine recovery values being so high (even including PDI of 8.5pts for the Zambia 24s).

Assuming PDI is capitalised with an exit yield of 10%, Zambia 24s are currently pricing in nominal haircuts of just c30% with no further cashflow relief. This seems optimistic, as it would only reduce Zambia’s debt by c16.5% of GDP assuming that domestic and multilateral debt is excluded from the restructuring, which would leave public debt at just over 100% of GDP post-restructuring. Further, with the 22s and 24s both maturing in the next three years, the IMF will likely require a maturity extension to push the amortisations outside of the timeline of the potential programme. All three eurobonds are now trading above where they were before Covid and before Zambia defaulted on its debt.

Sensitivity

We outline the impact of several different restructuring scenarios on the Zambia 24s (all of which assume PDI is capitalised). With HH previously saying that 20% was a reasonable starting point for discussions on haircuts, we use that as our "bullish" scenario, rising to 30% under our "base" scenario and 40% under our "bearish" scenario. We also consider different levels of cashflow relief, ranging from none in our "bullish2 scenario to a 4yr coupon step-up (in equal steps from 2.125% to 8.5%) alongside a 3yr maturity extension (to ensure no bonds mature during the IMF programme) in our "base" scenario, to the coupon step-up plus a 3yr maturity extension and 3yr grace period in our "bearish" scenario.

Scenarios

Weighting our base case with a 50% probability and our bullish and bearish scenarios each with a 25% probability, we find that the Zambia 24s appear to be roughly fairly valued at the current price at an exit yield of 8% but overvalued at yields above that. That said, with a tight group of bondholders who are unlikely to accept a restructuring that is seen as overly onerous, a new president who likely wants to keep the restructuring from dragging out (to seize on early momentum, attract new capital, and show that his competent management can get them out of the crisis more quickly than Lungu), and one who likely appreciates the need to restore market access by avoiding an acrimonious restructuring, markets could still be justified in their renewed optimism.

Indeed, in his first speech as President-Elect, HH told bondholders that "you have an administration that will get you to the table where you will be respected, you will be heard. And we will come to an amicable solution." He added that "we will ensure there is equity in the treatment of debt" and there will be no "cross-subsidisation" of one debt holder for another. But he also said that his administration will expect the mining industry to employ more Zambians, and that more locals will be shareholders of the mining companies, saying "you will see that the mines will come to the table, the mines will pay their fair tax." This raises some concern that HH will continue with Lungu's nationalist stance in the mining industry, potentially trying to squeeze more resources out of the sector and deterring further investment.

The economic outlook has undoubtedly shifted in a positive direction after HH's landslide victory, and the risk of post-election unrest delaying the transition seems to be contained. Compared to Lungu, we think HH is much better positioned to secure an IMF programme and restructure Zambia's debt by the end of the year, and is much more likely to do so in a way that is viewed as constructive and credible by the market, leading to lower exit yields and maximising the probability that Zambia sticks to its reform targets. That said, even assuming a very ambitious reform agenda, significant haircuts will likely be required for the IMF to be confident enough that debt is on a sustainable path to disburse funding, and the magnitude of the adjustment required means the risk of slippage will remain elevated.

Altogether, we think after today's rally the upside is now largely priced in and relies on overly optimistic assumptions on exit yield and restructuring terms, with risks skewed to the downside. While a well-organised bondholder committee could succeed in extracting relatively favourable terms and will likely limit the downside, we think today's rally is an opportune moment to take profits after an eye-watering rally of c40% ytd, c80% since October 2020, and c140% since the April 2020 trough.

As such, we downgrade our recommendation on Zambia’s eurobonds from Hold to Sell at a price of US$72.9 for the 22s, US$75.6 for the 24s, and US$74.6 for the 27s at the time of writing on Bloomberg. We will conduct a more thorough DSA analysis once HH's policy plans become clearer, which will help to inform the assumptions that underpin the IMF's own DSA (which in turn will be the key guide to the perimeter and terms of the restructuring). We would consider upgrading to Hold if prices drop below US$70 for the Zambia 24s.

Related reading

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Zambia is treading down the wrong path, January 2021

Zambia likely to default today after creditors reject standstill, November 2020

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Investor presentation kicks off ambitious restructuring timeline, September 2020

Botched budget a bad signal for bonds, September 2020

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Bleak reform prospects but potential upside for Eurobonds,  August 2020