This is an excerpt from our recently published report where we compare and contrast Sri Lanka's and Zambia's restructurings, and the sovereign debt restructuring architecture more broadly.
Zambia has been unable to finish its restructuring 27 months since it defaulted and nearly six months since it received IMF Board approval for its ECF programme. The reasons are two-fold: firstly, bondholders are upset with the IMF’s decision to classifying Zambia's debt carrying capacity as "low" rather than "medium", resulting in more stringent DSA thresholds that dictate more aggressive relief.
Secondly, (like Sri Lanka) is China's refusal to move forward due to its insistence that multilateral creditors also take a haircut and (unlike Sri Lanka) that domestic debt held by non-residents is restructured (bondholders will likely make similar demands if the DSA targets are not relaxed in line with their request). Non-resident holdings of domestic debt totalled US$3.2bn as of mid-2022 – more than the US$3bn face value of eurobonds – and is defined as external debt for purposes of the DSA but is currently outside the restructuring perimeter.
While Finance Minister Musokotwane reiterated recently that domestic restructuring "would risk unraveling macroeconomic stability" and will not be considered, he may be more amenable to restructuring domestic debt held by non-residents. However, these creditors may resist this as discriminatory and demand that other domestic debt be restructured as well, potentially creating a new avenue for disagreement/holdouts.
Having completed the difficult prior actions needed to get Board approval, these delays are causing obvious (and understandable) frustration from the Zambian authorities. In response to the ongoing discussions on the global restructuring framework, Musokotwane recently said that "Discussions at higher levels like those just make our situation worse, because what we are looking for is urgent solutions, not discussions that may drag out the matter" and said that restructuring delays are holding back the recovery.
A World Bank representative has echoed this sentiment, saying that Zambia needs "desperate debt relief" but that negotiations under the Common Framework are proving difficult, while an unnamed US Treasury official was cited as saying that China's insistence that multilateral creditors and domestic lenders take haircuts are both non-starters and are delaying negotiations (in addition to similar public comments by US Treasury Secretary Janet Yellen during her visit), both of which China vociferously denies.
IMF Managing Director Kristalina Georgieva has also expressed frustration, saying that "Zambia has done its part under the IMF programme and the country has performed really strongly, and now it's time for creditors to do their part," but added during her recent visit that "We have reached an understanding in principle that China will de facto accept NPV reduction on the basis of significant stretching of the maturities and reduction of interest" (see here for the post-visit statement).
Meanwhile, Zambia's economic situation is getting worse the longer the negotiations drag out as adverse weather has triggered lower crop production and widespread power cuts (totalling 4hrs/day earlier this month as reservoir levels ran dry), the current account surplus has fallen (to US$18mn in Q4 22 from a peak of US$937mn in Q4 21), copper production has dropped (by 4.7% in 2022), the ZMW has depreciated in a straight line since the beginning of September (falling by nearly 21%, amongst the worst globally), and inflation has likely bottomed out due to electricity tariff hikes, higher food prices, and ZMW depreciation (with the Bank of Zambia raising its 2023 inflation projection from 8.5% to 11.1%).
This prompted the Bank of Zambia to raise its policy rate by 25bps at February's MPC, which followed a decision to raise commercial lenders' reserve ratios, with Governor Kalyalya blaming the recent ZMW depreciation on "negative sentiments arising from the protracted debt restructuring negotiations and uncertainty over how government securities held by non-residents will be treated".
With Zambia's economy worsening and debt negotiations stuck in the mud, it may be time to look for ways to push the process forward without China's involvement. Indeed, IMF MD Georgieva said recently that "I am confident that the creditors will reach an agreement" in the near future and implied that the Fund may not wait for the restructuring to be completed to approve its first ECF review and second funding disbursement, saying that "We expect to complete a mission by the end of March on the basis of the projection that advancements will be made" and adding that "We will make a disbursement to Zambia. Zambia has met its commitments under the programme."
Still, it is unlikely Zambia's other bilateral and private creditors are willing to finalise the restructuring with China refusing to participate, meaning the process may continue to drag out even if the ECF is able to limp along. Zambia may have to explore ways to restructure its debt despite the holdout of a major creditor (and potentially two, if the IMF doesn't accede to the DSA threshold amendments requested by private creditors).
Investment implications
While Zambia's restructuring is bogged down at the moment due in large part to disagreements between Chinese and Western creditors, China's provision of "credible and specific" financing assurances to Sri Lanka last week could signal a softening of their stance, although it remains to be seen if there is any readthrough to Zambia's restructuring. At US$46.2, the Zambia '27s are currently trading near the middle of our updated US$39-57.5 recovery value range. However, if bondholders prevail in changing the classification of Zambia's debt carrying capacity from "low" to "medium", recovery value will likely be skewed towards the upper end of this range, so we think may still be some upside.
We retain our Buy recommendation on the ZAMBIN 8.97 07/30/2027s at US$46.05 (30.45% YTM) on a mid basis as of cob on 20 February on Bloomberg, and will consider revising our recommendation if prices rise above US$50.
On the local currency debt front, we revised our recommendation from Buy to Hold on the ZAMGB 11 01/25/2026s on 12 December due to its deteriorating balance of payments and increased concerns that local debt would be included in Zambia's debt restructuring. Since then, the bonds have delivered -2.5% in total return US$ terms compared to +2.8% for the Bloomberg EM Local Currency Government Index, with the 5.7% price gain and 2.9% interest return offset by ZMW depreciation of 11.1%.
Those concerns have only increased in the intervening months, with further ZMW weakness likely to chip away at the near 25% nominal yield (down from a peak of nearly 30% in October), yields likely to rise as inflation bottoms out and the Bank of Zambia tightens its policy stance, and the risk of restructuring meaning there could be significant downside to the current cash price of US$72.5.
As such, we downgrade our recommendation on the ZAMGB 11 01/25/2026s from Hold to Sell at US$72.5 (24.75% YTM on a mid-basis as of cob on 20 February on Bloomberg).