Debt Restructuring Deals Put Zambia in an Economic Catch-22

Gerald Hamuyayi (FMVA)? , Lusaka, Sunday, 21 April 2024 - Zambia is on the cusp of completing a deal to restructure its debt amounting to US$13.4 billion, a process the Southern African nation pursued in 2021 following its defaulted-on debt obligations. In a wave, the sovereign credit ratings through Moody’s, Fitch and other rating agencies’ lenses worsened from B+ (Highly speculative) since 2015 to RD (Restricted Default) by 2020. Despite successes in the Eurobond market, Zambia's has never exceeded the B+ rank, making “highly speculative” its highest rating since 2011. This article will highlight Zambia’s debt status, the agreements made with the creditors and the catch in the deals.

The country went into debt distress a few years after its success in the international credit market when it issued three Eurobonds. Upon default in November 2020 however, the nation found its way to the G20 Common Framework in February 2021, a framework established three months earlier to support distressed economies. The process has posed challenges for both the government and the parties involved. For Zambia, the inherent delays in this untested process are exacerbated by the different classes, interests, and obligations of creditors. Zambia, serving as the guinea pig, has borne the brunt of these initial hurdles.

After three years and two months into the complex process, Zambia managed to secure agreements with official creditors and Eurobond holders by the close of the first quarter of 2024. The total debt quantum under restructuring consideration amounts to US$ 13.4 billion, with repayment agreements reached on US$10.1 billion, split between official creditors (US$6.3 billion) and Eurobond holders (US$3.8 billion). This milestone marks a significant accomplishment, with circa 75% of the debt successfully renegotiated. Discussion are continuing for the remaining 25% (US$3.3 billion).

The previously issued Eurobonds of US$ 750 million, US$1 billion, and US$1.25 billion, maturing in 2022, 2024, and 2025 respectively, have been restructured into two amortised bonds, labelled as bond A and B. These bonds feature varying interest rates, tenors, and triggers across two scenarios: base, and upside scenarios which will be summarised below.

Agreement With Official Creditors

Base Case

The total consideration is US $6.3 billion with no debt write-offs in this scenario. An average maturity extension of 12 years is proposed, extending the payback period of claims with intertest rates capped at 2.5%. A grace period of 3 years spanning 2023 to 2025 (which is half way through) is provided with amortisation of 5% of the claims by 2035.

Upside Case

Total consideration is US $6.3 billion with no write-offs in the upside scenario. However, payment period extension is reduced by 5 years ending in 2030. Interest rates are expected to be higher than the base case but below the US Treasury interest rates. Amortisation will be at a faster pace.

Agreement with Bond Holders

In all scenarios, total consideration amounts to US $3.84 billion of central government debt owed to Eurobond holders. This debt will be split into two amortising bonds: Bond A with US$1.7 billion and Bond B with US$1.3 billion, including a debt haircut of accumulated interest arrears amounting to US$840 million.

Base Case

In the base case scenario, Bond A features include, a maturity extension of existing claims by over 10 years. Interest rates locked at 5.75% or lower from 2024 to 2031, and 7.5% from 2031 (5.75% and 7.5% semi-coupons will be paid in the transition year 2033) to 2033. However, Bond A has zero grace period for payment resumption. Bond B features include maturity extension of existing claims by 30 years, payable up to 2053. Interest rates are capped at 0.5% 5 while amortisation has a 27 years grace period.

Upside Case

In the upside scenario, Bond A features are the same as the base case. For Bond B, interest rates are not to exceed 0.5% for 2024 and 2025, but will increase significantly to 7.5% from 2025 to 2035. The maturity extension for Bond B reduces from 27 years to 8 years.

It is essential to underscore the pivotal aspect that the upside scenario of agreements reached in principle presents a compelling catch-22 situation for Zambia, primarily due to its punitive clause contingent upon economic prosperity. However, the stipulated adjustment barely allows strategic and tactical actions on the part of the government that could guarantee a lack of improvement in Zambia's debt carrying capacity until 2026. Such a scenario would imply locking in a low debt service amount for longer maturity which lowers the present value of the debt. At the same time however, it suggests a lacklustre economic performance, that would significantly reduce the likelihood of the United Party for National Development (UPND) under President Hakainde Hichilema continuing its rule after the 2026 election. Economist use game theory and intertemporal choice theories to uncover optimal reactions to situations with varying discount rates and outcomes.

The proposed upside adjustments suggest that if the country fails to grow its economy, the triggers for punitive measures will not be activated. Conversely, if the economy does grow and the debt carrying capacity improves from weak to medium by 2026, these triggers would come into effect, potentially hindering further growth. Consequently, the ultimate outcome, in either case, indicates a less than optimal economic situation. This clause penalises economic improvement by redirecting more funds towards servicing the existing debt as the interest rates rally while maturity reduces.

Some financial analysts have argued that the sharp upward adjustment of the interest rates and the reductions of the amortisation maturity, as highlighted in the agreements, may reset economic progress made prior and elevate risk of the debt distress. Given the potential implications of the aforesaid, a staggered and gradual approach to parameter adjustments would ensure more resources are made available to sectors that optimise the economic pie, while reducing Zambia’s risk of falling into the debt distress status.

Despite the catch, Zambia stands to immensely benefit from the restructuring of its fiscal purse. A successful restructuring is poised to trigger rating upgrades from the rating agencies as sovereign risk reduces. This in turn, would enhance Zambia’s access to international financial markets, and accelerate the inflow of investments into the country as confidence in the Zambian economy improves. Finally, the potential wave of investments is expected to substantially support the Zambian Kwacha in the foreign exchange market in the short to medium term.