Lowering the repayment risk of Zambia’s Eurobonds

By Shebo Nalishebo

In light of the Finance Minister Hon. Alexander Chikwanda’s announcement to Parliament that the budget deficit has ballooned from the earlier projected K8.5 billion to K20 billion, among the measures that government may have to consider to plug this deficit is going back to the international sovereign bond market. Now is a good time to think hard about how to manage the risks associated with increased government debt. Since 2012, Zambia has borrowed US$1.75 billion worth of what are called Eurobonds. Zambia’s first Eurobond worth US$750 million was issued in 2012, while the second one worth US$1 billion was issued in 2014. In 2014, these Eurobonds accounted for nearly two-fifths of the debt we owe other countries.

As with any debt, Eurobonds attract interest and the two Eurobonds so far issued will gobble up in excess of US$125 million in interest payments per year until the bonds reach maturity. Moreover, the two bonds have what are referred to as bullet repayment structures, meaning that lump-sum principal payments will be paid at the end of their respective ten-year maturity periods in 2022 and 2024. This may lead to significant repayment risks if there are adverse changes in the domestic or international market conditions at the time of repayment.

Some such risks are already on the horizon. We are currently facing a challenging macroeconomic environment, both at home and outside our borders. The recent depreciation of the Kwacha has increased debt servicing costs in Kwacha terms. Problems in the mining sector and the low copper prices on the international market have reduced the much-needed export revenue used to service the debt since copper accounts for about a third of the tax revenue. We have been running a high fiscal deficit averaging about 5% in the last three years. This means the country has been spending more than the revenue it has been generating. This has put a huge strain on the national budget.

Borrowing from abroad is not necessarily a bad thing. If we are spending the borrowed money in the right places that create jobs, wealth and prosperity, then we will have more than enough to dedicate a portion of it to repaying the loans. The Eurobonds have been used to mainly finance infrastructure projects in the transport and energy sectors. However, the 2013 Auditor General’s report has already raised an alarm on how the proceeds of the 2012 Eurobond have been used. Some of the issues highlighted in the report include misapplication of funds, lack of receipt and disposal details, delayed and irregular disbursements. Even though most of the selected projects are high-value and can potentially boost economic growth, the future economic benefits are likely to be delayed due to the ‘business-as-usual’ approach in the use of the proceeds so far. This increases the risk that Zambia will struggle to repay its debts between 2022 and 2024.

In order to ensure that we manage to pay back this debt, in a new report published on 12th June 2015, the Zambia Institute for Policy Analysis and Research (ZIPAR) argues that the country needs to make some tough decisions. This includes measures to reduce the high fiscal deficit by having more effective tax collection, getting public sector pay under control, rationalising spending on infrastructure projects, and generally growing the economy. We will also need to put various available financing options on the table. These include setting up a sinking fund to reduce the value of the existing Eurobond debt. In his address to Parliament, the Minister announced that he had approved the establishment of a sinking fund for the repayment of the two Eurobonds. Through the sinking fund, government will set aside funds annually, which would be used to make payments against the principal. The traditional view is that the sinking fund should be adopted only in the case of a government revenue surplus. However, a surplus is unlikely to happen any time soon in Zambia. Therefore, a small part of the current revenue receipts need to be earmarked for this fund even in the context of government deficits. Once set up, the level of funding to the sinking fund could be scaled up in the medium term after the high fiscal deficit is reduced and some fiscal space created.

If put in place, these measures will lower the repayment risk and will signal to bond holders that we do not want to default on the debt. Lowering of the repayment risk would also translate into a lower interest rate on future borrowings. As government considers its options for financing the fiscal deficit, it also needs to be thinking about how best to manage the risks associated with the growing debt.

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