Zambia Eurobond Round 2: Capping off a Game of Two Halves

When the Minister of Finance was presenting the K42.7bn 2014 national budget in October last year, he highlighted that 25% of it would be financed by a combination of domestic (K3.5bn) and foreign debt (K7bn). It’s no secret that there was a Zambian delegation which included the Bank of Zambia governor on a USA coast-to-coast roadshow which was wrapped up at the tail-end of last week in London. Yesterday Reuters  reported  that Zambia had launched a 10 year, $1bn Eurobond at a final yield of 8.625%. This is the second Eurobond launched in the space of 2 years. 

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Eurobond 1 vs. Eurobond 2

In September 2012, Zambia issued a 10 year, $750m bond at a yield of 5.625% which received orders in excess of $11bn. Yesterday, a 10 years $1bn bond was issued at a yield of 8.625% with orders in excess of $4bn – both oversubscribed, same term (bond one matures in 2022 and bond 2 in 2024), $250m higher in terms of principal and 300 basis points higher in terms of yield (which should translate to coupon payments as well).

The first bond is relatively much cheaper to service than the second bond. Why? Well, to use a football (soccer) analogy, “it has been like a game of two halves”.

2012 – First Half 

First of all, the referee (in this case the US Federal Reserve) was very kind to global investors through its Quantitative Easing program (QE) which resulted in an increase in the availability of ‘cheap’ liquidity. Global investors who were chasing high returns (which they weren’t getting in developed economies) would then invest that money in emerging and frontier markets (like Zambia) through various securities. 

Zambia played the first half very well – driven on by a lenient referee and the following factors:

· Low fiscal deficit which averaged 2.9% of GDP over the previous 3 years
· Low debt levels which averaged 17.2% of GDP over the previous 3 years
· LME Copper was trading at just over $8,000 per metric tonne
· Balance of payments surplus of $726.7m in 2012
· Rated B+(negative) by Fitch, B+(stable) by Standard & Poor’s 

On top of all the positive data highlighted above, the country had just held a relatively peaceful election with a smooth transition of power in the previous year. Despite Zambia having had a poor credit history before, bond investors, driven by QE assigned a yield of just 5.625% and threw over $11bn worth of orders at the transaction - to put this into perspective, Spain’s 10 year bonds had a yield of around 5.78% at the time. Did that mean Zambia was less risky than Spain? No, but it meant Zambia got a better deal than they deserved!

2013/14 – Second Half

Things went very sour in the second half driven on by the following factors:

· Exceeded fiscal deficit target of 4.3% in 2013, closing the year with a deficit of over 6.7% of GDP which occurred as result   of a number of factors led chiefly by an Ill-timed public sector wage increment and under-collection of tax revenue.
· Drop in copper prices which have decreased to around $6,500 per metric tonne (19% drop from September 2012 price)
· Depreciating Kwacha from late 2013 to early 2014
· Ratings downgrade from Fitch to B (stable) and outlook cut by S&P to negative – both in October 2013
· Balance of payment deficit of $344.9m in 2013

To add insult to injury, the US Fed started to cut back on its QE program which meant less and less ‘cheap’ liquidity for global investors. And with negative data coming out about Zambia’s fiscal situation/economic risks, some money was probably pulled out in a “ risk-off ” trade. So in yesterday’s transaction, bond investors assigned Zambia’s bond offering 300 basis points more in yield than the 5.625% in 2012, because they are perceived as more “risky” (and investors expect to be compensated for additional risk). Demand was still very high (because of the attractive yield and the fact that yields on debt in developed markets are still quite low) as the transaction received more than $4.25bn in orders.

So if one ‘averages out’ the two transactions, it could be said that this game ended in somewhat of a draw. External debt, without taking into account any debt that has matured since end-of-year 2013, should be about $4.5bn. 

The $1bn will be allocated to the energy and transport sector – no comprehensive breakdown has been issued as of yet. The funds were much needed - public sector wages will account for between 50 and 60% of the 2014 national budget which puts pressure on the finances for current and future economic/social development projects. The Minister of Finance did acknowledge the fact that this was unsustainable in an  economic brief  last month and went on to say, “The government will address structural distortions in the public sector pay structure, harmonize salaries to ensure that there is equal pay for equal work……and stabilize expenditure on wages to 35% of domestic revenues, among others”. This will be a very positive move especially if it is expedited to begin this year.