OREANDA-NEWS. Fitch Ratings has revised the Outlooks on Zambia's Long-term foreign and local currency Issuer Default Ratings (IDR) to Negative from Stable and affirmed both ratings at 'B'. Fitch has also affirmed Zambia's Short-term IDR at 'B' and the Country Ceiling at 'B+'. The issue ratings on Zambia's senior unsecured foreign and local currency bonds have been affirmed at 'B'.

KEY RATING DRIVERS
The revision of the Outlook reflects the following key rating drivers:

A combination of falling copper revenue and slowing growth has led to persistent and large fiscal deficits and a doubling of gross general government debt since 2012. Fitch forecasts the 2016 fiscal deficit to narrow slightly to 7.1% of GDP, materially higher than the 3.8% deficit forecast by the Zambian authorities in the 2016 budget. Mining revenues, which directly contributed about 17% of total government revenue in 2012, fell to under 13% of revenue by 2015. Lower than expected mineral royalties and higher than expected fuel subsidies and interest payments resulted in a fiscal deficit of 7.7% in 2015, widening from 5.9% in 2014.

These persistent fiscal deficits and a depreciating exchange rate have led to an increase in gross general government debt, which rose to 51% of GDP as of end-2015, above the 'B' median of 47% and twice the 24% level of 2012. In the absence of fiscal consolidation, Fitch forecasts that the country's debt trajectory will increase to levels that are incompatible with the existing 'B' rating.

Additionally, Zambia's three Eurobond issuances since 2012 have contributed to an increase in foreign-currency denominated debt, which now accounts for about three-quarters of general government debt, compared with 40% in 2011. Zambia's domestic debt issuances are generally undersubscribed and face increasing rollover rates. The 364-day T-Bill and 10-year Bond rate, which were 15.7% and 18.2%, respectively, at end-2013, had widened to 21.5% and 20% as of January 2016. In February 2016, the cabinet approved opening formal discussions about an IMF programme, but discussions are not expected to conclude before the August 2016 election.

Progress on fiscal reform measures that could help blunt the effect of falling copper prices has been slow. Fitch expects the authorities to continue implementing a number of expenditure and revenue measures, including reforms to electricity tariffs and agricultural subsidies and the implementation of a Single Treasury Account. However, with mining revenue likely to remain at 2015 levels and some upward pressure on expenditures ahead of the August general election, Fitch does not expect Zambia to achieve large fiscal consolidation in 2016.

The effects of low export earnings and tightening global conditions have also contributed to Zambia's current account deficit and increased the country's external vulnerability. The fall in copper earnings, which account for 75% of total export earnings and are the largest source of foreign exchange, contributed to the almost 70% nominal depreciation of the kwacha in 2015. This depreciation led to a marked increase in inflation, which averaged 7.3% year on year for the first nine months of 2015 and then jumped to over 20% for December 2015 and January 2016.

The pressure on the kwacha also contributed to a drawdown in official reserves over 2H15. As the Bank of Zambia intervened to manage an orderly depreciation, the reserves position fell from USD3.9bn in July 2015 to USD3.3bn, or an estimated 4.3 months of CXP, as of end-2015. In recent years, the authorities have used Eurobond proceeds to boost reserves, an option which is likely to be unavailable in 2016. Fitch expects that Zambia will rely on some combination of multilateral development bank lending and private sector financing to fill any external financing gaps, before reaching agreement with the IMF after the August elections.

Zambia's 'B' IDRs also reflect the following key rating drivers:

The long-term economic growth trajectory is in line with similarly-rated peers, but Zambia is unlikely to regain the high levels of growth that accompanied the booming copper sector in the decade leading up to 2014. Fitch expects growth of 3.7% in 2016 and 5.0% in 2017, which is equal to the forecast 2017 'B' median of 5.0%. However, a number of structural issues will present a short-term challenge to growth and could threaten the long-term growth potential. The drought affecting southern and eastern Africa has meant a contraction in agricultural production that will continue in 2016. The drought has also negatively impacted Zambia's hydropower generation and contributed to a power deficit of 1,000MW in February.

Average growth of 7.1% over the 10 years to 2015 has resulted in an improvement in social indicators, but per capita income (at 60% of the 'B' median) and measures of human development remain weak compared with 'B' category peers. Health and education outcomes are especially weak, with average life expectancy of 57 years. The lack of skills adversely affects the employability of the workforce, with only 10% employed in the formal sector.

RATING SENSITIVITIES
The main factors that could, individually, or collectively, lead to the ratings being downgraded include:

- A sustained inability to access external sources of financing, which could lead to a liquidity and funding shortfall.
- A failure to reverse fiscal deterioration and stabilise the government debt ratio.
- A further deterioration in external balances, for example through a sharp and sustained fall in copper prices, relative to Fitch's forecast.

The main factors that could, individually, or collectively, lead to a stabilisation of the Outlook include:

- The successful negotiation and implementation of an IMF support package would mitigate growing external risks and allow the country increased access to foreign exchange.
- Effective fiscal consolidation that leads to a sustained narrowing of the fiscal deficit.
- A rise in international reserve coverage, thereby reducing Zambia's vulnerability to external shocks.

KEY ASSUMPTIONS
- Fitch expects the elections in 2016 to proceed smoothly, with limited risk of political instability.