Spring tale of Zambia’s eurobonds – the ‘Copper – Baldini’ effect

  • Copper flirted with near 1-month lows causing a blow out in Zambia’s dollar bonds
  • IMF resident reps recall to Washington added more pressure on default spreads

Credit default spreads (CDS) on dollar bonds for Zambia, Africa’s largest producer of refined copper,  widened by between 92-145bps in the spring month of August to date. Bonds for maturity in 2022 widened the greatest by 145bps (to 1021.3bps from 881bps) as the 2024 maturity widened 127.3bps (to 1072bps from 944.9ps) while the 2027 widened the greatest by 92bps (to 1022.9bps from 834bps). The copper producer is running USD3billion of commercial debt on the international capital markets accounting for 32% of Zambia’s external debt position. Drivers of the lower bond valuations in the spring month range from risk- off emerging market environment to the Alfredo Baldini (IMF Resident Representative) recall effects.

Credit default spreads, also known as a credit default swap spread or a credit spread (or sometimes, simply, the spread). In derivatives, an amount, typically specified in basis points, above LIBOR that a credit protection seller charges a credit protection buyer for credit protection in a credit derivative transaction, usually a credit default swap (CDS). The spread is essentially a fee that represents the price of selling credit protection on a particular reference entity. The higher the spread, the greater the credit risk of the reference entity.

Credit risk on dollar bonds has widened between 139% – 223% from February 2018 levels when copper was at its peak. Yields on the Zambian assets have risen above 13% for all maturity tenors: 2022 (13.12%), 2024 (13.78%) and 2027 (13.53%). This then ranks the copper producer’s dollar assets second worst after Mozambique’s 2023 bonds paying 17.145%.

See summary table below of credit spread risk on Zambia’s Eurobond:

A table showing performance of Zambia’s outstanding dollar bonds.

‘Risk-off’ emerging markets 

The month of august has had the greatest impact on emerging market assets. The vulnerabilities of the EM’s is due to high dependence on commodities for export revenues and as such dollar strength has made risky assets such as oil, copper and other industrial metals. Dollar strength makes dollar denominated assets such as stocks and treasuries very attractive and this causes asset sell-offs in emerging market assets such as discount instruments and as such investors sell off to exit (EM’s) with intent to invest in dollar assets. With the trade wars that have loomed with global giants such as China with ridiculous tariffs designed to protect the  US economy, commodities have shaved significant value in emerging market currency terms. Right about August 13 the dollar index was at its peak at 96.7 (a 13 month high) which saw commodities such as copper flirt with close to 1-month lows just below USD6,000/mt at USD5,965/mt. Since Zambia is dependent on copper for 75% of export revenues, such a sell – off impacted the credit risk spreads on the Zambia’s dollar debt (Eurobonds). Copper is not only a barometer for global economic health but for Zambia and the DRC’s growth prospects. Donald Trump’s tweets on imposition of a 50% tariff on Turkey so the largest sell-off that sent commodities to lows.

IMF resident rep ‘Baldini’ effect

The dollar bond markets have priced in news around the exiting of the IMF resident representative Alfredo Baldini on August 23 when Bloomberg reported the news. Every trader and fund manager across the globe managing Zambian assets must have seen this news that sent default risk spreads on the copper producers dollar bonds between 38-75bps (22 -24 Aug). The asymmetry still remains because the IMF has not issued an official statement on the resident representatives recall to Washington. However to allay fears of market effects, the Minister of Finance Margaret Mwankatwe issued a statement on the finance ministry’s website stating that Zambia’s relationship with the IMF is healthy and intact and the resident office in country will remain operational beyond the tour of duty of Alfredo Baldini who has been recalled by the IMF to Washington for redeployment.

The development comes at a time when Zambia is grappling with high risk of debt distress that the dollar bond markets have already ‘priced in’ such that additional negative news causing a blow out in spreads but at a decelerated pace. Zambia’s talks with the IMF appear to have stalled with no program in the last two years that has seen the Southern African nation announce austerity measures to assist curb ballooning debt.

Kwacha volatility

The kwacha has been on a volatile streak having started the week on a bearish note to K10.45/USD levels amidst dollar demand as most players hedged their earnings in the world’s safest haven currency the dollar. This is a behavioral pattern very common in Zambia especially when uncertainty and sentiment dampen. A few players such as the mines courted the markets to sell dollars to meet kwacha obligations such as salaries at month end but however was not enough to cushion the pressure as the kwacha still closed 25 points north of K10 (K10.25/USD). Spring is supposed to be a flowery month but for the kwacha this hasn’t been the case. Just when the markets were expecting support from increased kwacha demand to pay mining taxes, tax authorities (ZRA) just paid out refunds in VAT in excess of K385million against the odds. This then meant that the usual dollar conversions to kwacha were replaced by kwacha VAT refunds that were used to absorb tax obligations. This gave little support to the local unit which would have ideally helped reverse some losses to cushion pressure from the risk off environment. However, weakness in the kwacha against the dollar doesn’t make its exchange rate to the rand any better as the dollar and appreciated after the South African government dropped the land appropriation law which saw the SA unit gain to levels of ZAR13.89/USD from last week’s highs of ZAR14.28/USD. The rand can never be trusted because it had then pushed back to ZAR14.39/USD levels. This makes import inflation risk high for Zambia whose trade basket (33%) comprises SA goods. We cannot rule out price volatility that could further slow private sector pulse as measured by Purchasing Managers Index – PMI for August.

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