Stuart Culverhouse, Head of Sovereign and Fixed Income Research at Exotix, said: “Until it does, absent a credible fiscal anchor, we think there is little to stop the bonds falling further. Indeed, the macro situation may get worse before it gets better as domestic financing difficulties mount and inflation risks are skewed to the upside.”
The firm has downgraded its recommendation on Zambia 2027 bonds to Sell from Hold (yield 11.5%).
“Market yields that have now reached 11.5% show the market has lost faith in Zambia and, if there was any confidence back in October that an IMF programme was still possible, this has now all but disappeared,” commented Culverhouse.
“As the government has relied increasingly on issuing domestic securities for financing, absent a Eurobond and an IMF programme, we think non-resident outflows present a further risk to financing and macro-stability, amid already low reserves,” he said.
Culverhouse thinks that a key risk stems from the significant presence of non-resident investors in government securities, who are less stable than domestic investors, and any outflows would put additional strain on reserves and the financing outlook.
Non-resident investors had been attracted by Zambia’s relatively high real yields (carry trade) and have helped the government to cover its domestic financing needs.
Non-resident holdings of domestic government securities were 17.1% at end- March, according to the central bank’s May Monetary Policy Committee statement.
“While not the highest share in SSA (Ghana is nearly 40%), it is significant in absolute terms. It equates to cUS$860mn (at today’s exchange rate), which is c46% of reserves (gross reserves stood at $1.8bn in March, according to the central bank). We are not aware of any signs of non-residents rushing for the exit (either through outright sales or unwillingness to roll over maturities), but if they did, accommodating any outflows, given low reserves (reserves/import cover was c2.1 months in March, according to the central bank), would pose a significant risk to the currency (with echoes of Argentina’s recent LEBAC woes),” Culverhouse said.
“And expectations of a weaker currency (as part of the adjustment process) could lead to non-resident outflows. Lack of further foreign inflows would also strain future financing. It is not obvious that the domestic market could absorb the difference, while resorting to central bank financing would be a negative signal and inflationary,” he added.
Culverhouse said that a crucial test of investor confidence will come at the next scheduled government bond auction on June 29.
“If the auction is undersubscribed (as has been seen in recent T-bill auctions) and/or yields go higher this could signal problems ahead for financing the deficit. Ultimately, this could force the government’s hand, either to take remedial action itself, or return to the Fund for help,” he said.