The Potential Implications of a Debt Default For Zambia’s Economy

By Wakumelo Mataa

Following a rapid increase in its debt stock over the past decade, Zambia has continued to run the economy under a very tight fiscal space as debt repayment obligations left Government with little resources to allocate towards social and economic sectors that safeguard the livelihoods of Zambians and grow the domestic economy.

Recent revelations from the Ministry of Finance indicate that, besides the country defaulting on its interest payment on one of its euro bonds that was due on 14th October 2020, Zambia has actually already defaulted with other creditors. While we remain hopeful that the Country will manage to honour its debt obligations, it has become apparent that we take a glance at the social and economic implications of a sovereign default for an economy like Zambia.

A common finding is that a default may lead to a diminution in capital flows (this may be in part because sovereign defaults often occur together with devaluations). The reduction in investor confidence that follows after a sovereign default in tells a subsequent reduction in foreign exchange inflows over the medium-term which may, in turn, lead to an even deeper depreciation in the Kwacha against major currencies.

Ultimately, this would consequently trigger a sharp rise in the amount of Kwacha that will be needed to service the same amount of debt repayment in dollar terms. Thus, the country may actually find itself in a worse position post-the relief period if exchange rate pressures are not addressed as a matter of urgency.

Moreover, a default ruins the reputation of the country thereby leading to an exclusion of the defaulting country from the international financial market. Hence, Zambia may temporarily lose access to the international capital markets and may be subjected to higher sovereign borrowing costs in its future transactions.

Additionally, holders of defaulted bonds may interfere with cross-border payments to other creditors who had previously agreed to a debt restructuring, such as the G20 creditors and the China Development Bank. If all cross-border payments are blocked, Zambia would not be able to borrow abroad—no creditor would lend if it were unable to collect the payments. This will inevitably present serious challenges to the implementation of the 2021 National budget whose 43% of funding is projected to come from domestic and external financing.

A debt repayment default may also lead to a decline in international trade for at least three reasons: First, creditors could use tariff and nontariff barriers to reduce trade with Zambia. Second, default could lead to the collapse of trade credit, thereby increasing the costs of trade.

Finally, creditors could seize the debtor’s foreign assets, including tradable goods. However, there is little evidence of asset seizures following a default, although, from the creditor’s point of view, this may be a viable option should the negotiations completely break down. For much of history, the doctrine of sovereign immunity prevents creditors from suing a defaulter in foreign courts. Moreover, even if creditors could win a judgment, they would find little to take, since Zambia does not own extensive assets in foreign jurisdictions.

Several recent court cases have illustrated the near impossibility of taking sovereign assets as compensation for default. For example, an Argentine naval ship detained in Ghana on behalf of creditors was released after an appeal to the International Tribunal on the Law of the Sea. Furthermore, a default may lead to costs in other spheres of international relations, particularly those that are called reputational spill-overs. A default will most likely signal that the government is unreliable, not just in terms of debt management, but also in terms of international affairs more generally. Foreign partners might be less willing to make direct investments or enter into trade agreements with Zambia.

The debt implications on social sectors and welfare of the people are quite diverse and are one which Zambia has a history of grappling with. With rising debt, comes also a rise in the cost of debt service which has evidently crowded out Government spending on critical social sectors. Government spending on education and health as an allocation in the national budget has been reducing for the past 5 years. This is below international standards set like the Abuja and the Cairo protocol for which Zambia has committed. This can be strongly tied to the rising allocations towards debt service.

Moreover, the economic impacts of a debt repayment default may have a significant bearing on the social wellbeing of the people. As prices of goods and services increase, the cost of living also increases. For instance, the basic cost of living in Lusaka is K7, 060.00 for a family of 5 according to the Jesuits Centre for Theological Reflection (JCTR). This means more people need assistance through Government welfare schemes such as social cash transfer.