April 26, 2018/Fitch Ratings
Continuing uncertainty over Zambia’s prospects for an IMF programme highlights two of the country’s key sovereign rating weaknesses: weak public finances and high commodity dependence. The dispute over the tax bill presented to mining company First Quantum Minerals Ltd. could discourage foreign investors.
Zambia’s finance minister said this month that the government would complete a debt sustainability exercise and re-start talks with the IMF. Disagreements over the government’s plans for new borrowing to fund infrastructure investment have been a key stumbling block. In February, the IMF said that the latest plans “compromise the country’s debt sustainability”.
An IMF programme would support fiscal adjustment and make additional sources of long-term external financing available to Zambia. More broadly, credible efforts to secure a programme would likely see the government clarify its future borrowing plans and their potential impact on the sovereign’s fiscal position and its external debt. The Finance Ministry has reported an increase in external debt to USD8.7 billion at end-2017. We think recent speculation that external debt is higher may relate to contracted but undrawn loans to be disbursed gradually over several years.
The Negative Outlook on Zambia’s ‘B’ sovereign rating reflects continuing risk from deficits and external debt servicing costs. Further growth in the stock of non-concessionary, foreign-currency debt increases exposure to external shocks and underscores the importance of copper exports as a source of hard currency and potentially of increased government revenue. We do not believe the Zambian Revenue Authority’s (ZRA) presentation of a USD7.9 billion tax assessment to Canada-based First Quantum in March is a deliberate attempt at expropriation, but how the dispute is eventually resolved may have an impact on Zambia’s investment climate.
First Quantum contests the assessment and has said it will “continue working with the ZRA, as it normally does, to resolve the issue”. As we noted when we affirmed First Quantum at ‘B’/Stable in March, we think the bill is likely to be settled at a considerably lower level. A portion of the import duties has been paid, and some errors in the declared duty rates may be identified. We think the ZRA will apply penalties and interest at a lower level than initially assessed.
We believe the ZRA’s initial calculation of penalties and interests reflects the nature of the Zambian tax regime, which has scope for negotiation and the reduction and cancellation of penalties. We also think the Zambian government will seek to avoid jeopardising its key foreign exchange earning industry and a major source of employment. The government’s challenge will be to satisfy its domestic constituency that Zambia’s mineral wealth is being fully harnessed for the country’s benefit while reassuring foreign investors that it has a functional and predictable tax regime. It is pursuing reforms aimed at increasing tax revenues by improving tax administration, enlarging the tax base, and ending widespread tax exemptions.
Zambia’s World Bank Doing Business Survey rankings are above the ‘B’ category median, and the 2017 budget attempted to clarify the mining tax regime after several policy announcements and reversals. But the size of the tax demand, and uncertainty around the ZRA’s calculations and any final settlement, suggest that lack of predictable tax treatment remains a weakness in the operating environment.
Other weaknesses include poor power provision and transport infrastructure to Zambia’s copper belt. The government is trying to address these constraints. The Ministry of Mines estimates that copper production grew 3.5% to 800,000 tonnes last year. Rising production and prices have supported a recovery in growth and export earnings, bringing the trade balance into surplus in 2017. Policies that, intentionally or otherwise, damage investor confidence could limit or reverse production growth.