The ‘Copper – Baldini’ effect on Eurobonds….
• 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
SPRING has been a very tough and bearish month for Zambia alongside other emerging markets. Ideally we expect to see bright flowers at the beginning of August...
SPRING has been a very tough and bearish month for Zambia alongside other emerging markets. Ideally we expect to see bright flowers at the beginning of August but for the Zambia this wasn’t the case. Both dollar and kwacha assets have been at record lows as a consequence of a number of factors ranging from global risk appetite to market specific developments causing waned investor sentiment.
Credit default spreads (CDS) on dollar bonds for Zambia, Africa’s largest producer of refined copper, widened by between 470-471bps in the spring month of August to date. Credit risk on bonds for maturity 2024 widened the greatest by 504bps (to 1,288bps) as the 2022 bond spread widened 472bps (to 1,260bps) while the 2027 widened the least by 470bps (to 1,197bps). The copper producer is running an external debt stock of USD9.37 billion (according to MOF H1: 2018 Performance report) of which 32% totalling USD3 billion comprises of three (3) Eurobonds trading on the international capital markets. Drivers of the lower bond valuations in the period range from ran autopsy of the risk- off emerging market environment as a result of a very strong dollar environment to the Alfredo Baldini (IMF Resident Representative) recall to Washington 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 between doubled and tripled (185% – 297%) from February 2018 levels when copper was at its peak. This period had bullish fundamentals ranging from a Fitch positive outlook rating on a B rating for Zambia and London Metal Exchange – LME recording copper above USD7,000/mt. Yields on the Zambian dollar assets have risen above 14% for all maturity tenors: 2022 (15.15%), 2024 (15.33%) and 2027 (14.24%). 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:
‘Risk-off ’ emerging markets
Vulnerability of 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. Zambia’s Dutch disease for copper makes the nation prone to external shocks such as a plummet in the red metal price and as such results in credit risk concerns. Why would this be so? Copper is not only a barometer for global economic health but signals Zambia and the DRC’s growth prospects (DRC and Zambia are Africa’s top copper hotspots). Even the rating agencies look to copper pricing to roughly proxy Zambia’s growth prospects. So Donald Trump’s tweets on imposition of tariffs on global trade partners that causes investors to offload risky assets that send metal prices to lows, indirectly impacts nations like Zambia and other emerging markets.
IMF resident rep ‘Baldini’ effect
The dollar bond markets have priced – in (and still pricing -in) news around the recall of the IMF resident representative Professor Alfredo Baldini on August 23 when Bloomberg reported the news which every trader and fund manager across the globe trading or managing Zambian assets must have seen. This then added more pressure on default risk spreads of the copper producer’s dollar bonds. The information 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’. What remains worrying is that all these developments have sent Zambia’s bond valuation to its lowest ever. 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.
The kwacha has been on a volatile streak having started last 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 behavioural 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 funding salaries at month. However, this was not enough to hedge pressure as the kwacha still closed 25 points north of K10 (K10.25/USD).
Former IMF Resident Representative for Zambia – Professor. Alfredo Baldini.
A comparison of African dollar assets showing Mozambique having the highest credit default risk at 1,453basis points followed by Zambia at 1,198 basis points.
A table showing credit spread risk on Zambia’s outstanding dollar bonds for maturity in 2022, 2024 and 2027.