The economic fallout from the pandemic has left several poorer nations struggling to repay debt. China, the biggest single creditor to many, could carry considerable clout in negotiations. Zambia will prove an early test case, argues Carmen Altenkirch.

Read this article to understand:

  • What Zambian debt restructuring could imply for other countries
  • Why China will play a key role in negotiations
  • What markets are pricing in in terms of recovery rates

On June 9, 2012, Zambia beat Ghana 1-0 in a regional qualifier for the 2014 World Cup. The venue was the Levy Mwanawasa stadium in Ndola, a small city of 475,000 people in the heart of Zambia’s copper belt.

Built by the Shanghai Construction Group at a cost of US$65 million – financing was provided by China’s Ministry of Commerce – the stadium is one of the more egregious examples of white elephants now littering the continent. Since that win over Ghana, it has stood largely deserted, rarely attracting crowds of more than 5,000.

This is an all-too-familiar theme playing out over a continent that has binged on Chinese capital: both through loans to public and private sectors and foreign direct investment. The China Africa Research Initiative (CARI) estimates that between 2000 and 2019, Chinese financiers committed US$153 billion to African public sector borrowers.1

China becomes a vital economic ally

Having overtaken the United States to become Africa’s biggest trade partner in 2009, China is now a vital economic ally for many of the continent’s nations. That said, Chinese lending has been in decline for several years.

Two forces are likely responsible for the recent decline. Domestic political pressure is causing some African governments to think twice about taking on new Chinese debt. This reflects mounting anger and political opposition to the disadvantageous terms on offer, with loans often collateralised against oil reserves and other natural resources. Tying loans to the use of Chinese labour and goods has added to the disquiet. 

In 2019, Beijing said that, as part of a much bigger US$19 billion loan agreement with Ghana, it would finance US$2 billion worth of rail, road and bridge networks. In return, it will be granted access to five per cent of the African nation’s bauxite reserves. 

Chinese lenders overexposed

More significantly, China’s appetite for lending appears to be waning. Efforts to boost flagging rates of domestic economic growth are causing it to turn inwards, a trend that seems to have been accelerated by the pandemic. But perhaps of most concern to Beijing, a high degree of concentration has left its lenders heavily overexposed to several of the world’s more heavily indebted nations, among them Zambia.

There are signs Chinese foreign direct investment (FDI) may be going into reverse

China has not only been a source of lending for hard-up African nations, it has been a huge investor in the region too. According to Johns Hopkins University SAIS China-Africa Research Initiative, Chinese companies have invested far more in the continent than their American counterparts since 2010.

This is partly explained by Chinese companies’ desire to secure access to Africa’s vast natural resources, in particular industrial metals and fuels. However, as with its lending, there are signs Chinese foreign direct investment (FDI) may also be going into reverse.

The withdrawal of loans and investment is a big blow for countries hoping to secure capital to build highways and rail lines linking landlocked countries to ports. The continent faces an estimated annual infrastructure investment deficit of around US$100 billion, according to the African Development Bank.2

Zambia became Africa’s first pandemic-era sovereign default when it bowed out of a $42.5 million Eurobond repayment in November 2020.3 The country’s woes are a warning that a debt tsunami could engulf the continent’s most heavily indebted nations.

Hidden debt?

This is particularly true of those countries that have borrowed heavily from China for two reasons.

Firstly, there is concern the true scale of borrowing from China may be higher than some countries admit. Secondly, the fact bilateral loan terms are often hidden means Chinese creditors may be able to secure preferential treatment in the event of defaults.

The World Bank is worried true debt could be underreported. Its first concern is there is often a lack of oversight of the non-state guaranteed borrowing activities of state-owned enterprises. State guarantees given in the context of public-private partnerships (PPPs) are a second reason debt may be going underreported.

The true scale of borrowing from China may be higher than some countries admit

The World Bank says the scope of guarantees offered to make PPPs look viable may be “substantial”. They include loan repayments, guaranteed rates of return, minimum income streams, guaranteed currency exchange rates and compensation should new legislation affect an investment’s profitability.

In October 2021, Zambia said that, as of that June that year, total public debt was just shy of US$27 billion, equivalent to just under 125 per cent of 2021 GDP, according to IMF estimates.4 Of that, US$14.67 billion was external debt, including US$5.75 billion owed to Chinese entities.

A September 2021 report by CARI noted Zambia and its state-owned enterprises had entered into at least 53 different loan contracts between 2010 and 2019. In what was described as an example of “poor fiscal transparency, oversight and co-ordination”, Zambia was said to have “misclassified” Chinese debt which, as a result, was larger than the government had been admitting.5

Equal burden sharing

However, while this has bought the country some much needed breathing space, it remains to be seen how it will balance the competing interests of creditors.

 Zambia opted for a debt restructuring under the so-called ‘Common Framework’

In February last year, Zambia opted for a debt restructuring under the so-called ‘Common Framework’. Launched by the Group of 20 major economies and the Paris Club of official creditors in 2020, it aims to provide debt relief for countries eligible for repayment moratoriums under the Debt Service Suspension Initiative. Central to the framework is the idea of equal burden sharing.

The Zambian government has stated all creditors will be treated equally. But bondholders are concerned Chinese lenders may demand preferential treatment and any money they give up might simply be used to pay off the Chinese.

Will China flex its muscles?

Chinese lenders’ leverage is often enhanced by the way in which debt contracts are worded. A 2021 study published by the Capital Markets Law Journal analysed 100 contracts between Chinese state-owned entities and government borrowers in 24 developing countries.6 Three main insights emerged.

First, the Chinese contracts contain unusual confidentiality clauses that bar borrowers from revealing the terms or even the existence of the debt. Second, Chinese lenders seek an advantage over other creditors, using collateral arrangements such as lender-controlled revenue accounts and promises to keep the debt out of collective restructuring (“no Paris Club” clauses). Third, cancellation, acceleration, and stabilisation clauses in Chinese contracts potentially allow the lenders to influence debtors’ domestic and foreign policies.

Zambia will be the first nation with outstanding Eurobonds to use the new Common Framework

Since Zambia will be the first nation with outstanding Eurobonds to use the new Common Framework, the outcome of talks with its creditors will be seen as a crucial test case for others such as Chad and Ethiopia, which have applied to use the same mechanism to restructure debt.

While the Common Framework’s objective to treat all creditors equally can be met in different ways – by extending maturities, reducing interest rates or haircuts, or a combination thereof – China’s historical preference for maturity extension threatens to complicate negotiations. There is also some concern China is labelling debt as commercial, rather than bi-lateral, to reduce the proportion of debt re-negotiated under the Common Framework.

Nonetheless, it is more important than ever for investors to understand the composition of government debt, not just headline levels, to gauge potential restructuring terms and recovery values. For Zambia to get on a more sustainable fiscal path, we estimate all debt holders will need to take a haircut of around 20 per cent. The fact Zambian debt is currently pricing in more than this reflects uncertainty as to the outcome of the negotiations.

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