Citigroup, JPMorgan Favor Zambia’s Dollar Debt in Bet on IMF Aid

(Bloomberg) -- Citigroup Inc. and JPMorgan Chase & Co. are among investors stocking up on Zambian dollar debt, anticipating that a growth revival and an International Monetary Fund aid package will help the southern African nation plug its yawning budget deficit.

Citigroup started adding Zambian debt on June 10, while JPMorgan moved its holding of the nation's dollar bonds to overweight, seeing room to “earn considerable pickup” amid signs of an improving economy. The bonds returned 7.3 percent in June, the most among 18 African nations monitored by Bloomberg.

The yield on Zambia's dollar bonds due in 2024 has fallen more than 500 basis points from a February high of 16.3 percent, but is still more than 3 percentage points higher than that of debt by similarly rated Ethiopia. Ranked five levels below investment grade by S&P Global Ratings and Fitch Ratings, Zambia, heavily reliant on copper, expects negotiations with the IMF to start in October and move to board level in December.

With developed-nation yields likely to remain lower for an extended period after the U.K.'s vote to leave the European Union, Zambian debt offers returns that are hard to find elsewhere, according to Citigroup.

“We continue to like the position” in Zambian bonds, said Luis Costa, Citigroup's London-based chief strategist for eastern Europe, the Middle East and Africa. “The IMF deal is a supportive factor. From the risk-reward point of view it is a very interesting long, despite Brexit.”

The yield on Zambia's Eurobonds due 2024 dropped 6 basis points to 10.57% by 3:35 p.m. in the capital, Lusaka.

While the southern African nation has said it expects an aid program from the fund by the end of the year, a deal may not be that easy as it's likely to require the government to cut energy subsidies. The IMF in March estimated the payments could cost the Zambian treasury $660 million this year. Increasing prices at a time when inflation already exceeds 20 percent may be unpopular in the build-up to general elections next month.

Better Rains

The 2016 budget shortfall will probably be slightly smaller than last year's 8.1 percent of gross domestic product, Deputy Finance Minister Christopher Mvunga told reporters in May. That's still more than twice the 3.8 percent deficit Finance Minister Alexander Chikwanda targeted in his 2016 budget statement.

JPMorgan sees a stabilizing exchange rate and improved rainfall supporting Zambia's economy, while expecting that fiscal austerity will get the government through the coming months. The bank expects the fiscal deficit to remain below 8 percent of GDP in 2016.

President Edgar Lungu, who will seek re-election in Aug. 11 polls, said in May the country will only access IMF support if the lender's conditions are acceptable, and not all investors are convinced about the positive outlook for the nation's debt.

While Zambia's Eurobonds have remained buoyant, underpinned by anticipation of an IMF support package materializing within months of the new government being formed after the August vote, the optimism is misplaced, according to Rhombus Advisors LLC, a consultancy that advises hedge funds and private-equity firms on African economies.

Zambian ‘Ambivalence'

Given “the ambivalence of local authorities, we have considerable reservations about any investment strategy that is dependent on an IMF support package,” Omotunde Mahoney of Rhombus wrote in a research note on June 21. This “would set the stage for a potentially significant correction in Zambian asset prices.”

While there may be delays on the path to an IMF agreement, demand from China will support the copper price, buoying the economy, which relies on the metal for more than 70 percent of export revenue, said Lutz Roehmeyer, director of fund management at Landesbank Berlin Investment.

“We are positive on economic growth and expect normal demand for commodities,” said Roehmeyer, who is overweight Zambian dollar bonds. “African exporters should perform well with rising commodities.”

--With assistance from Matthew Hill and Srinivasan Sivabalan To contact the reporter on this story: Lyubov Pronina in London at lpronina@bloomberg.net. To contact the editors responsible for this story: Daliah Merzaban at dmerzaban@bloomberg.net, John Viljoen, Antony Sguazzin