A landmark deal for Zambia as agreement was reached on restructuring its $6.3bn debt. We explore what it means for other defaulters
- Though Zambia has reached a landmark deal with official creditors, we only see limited positive knock-on effects for other defaulters.
- Given Ghana’s medium debt-carrying capacity categorisation and Sri Lanka’s middle income country status, applying the G20 framework to their debt profile would be more difficult.
- After a disordered rally in emerging markets (EM) distressed credit year-to-date (YTD), we no longer find valuations attractive in defaulted credit as the return profile is now more dependent on broader market risk appetite and less on idiosyncratic price gains.
In June, Zambia reached an agreement in principle with official bilateral creditors to restructure its $6.3 billion debt, unlocking a $188 million International Monetary Fund (IMF) disbursement and marking a significant step forward in placing the country’s debt on a sustainable trajectory following its default in 20201. Notably, after many years of disagreements with multilateral institutions, China agreed to restructure Zambia’s official debt under the G20 Common Framework, an initiative designed to structurally support low-income countries with unsustainable debt 2. By accepting the Paris Club’s “comparability of treatment” criteria that tasks all creditors with providing similar levels of debt relief, this current breakthrough could potentially herald a way forward for other defaulted emerging market sovereigns3. A major innovation that finalised the deal is the cashflow structure that allows for higher creditor recoveries if the World Bank upgrades Zambia’s “debt-carrying capacity” from “weak” to “medium” by the end of the IMF program in 2026. This template is expected to be replicated in negotiations with its private commercial creditors.
In Ghana, the Zambia deal potentially de-risks its own official creditor negotiations given participation in the same G20 Common Framework. While we believe China will be less of a headwind in Ghana given its much lower share of the debt stock, crafting a similar upside cashflow recovery is more difficult as Ghana is already categorised as a “medium” debt-carrying capacity country. After restructuring its domestic debt, including a risky strategy to impose deep losses on the central bank’s holdings of government debt, the remaining headwind for Ghana to exit its default state would be a conclusion of negotiations with many Eurobond holders4.
In Sri Lanka, China makes up a significant share of its external debt which makes this case more comparable to that of Zambia, raising hopes that a similar deal can be reached soon. However, Sri Lanka’s status as a low middle income nation means that it does not qualify for a debt treatment under the Common Framework5. China is currently taking part in the official creditor meetings only as an “observer” rather than a participant, signalling its preference for a bilateral side deal under more favourable terms. While we think China could be open to expediating the process, it remains unclear whether there is political consensus within China’s leadership on whether loans from state-owned policy banks (the source of most of Sri Lanka’s China borrowings) should be treated as “official” lending.
From a performance perspective, distressed EM credit has significantly outperformed YTD, with C-rated names returning nearly 30% relative to the 3.25% EMBIG index return. Coming into the year, these holdings were perhaps oversold, but we are now more circumspect about the prospects for the distressed credit bucket following this recent rally. In the case of Ghana, we think a deal with bilateral creditors can come together by year-end, although current market prices no longer offerbmuch margin of safety for what we see as growing downside risks. Without higher conviction in the underlying credit story in Ghana, we no longer believe that the risk/reward profile is an attractive one.
In Sri Lanka’s case, we are less optimistic that the Zambia deal can provide an effective template to restructure debts with China. We believe these uncertainties could add complexities to the restructuring process and threaten to drag negotiations beyond what the government currently expects, limiting near term price upside.
While Zambia’s deal with official creditors is certainly a positive development that can help other distressed sovereigns avoid the same extended 3+ years in default, it is no silver bullet. EM distressed investing remains highly idiosyncratic and requires a deep understanding of the many factors at play. Our focus on fundamental credit research is well placed to capitalise on these conditions.