Mozambique heading for default as Credit Suisse and VTB are investigated
As we previously warned, Mozambique continues on course for default on its national debt; furthermore, following revelations of hidden costs, the International Monetary Fund (IMF) has suspended its emergency aid to Mozambique. Mozambique has missed a deadline for a scheduled repayment on the $535m loan arranged by Russia’s VTB Bank, but without international aid Mozambique will not be able to do anything; to avoid further escalation, the country needs to focus on stabilising the currency, curb inflation, and repair lost trust with financial institutions. Credit Suisse and VTB are now being investigated by financial watchdogs over the heavy undisclosed sovereign borrowing; both banks have been very active in the country, arranging loans for state-owned firms as well as helping with a eurobond issue. Mozambique is under huge stress due to collapsed commodity prices and worldwide economic uncertainty, as well as an acute downturn in its construction and real estate industries, which were driving the nation's boom.

After the revelation of hidden debts, the IMF has suspended its emergency aid to Mozambique, and the country is now on course for defaulting on its national debt.

In October 2015, Mozambique and the IMF announced that they had agreed on an emergency aid loan in several tranches after the currency lost about a third of its value. At the beginning of May 2016 Mozambique confessed up to holding more than $1.1 billion extra in hidden loans it had failed to inform the IMF and investors about, adding up to a total of $11.64 billion in public debt.

Unsurprisingly, the IMF was not pleased with this announcement, suspended its aid and held off its planned visit to the country in order to reassess the situation. Now, only 3 weeks later, Mozambique has missed a deadline for a scheduled repayment on the $535 million loan organised by Russia’s VTB Bank. It seems that Mozambique is rapidly spiralling downwards on course for a default.

December 2015: IMF emergency aid

As a major oil and gas producer, Mozambique has been hit hard by the low oil prices. On top of that, lower commodity prices has slowed down the country’s exports tremendously, its international debt has increased while there has been a great decline inthe foreign exchange inflow, and the currency, the metical, has deprecated about 30 per cent against the dollar in 2015. With a public debt of more than 80% of the national GDP, turning to the IMF for help has become unavoidable.

Mozambique is certainly not the only country in the region in dire need of IMF support, and talks between Zambia and the IMF are now in a final stage. Although recurring to international financial institutions seems like an attractive thing to do, they are seen as a last resort.

The IMF is known for setting harsh conditions for cutting back government spending. These are generally very unpopular with the general public as they materialise into cutting salaries of civil servant, reversing public subsidies for instance in the vital areas of agriculture and energy, and are often followed by high inflation. In the case of Mozambique, the deal with the IMF entails an 18-month programme and is focused on public spending, fiscal reform and transparency.

April and May 2016: Hidden debts and missed deadlines

Ironically, only four months later, it turned out that Mozambique had hidden two major international loans given to the state-owned companies Proindicus, worth US$622 million for maritime security projects, and Mozambique Asset Management (MAM), worth US$535 million, both arranged by Russia’s VTB Bank. Fitch estimates that, when factoring in these loans, Mozambique’s government debt was equal to 83 percent of gross domestic product in 2015.

By failing to disclose these two large loans, it has put the IMF loan in jeopardy. Reasonably, the IMF is worried that Mozambique will not be able to meet its liability commitments with this extra debt on its shoulders.

But more importantly, since none of the purposes of the hidden loans have been materialised, IMF managing director Christine Lagarde has already stated that the secret borrowing was “clearly concealing corruption”. This is extra painful as one of the objectives of the IMF programme was fiscal transparency.

After the disclosure, the IMF immediately cancelled the disbursement of the second tranche of a US$283 million emergency loan, the World Bank’s International Development Association (IDA) suspended its loans, and countries such as the UK followed suit with suspending their financial aid as well. With barely any foreign currency inflow, its foreign reserves have nearly dried up and are now well below the IMF’s recommended threshold.

Moreover, the metical has now fallen another 13 percent against the dollar. And while inflation was only 5-6 per cent in December 2015, the inflation rate accelerated 17.3 per cent last month, as a drop in commodity earnings and the weak currency pushed prices up even further.

The positive forecasts of the IMF and Fitch in December, predicting stable robust economic growth of about 6 per cent, have turned out to be 180 degrees off and Fitch has now downgraded Mozambique from B+ in December to CCC by the end of April.

This was already the situation before the MAM missed its deadline for a US$178 million interest payment with VTB on 25 May. While talks are still ongoing, VTB expects that the loan will be covered by Mozambique guarantees. However, the Mozambique government is not willing to convert the loan into its sovereign debt as this would inevitably lead to sovereign default.

June 2016: Picking up the pieces

Mozambique wants to avoid defaulting on its Russian loans, but without international aid it will not be able to do anything. To avoid further escalation, Mozambique needs to focus on stabilising the currency, curb inflation, and repair lost trust with financial institutions.

The only possible solution would be to reschedule its debt payments, but in order to do so it would have to address fiscal mismanagement and transparency. Lagarde has said that the hidden debts point at large-scale institutional corruption, and the IMF has planned to visit the country next month to discuss the situation.

It is unlikely that the IMF will cancel its emergency aid entirely, but it has become impossible to continue with the same package. Either way, almost all financial help has been suspended, VTB will not allow another grace period, keeping Mozambique on track for default in the coming days and leaving it up to the IMF to pick up the pieces.