Debt Overhang and Small Business Growth in Zambia: Historical Dynamics, Transmission Mechanisms, and Policy Pathways

Abstract

Zambia's recurring encounters with sovereign debt distress, spanning the structural adjustment era of the 1980s and 1990s, the Heavily Indebted Poor Countries (HIPC) completion of 2005, a second wave of debt accumulation from 2011 to 2020, and the Eurobond default of November 2020, have produced lasting macroeconomic scars that extend well beyond the public sector balance sheet. This paper examines how successive debt overhangs have impaired the growth trajectory of Zambia's small and medium enterprise (SME) sector through four principal channels: (i) fiscal crowding out of private sector credit, (ii) persistently high lending rates driven by elevated policy rates and the risk premium embedded in government borrowing, (iii) currency depreciation and imported input cost inflation, and (iv) the contraction of public expenditure that would otherwise generate demand for SME goods and services. The paper further introduces a fifth, underanalysed transmission channel: the structural failure of monetary policy to transmit to the segment of the financial system, non-bank financial institutions, microfinance institutions, savings and credit cooperatives, and salary-backed lenders, that most directly serves SMEs and lower-income borrowers. This segment, which mobilises substantial public deposits and dominates SME and household lending in volume terms, operates on fixed-rate pricing models that are largely decoupled from the Bank of Zambia's monetary policy rate. Borrowers in this segment therefore derive no benefit from monetary policy easing, regardless of the scale or frequency of rate reductions. The paper documents the significant post-distress macroeconomic recovery of 2025 and 2026, including declining inflation, successive monetary policy rate cuts to 13.25 percent, falling government securities yields, record foreign exchange reserves, and the landmark June 2026 Eurobond buyback and assesses the extent to which these gains have, and have not yet, translated into improved SME financing conditions. It argues that while macroeconomic direction is favourable, the structural architecture of SME credit access remains deeply inadequate, and proposes a targeted policy agenda to convert macroeconomic momentum into firm-level investment and employment.