The disorderliness in Ghana’s public finances has now hit a crescendo with the country seeking the help of the International Monetary Fund (IMF).
An agreement with the fund will likely consist of $3 billion in financing over a three-year period. And because IMF bailouts often come with several strings attached, in response, Ghana has put forward a set of time-bound structural reforms and fiscal consolidation measures to place its debt levels and fiscal accounts on a sustainable path over the medium-term. Top of the list is debt sustainability.
Sustained fiscal indiscipline (expenditure overruns and debt binge) has meant Ghana’s reliance on borrowings to finance budget deficits. At the close of 2021, Ghana’s total public debt stood at an equivalent of $58.6 billion, or the equivalent of 77 percent of its (revised) gross domestic product (GDP). Of total debt, 48 percent was owed to external while the balance owed to domestic entities. Commercial creditors, predominantly Eurobonds, accounted for two-thirds of the total external debt portfolio.
This reliance on commercial external creditors, rather than concessional multilateral creditors, has exposed the country’s fiscus to global swings in the cost of external debt. To make matters worse, Ghana’s credit quality was recently downgraded by the ratings agencies, making it hard for the country to refinance some of the obligations in the global debt markets.
Indeed, with the US Federal Reserve’s rate hike path expected to peak at 4¼ percent, developing economies with weak public finances, such as Kenya and Ghana, will continue to be squeezed out of the international debt markets.
As part of debt sustainability, Ghana has targeted restructuring of its domestic debt portfolio, primarily due to its steep cost. In 2021, Ghana’s domestic debt service was 8.3 times what it spent on external debt service. As a result, on September 28, 2022, Ghana’s Finance minister announced the formation of a five-member Committee consisting of prominent financial services professionals to lead extensive stakeholder engagements across all the key segments of the financial sector – comprising banking, asset, management, pensions, and insurance.
The target of the engagements will be to find an agreeable restructuring plan. A restructuring could take different forms, but typically could entail lengthening maturity of existing stock, a haircut on interest or even a haircut on the principal. At the biggest risk is the banking sector, which held half of the domestic debt portfolio. For commercial banks, this introduces a risk on government debt holdings and subsequent capital allocation. This could weaken bank balance sheets and trigger prolonged dividend sterilisation. Essentially, the ‘risk-free’ adage only becomes a perception rather than a reality.
For Kenyan banks, this should never be far from home. Ben Bernanke, the former chairman of US Federal Reserve, best captured it: “You have a neighbour, who smokes in bed…Suppose he sets fire to his house. You might say to yourself: ‘I’m not going to call the fire department. Let his house burn down. It’s fine with me’. But then, of course, what if your house is made of wood? And its right next door to his house? What if the whole town is made of wood?” I can confidently say the whole town is made of wood.
The Parliamentary Budget Office (PBO), in its note “Budget Options for 2022/2023 and the Medium Term”, has cited restructuring of Kenya’s domestic debt as a debt sustainability option due to its steep costs (just like in the case of Ghana). Domestic debt service accounts for 74 percent of total public debt service even though it accounts for only 48 percent of total debt stock. In comparison, external debt, while accounting for 52 percent of total debt stock, accounts for only 26 percent of debt service. This, according to the PBO, implies that restructuring domestic debt can have a greater impact on alleviating the current debt-service burden.
While the Ruto administration has not yet put forward its debt sustainability plans, restructuring the domestic debt portfolio could be on the table (especially given that the IMF has been making most of the calls). Perhaps this could mark the beginning of the end of lazy banking.
The writer is an investment analyst. @GeorgeBodo