IMF points to domestic borrowing as answer to growing debt

• Posted on April 20, 2017
• by Nana Kwesi Coomson
• Comment

The International Monetary Fund (IMF) has thrown its weight behind the government’s decision to rely primarily on domestic borrowing to finance the deficit this year.

It says the country’s strong appetite for foreign debt in recent times could prove injurious to the economy in the long run, given its implication on debt refinancing and exchange rate risk.

With almost a half of the debt stock – GH¢68.9 billion or 40.8 per cent – in the hands of foreign investors, the fund noted that any attempt to refinance the fiscal deficit through foreign borrowing could worsen the debt portfolio and increase the exchange rate risk. 

In a statement to conclude the Article IV Consultation and discussions for the fourth review of the three-year Extended Credit Facility (ECF), the IMF said prudent debt management could help meet the government’s financing needs at reasonable cost while reducing debt sustainability risk. 

“Gross financing needs remain sizeable in 2017 (equivalent to 13 per cent of GDP) and the exposure to foreign investors is large,” the fund said in the statement presented by the new Mission Chief to Ghana, Ms Annalisa Fedelino, on April 13.

“This calls for a financing strategy that reduces refinancing and exchange rate risk. The mission supports the government’s medium-term debt management strategy to rely primarily on domestic currency financing while lengthening maturities and pre-finance annual borrowing needs to avoid temporary cash shortfalls,” it added.

Clear vision 

Although soothing to the government’s debt management strategy of using domestic funds to plug last year’s 8.7 per cent fiscal deficit, the fund’s comments on the need to shift to domestic borrowing could prove a challenge to the private sector.

While domestic borrowing is generally less costly and lowers exchange rate and inflation pressures, the measure could limit the outflow of credit to the private sector for growth and expansion.

Known as crowding out, intense domestic borrowing by a government means that the state is in competition with corporate institutions and individuals for the same funds. 

Given that the government can pay for such funds at any given rate, lenders will mostly prefer to lend to the government and not the private sector. Those lenders that will look to the private sector will also do that with punitive rates, then making it difficult for businesses to access funds at moderate rates to operate and expand.

The Association of Ghana Industries, which is the umbrella body of about 300 manufacturing businesses and related service providers, fears such a trend could befall the private sector if domestic borrowing picks up tremendously.

While emphasising that the 200 per cent basis points drop in the policy rate of the Bank of Ghana was soothing to businesses, the Chief Executive Officer of the association, Mr Seth Twum-Akwaboah, feared that the gains from that historic rate drop could be neutralised by any intense domestic borrowing by the government.

“On one hand, the government is trying to bring down the policy rate and reduce the Treasury bill rate to make borrowing cheaper, which is good. On the other hand, if you say you are going to rely so much on the domestic market, how will you balance the two, because that will impact negatively by way of higher interest costs.

“So, I am not seeing my way clear here,” he told the paper on April 17.

Trade-offs 

While agreeing with Mr Twum-Akwaboah’s comments, Prof. Peter Quartey of the Economics Department of the University of Ghana, Legon, said the decision to finance a deficit through domestic debt would normally depend on what the country wants to trade off and the net effect of its actions.

Beyond lowering the cost of repayment, Prof. Quartey, who is also with the Institute of Statistical, Social and Economic Research (ISSER), said domestic borrowing for debt financing often relieved a country of having to hunt for foreign exchange to meet repayment schedules.

“Also, it has implications for inflation; if you are mopping up liquidity through the sale of these bonds, it is excess money that people could spend but they are investing through the purchase of the bonds. So, it helps you to fight your inflation,” he explained.

“It is a trade-off; there are things that you will gain and others that you will lose. It depends on the net effect; whether by starving the private sector of funds at the same time ensuring exchange rate stability and balancing your finances at reduced cost which will outweigh the challenge of competition with the private sector for funds,” he added.

Going forward, Mr Twum-Akwaboah and Prof. Quartey agreed that it was necessary for the government to moderate its appetite for domestic borrowing, explaining that the measure in itself was not detrimental to businesses but the intensity with which it is done.

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