Lessons on Ghana’s Debt for Kenyan Banks
Ghana’s fiscal mess has now reached a crescendo, with the country seeking assistance from the International Monetary Fund (IMF).
A deal with the fund will likely consist of $3 billion in funding over a three-year period. And because IMF bailouts often come with multiple strings attached, Ghana has offered a set of structural reforms and time-bound fiscal consolidation measures in response to put its debt levels and fiscal accounts on a trajectory. viable in the medium term. At the top of the list is debt sustainability.
Persistent fiscal indiscipline (spending overruns and over-indebtedness) has resulted in Ghana’s dependence on borrowing to finance budget deficits. At the end of 2021, Ghana’s total public debt stood at $58.6 billion, equivalent to 77% of its gross domestic product (GDP) (revised). Of the total debt, 48% was owed to external entities while the balance was owed to domestic entities. Commercial creditors, mostly Eurobonds, accounted for two-thirds of the total external debt portfolio.
This reliance on external commercial creditors, rather than concessional multilateral creditors, has exposed the country’s tax authorities to global fluctuations in the cost of external debt. To make matters worse, Ghana’s credit quality has recently been downgraded by rating agencies, making it difficult for the country to refinance some of the bonds in global debt markets.
Indeed, with the US Federal Reserve’s rate hike path set to peak at 4¼%, developing economies with weak public finances, such as Kenya and Ghana, will continue to be squeezed out of international debt markets.
As part of debt sustainability, Ghana has targeted the restructuring of its domestic debt portfolio, mainly due to its high cost. In 2021, Ghana’s domestic debt service was 8.3 times what it spent on external debt service. Accordingly, on September 28, 2022, the Minister of Finance of Ghana announced the formation of a five-member committee comprised of eminent financial services professionals to conduct broad stakeholder engagements across all key segments of the financial sector. – including banking, assets, management, pensions and insurance.
The purpose of the commitments will be to find an acceptable restructuring plan. A restructuring can take many different forms, but can usually result in an extension of the duration of the existing stock, a discount on interest or even a discount on principal. The banking sector is most at risk, which held half of the domestic debt portfolio. For commercial banks, this introduces risk to government debt holdings and subsequent capital allocation. This could weaken banks’ balance sheets and trigger prolonged dividend sterilization. Essentially, the adage “risk free” becomes just a perception rather than a reality.
For Kenyan banks, it should never be far from home. Ben Bernanke, the former chairman of the US Federal Reserve, summed it up nicely: “You have a neighbor who smokes in bed… Suppose he sets his house on fire. You might say to yourself, “I’m not going to call the fire department. Let his house burn. It’s good for me’. But then, of course, what if your house was made of wood? And is it right next to his house? What if the whole city was made of wood? I can say with confidence that the whole city is made of wood.
The Parliamentary Budget Office (PBO), in its note “Budget Options for 2022/2023 and the Medium Term”, cited the restructuring of Kenya’s domestic debt as a debt sustainability option due to its high costs ( as in the case of Ghana). Domestic debt service represents 74% of total public debt service, even though it represents only 48% of total debt stock. In comparison, the external debt, although it represents 52% of the total outstanding debt, represents only 26% of the debt service. This, according to the PBO, implies that domestic debt restructuring may have a greater impact on alleviating the current debt service burden.
While the Ruto administration has yet to present its debt sustainability plans, restructuring the domestic debt portfolio could be on the table (especially since the IMF has made most of the calls). This could perhaps mark the beginning of the end for lazy banking.
The author is an investment analyst. @GeorgeBodo