In late-September 2018, I appealed to Sub-Saharan African (SSA) states to find credible and sustainable alternatives to sovereign guarantees, which are used indiscriminately to support almost all public sector and quasi-fiscal loans, both commercial and non-commercial projects, and crystalise immediately as public debt.
The occasion was a roundtable event in Abidjan (Cote d’Ivoire) on project financing organised by TXF (Trade Finance) Network and co-sponsored by African Development Bank (AfDB) and others.
These conditions for guaranteed loans, notably their inclusion on gross basis as “pure” public debt in SSA’s debt sustainability analysis (DSA) retards the continent’s development and progress.
The evolution of convincing and credible alternatives may take time but SSA states can start with commercially-viable projects that can generate revenues to pay for most loans.
SSA Finance Ministers, especially those that have attained “middle income country” (MIC) status, and are losing access to concessional loans and grants, must work harder on alternative financial and fiscal regimes to replace sovereign guarantees.
Criticisms: SSA Debt Sustainability Analysis (DSA)
Most sovereign guarantees have no real value except to provide a comfortable cushion against risk for lenders. SSA is probably the only region where a country’s DSA is “grossed-up” absolutely and not calculated within the acceptable “contingent liability” that is used in other regions. The approach ignores loan repayment terms, conditions and structures that should minimise the risk of non-payment or default. We cite specific examples of DSA “grossing” to buttress the point.
- Debt service (reserve) accounts: where state asset are verifiable on-lending, escrow and debt service (reserve) accounts that rely on revenue flows from a project and separate them from general budget funds.
- Sinking funds (SF) and sovereign wealth funds (SWF): resource-rich and MIC states (e.g., Ghana, Nigeria and Angola) have set up SF/SWFs to leverage the capital markets to improve their financing and management of commercial projects and underlying debt.
- Loans for refinancing: SSA states are borrowing long-term funds to refinance existing debt to minimise the“roll-over” risks posed by short-term debt to allow for the use of SF/SWFs to service the debt over a longer tenor or repayment period.
As practical example, the Ministry of Finance uses a Sinking Fund (SF) under the Petroleum Revenue Management Act (PRMA) passed by Parliament to exchange or redeem Ghana’s Sovereign Bonds, through secondary market “buy-backs”. A second example is Ghana’s commodity-backed China Development Bank (CDB) facility for its gas pipeline and processing plant infrastructure.
The loan is repaid through debt service (reserve) accounts, fed from “ring-fenced” petroleum flows. The price for the product is benchmarked to “Brent” and paid into the relevant accounts at Bank of Ghana (BOG) and CDB.
The final example is proceeds from the US$1 billion 2015 Sovereign Bond that was“ring-fenced” paid into a BOG “escrow” account in a New York bank—under the Prospectus and against a World Bank guarantee.
The exclusive purpose was to refinance or replace existing short-term domestic and foreign debt under a soft-amortisation plan that allowed the country to extend the tenor or maturity date to 15 years—to allow gradual repayment of several “bullet” bonds from the Sinking Fund.
Needless to say the DSA ignores all the “asset” accounts underlying these loans, resulting in triple DSA jeopardy: setting aside (a) a solid World Bank/IDA-backed guarantee; and (b) a verifiable “cash” (asset) against the loan (liability) accounts and balances; while (c) “double-counting” as debt, both the 2015 Sovereign Bond and existing short-term debt they were to replace.
Alternative structures to sovereign guarantees
Despite these setbacks, SSA’s MIC-states must persist in creating these market-friendly debt service structures that work in advanced and emerging economies. They should also push for “offsets”, based on “contingent liability” DSA mechanisms, as an equitable move that will require enormous fiscal discipline on the part of SSA states.
- Improved interest payment in Budgets: SSA states inefficiently spend substantial amounts on short-term loans, mainly Treasury Bills, to finance capital budgets. The outcome is high domestic borrowing costs which they can reduce by strategic use of long or medium-term debt instruments.
- Deficit and borrowing: MIC-Africa must not view tactical loan policies as secondary to revenue mobilisation and expenditure plans for controlling budget deficits. It results in poor borrowing strategies, often under the central bank’s short-term open market operations (OMO) for central banks.
- Debt management structures: Against this background, MIC-Africa must set up Debt Management Offices to improve oversight of borrowing, debt service, and debt stock obligations under recognised domestic and foreign capital market mechanisms.
- Debt service accounts: MIC and resource-rich SSA states must create “escrows” (i.e., debt service accounts) from the revenue flows from commercial projects—to complement SFs and SWF flows that leverage the capital markets for funds. These debt service accounts must be set aside from general budget flows for recurrent expenditures.
- Public Accounts: The coding and classification for loans and debt service accounts must be properly defined in Charts of Accounts (COA) and public accounts frameworks, including IFAC’s IPSAS and IMF’s GFS rules and nomenclature.
- Contingent liabilities: The ultimate fiscal goal is use the “ring-fenced”debt service accounts to assess the probability of debt default or non-payment in DSAs. This is to prevent unnecessary grossing-up of debt and, consequently inflating the debt-to-GDP and other ratios SSA DSAs.
These enhancements will necessitate the setting up of sound treasury management practices and development of domestic capital markets, including the gradual shifting of medium-term bond issuances to domestic and external stock exchanges or capital markets.
SSA consistency will pay — examples that work
A notable exception to “grossing-up” in Ghana is COCOBOD’s annual loans for buying cocoa from thousands of farmers. A reason given for its success and competitive nature is that they are short-term loans. However, since other short-term loans have not matched the terms of the cocoa loans, a more credible explanation lies in the Board’s consistent use of escrow accounts to service the debt since 1993.
The Board does not repatriate the debt service component of the revenues from crop sales overseas. The probability of default is minimised. Hence, while the cocoa loans are approved by Parliament under the 1992 Constitution, they are not added to public debt, unlike the borrowing by other state-owned enterprises (SOEs). Yet there continues to be more reminders of the Board’s quasi-fiscal status than the market advice it needs to improve on its market performance.
As noted, the confidence of finance houses has enhanced the facility’s competitiveness at about Libor plus two per cent. Ghana is keen to duplicate this model and has ring-fenced the “airport tax” to attract financing for its newest Terminal 3 project at the Kotoka International Airport for international flights.
Conclusion—inclusion in structural reforms
While the need for improved debt management mechanisms has become key, at a point in 2015, as crude oil prices fell precipitously, there was pressure on Ghana to “sweep” the Sinking Fund to reduce the Budget deficit under an IMF ECF Programme.
It persisted in keeping the SF account and this has yielded dividend since, from 2014 to 2016, Ghana used about US$500 million of SF flows to redeem a large part of the US$750 million obligation on its first 10-year Sovereign Bond.
The debt management methods must form part of best practice and generally-accepted accounting principles in MIC-Africa’s structural reforms, such as the World Bank’s Integrated Financial Management Information Systems (IFMIS). The loan and debt service accounts must be part of Charts of Accounts that code and classify fiscal transactions under nomenclatures such as the IMF’s Government Fiscal Statistics (GFS) and IFAC’s International Public Sector Accounting Standards (IPSAS).
A very important reform move is for MIC-Africa to shift from cash-based methods to IPSAS (semi) accrual accounting rules that recognise both escrow (i.e., assets) and loan (i.e., liability) accounts in audited Public Accounts to make them relevant to, and evident in, DSA computations.
The writer is a former Minister of Finance