The unsustainable debt: From theoretical perspectives (crowding-out, debt hangover; and default); policy recommendations



This paper attempts to analyze theoretical perspective behind Ghana’s unsustainable debt on the past fourteen years. This enquiry is important from the standpoint of the reasons that have been discovered to be the core of the rising Ghana’s debt. The research is a qualitative study which is based on secondary data gleaned from Ministry of Finance and Economic Planning Annual Debt Reports 2009-2021[1] and various Bank of Ghana MPC reports, journal articles and books on the subject matter from the virtual and physical libraries. Governments tend to borrow financial resources from domestic as well as external sector when its tax revenues are not sufficient to meet the required financial needs.

In the Ghanaian context, there has been a gradual increasing trend in the accumulation of public debt over the past decade, as a result of annual financing gap of US$ 2.5 billion- US$3 billion that is needed to be borrowed from both domestic and international markets to finance the gap.  Over the years Ghanaian debt has been rising again because of range of factors, from after-effects of the 2008-2009 global financial crisis, energy debt between 2013 to 2016; 2017-2019 financial sector bail out, persistent budget deficits, Covid 19 pandemic and commodity pricing slowdown to low domestic savings rates and infrastructure investment promises made by democratically elected governments.

Due to narrow tax base the economy of Ghana has been facing poor growth of revenue for a number of decades, which in turn forced various government to rely on continuous borrowing both from internal and external sources to finance the budgetary deficit.  Along with its public sector corporations, owing to relatively weak financial position, also borrow from different sources.

The study shows that due to persistent borrowing, economy is burdened with public debt. Consequently, the problem of twin deficits emerged and to finance the developmental activities government has to rely on public external and domestic debt.

The study shows that there is a positive effect of public debt relate to the fact that in resource-starved economies debt financing if done properly leads to higher growth and adds to their capacity to service and repay public debt. However, this study also indicates that negative effects work through three main channels-i.e., “Debt Overhang”, “Crowding Out” and Default effects. The paper concludes that public debt has a negative influence on the GDP and investment confirming the existence of Debt overhang effect, Crowding out and Default effect on the Ghanaian economy.

The paper concludes that apart from the debt overhang, crowding and default effects, the biggest threat to Ghana’s economy is that of sharp decline in global financial conditions, which could cause higher debt servicing and refinancing risks, as well as putting stress on vulnerable sovereign bond issuances and those with unhedged foreign currency exposures and while possible default could cause collateral damage the economy.

The unsustainable debt burden could spill over to domestic banking sector as international credit rating agencies down grade as a result of deterioration of public finances, if the government continues to borrow from domestic market at higher prevailing rates between 25% to 29% over second half of 2022 there could be serious crowding out of the private sector which is said to engine of growth.

From theoretical evidence showed that developing countries like Ghana with heavy indebtedness, “external debt overhang” is considered a leading cause of distortion and slowness of economic growth (Sachs, 1989; Bulow and Rogoff, 1990) while default effect could have collateral damage the domestic banking sector as well as reputational damage on the country.

The default effect could impact negatively on the country’s creditworthiness of Ghanaian banks holding large government debt in the form of medium and long bonds and bills. This is could be largely attributed to the heavy dependence on income from the country’s central bank and government long- term gilt edged securities.

The crowding out also impacts negatively on economic growth as it slows down because these countries lose their pull-on private investors while servicing of debts exhausts up so much of the indebted country’s revenue to the extent that the potential of returning to growth paths is abridged (Levy-Livermore and Chowdhury, 1998). Next to debt overhang is the crowding out effect that has also been established to hold strong presence in the side effects of external debts.

The theory is strongly supported by studies like Claessens et al. (1996) and Patenio and Agustina (2007). Philosophy behind the crowding out effects concept assumes that government debts expend a greater part of the national savings meant for investment due to increase in demand for savings while supply remains constant, the cost of money therefore increases to make it difficult for the private sector to source funds for production which is expected to be engine of growth.

The presence of debt overhang could prevent private investment programmes due to uncertainty and adverse incentive effects it creates along the way.  Ghana’s high debt burden also could encourage capital flight through creating risks of devaluation, increases in taxation and thus the desire to protect the real value of financial assets. Capital flight in turn reduces domestic savings and investment, thus reducing growth, the tax base and debt servicing capacity. The diversion of foreign exchange to debt servicing also limits import capacity of the Ghanaian private sector, competitiveness, and investment and thus economic growth.


Heavy indebtedness of the developing countries is one of the major challenges at the beginning of 21st century. Needless to point out that government can finance its budget and development efforts by borrowing or taxing the output. However, taxes tend to distort the structure of relative prices, borrowing, if pushed beyond the carrying capacity of an economy, creates problems of intergenerational equity, and it can cause a transfer of resources that tends to be undermining growth. Yet borrowing has to be done to finance the public expenditure in order to increase social welfare and promote economic growth (Akram, 2011)[2].

Public debt can be classified as sum of external debt and domestic debt. As far as the relationship between external debt and economic growth is concerned, a reasonable level of borrowing is likely to enhance economic growth, through capital accumulation and productivity growth (Chowdhury (2001))[3]. Because at early stages of development, countries have small stocks of capital and they have limited investment opportunities. External borrowing for productive investment creates macroeconomic stability (Burnside (2000)[4].

It is also been seen as capital inflow having positive effect on domestic savings, investment and economic growth; it implies that foreign savings complement domestic savings to cater for investment demand (Eaton 1993)[5]. However, high level of accumulated debt has an adverse effect on rate of investment and economic growth. Most broad rationalization of the adverse effect of debt is “debt overhang” effect. If there is likelihood that in future, debt will be larger than the country’s repayment ability then anticipated debt service costs will depress the domestic and foreign investment [Krugman (1988)[6]; Karagol (2002)[7]].

The other channel through which debt obligations affect economic growth is known as “crowding out” effect. If greater portion of foreign capital is used to service external debt, very little remains available for investment and growth. Debt servicing cost of public debt can crowd out public investment expenditure, by reducing total investment directly and complementary private expenditures indirectly Diaz-Alejandro (1981)[8].

However, various authors [Pattillo, et al. (2002)][9] are unable to find evidence of a significant crowding out effect, while others [i.e., Chowdhury (2004)[10]; Clements et al (2005)[11]; Elbadawi, et al. (1999)][12] finds that both debt burden and debt service obligations have reduced the investment and economic performance. Default effects is simply defined as broken promise or a breach of contract. For sovereign default, including missed payment, involuntary subordination, or data misreporting.

Should government miss any repayment due any time Ghana could be described as a bankrupt or failed state like Argentina in the 1990s, and more recently Sri Lanka. Payment default is failure to pay principal, interest, or other amounts when due, after the expiration of any applicable grace period (Gooch & Klien, 1992).

In the past two decades, public debt level has been arising in the Sub-Saharan African Economic report (2017)[13] on the public debt showed that Africa’s stock of public external debt averaged about US$ 309 billion over 2000-2006 and then rose further to US$ 707 billion in 2017, with 15.5% increase from 2016 alone. The Economic Report on Africa (2018) indicated that Eritrea recorded the highest 131% of GDP; Cape Verde 129% of GDP; Gambia 122% of GDP; Congo 118% of GDP; Egypt 103% of GDP; Mozambique 112% of GDP; Mauritania 98.7% of GDP; Sao Tome 94% of GDP; Togo 77.3% of GDP; Zimbabwe 69.7% of GDP; Sudan 66.5% of GDP and Ghana 57.9% of rebased GDP in 2018 and as at June 2022 stood at 78.3% of GDP (BOG,2022).

At the same time, ratios of public debt to GDP had been rising steadily thus giving rise to worries about sovereign default and fiscal vulnerabilities. According to the report, about 60% of low-income countries in Africa faced debt servicing challenges, and an increasing number of countries are at high risk of debt distress or in default. Five countries are in unsustainable debt crisis (Zambia; Tunisia, and Egypt). Rising public debt levels are the result of swelling fiscal deficits, leading to the accumulation of domestic and external debts. Public debt stock levels of the African countries such as Mozambique, Ghana and Kenya that have discovered oil and gas over the past two decades.

The regional ratio of general government debts to the GDP has risen from 32.2% at the end of 2013 to an estimated 60% by the end of 2020. According to Aemro-Selassie (2018)[14] Sub-Saharan Africa has been confronting a pronounced rise in public debt. At the end of 2017, average public debt in the region was 57% of its GDP, an increase of 20% points in just five years (Abebe-Aemro Selassie, 2018). Compared to the developed economies, these ratios might not appear worrying but with the developing countries such as Ghana is quite worrying phenomenon, because interest rates on the public debt in Sub-Saharan Africa are much higher and public revenue collection capacity is much smaller. These countries therefore have much difficulties coping with higher debt levels in terms of principal and interest payments. Additionally, there are a number of aspects concerning the debt build up in recent years that are particularly worrying.

First of all, in the early 1990s public debt accumulation led to the Highly Indebted Poor Countries Initiative (HIPC), Multilateral Debt Relief Initiative (MDRI) and a number of bilateral debt programs. Secondly, government borrowing in Sub Saharan Africa has become increasingly non-concessional (at commercial term). Thirdly, unprecedented borrowing in foreign currencies exposed the countries to exchange rate risks. Fourthly, while foreign borrowing has increased strongly, the export revenues have grown much slower, leading to high external debt to export ratios and thus raising questions concerning the abilities and capabilities of countries to pay their domestic and external debts. Ghana is no exception to other developing countries where rising public debt are as result of swelling fiscal deficits, low domestic revenue mobilization, unfavorable terms of trade, unprecedented foreign currency borrowing exposing the country to exchange rate risk, and poor debt management strategies over the past two decades. High debt also creates uncertainty, deterring investment and innovation, and has a negative impact on economic growth.

Ghana is currently ranked highest Sub-Saharan Africa heavily indebted countries with a stunted GDP growth rate, currency depreciation, dwindling foreign exchange reserves, retarded export growth rate, a fast -dwindling income per capita and an increasing poverty level. Most of these countries, Ghana inclusive, have been trapped by hasty and distress borrowing which they are often unable to service. Worse still, they need to borrow more because of the deteriorating world prices of their primary exports, Covid 19, the global sudden rises in oil and gas prices and the Russia and Ukraine war but access to international capital markets has been cut off since downgrade by international credit rating agencies from the beginning of January 2022.

Ghana’s 2006 debt relief provided by the Paris Club of creditors motivated largely by the need to free-up resources for investment and faster economic growth led to a significant decline in the country’s debt burden in 2008. Unfortunately, 14 years after, the country is back in bigger debt crisis. Successive governments have been accumulating debt at an alarming rate while debt servicing cost has again increased astronomically to become a sour point in Ghana’s budgetary process in the last decade.

The economy is, therefore, over-burdened with massive government debt and debt service costs that consume more than half of government scarce revenue, narrowing down the fiscal space for government to invest in critical infrastructure that supports private investment and sustain growth. The recent rising global interest rates in USA, UK. Euro zone and the increasing debt burden of Ghana is pointing toward another debt crisis which may not be far ahead. It is evident that unsustainable public debt is discouraging investment and lowering growth in Ghana, thereby reducing the country’s global competitiveness, and increasing financial market susceptibility to international shock.

Over the past fourteen years.  Ghana’s public debt stock has seen a dramatic increase from GHC 9.51 billion in 2008 to GHC122.1 billion in 2016 further to GHC 393.4 billion as at the end of June, 2022 or 78.3% of the country’s gross domestic product (GDP) (BOG,2022). Out of the GHC 393.4 billion. GHC 203.4 billion (US$ 28.1 billion) represented foreign debt.   The country’s debt increased from GHC 9.50 billion in 2008 to GHC 122billion in 2016 and has further increased to GHC 393.4 billion in June 2022 by a whooping GHC 271 billion.

For Ghana, a better indicator of debt sustainability is the debt service-to-revenue ratio, a metric that reveals whether the government is generating enough revenues to pay down its debts as they mature. The challenge has always been the debt service to revenue ratio which in Ghana has in recent years risen to worrying levels, leading analysts to ask whether the country is bankrupt and heading to bankruptcy.

According to IMF debt unsustainable is when there is a non-negligible risk that, under existing and likely future policies, the ratio of debt to GDP will steadily increase, leading to default at some point. A country’s debt is usually deemed unsustainable based on a politically feasible monetary (interest rate) and fiscal (taxes and spending cuts) framework, and requires debt -restructuring of some kind to interest rates at a manageable level.

The International Monetary Fund Executive Directors after annual article IV Consultation said ” the Ghana is faced with mounting challenges, including public debt that has risen to unsustainable levels (78.3% of GDP), dwindling international reserves, declining exchange rates and   persistently large financing needs in the coming years. In the recent visit to Ghana, IMF concluded that Ghana is facing economic and social situation amid an increasingly difficult global environment.

The fiscal and public debt situation had severely worsened following the Covid 19 pandemic. At the same time, investors’ concern about downgrades, resulting capital outflows, loss of external market access and rising domestic borrowing costs. The country’s unsustainable debt could contribute to slowing economic growth, higher unemployment, accumulation of unpaid bills including that of some road contractors, a large exchange depreciation and surge in inflation to 31.7% in July,2022 deteriorating economy have triggered international credit rating agencies7 down grade since January 2022.

Unsustainable debt can lead to debt distress where the country will not be able to fulfill its financial obligations and debt restructuring is required. Default can cause the country to market access and suffer higher borrowing costs as being experienced on the domestic market in Ghana, in addition harms economic growth and investment (Hakura, 2020).


[1] Ministry of Finance and Economic Planning Annual Debt Reports 2009-2021

[2] Akram, N. (2011) Impact of Public Debt on the Economic Growth in Pakistan. Center for Policy Reduction and Social Policy Development. Islamabad.

[3] Chowdhury, K (1994) A Structural Analysis of External Debt and Economic Growth. Applied Economic Journal 26 pp 1121-1131

[4] Burnside, C and Dollar, D (2000) Aid, Policies and Growth. American Economic Review, 90 (4) 847- 868

[5] Eaton, J (1993) “Sovereign Debt: A Primer. The World Bank Economic Review. Vol 7 (3) pp137- 172

[6] Krugman, E. (1998) Financing and Forgiving a Debt Overhang. Journal of Development Economics 29(3) pp 253-268.

[7] Karagol, E. (2002): The Causality Analysis of External Debt Service and GDP / GNP: The Case of Turkey: Central Bank Review pp 39-64.

[8] Diaz Alejandro, C (1981) Open Economy; Closed Polity. Journal of International Studies Vol. 10 (3) pp 203-232

[9] Patillo, C; Poirson H. and Ricci L (2002) External Debt and Growth IMF Working Paper 02/69 IMF Washington USA.

[10] Chowdhury, K (1994) A Structural Analysis of External Debt and Economic Growth. Applied Economic Journal 26 pp 1121-1131

[11] Clements, B; Bhattacharya, R & Nguyen, T. Q (2005). External Debt, Public Investment and Growth in Low Income Countries, IMF Working Paper No. 03/249.

[12] Elbadawi, I. A; Ndulu BJ: and Ndungu, N (1997). Debt Overhang and Economic Growth in Sub-Saharan Africa. In Igbal. 2. Kanbar, R. Editors. External Finance for Low-Income Countries. Washington DC. IMF

[13] The Sub-Saharan African Economic report (2017)[13] on the public debt showed that Africa’s stock of public external debt averaged about US$ 309 billion over 2000-2006 and then rose further to US$ 707 billion in 2017.

[14] Abebe-Aemro, S (2018) The Debt Challenge to African Growth. IMF, World Economic Outlook 2018.

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