A close-up of Ghana’s Debt Exchange Programme

Source: GCB Capital

…amid elevated inflation, interest rate and credit rating downgrades, and impacts on the financial market

Addressing the country’s debt burden, government on Monday, December 5, 2022 launched the Domestic Debt Exchange programme aimed at restructuring the country’s domestic debt to ensure sustainability. This programme is particularly relevant in the context of Ghana’s current economic challenges, including elevated inflation and interest rates, as well as a weakening cedi and recent multiple credit rating downgrades on the back of a deteriorating economic situation.

This programme, as indicated by government, is meant to alleviate the debt burden in a most transparent, efficient and expedited manner, which would minimise impacts from the domestic debt exchange policy on investors holding government bonds.

Overall, government’s policy for investors in this domestic debt exchange programme appears to be focused on minimising the impact on individual bondholders and assuring them that their investments will not be affected. Government states that it will not implement a principal haircut on eligible bonds, and that Treasury bills will be completely exempted from the exchange programme. Individual bondholders will not be affected, and will be able to exchange their existing bonds for new ones with longer maturities and stepped-up interest rates.

Government also emphasises that this domestic debt exchange programme is part of a broader agenda to restore debt and financial sustainability, and that it is working toward a restructuring of its external indebtedness. It is also seeking support from the International Monetary Fund.

Leading Indicators

Inflation in Ghana has been on the rise in recent months, reaching an annual rate of 50.3% in November 2022. This has put pressure on the country’s central bank to raise interest rates to curb inflation. The monetary policy committee (MPC) of the Bank of Ghana (BoG) concluded its last MPC meetings of the year in November 2022 by raising the benchmark interest rate another 250bps to 27.0% – continuing its fight against surging inflation and re-anchoring inflation expectations. This brings full-year rate increases to a historic 1,250bps (12.50%) in 2022.

A higher benchmark rate is targetted at reducing demand for goods and services, thus slowing the rate of inflation. However, this can also have negative consequences for the financial market as higher interest rates can make it more difficult for businesses to access credit, which could in turn slow economic growth and job creation.

Headline inflation is expected to peak in Q1-2023 and settle around 25% at end of Q3-2023 in their baseline scenario. However, implementation of the 2.5% increment in VAT and the pass-through effects of exchange rate losses remain significant risks.

The cedi, Ghana’s currency, has also been struggling in recent months – depreciating against the dollar and other major currencies. The cedi lost 0.73 against the greenback on the BoG’s interbank market in Nov 2022. Cumulatively, the local currency has depreciated by some 52% this year, rendering imported goods more expensive and reducing the purchasing power of businesses. This has also made it more difficult for government to repay its foreign debt, as it must use more cedis to buy the same amount of dollars or other foreign currencies.

Per 2023 budget, the Public Debt-to-GDP ratio stood at 75.9 percent at the end of September 2022; largely reflecting the impact of currency depreciation. The external debt as a percentage of total debt stock was 58.1 percent as at end of September 2022, up from the 48.4 percent recorded in 2021. The sharp growth in external debt stock was largely on account of the local currency’s sharp depreciation. The Ghana cedi’s depreciation added GH¢93.86billion to the external debt stock compared to the transaction effect of GH¢7.55billion.

Overall, the rate of debt accumulation increased from 20.7 percent at end-December 2021 to 32.7 percent for end-September 2022; reflecting the impact from depreciation of the Ghana cedi on external debt.

Impact on the financial market

Against this backdrop, the Domestic Debt Exchange programme can be seen as a potentially positive development for the financial market in Ghana. By swapping high-interest domestic bonds with lower-interest ones, the programme can save government millions of dollars in interest payments, which could be used to help boost the economy and address other challenges such as inflation and the depreciating cedi.

However, the DDE programme could also have negative consequences for the financial market which might be complex and very much uncertain. While it has potential to improve the country’s fiscal health and reduce the debt burden, it could also lead to increased volatility in the market.

The proposed interest rate being offered in this domestic debt exchange programme is 10% per year, with a stepped-up schedule starting at 0% in 2023, 5% in 2024 and 10% from 2025 until maturity. This proposed interest rate may have a number of impacts on investors.

Instructively, one potential impact of the DDE programme is on attractiveness of the new bonds compared to existing ones. Given that the current interest rate on existing bonds hovers around 38.82% for the 2-yr note and 48.71 % for the 20-yr bond, the proposed interest rate of 10% per year may be seen as less attractive to investors.

The debt restructuring programme’s details further dampened investor-sentiment and sent investors into a quandary, as there could be a potential loss on their investment in the long-term. Signals from the secondary market as of Friday, December 9, 2022 showed selling interest remained elevated while buying interest was elusive. Trading activities hovered around the medium- to long-term papers. At the far end of the curve, Jul-2033 (Coupon of 11.65%) was actively traded and settled at 40.50%, while Nov-2026 (Coupon of 19.00%) at the belly of the curve cleared at 39.03%.

The market very much expects yields to continue their upward trajectory as participants offload their holdings to reduce exposure amid elevated risk due to the proposed debt exchange programme.

In the context of Ghana’s current economic challenges – including elevated inflation, a depreciating cedi and interest rate increases – it will be important to closely monitor effects of the DDE programme and make any necessary adjustments to ensure its success.

It is worth noting that the exchange programme is not the only measure being taken by the government of Ghana to address the country’s economic challenges. For example, government has also implemented measures to increase revenue and reduce spending, such as increasing taxes and cutting subsidies. Additionally, government has been working with international organisations such as the International Monetary Fund (IMF) to obtain financial assistance and support as the staff level agreement (SLA) has been achieved in record time, marking a significant milestone in Ghana’s quest for policy support for its post-COVID-19 economic recovery efforts.

Disputes over the proposed DDE programme

Despite any possible success the domestic debt exchange programme could make, it has faced opposition from some groups within the financial sector and the public at large. These groups have argued that the programme is not sustainable in the long-term, and that it exposes investors to significant risks.

One of the main concerns raised by opponents of the programme is lower interest rates on the new instruments being offered as part of the exchange. These lower rates may not be sufficient to compensate investors for the risks associated with holding Ghanaian debt, and may make the new instruments less attractive to investors. This could limit the programme’s overall success, and hence make it more difficult for government to attract investors’ participation.

Another concern raised by opponents of the programme is its potential impact on the country’s credit rating. The programme will successfully reduce the overall cost of Ghana’s domestic debt, but has led to further a downgrade of the country’s credit rating since it was first announced. This could make it more difficult and expensive for government to borrow in the future, and could have negative consequences for the country’s economy.

Despite these concerns, government remains committed to the domestic debt exchange programme and continues to believe it is a necessary and effective tool for addressing the country’s economic challenges. The programme has been adjudged appropriate for reducing overall cost of the country’s domestic debt, and improving investor confidence and liquidity in the domestic debt market. This, when fully completed, will afford government some fiscal space to operate – as it envisages reducing, particularly, the domestic interest cost in 2023; which is estimated at GH¢31.29billion out of the total GH¢52.55billion.

These could lay the foundation for a more sustainable financial market in Ghana, and also contribute to overall stability of the country’s economy.

Addressing the Investors’ Concerns

Government can take steps to address concerns about the programme’s potential impact on the country’s credit rating. These could include implementing policies that improve overall sustainability of the country’s debt and reduce the risks associated with holding Ghanaian debt. By taking such steps, government could help convince the financial sector that the domestic debt exchange programme is a worthwhile investment and can help attract more investors.

Overall, Ghana’s government will need to take a proactive approach to address the concerns raised by opponents of the domestic debt exchange programme. By implementing policies that increase the attractiveness of new instruments being offered as part of the exchange, and which provide investors with greater confidence in the programme’s long-term sustainability, government can convince the financial sector to join the programme and support the country’s economic growth and development.

What’s next?

In conclusion, the Domestic Debt Exchange programme is a significant initiative that has potential to improve the country’s fiscal health and reduce its debt burden. The proposed interest rate may have an impact on the overall level of interest rates in the economy. If government is successful in attracting a large number of investors to participate in the exchange programme and the new bonds are widely held, this could lead to an increase in overall supply of government bonds in the market. This, in turn, could put downward pressure on interest rates more broadly, as the increased supply of bonds may lead to a decline in their prices and a corresponding increase in their yields. On the other hand, if government is unable to attract sufficient investor interest in the new bonds, this could lead to a decline in the supply of government bonds – which could put upward pressure on interest rates.

However, it is important to carefully monitor its implementation and effects and take any necessary steps to ensure its success. By working together, government, the financial market and other stakeholders can help to support the stability and growth of Ghana’s economy.

It is also worth noting that success for the DDE programme will not depend only on the actions of government and the financial market. The broader economic environment will also play a role in determining the programme’s success. For example, factors such as global economic conditions and commodity prices could impact Ghana’s economy, and in turn effectiveness of the DDE programme.

Furthermore, the DDE programme’s success will also depend on the willingness and ability of Ghanaians to support and participate in it. For example, individual investors and institutions holding domestic bonds will need to willingly exchange their bonds for new ones with different terms for the programme to achieve its goals.

To support the DDE programme’s success, it will be important for government to communicate clearly and transparently with the public about the programme and its benefits. By providing clear and accurate information, government can help build trust and support among the public – which will be essential for the programme’s success.

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