It is often said that the builders of the famous ship, Titanic, were of the view that nothing could sink the ship, except God. Almost every book on banking and finance points to the idea that government securities are ‘risk-free’. In other words, it is very unlikely that the government will default on its debt obligations, so you bear literary ‘no risk’ when you invest in securities issued by the government. So government securities are like the Titanic in banking and finance, but we are all aware of the fate that befell the Titanic in 1912 on the Atlantic Ocean.
Similarly, the fate of government securities in Ghana has crushed the long-held idea of government securities being ‘risk-free’. The Government of Ghana has technically defaulted on the payment of its GH¢ bonds by restructuring and re-issuing them anew. The banking industry of Ghana, like all other industries that invested heavily in government securities, is now faced with significant losses and other issues that threaten their very survival.
2020: A year of risk-free
It was very interesting to observe the amounts of profits banks reported in the year 2020 at the peak of the COVID-19 pandemic. Almost every sector of the economy suffered from the lockdowns and ensuing drop in production. Most businesses were not operating due to the lockdown, they had little need for their working capital and other funds. These funds of the businesses were left to the banks, which comfortably placed them in government securities. Being an election year and having COVID-19 as an excuse, the government had enough reason to borrow and spend. So, the banking industry invested in government securities and made significant profits during the year 2020. The year 2020 is the classic proof of government securities being risk-free because despite the negative effects of COVID-19, the government still honoured all coupon and principal payments.
2022: Government’s debt financing options
It is very difficult to understand why a government that did not default in honouring its debt obligations at the peak of the COVID-19 pandemic will now default two years post pandemic. The answer lies in further understanding of the concept of government securities being risk-free. It is assumed that the government finances its debts from revenue it mobilises mainly through taxation. In a case where the government’s revenue is not sufficient to meet its debt obligations, the government has two main options to pay its debts. The first option is printing money through the Bank of Ghana to pay the debt. However, printing money is not recommended during high inflation rate periods.
The second option is taking new debts to pay off the old debts. The risk with the second option is that it leaves the government at the mercy of the market. Should the market refuse to provide the government with the needed funds, there will be no other option than to default. Government Ghana cedis-denominated debts are easily resolved by using any of the two options, but foreign currency-denominated debts are best resolved using the second option. This is because the government cannot print foreign currency, and if it prints Ghana cedis to buy foreign currency to pay its foreign currency-denominated debt, it will not only lead to an increase in the inflation rate, but also the exchange rate since more Ghana cedis will be chasing less foreign currency.
In 2022, the inflation rate was very high, making the first option inadvisable, and the second option the reasonable cause of action. The government would have gone to the market as usual to borrow from Peter to Pay Paul, particularly in relation to its foreign currency-denominated debts. But the credit rating of the country was downgraded at the same time major economies like the United States increased interest rates, making them more lucrative to investors. In essence, the government could not borrow new debts to pay the old debts, and the lender of last resort became the International Monetary Fund (IMF).
DDE programme: biting the bullet
The primary issue every lender considers in the advancement of credit is the borrower’s ability to repay the interest and principal as and when they fall due. This is true for individual lenders as it is for multinational organisations like the IMF. The IMF, in assessing the ability of the Government of Ghana to repay the loan it is requesting, realised that the government is already heavily indebted. The government was, therefore, required to reduce its existing debt obligations and improve its revenue generation. To achieve this, the government undertook the DDE programme as the first step in reducing its existing debt obligations and introduced new taxes to improve its revenue generation. The banking industry of Ghana and all other industries that invest heavily in government securities are experiencing the effects of the steps the government is undertaking to manage its debt obligations.
Déjà vu: Begging for debt relief
In 2001, the Government of Ghana applied for HIPC relief due to issues of debt sustainability. After 20 years, the Government of Ghana is again seeking debt relief due to debt sustainability issues. The Ministry of Finance has identified the adverse effects of COVID-19, Russia’s invasion of Ukraine, and global monetary policy tightening as the causes of the current situation. Essentially, Ghana did nothing wrong because clearly, all the listed causes are not within our control. The problem with this way of viewing our current economic situation is that we will not do anything different, with no change in government policy and no change in industry regulation to prevent recurrence. Post HIPC, Ghana discovered oil in commercial quantities and witnessed significant growth in several industries.
Yet, 20 years later, the country is back to begging for debt relief. Ghana played a role in getting to this point of economic distress, and a comprehensive review of our economic policies and industry regulations must be undertaken to determine how to avoid the reoccurrence of this economic distress. We must put in place more checks and balances in the financial behaviour of the government, particularly in foreign currency denominated borrowings. Proper policies and strategies must be developed for borrowing and for paying back the amount borrowed rather than the regular borrowing from Peter to pay Paul strategy.
Ostrich defense: Politics of public debt management
The DDE programme was 2 years late because the ideal period for the government to have restructured its debt was in 2020, at the peak of the COVID-19 pandemic. The government, using COVID-19 as its major reason, incurred new debts to pay for the old debts and created the impression that all was well. The government acted as though it was not aware of the debt sustainability problems of the country prior to the IMF bail-out. It is important that the government be honest about the financial issues of the country to the citizenry, who are directly affected by the repercussions of unsustainable public debt. It is the honesty of the government that will encourage the citizenry to patriotically support the government in the successful implementation of measures that will help return the country to debt sustainable levels.
Private sector: The Lamborghini of the banking industry
It is often said that the public sector, particularly in Africa, is inefficient mainly because of corruption and red tape. The private sector, on the other hand, is considered efficient mainly because it operates in a competitive environment and is driven by the profit motive. Although both sectors play important roles in economic development, the private sector is seen by most economists as the primary engine of economic growth and development. However, the current effect of the DDE programme on the banking industry indicates that banks invest most of their funds in the government, not the private sector. It is easy to understand why because it makes logical sense for banks to invest in the certainty (risk-free) of government than to gamble with the private sector.
The loans given are mostly given to multi-nationals and established conglomerates that the banks are quite confident will not default. Very few banks spend time these days carefully examining the business plans of small and medium-scale enterprises to spot innovative ideas and provide them with the loans and reasonable rates that will help them grow into multi-national companies. Giving loans to start-ups, small and medium-scale companies, in the view of some banks, is synonymous with throwing money away. But in the movie entitled ‘Lamborghini: The Man Behind the Legend’, Ferruccio Lamborghini makes a profound statement when his father tells him he will throw his life away: “What better way is there to do it than in search of greatness”? What better way is there to incur impairment expense than in the search for greatness? How many banks in Ghana can boast of providing facilities to start-ups, small and medium-scale companies that have grown into multi-nationals? How many banks can boast of business development teams that have the expertise to identify start-ups, small and medium-scale companies with the potential for greatness?
The most highly rewarded business development teams in the banking industry currently are the treasury teams because they take advantage of the unstable foreign exchange rates and trade in foreign currency and take advantage of the unstable interest rates and trade in government securities. The private sector can be very rewarding if the banking industry will train their business development teams in business evaluations to identify start-ups, small and medium-scale companies with growth potential. These small companies will grow into the cash cows for the banking industry and propellers of economic growth for the country. The economy will only grow and develop if the banking industry is willing to put in the same or more investments in the efficient private sector as it puts in the less efficient government.
The author is an MPhil Finance graduate of the University of Ghana Business School and a member of the Institute of Chartered Accountants, Ghana.