Ghana’s unsustainable debt: From theoretical perspectives to impact on economy – crowding out, debt hangover, others

Ghana’s unsustainable debt: From theoretical perspectives to impact on economy - crowding out, debt hangover, others
Banking and Corporate Governance Consultant, Dr. Richmond Atuahene

This paper attempts to analyse theoretical perspective behind Ghana’s unsustainable debt over 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 the Ministry of Finance and Economic Planning Annual Debt Reports 2009-202 and various Bank of Ghana Monetary Policy Committee 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 $2.5 billion-$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.

Corruption and financial irregularities at the Ministries, Departments and Agencies contributed to the rising debt over the country over the past decades.

According to the 2021 Auditor General Report, the country lost some ¢1.080 billion to various financial irregularities at the various MDAs, however, a significant drop in the ¢2.053 billion in 2020. These irregularities according to Auditor General represented either losses that had be incurred by the state through the impropriety or lack of probity in the actions and decisions of public officers or on other hand, the savings that could have been made, if public officials and institutions had duly observed the public financial management framework.

These financial irregularities have been weak feature of the country’s debt management and weak internal control systems in the MDA’s. This has  contributed to not in a way to the rising debt

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 also showed that there is a positive effect of public debt relative 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 country’s GDP and investment confirming the existence of Debt overhang effect, Crowding out and Default effect on the Ghanaian economy.

The paper further added 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 spilled  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% during the second half of 2022 there could be serious crowding out of the private sector which is said to be the 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-term 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.

With downgrades by international credit rating agencies give rise in sovereign risk that adversely affect domestic banks funding costs through several channels, due to the pervasive role of government debt in the financial system. The downgrade of the country’s public debt will reflect on the domestic banking sector depend on the concentration on their operations within the country, also depending on their reliance on sovereign derived income and their high exposure to the sovereign debt to their capital. The downgrade of sovereign debt could impact on the domestic banking in four main channels.

First, losses on holdings of government debt weaken banks’ balance sheets, increasing their riskiness and making funding more costly and difficult to obtain. Second, higher sovereign risk reduces the value of the collateral banks can use to raise wholesale funding and central bank liquidity. Third, sovereign downgrades by the credit rating agencies generally flow through to lower rating for domestic banks. increasing their wholesale funding costs and potentially impair their market access.  A weakening of the sovereign reduces the funding benefits that banks drive from implicit and explicit government guarantees