OVER the past 18 months, interest rates on government debt in the UK, Eurozone, and United States have dramatically increased.
This is in response to core inflation numbers exceeding the market’s expectations. This development puts upward pressure on interest rates of any new public debt for Ghana and presents a dynamic where existing debt must be refinanced at a higher rate.
This situation can accelerate the risks associated with being over-leveraged and create an acceleration in the cedi’s depreciation and domestic inflation.
Any policies/spending implemented must consider the global macroeconomic cycle to maximise any debt proceeds.
Implications of excessive debt accumulation on the economy
The recent increase in public debt has long-term implications for the economy. Evidence from the empirical literature on the impact of debt on the economy suggests excessive debt accumulation can result in debt overhang.
At a certain level, which the IMF defines as 60 per cent debt to GDP for developing countries, the potential debt overhang discourages domestic and foreign investments due to the higher marginal tax rates those investments will likely face.
The long-term implication being lower living standards (Ndikumana et al., 2020). Moreover, as total debt service costs for total government expenditure rise, the resulting budget deficits increase long-term interest rates, crowding out investment in the private sector and further hurting economic growth (Kumar & Baldacci, 2010).
Tax and government expenditures
The magnitude of the increase in debt in recent years raises concerns about its implications for public expenditures and domestic revenue mobilisation.
When the ratio of debt to GDP for a developing country rises beyond 60 per cent, the following are likely to occur as the government budgets to meet estimated debt service requirements: (i) cuts on government expenditures; (ii) increase domestic revenue mobilisation efforts.
The former poses a challenge to public spending that affects poverty-reducing social sectors and critical infrastructure investments with implications for current and future economic welfare.
Evidence from literature shows that most SSA countries respond to rising debt levels by cutting social and capital expenditures (AfDB, 2018; Mahdavi, 2004; Mello, 2008).
This is clearly illustrated in Figure 19. Since 2015, the interest expense on public debt has exceeded health and education expenditures.
Currently, health expenditures are less than 10 per cent of total government expenditures, falling from about 29.5 per cent in 2011 to 7.6 per cent in 2020.
Education expenditures have also declined, falling from 20 per cent in 2015 to approximately 15 per cent in 2020. In 2022, total interest expense is projected to be 27.2 per cent of the 2022 budgeted total government expenditure, and the largest expenditure item for the year.
Therefore, it is of critical importance for fiscal consolidation efforts by the government to target recurrent expenditures, such as interest expense due to debt overhang, and not social or capital expenditures, as doing so will compromise accelerated growth, poverty reduction, and the country's progress towards attaining sustainable development goals.
Addressing domestic revenue shortfalls: Is E-levy the solution?
In recent years, Ghana's revenue mobilisation efforts have lagged behind the pace of debt growth.
At the end of December 2021, the Total Revenue and Grants to GDP stood at 15.3 per cent (domestic revenue was 15.2 per cent of GDP); Tax Revenue to GDP was 12.3 per cent. In comparison, total expenditures to GDP was 25.1 per cent.
It’s worth noting that at the end of 2021, compensation of employees (including wages and salaries, pensions & gratuities, and other wage-related expenditure) and total interest payments accounted for 47.5 per cent and 50.4 per cent of domestic revenue, respectively.
The generally low tax base is a source of concern, and innovative strategies which would enhance revenue mobilisation efforts while not compromising the welfare of the vulnerable in society are urgently needed.
The government has proposed to introduce an "Electronic Transaction Levy" or "E-Levy" in the 2022 budget, to take effect from February 1, 2022.
The levy is imposed on mobile money payments, bank transfers, merchant payments, and inward remittances which will attract a rate of 1.75 per cent, to be borne by the sender, except inward remittances, which the recipient will bear (Ministry of Finance, 2022 Budget).
Although the levy is expected to expand the tax net, at least in the short term, the burden is likely to fall more heavily on the side of the market that is less responsive to the changes in transaction costs from the imposed levy.
In other words, the relative responsiveness of supply and demand for electronic transactions will determine the welfare impact of this levy. Demand may be less responsive and, as a result, would impact consumers negatively.
Public debt jeopardising single currency (Eco) prospects
While no member state of the Economic Community of West African States (ECOWAS) consistently meets the convergence criteria for the introduction of the Eco, Ghana’s rising public debt is further jeopardising its ability to consistently meet the convergence criteria for joining the Eco.
The proposed Eco now scheduled for introduction in 2027 is hinged on the attainment of a convergence criteria made up of four primary and two secondary criteria.
The primary criteria include single digit year end inflation, fiscal deficit including grants not exceeding three per cent of GDP, central bank financing of fiscal deficit not exceeding 10 per cent of previous year’s tax revenues and gross foreign reserves of at least 3 months import cover.
The secondary criteria for convergence are exchange rate depreciation not exceeding 10 per cent and debt to GDP of not more than 70 per cent.
Public debt is regarded as the most important criterion as a sustained attainment of same will be a launch pad for the achievement of the remaining criteria (Olowofeso et al, 2021).
To keep public debt under control requires fiscal discipline; an essential ingredient in keeping a stable exchange rate and subduing inflationary pressures, particularly imported inflation.
Additionally, there will be no need to utilise external reserves to support stability of the exchange rate. Ghana’s public debt has trended above the convergence threshold of 70 per cent of GDP from 2020, putting the country at a high risks of debt distress.
The effects of the public debt level on meeting the convergence criteria are exacerbated by the growing component of external debts. This magnifies susceptibility to external shocks.
The Ghana Cedi is experiencing one of its worst performances in recent times, depreciating around 22 per cent within the first five months of 2022.
This compelled Bank of Ghana to intervene at the peril of international reserves. Inflation for May 2022 is at an almost 30 year high of 27.6 per cent (Bank of Ghana).
High public debt, weakening currency and rising inflation are driving up cost of borrowing as investors look for higher returns for the elated risks associated with Government of Ghana instruments.
The attendant high interest costs are widening current account deficit well beyond the three per cent envisaged for convergence. The international capital market has also become inaccessible to Ghana implying stronger push for Central Bank financing of government’s budget gap.
The lack of access to the international capital market leaves government with little room to manoeuvre but to crowd out the private sector in the domestic market.
This is filtering through in the increasing allocation of bank assets to investments in government securities. Ghana also becomes vulnerable to predatory bilateral lenders. Both are counter to GDP growth.
The unsustainable public debt levels do not only pose dire consequences to sustainability of the country’s economy in the short term but also hampering its medium to long term prospects including advantages associated with being a member of a regional monetary union like the Eco.