A Year of the ECF-backed Program (Fiscal Performance)
News date: 15th July 2016

Introduction

Ghana faces a looming financing crisis as a result of the way its medium-term debt strategy (MTDS) has been implemented since 2014. In the course of that year, the yield curve rose despite a US$1.0 billion Eurobond issuance. With headline inflation at 17 percent, real interest rates on short maturities reached about 8 percent at the close of the year. As yields rose, the government's focus shifted to cost minimization resulting in increasing refinancing risks despite the MTDS. The MTDS had the lengthening of the average maturity of the domestic debt stock as its primary objective. Nevertheless, several auctions of 3-year and 5-year notes were cancelled. In practice, the MTDS de facto became one of securing the government's financing needs at minimum cost.

With its focus on financial cost containment, the MTDS forced a shift in the debt portfolio composition towards the short end of the yield curve (Chart 3 below). This rebalancing towards short maturities to avoid locking in high rates into the medium term is a natural reaction of debt managers in the context of liquidity constraints and pressure to achieve overall fiscal targets. This shift, however, raised the general level of interest rates because capital is not mobile along the curve. The buyers in the long-end of the market -  the non-resident investors -are mostly foreign institutional investors who are not allowed to participate in the short-term - originally 2-year or below, now one-year and below --government debt auctions.

The shortening of maturities also gave rise to liquidity and refinancing risks, which put upward pressure on risk premiums. Given Ghana's high debt level, the consequent rise in interest rates led to perceptions of unsustainable debt which further increased the risk premium. (World Bank Report No. 95284 - GH, June 2015, paragraph 21 page10) The high borrowing cost and the consequent high interest payments on the annual budget are the result of the way the MTDS pre-existing the stabilization program was implemented and not attributable to the increases in the MPR in the IT framework of the BoG.

Deepening the domestic debt market, however, is critical to enable the government to secure a stable source of financing without recourse to monetary financing and to implement its new and more comprehensive MTDS fully, thereby reducing debt and fiscal vulnerabilities (IMF Country Report No. 15/103, April 2015, Annex 1 paragraph 4 page 35).The credibility of the auction calendar needs to be reinforced..

To achieve the objective of lengthening the domestic debt maturities and reduce refinancing risk, secondary market trading is needed. Improved secondary market liquidity would minimize the risk of investor losses when selling the security for cash. It would broaden the universe of investor base willing to purchase longer-dated securities. Shortening maturities may reduce financial cost, but deviating from schedules reduces the credibility of the debt manager, and ultimately increases the cost of financing. Policy uncertainty is a major obstacle to issuing longer-term debt and reducing rollover risk. (ibid para 57 page 24)

The joint Debt Sustainability Analysis completed in March 2015 classified Ghana at high risk of external debt distress making Ghana not eligible for the guarantee the government had requested of the World Bank to support its borrowing in the Eurobond market. A waiver of some provisions in the bank's Development Policy Financing statutes had to be obtained from the Board of Executive Directors. Success of the complementary World Bank program and its partial guarantee in support of a Eurobond of up to US$$.0 billion itself is contingent on the successful implementation of the stabilization program. Consequently, the partial guarantee is a policy-based guarantee (PBG) - requiring the prior existence and successful implementation of the stabilization program. Without the stabilization program, there could be no support (including the PBG) from the World Band or for that matter from other development partners (DPs).

To somewhat paraphrase the World Bank: Supported by its US$150 million loan and its policy-based guarantee (PBG) for up to US$1.0 billion Eurobond, Ghana's net financing requirements will remain manageable, so long as the stabilization program is successfully implemented and the new medium-term debt management strategy (MTDS) is implemented. On the other hand, inadequate implementation would undermine policy credibility, forestall the expected decline in the interest rate and destabilize the exchange rate....

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Source: CEPA