New Debt Situation And Prospects. In 2024, more low-income countries are facing debt distress or are at risk of debt distress than ever before. According to the latest IMF low-income country debt sustainability analysis. 10 countries are in debt distress, while 52 countries are at moderate or high risk of debt distress. Out of these 62 countries, 40 are in Africa.
Understanding the Growing Debt Situation And Prospects
African countries have suffered gravely a Debt Situation And Prospects from global shocks such as the COVID-19 pandemic, the war in Ukraine. And the spillover effects of high interest rates in many developed countries, which have increased debt levels across the continent. Debt levels are particularly high in the continent’s larger lower middle-income economies. Including Egypt at 92 percent of GDP, Angola at 84.9 percent, and Kenya at 70.2 percent.
Managing Domestic Debt in African Economies: Challenges and Strategies
For many African countries, the growing debt levels and associated high debt servicing costs are an impediment to long-term sustainable economic growth prospects. Revenues have also not kept up with expenditures. In sub-Saharan Africa, average government revenue declined from 19.7 percent of GDP in 2010 to 17.5 percent in 2023. Shrinking revenues in the face of higher debt servicing costs further limit the scope for public expenditures, setting back progress towards the SDGs while increasing pressures for additional borrowing.
Whether debt is external or domestic can be assessed based on three criteria. The currency of issuance, the governing jurisdiction, or the residence of debt holders. Domestic debt can therefore be described as debt that is issued in the sovereign’s local currency or that is governed by the domestic sovereign’s laws. Additionally, it is debt that the citizens of the issuing sovereign hold.
The African Debt Dilemma: Causes and Consequences
Most African countries have historically relied on external debt in the form of long-term concessional financing from multilateral and bilateral lenders or non-concessional private finance. However, in efforts to diversify financing sources and reduce the risks of external debt vulnerabilities. Many countries have increasingly turned towards domestic debt markets over the past two decades, reflecting a trend seen more broadly across developing countries. In emerging markets and developing economies, on average, domestic debt made up approximately 58 percent of debt in 2022. And accounted for approximately 66 percent of government debt accumulation since 2010.
Domestic debt has, however, presented a new set of challenges to debt sustainability. The S&P Global Africa Domestic Debt Vulnerability Index ranks Egypt, Ghana, Kenya, Mozambique, Angola, and Zambia among the most vulnerable countries as of 2023. Due to limitations in data availability, subsequent data analysis in the brief will focus largely on these countries. Figure 1 shows the total public debt in selected countries, with the corresponding share of domestic debt. Figure 2 shows the trend in domestic debt accumulation in the selected countries.
Potential benefits derived from domestic debt in Africa
Most of the domestic debt in Africa is denominated in local currencies and is therefore shielded from exchange rate volatility and currency mismatches. Since 2022, a number of African currencies have recorded significant depreciation against the US dollar, as shown in figure 3. Currency depreciation leads to an increase in foreign currency-denominated external debt. In Kenya, for instance, as of December 2023, external debt—67.3 percent of which was dollar denominated—increased by $1.3 billion. Owing in part to the depreciation of the Kenyan shilling. As well, approximately 98 percent of Ghana’s external debt stock growth in 2023 was a result of the cedi’s depreciation against the dollar. Nigeria’s external debt in 2023 also increased by 100.1 percent over a year because of the naira’s depreciation. Avoiding sharp and unexpected depreciation of domestic currencies can ensure that governments maintain predictability on domestic debt stock and movements. In addition to this, the issuance of debt in domestic currency grants central banks and governments flexibility to employ monetary policy tools in domestic debt management.
Debt Situation And Prospects:
Well-developed domestic public debt markets provide local investors with opportunities to invest in government securities, thus presenting a two-pronged advantage. Firstly, domestic investors are able to participate in the economy while deriving a decent return on their investment. Given the relatively low risk and attractive interest rates on government securities. Figure 4 shows domestic debt in selected African countries.
Illustrating the relatively small non-resident holdings of domestic debt in most countries. Secondly, governments, by sourcing financing from the domestic market, reduce the risk of capital outflows. Some countries have measures in place to reduce capital outflow exposure. Zambia, for instance, which, as shown in Figure 4, has a relatively higher non-residents participation in the domestic debt market. Has enacted measures to limit non-residents participation in the primary market of government bonds to 5 percent to lower external pressure on debt sustainability.
Domestic debt defaults tend to be rarer than external debt defaults.
This could be because policymakers have the option of inflating domestic debt rather than resorting to outright default (Herman, Ocampo, and Spiegel, 2012). Also, in countries where domestic financial institutions are the main holders of government domestic debt. The effects of a domestic debt default could be severe and, if not properly managed. Could result in a widespread financial crisis. In the case of debt default, domestic debt tends to be easier to restructure since it is subject to the jurisdiction of domestic courts. According to a case study the IMF conducted on debt restructurings. Between 1988 and 2020, domestic debt restructuring took a lot less time to complete than external debt restructuring. Largely because domestic debt is subject to more sovereign control over the terms and laws governing it. Additionally, by restructuring domestic debt. Countries can avoid the reputational costs associated with external debt restructuring and, in some cases, maintain access to external finance.
Risks associated with domestic Debt Situation And Prospects
Increased reliance on domestic debt, even with the benefits outlined above, carries risks that. If not well managed, could be detrimental to economic growth. One of the key arguments against domestic debt. Is that it can entail significant crowding-out effects for the domestic private sector. When the government is the largest borrower, credit from banking and non-banking financial institutions available. To the private sector could diminish (Bua, Pradelli, and Presbitero, 2014). Arnone and Presbitero (2010) note that domestic public debt. Might undermine economic activity through crowding out effects and inflationary pressures if it represents a large share of bank deposits. In Egypt, as of October 2023, domestic public debt was approximately 77 percent of total domestic credit.
In Kenya, as of 2022, the exposure of financial institutions to government securities was approximately 40 percent of the total deposits. As a result, the private sector is more credit constrained than the public sector in many African countries. This in turn curtails the private sector’s growth potential since reduced private credit discourages investments in the private sector. Ultimately, crowding out can affect government revenue in the long run if the private sector taxable base grows at a subpar pace. Which could in turn in to a Debt Situation And Prospects to the government’s ability to repay its debts. Banks may also find it challenging to adequately diversify their risks if the high cost of capital. Leaves a preponderance of more risky projects seeking finance.
Shifting Trends: From External to Domestic Debt Financing
Another considerable challenge is the maturity structure of domestic debt instruments. Many developing countries are unable to issue long-term government instruments at reasonable interest rates, in turn issuing mainly short- and medium-term securities (0–9 years). As of 2022, Zambia and Kenya’s domestic debt portfolios comprised 78.5 percent and 77.8 percent of short- and medium-term securities, respectively. The proportion was even higher in Ghana. Where short- and medium-term securities accounted for approximately 89.8 percent of marketable instruments at the end of 2022. This short-term maturity structure increases rollover risks because governments continually borrow to settle maturing obligations, thus risking macroeconomic instability.
High domestic debt service burdens in some African countries weigh heavily on government finances. Further reducing spending that could be directed to investments in critical sectors such as health, education, and infrastructure. Figure 5 compares domestic and external debt service payments in selected African countries in 2022. In this time period, in all the countries below, domestic debt service was higher than external debt service, despite domestic debt stock being lower than external debt stock.
Mozambique, for instance, paid 5.5 percent of GDP in service for domestic debt, which was a quarter of the total debt stock. Compared to 3.1 percent of GDP for external debt, which made up three quarters of the debt stock. Even more alarmingly, in 2022, Kenya, Uganda, and Zambia spent less on education than they did on domestic debt service. At approximately 4 percent, 2.5 percent, and 3.5 percent of GDP, respectively.
Tackling Challenges: Crowding Out Effects and Maturity Structure Concerns
In principle, policymakers could lower the cost of domestic debt servicing by inflating the debt. In such cases, governments may adopt expansionary monetary policies to increase inflation, thus effectively lowering the real value of their debt. While this might have some short-term benefits, in the long term, high inflation may reduce investors’ confidence. Increase the cost of borrowing through an inflation-risk premium, and affect the long-term performance of the economy.
Why they have a Debt Situation And Prospects?
In some African countries, average real interest rates on domestic debt tend to be higher than the nominal interest rate on external debt. This is, however, not always the case because of high inflation in many countries.
According to the IMF, the projected average real interest rate on domestic debt for Ghana and Zambia over the period 2023–2032 will be lower than the nominal interest rate on external debt. Figure 6 shows the 10-year government bond yield in selected countries, with Kenya and Nigeria above 18 percent as of March 2024.
This high yield spread, compared to the US 10-year government bond yield of 4.21 percent. Illustrates the high-risk perception of many African sovereign debt instruments. Market sentiments, including preference for short-term maturities, as well as a narrow investor base. Some of the factors that could drive up the interest rate on domestic debt.
Towards Sustainable Debt Management: Strategies for African Nations
Implications of domestic debt restructuring on the financial sector and broader economy. Ghana’s experience Ghana’s debt defaults (external and domestic) and the subsequent restructuring have put the spotlight on domestic debt in Africa. The country’s public debt has steadily risen in the last decade. From 55.4 percent of GDP in 2015 to 76.6 percent in 2021.
With 15 outstanding Eurobonds at the end of 2022, Ghana’s access to international financial markets was the driving force behind this trend. In the same time period, domestic debt grew from 22.4 percent of GDP to approximately 39.6 percent of GDP. Mainly because of government borrowing to finance the energy sector and to bail out the finance sector following the 2018–2019 financial crisis. The COVID-19 related expenditure also increased debt by approximately 4.6 percent of GDP in 2020.
At the time of default in December 2022, total public debt stood at 92.3 percent of GDP. Some of the factors contributing to the default included an inflated import bill due to the effects of the war in Ukraine. A drastic depreciation of the cedi, and an increased cost of debt service. At the same time, external shocks triggered significant capital outflows and diminished access to international financial markets. Moody’s and Fitch downgraded the country’s sovereign credit rating in September 2022. Foreign exchange reserves dwindled to 2.7 months of import cover at end-December 2022, down from 4.3 months at end-December 2021.
Balancing Act: Managing Debt Servicing Burdens and Public Expenditures
In December 2022, the government initiated a domestic debt exchange program. Aimed at restoring sound public finance management and debt sustainability. Domestic bond holders were offered a chance to exchange their holdings. With a fresh issuance of bonds with longer average maturities and lower coupon rates. New bonds were issued at a coupon rate staggered between 0 and 10 percent. Before the exchange, interest rates for 2–6-year notes ranged between 21.5 percent and 29.85 percent. Although the program managed to lower interest rates on government securities and lengthen their maturities, analysis. By the country’s financial sector regulators showed that it adversely affected the solvency of some banks and insurance companies.
The government formed the Ghana Financial Stability Fund to minimize the impacts of the restructuring process on the financial sector. And to avoid the risks of a potential financial crisis. The IMF demanded satisfactory completion of the domestic debt exchange program as a prerequisite for continued engagement with external creditors. The restructuring also took a relatively short time, with the domestic debt exchange program concluding successfully in 2023. In January 2024, Ghana reached an agreement with official creditors under the G20 Common Framework on Debt Treatment.
Domestic Debt Situation And Prospects
Ghana’s experience with domestic debt restructuring can teach us some valuable lessons. This includes the need to protect the banking sector against the negative effects of a domestic debt default. Importantly, countries should focus on protecting vulnerable individuals by enhancing social protection during times of economic difficulty. Ghana will quadruple the benefits granted through the cash transfer program aimed at low-income people by 2023. The government also increased spending on education and health care. Strong financial and monetary policies aimed at restoring macroeconomic stability and debt sustainability have helped Ghana maintain its growth momentum throughout this experience.
Inflation fell from 54.2% in December 2022 to 23.2% in February 2024. The economy also increased at an average rate of 2.8% in the first three quarters of 2023, nearly doubling the government’s initial estimate of 1.5% GDP growth. The International Monetary Fund (IMF) stated that “ambitious structural fiscal reforms are bolstering domestic revenues. Improving spending efficiency, strengthening public financial and debt management, preserving financial sector stability. And enhancing governance and transparency, and helping create an environment more conducive to private sector investment.”
How can African nations effectively access and manage their domestic debt?
Domestic debt is a significant source of financing for African countries. However, it remains a potential source of vulnerability, and the effects of defaulting on domestic debt can quickly spread throughout the economy. Short-term maturity preference, a restricted, or financial sector focused, investor base, and high interest rates will continue to put domestic debt’s viability at risk. If these issues remain, governments will continue to struggle to meet debt repayment obligations, compromising debt sustainability.
African countries must enhance macroeconomic policies, debt management, and regulatory frameworks to ensure the long-term viability of their domestic debt. To begin, a stable macroeconomic environment, particularly a low and stable inflation rate. Is required to boost investor confidence and desire for medium- and long-term government debt securities. Furthermore, a diverse investor base, including non-financial institutional investors, is essential to mitigate the danger of a private credit crunch induced by financial institutions’ excessive exposure to government lending.
This will also hasten the establishment of domestic bond markets, increasing resilience to global shocks by lowering reliance on external borrowing. Finally, and most significantly, debt funds must be used wisely. Such as by investing in high-return projects, to secure governments‘ capacity to service their debt commitments in the long run.
Assessing the Benefits of Domestic Debt: Opportunities and Risks
As African governments strive for an optimal debt structure, they will need to develop their debt sustainability frameworks in order to effectively balance the trade-offs associated with domestic debt. Failure to act quickly on this will only worsen current debt vulnerabilities. Ieopardizing development progress and pushing the SDGs even further out of reach for the poorest nations.
The Monthly Briefing on the World Economic Situation and Prospects is part of the Global Economic Monitoring Branch’s (GEMB). Is monitoring and analytical efforts of UN DESA’s Economic Analysis and Policy Division (EAPD). Nelly Rita Muriuki prepared this issue under the direction of Hamid Rashid (Chief, GEMB) and general guidance from Shantanu Mukherjee (Director, EAPD).
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