In terms of Government’s debt management strategy, borrowing money heavily from China clearly conflicts with the stated objective of “restricting foreign borrowing to the bare minimum” and reversing the 70 percent/30 percent foreign/domestic mix as it increases the foreign debt share, rather than reducing it, argues econimist and former Bank of Botswana Deputy Governor Keith Jefferies.
According to Jefferies borrowing from China doesn’t appear to be a very good deal, in terms of the government’s own strategy. It does not support the stated objective of reducing foreign borrowing and increasing domestic borrowing, and does not minimize financing risks. It is probably more expensive than borrowing domestically, and so does not meet cost minimization objectives. It also does not meet the objective of domestic capital market development. More generally, it raises the question of what is the point of having an official debt management strategy if it is going to be ignored on implementation
Following the recent visit by President Mokgweetsi Masisi and other senior officials to China, it is reported that the government intends to borrow a significant sum from China, possibly as much as USD1.1 billion, or P12 billion. The loan(s) would be applied to infrastructure development, notably the rebuilding of major trunk roads in the north and east of the country, as well to construct a new northern railway link from Mosete (north of Francistown) to Kazungula and across the new Zambezi bridge into Zambia. Assuming that the money is indeed on offer from China, part of a reported USD60 billion offered to various African countries at the recent Forum on China Africa Cooperation (FOCAC), Jefferies, who is currently Managing Director at economic think tank Econsult Botswana says the government should evaluate whether this is indeed a good deal to accept.
In a recent 2018 economic review publication, the economist argues that as a starting point, it is important to note that the Government of Botswana has many more choices with regard to the financing of infrastructure development than most African governments. He said Botswana is not obliged to borrow from China if it deems the designated projects to be worthwhile, as it could also borrow domestically (by issuing bonds) or finance the investments from its accumulated savings in the Government Investment Account (GIA) at the Bank of Botswana. With these available choices, it is important to evaluate the various options and determine, on the basis of the costs and benefits of each, which financing option(s) to use for infrastructure financing, according to Jefferies.
Government’s financing decisions are taken within the context of relevant laws and policies. The key law is the Stocks, Bonds and Treasury Bills Act, which specifies that the total of government debt and guarantees is limited to 40 percent of GDP (in two tranches, 20 percent of GDP each for domestic and foreign debt). The key policy is the Medium-term Debt Management Strategy (MTDMS), 2016-2018, which lays out the principles to be followed in managing debt. According to the MTDMS, “the primary objective of Botswana’s debt management will be to ensure that the financing needs and payment obligations of Government are met at the lowest possible cost consistent with a prudent degree of risk, and in coordination with fiscal and monetary policies while the secondary objective of the debt management will be to support the development of the domestic capital market”.
As of March 2018, total government debt and guarantees totaled 21 percent of GDP, of which 13 percent was external and 8 percent domestic, according to the Econsult boss. He added that the MTDMS notes that while the overall level of debt is well within statutory limits, the structure is far from ideal. In particular, Jefferies said there is too much foreign debt and too much debt with variable interest rates, both factors that raise the level of risk (due to fluctuations in exchange rates and interest rates). He said it therefore sets an objective of reversing the current composition of total debt from 30 percent domestic/70 percent foreign to 70 percent domestic/30 percent foreign. “To achieve the goal of having a higher proportion of domestic debt in total debt portfolio would involve restricting foreign borrowing to the bare minimum in the medium term, and prepaying some of the external loans, while continuing and/or increasing with the Government Bond Issuance Programme”
A second objective according to him is to minimize the cost of debt issuance. The MTDMS notes that in order to make an appropriate comparison between the cost of foreign debt (mostly contracted in US dollars) and domestic debt (in Pula), it is necessary to take into account changes in the Pula/US dollar exchange rate. Over the ten years from the end of 2007 to the end of 2017, the average annual change in the BWP/ USD exchange rate was 5 percent; on the assumption that this trend will continue, this has to be added to the interest rate charged on a US dollar loan to determine its true cost.
So how does the proposed loan from China stack up in terms of the legal and policy parameters regarding borrowing, he asked in rhetoric. First, he said the legal limit of 20 percent of GDP for foreign debt and guarantees translates to around P40 billion in 2018/19; with around P23 billion currently outstanding, an additional P12 billion can be accommodated with the legal limit.
In terms of the Government’s debt management strategy, clearly it conflicts with the stated objective of “restricting foreign borrowing to the bare minimum” and reversing the 70 percent/30 percent foreign/domestic mix – as it increases the foreign debt share, rather than reducing it.
With regards to the cost of borrowing, Jefferies said nothing has been said publicly about the interest rate that would be paid on Chinese loans.
“But we understand that the average rate would be around 2 percent. This may sound low, but once we add on the exchange rate impact, the total cost becomes 7 percent (i.e., 2 percent + 5 percent),” Jefferies revealed.
He also said loans from China can be compared with the cost of borrowing locally.
At the most recent government bond auction, the benchmark 10-year bond yield was just under 5 percent, and even the 25-year bond had a yield of only 5.2 percent. While the cost of domestic debt might increase if bond issuance jumped sharply, it is evident that domestic borrowing is significantly cheaper than borrowing from China, says Jefferies, further adding that it is also cheaper to issue domestic bonds than to use the savings in the GIA, which Econsult estimate to have earned an average annual return of 8.1percent over the past decade (and hence have an opportunity cost higher than the bond interest rate). In essence borrowing from the local finance and capital market means that the returns stay within the borders, money that can be used to develop the economy and further capacitate the financial sector.
On the contrary, how does foreign borrowing contribute to the secondary objective of developing the domestic capital market? Not at all, as capital market development depends on the issuance of debt instruments (such as bonds) in Pula. Indeed, domestic institutions such as pension funds and life insurance companies have long been requesting greater government bond issuance in order to meet their investment needs. Estimates prepared recently by Econsult for the pension sector conclude that the industry requires P1.5 – P2.5 billion of additional bonds each year over the next five years, with a total demand of P11 – 12 billion over the next five years , exactly the same amount as the envisaged borrowing from China. This is without factoring in potential demand from foreign investors in Pula bonds.
There are also other issues associated with borrowing from China, normally tied to procurement from Chinese firms, which may not always offer the best value. It is important to realize that the financing decision is independent of the investment decision. The infrastructure projects should be evaluated in their own right, and if they pass the economic viability tests that are (or should be) central to the development planning process, they should proceed. Once this decision is taken, the financing question can be addressed. If they are good projects, they do not depend on loans from China, but can be financed from domestic capital markets. Indeed, financing the projects from other sources enables a much more rigorous and procurement process to be undertaken based on competitive, open international tendering.