Following the recent visit by President Dr 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 Co-operation (FOCAC) – how should the government evaluate whether this is good offer to accept? 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.
It 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.
Legal and Policy Framework for Project Financing
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% of GDP (in two tranches, 20% 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 totalled 21% of GDP, of which 13% was external and 8% domestic (Figure 2). The MTDMS notes that while the overall level of debt is well within statutory limits, the structure is far from ideal. In particular, 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). It therefore sets an objective of reversing the current composition of total debt from 30% domestic/70% foreign to 70% domestic/30% 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” [para 38].
A second objective is to minimise 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%; on the assumption that this trend will continue, this has to be added to the interest rate 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%; 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.
Assessing the Options
So how does the proposed loan from China stack up in terms of the legal and policy parameters regarding borrowing? First, the legal limit of 20% 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.
Where does it stand 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%/30% foreign/domestic mix – as it increases the foreign debt share, rather than reducing it.
How about the cost? 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%. This may sound low, but once we add on the exchange rate impact, the total cost becomes 7% (i.e., 2% + 5%). We can compare this with the cost of domestic borrowing. At the most recent government bond auction, the benchmark 10-year bond yield was just under 5%, and even the 25-year bond had a yield of only 5.2%.
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. It is also cheaper to issue domestic bonds than to use the savings in the GIA, which we estimate to have earned an average annual return of 8.1% over the past decade (and hence have an opportunity cost higher than the bond interest rate).
Finally, 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 borrowing from China. This is without factoring in potential demand from foreign investors in Pula bonds over the next five years – exactly the same amount as the envisaged.
So 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 minimise financing risks. It is probably more expensive than borrowing domestically, and so does not meet the cost minimisation objective. Thirdly, it 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.
There are also other issues associated with borrowing from China, which is normally tied to procurement from Chinese firms, which may not always offer the best value. AsThe Economist wrote in September this year, when discussing the decision by the new Malaysian Prime Minister to cancel loans from China, one reason was that “we know how inflated the costs are, and how skewed the deals are in China’s favour”.
Finally, it is important to realise 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. Chinese firms would be welcome to participate in such tenders, as could firms from other countries. The pricing of projects in these circumstances is likely to be much more attractive than when procurement and project implementation is tied to specific sources of finance.
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The recent discovery of a pandemic, Covid-19, which moves at a pace of unimaginable and unpredictable proportions; locking people inside homes and barring human interactions with its dreaded death threat, is currently being felt.
Member of Parliament for Kanye North, Thapelo Letsholo has cautioned Government against excessive borrowing and poorly managed debt levels.
He was speaking in Parliament on Tuesday delivering Parliament’s Finance Committee report after assessing a motion that sought to raise Government Bond program ceiling to P30 billion, a big jump from the initial P15 Billion.
Government Investment Account (GIA) which forms part of the Pula fund has been significantly drawn down to finance Botswana’s budget deficits since 2008/09 Global financial crises.
The 2009 global economic recession triggered the collapse of financial markets in the United States, sending waves of shock across world economies, eroding business sentiment, and causing financiers of trade to excise heightened caution and hold onto their cash.
The ripple effects of this economic catastrophe were mostly felt by low to middle income resource based economies, amplifying their vulnerability to external shocks. The diamond industry which forms the gist of Botswana’s economic make up collapsed to zero trade levels across the entire value chain.
The Upstream, where Botswana gathers much of its diamond revenue was adversely impacted by muted demand in the Midstream. The situation was exacerbated by zero appetite of polished goods by jewelry manufacturers and retail outlets due to lowered tail end consumer demand.
This resulted in sharp decline of Government revenue, ballooned budget deficits and suspension of some developmental projects. To finance the deficit and some prioritized national development projects, government had to dip into cash balances, foreign reserves and borrow both externally and locally.
Much of drawing was from Government Investment Account as opposed to drawing from foreign reserve component of the Pula Fund; the latter was spared as a fiscal buffer for the worst rainy days.
Consequently this resulted in significant decline in funds held in the Government Investment Account (GIA). The account serves as Government’s main savings depository and fund for national policy objectives.
However as the world emerged from the 2009 recession government revenue graph picked up to pre recession levels before going down again around 2016/17 owing to challenges in the diamond industry.
Due to a number of budget surpluses from 2012/13 financial year the Government Investment Account started expanding back to P30 billion levels before a series of budget deficits in the National Development Plan 11 pushed it back to decline a decline wave.
When the National Development Plan 11 commenced three (3) financial years ago, government announced that the first half of the NDP would run at budget deficits.
This as explained by Minister of Finance in 2017 would be occasioned by decline in diamond revenue mainly due to government forfeiting some of its dividend from Debswana to fund mine expansion projects.
Cumulatively since 2017/18 to 2019/20 financial year the budget deficit totaled to over P16 billion, of which was financed by both external and domestic borrowing and drawing down from government cash balances. Drawing down from government cash balances meant significant withdrawals from the Government Investment Account.
The Government Investment Account (GIA) was established in accordance with Section 35 of the Bank of Botswana Act Cap. 55:01. The Account represents Government’s share of the Botswana‘s foreign exchange reserves, its investment and management strategies are aligned to the Bank of Botswana’s foreign exchange reserves management and investment guidelines.
Government Investment Account, comprises of Pula denominated deposits at the Bank of Botswana and held in the Pula Fund, which is the long-term investment tranche of the foreign exchange reserves.
In June 2017 while answering a question from Bogolo Kenewendo, the then Minister of Finance & Economic Development Kenneth Mathambo told parliament that as of June 30, 2017, the total assets in the Pula Fund was P56.818 billion, of which the balance in the GIA was P30.832 billion.
Kenewendo was still a back bench specially elected Member of Parliament before ascending to cabinet post in 2018. Last week Minister of Finance & Economic Development, Dr Thapelo Matsheka, when presenting a motion to raise government local borrowing ceiling from P15 billion to P30 Billion told parliament that as of December 2019 Government Investment Account amounted to P18.3 billion.
Dr Matsheka further told parliament that prior to financial crisis of 2008/9 the account amounted to P30.5 billion (41 % of GDP) in December of 2008 while as at December 2019 it stood at P18.3 billion (only 9 % of GDP) mirroring a total decline by P11 billion in the entire 11 years.
Back in 2017 Parliament was also told that the Government Investment Account may be drawn-down or added to, in line with actuations in the Government’s expenditure and revenue outturns. “This is intended to provide the Government with appropriate funds to execute its functions and responsibilities effectively and efficiently” said Mathambo, then Minister of Finance.
Acknowledging the need to draw down from GIA no more, current Minister of Finance Dr Matsheka said “It is under this background that it would be advisable to avoid excessive draw down from this account to preserve it as a financial buffer”
He further cautioned “The danger with substantially reduced financial buffers is that when an economic shock occurs or a disaster descends upon us and adversely affects our economy it becomes very difficult for the country to manage such a shock”