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Econsult advises against P12billion China loan

Introduction

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.

Adopted from the Econsult Economic Review.

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China’s GDP expands 3% in 2022 despite various pressures

2nd February 2023
China’s Gross Domestic Product (GDP) expanded by 3% year-on-year to 121.02 trillion yuan ($17.93 trillion) in 2022 despite being mired in various growth pressures, according to data from the National Bureau Statistics.

The annual growth rate beat a median economist forecast of 2.8% as polled by Reuters. The country’s fourth-quarter GDP growth of 2.9% also surpassed expectations for a 1.8% increase.

In 2022, the Chinese economy encountered more difficulties and challenges than was expected amid a complex domestic and international situation. However, NBS said economic growth stabilized after various measures were taken to shore up growth.

Industrial output rose 3.6% in 2022 over the previous year, while retail sales slightly shrank by 0.2% data show that fixed-asset investment increased 5.1% over 2021, with a 9.1% hike in manufacturing investment but a 10% fall in property investment.

China created 12.06 million new jobs in urban regions throughout the year, surpassing its annual target of 11 million, and officials have stressed the importance of continuing an employment-first policy in 2023.

Meanwhile, China tourism market is a step closer to robust recovery. Tourism operators are in high spirits because the market saw a good chance of a robust recovery during the Spring Festival holiday amid relaxed COVID-19 travel policies.

On January 27, the last day of the seven-day break, the Ministry of Culture and Tourism published an encouraging performance report of the tourism market. It said that domestic destinations and attractions received 308 million visits, up 23.1% year-on-year. The number is roughly 88.6% of that in 2019, they year before the pandemic hit.

According to the report, tourism-related revenue generated during the seven-day period was about 375.8 billion yuan ($55.41 billion), a year-on-year rise of 30%. The revenue was about 73% of that in 2019, the Ministry said.

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Jewellery manufacturing plant to create over 100 jobs

30th January 2023

The state of the art jewellery manufacturing plant that has been set up by international diamond and cutting company, KGK Diamonds Botswana will create over 100 jobs, of which 89 percent will be localized.

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Investors inject capital into Tsodilo Resources Company

25th January 2023

Local diamond and metal exploration company Tsodilo Resources Limited has negotiated a non-brokered private placement of 2,200, 914 units of the company at a price per unit of 0.20 US Dollars, which will provide gross proceeds to the company in the amount of C$440, 188. 20.

According to a statement from the group, proceeds from the private placement will be used for the betterment of the Xaudum iron formation project in Botswana and general corporate purposes.

The statement says every unit of the company will consist of a common share in the capital of the company and one Common Share purchase warrant of the company.

Each warrant will enable a holder to make a single purchase for the period of 24 months at an amount of $0.20. As per regularity requirements, the group indicates that the common shares and warrants will be subject to a four month plus a day hold period from date of closure.

Tsodilo is exempt from the formal valuation and minority shareholder approval requirements. This is for the reason that the fair market value of the private placement, insofar as it involves the director, is not more than 25% of the company’s market capitalization.

Tsodilo Resources Limited is an international diamond and metals exploration company engaged in the search for economic diamond and metal deposits at its Bosoto Limited and Gcwihaba Resources projects in Botswana.  The company has a 100% stake in Bosoto which holds the BK16 kimberlite project in the Orapa Kimberlite Field (OKF) in Botswana.

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