When a Country is Insolvent

Posted on Apr 14, 2023. by NTI

In November of last year Neil wound his way to Ghana to work as a consultant for the World Bank to implement a licencing insolvency practitioner regime in the country. He faced 30 incredible souls with the energy and willingness to become the first trainers of new restructuring and insolvency legislation. One week later the regime was up-and-fizzing.

What are the odds that any or all of these 30 brilliant folk can come to the rescue of their homeland? In January of this year Ghana was facing multiple financial and economic challenges and requested a US$3 billion bailout from the International Monetary Fund (IMF) to help it restore macroeconomic stability. This included bringing public debt down to more manageable levels from the currently estimated 105 per cent of GDP to 55 per cent in present value terms by 2028.

It is interesting to note that before agreeing to this deal, the IMF said Ghana must first address its domestic debts; this is, money typically borrowed from local banks, pension funds and insurance companies. This is a real issue for the country's Government and for any other countries looking to the likes of the Fund or the World Bank for assistance with its level of national indebtedness. If they force overseas creditors to shoulder all the pain, they risk losing access to foreign capital while struggling to restore their overall debt to a sustainable footing. Yet pushing losses on to domestic creditors risks wiping out local banks, pension funds and insurance companies.

It is not a coin toss; it is one of the most drastic choices a Government has to take. The truth is that the cost to a country's taxpayers of recapitalising a banking sector can be more than the savings achieved through debt restructuring.

If you look back to the beginning of the last century when emerging markets, such as those in Africa, suffered two decades of almost continuous debt crises, domestic debt was barely an issue. In fact, the lack of local debt markets was a serious concern. As a result, many countries borrowed heavily by issuing bonds denominated in US dollars. These appealed to foreign investors because they shielded them from currency risk and other instabilities. For borrowers, they were cheaper than bonds issued at home, where lenders demanded compensation for risks such as high inflation.

The thing is, borrowing in US dollars left such countries exposed to shocks beyond their control and so, urged on by the likes of the IMF and the World Bank, many emerging economies developed deep domestic capital markets that allow them to borrow primarily at home. Some Governments put limits on the amount local banks and others could invest overseas, obliging them to hold a big share of their assets in domestic Government debt.

And it is not just Ghana. Pakistan is on the brink of default, with public debts equal to 75 per cent of GDP, according to the IMF, of which two-thirds is domestic. But its interest payments on domestic debts are six times those on external debts. The result is restructuring of local Government bonds on terms that Ghanaian finance minister Ken Ofori-Atta describes as “punitive” for banks and other lenders.

The next time you are still at work at 10.30pm, spare a thought for those juggling with the debts of a nation. You will sleep easier than some that night.

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