In April 2023 the Minister of Finance and Bank of Ghana (BoG) Governor held a joint presentation with investors in which they announced a further debt exchange program targeting GH¢123 billion of domestic debt. This debt included GH¢77.6 billion of debt owed to the BoG.

This information was puzzling because unlike independent foreign or domestic investors, the BoG is a state institution. What mechanism is the BoG and the government going to use to determine what percentage of debt the government can sustainably pay and over what period? How do we know the transaction was an arms-length transaction, as accountants would say? Simply put, how do we know that the BoG will be able to exercise full independence and seek to secure as good a deal as the independent bondholders who organized and lobbied extensively for better terms or to be excluded from the restructuring all together?

While I was pondering over this academic exercise, the BoG released its annual report for 2022 which showed that this significant and (perhaps) unprecedented decision had already been taken. In the foreword to the annual report, the BoG Governor, Dr Ernest Addison states:

The Bank of Ghana incurred a significant loss in 2022 largely as a result of the DDEP. The central bank’s holdings of government debt were restructured. Non-marketable holdings of Government of Ghana instruments including long-term stocks, a Covid-19 Bond and overdraft were subjected to a 50 per cent haircut. Bank of Ghana’s other claims (holdings of marketable instruments) were exchanged under similar terms as other financial institutions under the DDEP. This led to an impairment of GH¢48.40 billion in 2022. At the same time, the Bank incurred revaluation losses on its foreign assets and liabilities due to exchange rate depreciation. The impairments and revaluation losses led to a negative equity position of GH¢55.12 billion for 2022.

Dr Ernest Addison, Foreword, Bank of Ghana 2022 Annual Report and Financial Statements

Following this announcement a lot of people have been trying to understand what is going on. Most people have the right idea that something significant has happened but they are unable to explain what it is or what its implications are. In this post I will break down what has happened in the simplest terms and explain what the implications are.

The Bank of Ghana, like almost every other central bank in the world, has two functions – to ensure stability in general price levels and to regulate the activities of financial and credit institutions in the country. Central banks that use the inflation-targeting approach to monetary policy try to keep price levels in the economy stable through setting an interest rate at which it lends to banks. In Ghana this interest rate is called the policy rate, and it largely determines the rate at which banks lend to businesses and individuals in the economy. When the BoG increases the policy rate, banks charge higher interest rates on loans and individuals and businesses thus have less money to spend. This reduces their overall consumption and investment leading to a reduction in demand for goods and services and a fall in prices as a result.

However, many factors can make the BoG’s inflation-targeting tool ineffective. Let’s say that a government wishes to win favour with its electorate and therefore increases expenditure and reduces taxes. The excess expenditure over revenue is known as the fiscal deficit and government needs to borrow money either from local investors (through arrears, treasury bills and bonds), foreign investors (through eurobonds, bilateral loans, trade financing), or directly from the BoG in order to make up for the revenue shortfall. If a government racks up too much debt then creditors will demand higher interest rates because the risk of it defaulting on the debt is too high. At that point it would not matter what a central bank does with its policy rate, interest rates in the economy will simply not come down. The situation in which the government’s borrowing and spending decisions (altogether known as fiscal policy) makes the central bank’s actions (collectively known as monetary policy) ineffective is known as fiscal dominance.

It is important to understand these concepts in order to get the context within which the debt restructuring has happened. As far back as mid-year 2020, I wrote about how COVID-19 had all but guaranteed that Ghana’s already precarious debt situation will teeter into the unsustainable category. Government decided that tackling COVID-19 was more important than managing its debt and so it borrowed a combined $6 billion on the international capital markets in 2020 and 2021 as well as accessing GH¢10 billion in emergency financing from the BoG.

This borrowing took our debt to a level where by mid-year 2022, 55% of all government revenue was going into paying interest on debt. Ratings agencies, whose job it is to assess the credit risk of governments, downgraded Ghana’s debt to levels and shut out the possibility of us returning to the international capital markets. The government turned to more and more borrowing from the BoG after even local investors stopped buying government bonds, racking up an overdraft of over GH¢25 billion as at October 2022. After wasting precious time rebuffing the IMF, the government finally applied for a program in July 2022.

The punishing toll of interest payments put BoG in a dilemma, because it needed to increase the policy rate in order to tackle inflation. Meanwhile increasing the policy rate would also increase the interest on government debt thus opening a larger hole in the public accounts. The government needed two reliefs – to reduce the size of the debt and to reduce the amount it was paying in interest. It did this by first suspending interest payments to external creditors in December 2022 and then restructuring domestic cedi bonds, cocoa bills, and domestic dollar bills.

Ghanaian governments turning to borrowing from the central bank after exhausting all other sources of financing is not new. In fact, the IMF believes it is one of the reasons for Ghana’s consistent struggle with inflation. During our engagement with them in 2014, they wanted government to commit to not borrowing at all from the central bank. Parliament however voted against this provision, and limited government’s borrowing from the central bank to not more than 5% of government revenue in any particular year. Government has not adhered to this requirement as evidenced by the GH¢77 billion debt it had with the BoG as at the end of 2022. This was equivalent to 80% of government revenue for that year.

Government has to pay back this debt. And there are options open to it. Section 30(4) of the Bank of Ghana Act (Act 612 as amended) states that “Where repayment of the advances and overdrafts is unduly delayed, the Bank may transfer the debt to the public through the sale of treasury bills.” The BoG could use this option to gradually reduce the bank’s exposure to government by issuing treasury bills to the public. This will however not solve the government’s debt or interest payment problem, and so the government and BoG chose the option of writing off 50% of the debt thus leading to GH¢60.8 billion loss and BoG’s liabilities exceeding its assets by GH¢55.1 billion. This means that the BoG would be unable to pay its creditors by an amount of GH¢55.1 billion should they all seek to be paid immediately.

Now this debt cancellation helps the central government because their interest payments as well as their debt stock reduces, but I think that solution only creates more concerning problems. In order not to make this post much longer, let me briefly list the problems.

1. The BoG, like every central bank, is the lender of last resort. This means that it is to be the safety net for the whole financial system of a country as well as its central government. Now if the BoG is in technical insolvency, while banks which have taken huge losses from the debt restructuring are counting on help from the BoG in the form of the Financial Sector Stability Fund, then we have a loss of confidence in the stability of the whole financial sector on our hands.
2. The BoG is the issuer of the Ghana Cedi. A major determinant in the stability of a currency is the credit risk attached to debt issued in that currency. If investors must now include the possibility that even loans issued by the central bank to the government will not be paid, that essentially removes the idea that any kind of cedi-denominated debt can be considered risk-free. Already some collective investment schemes have served notice that they want to increase allocation to US Government treasuries instead of Government of Ghana treasury bills as the risk-free assets in their portfolio.
3. This move reduces the capacity of the central bank to support the government with emergency financing if it were to need one. Already this transfer of indebtedness will not convince investors that government has indeed reduced its debt. It would be better for government to keep the debt on its books and open the window for emergency funding if there ever was such a situation. But right now it would look quite dangerous were the BoG to significantly finance government when government has just written of GH¢48 billion it owed to the bank.
4. The final problem is the precedent we are setting. Subsequent governments will now know that when they are faced with a cash crunch, they can borrow beyond the limit from the central bank and they can write the debt off. This feeds the idea that the government will encourage “money printing” to finance its activities thus undermining the confidence in the economic value of the Ghana cedi.

I will be observing as the reactions to this restructuring comes from parliament, the IMF and investors. And I will keep you updated right on this blog.