Reluctant borrower faces $250m life and debt choice
Government traditionally has been hesitant to take on external loans for budget support, but with the depletion of its reserves due to COVID-19 spending, its choices have become limited. With local investors shying away from lending to the government, more loans from financiers such as the World Bank could become unavoidable. Staff Writer, reports
Local pension funds enjoyed a stellar year in 2020, with their returns swimming against the tide of COVID-19’s impact on global economies. Cumulatively, pension funds started the year with P94.3 billion in assets and ended with P105.2 billion, coasting above the psychological P100 billion mark for the first time in history in November.
Government, meanwhile, watched its reserves, as housed in the Government Investment Account, drop from P20.5 billion in January 2020 to P3.3 billion in December 2020, as authorities tapped more funding for COVID-19 economic interventions. Questions have previously been asked about why large, long-term investors in the economy, such as pension and insurance funds, are not coming to the government’s rescue more by partnering in or financing public infrastructure investment.
The $250 million (P2.6 billion) World Bank loan announced this week is expected to reignite these conversations, particularly as the bank has highlighted that it is pleased to be in a position to use its loan to start ‘policy dialogues’ with the government. Policy-based lending in other African countries has been viewed with great suspicion and criticism, particularly after some countries such as Zambia and Zimbabwe were pushed to enact structural adjustment programmes in the 1990s that they blame for their economic woes. For Botswana, the policies recommended by the World Bank are more benign, as they are supportive of actions the government is already taking in the Economic Recovery and Transformation Plan (ERTP).
But with pension funds apparently awash with cash and government obviously in need, why did fiscal authorities reach out across the borders for help? The decision also goes against government’s well-known fear of the Original Sin, a term coined by economists to roughly describe a situation where countries find themselves stuck with high foreign debt obligations.
In 2009 at the height of the global recession, government took up a $1.5 billion loan from the African Development Bank (AfDB), payable in dollars over 15 years and figures show the obligation has fluctuated over the years due to exchange rate movements. The last available figures exemplify the loan’s fluctuations, with P11.4 billion outstanding in March 2018 and P11.8 billion outstanding in March 2019. “The cost of external debt has been rising over the years because the pula has been falling against the dollar over those years,” Moemedi Phetwe, the Bank of Botswana’s (BoB) deputy director of financial markets explained previously. “This is a case for improving the domestic market borrowings.”
Market resistance
One factor the government apparently considered in deciding to include the World Bank in its funding options, is the state of the local market. Local pension and insurance funds primarily lend to government by participating in the monthly auctions of government bonds conducted by the BoB.
When government’s domestic borrowing limit was doubled to P30 billion last September, it was expected that local capital market participants would fall over each other to lend to government, which is viewed as the market’s best borrower.
Instead, however, at each auction since September, the government has failed to raise the full amounts of debt it was looking for, with market participants apparently pushing for higher yields as they price in government’s credit rating downgrade and the competing yields of alternative assets in countries such as South Africa.
“The interest in longer maturity notes really comes down to aligning pricing expectations between the issuer and investors, which is partly a function of forward-looking risk/reward expectations of those instruments relative to other investment opportunities in the market,” says Kgori Capital managing director, Alphonse Ndzinge. The result has been lower than optimal debt auctions, with government only raising 5.6 percent of the amount it was looking for in bonds at the last auction on May 28, 2021.
Shortage of instruments
Analysts have pointed out that government’s debt programme is not the only way in which large, long term investors such as the pension and insurance funds can participate in public infrastructure investment. By floating bonds, government raises funds that it can use for its recurrent or development budget, but some vehicles can be used to exclusively raise funds for infrastructure and projects, which are captured under the development budget. The Botswana Bond Market Association, for instance, has been calling on government, both central and local, to consider floating infrastructure bonds that investors can tap into.
An infrastructure bond involves government raising debt for an infrastructure project by borrowing from the local market. In countries like Kenya, which floated a $350 million infrastructure bond in 2011, these types of instruments can offer high returns for investors as well as tax benefits. In South Africa, municipalities there had bonds for infrastructural projects amounting to R34.8 trillion by 2016.
“Trends generally show that more funding will be needed for infrastructure development given the increased migration of people to cities and towns,” the BBMA said in a recent paper. “These trends mean, for example, that a lot of funds will be needed to improve and maintain roads, health facilities, schools, water and energy infrastructure.”
In fact, the BBMA has said a previous P1.5 billion loan by the World Bank to finance various water projects in the country, could have taken the form of a local currency infrastructure bond. “The government could have alternatively tapped into the local market and issued infrastructure bonds to raise the amount needed.
“The government has for some time been contemplating issuing infrastructure bonds and inflation-linked bonds, but to date, that has not materialised.” Another avenue to bring in the pension and insurance funds is through the Public Private Partnership (PPP) model, a policy first developed by government 11 years ago, but that is only now gathering momentum due to the pressure on the fiscus. PPPs involve a contractual arrangement between a governmental institution and the private sector, where the private sector party provides public infrastructure and/or infrastructure-related services.
Typically, government’s contributions, over and above equity in the venture, may include subsidies, incentives, provision of service, the cost of providing the service and others. The private sector can be asked to contribute up to 80% of the project’s funding. In January, then finance minister, Thapelo Matsheka told Mmegi the government wanted to accelerate the PPP programme in light of the tighter budget situation.
“We just about lost 2020 as a planning or financial year because of COVID-19 and what is going to be important is to frontload more of these projects,” he said. “That’s the only way to kickstart the economy. “We want a multiplicity of projects away from the financial years so that they can run concurrently and we have a limited time till the end of NDP 11 in 2023.
“We have to adopt a different approach.” Matsheka said fast-tracking the PPPs would also move some of the technical costs off government’s balance sheet by engaging private sector capital and expertise. He said the PPP thrust is also to empower the private sector by engaging it in major public works. Recently, the finance ministry updated its list of 15 PPP projects to show that since January, two have moved to the procurement of the private party stage, while two others are at the feasibility stage. Another seven are at the procurement of the project consultant stage, giving hope that the plan to accelerate PPPs is going ahead.
Reaching outside borders
Government’s decision to engage external financiers for budget support was further justified by remarks made by BoB executives on Thursday.
As the agency responsible for helping government raise funds in the domestic market, the BoB is uniquely placed to spot trends and feel the pulse of investors capable of supporting government’s infrastructure ambitions. “The pension funds’ asset base is more than P105 billion and of that more than 50% is offshore so clearly if the government is looking at financing a deficit, that’s a possible source of borrowings,” governor, Moses Pelaelo said. “Some of the issues we are experiencing with the bond programme are issues of skills within the participants, marketing and outreach programmes that we need to do. “There’s a lot of learning that needs to be done.” However, as revealed by the BoB, a more worrying signal has been sent by pension and insurance funds about their ability or willingness to support the fiscus.
“We have engaged the pension funds and other investors who have said they think they are close to reaching their limits on what they can take with the government bonds,” Caster Moseki, acting director of financial markets at the BoB said on Thursday.
Moseki further explained that with inflation on the rise and expected to peak at 8.5 percent later this year, investors were pressing for higher yields on the bonds being offered by the government. “We are in discussion with the Ministry of Finance (and Development Planning) to allow yields to trend upwards somehow. “Some of the yields we are seeing are not in line with what you would expect for a market with a credit standing like Botswana.
“We have competition from other domestic corporates and external issuers in places like South Africa. “We are trying to reach out to external investors and it must be noted that while P30 billion looks like a lot here, for the external investors it’s a minuscule amount and it may not be appetising for them.” The situation suggests that government, as reluctant as it is, will likely press ahead with talks with external financiers, a situation anticipated by the World Bank which has said its recent loan is the first of two ‘operations’ set aside for Botswana.
Concerning the fear of the Original Sin, government technocrats will feel that if the borrowing can be spent efficiently on the ERTP (Economic Recovery and Transformation Plan) and similar development initiatives, the economy can be strengthened to not only rebuild the reserves but also stabilise the pula and keep pace with repayments. That type of best case scenario, analysts say, will rely a lot on the delivery of sound infrastructure projects that can support the private sector growth needed to reignite the economy.