Africa Banking Economy Finance

Why governments borrow and who do they borrow from?

According to Moody’s, the rating agency, 21 African countries have outstanding foreign currency debt obligations in the form of Eurobonds of roughly $115bn.

Covid-19 has encouraged the likes of Strive Masiwa and Tidjane Thiam pressing to request a two-year moratorium on the $115bn of sovereign African debt owned by the private sector according to the Financial Times. Since the governments must continue to borrow under the current circumstances impacted by Covid-19, this article seeks to provide insight on why governments borrow and from whom.

Governments need money to spend on public goods; examples include transportation, aid, education and military. For the government to fund those/these economic activities, they must generate income which would also provide wages (civil servants etc). Governments mainly generate their income through taxes (Indirect tax, National Insurance and Income tax). Other government income could be generated through investments or businesses.

If the government revenue, income generated through taxes and investments, is equal to government expenditure, then the government will not need to borrow or save. In economic terms, saving is accumulated through income surplus and borrowing through income deficits.

Also read:  Mozambique offers US$2.25B funding guarantee to LNG project, says report

In most cases, especially during Covid-19, most African countries are unable to accumulate enough revenue to meet their spending, therefore they must borrow to finance their economic activities. The shortfall between government spending and government revenue generated is known as a fiscal deficit. Total accumulation of fiscal deficits which have resulted in government borrowing is known as sovereign debt which is the total debt government owes. Other names for sovereign debt are public debt, national debt and government debt. The debt which the government generates would be financed by government revenue.

So, who does the government borrow from?

Covid-19 has put pressure on government spending. Under the current economic conditions where lockdowns exist, overall tax revenue has reduced and therefore the government would have to borrow from the relevant stakeholders.

First, governments issue bonds to finance deficits. Examples of bonds include, RSA bonds (South Africa), Gilts (UK) and Treasury bills (Zambia). They are issued to raise money required to finance government spending. Treasury bills are short term financial instruments issued to borrow money for a period of one year or less. Government bonds are relatively longer-term and for a period of more than a year. The other main differences lie in how the two instruments are bought and how the interest is paid.

In addition, the bonds could also be used to finance government bonds that were previously issued. For example, the UK had planned to borrow over £160 billion in 2020/21; where £60 billion was to finance fiscal deficit and £100 billion to pay back previous debt.

According to Jubilee Debt Campaign  20% of African government external debt is owed to China and 17% of African government external interest payments are made to China. This is an example bilateral external debt where country’s debt is financed by another country which could be done through purchasing government bonds or Treasury bills. Therefore, governments could borrow from other governments. In addition, international institutions, such as World Bank and International Monetary Fund, contribute to African Debt by providing loans which is also another form of external debt. Covid-19 has led to African countries seeking IMF loans, which in turn would need to be paid back in the future increasing the overall debt payments in the future. Another example of potential government creditors would be investment funds, commercial banks and Central banks. Central banks own the debt by purchasing bonds which increase the money supply into the economy.

The ability to repay the debt contributes to the decisions made by Rating Agencies (Fitch Ratings and Moody’s). This also determines whether creditor would provide or continue to provide loans.

Leave a Reply

This site uses Akismet to reduce spam. Learn how your comment data is processed.

%d bloggers like this: