- Govt warned to resist temptation to issue bonds lest it crowds out other participants
- Crowding out will be felt on the shorter curve
- Cost of external financing may rise amidst geopolitical tensions
- Revenue forecasts may be overly optimistic
- Measures to restore budget sustainability lack follow-through
Analysts at Ninety One have encouraged the government to resist the temptation to issue bonds to finance expenditure. The Portfolio Manager, Pako Thupayagale and analysts Leano Babitse and Onkabetse Tadubana argue that this is particularly worrisome in the current context where government bond yields are at levels that are close to “crowding out” other market participants.
In other words, they say there is no incentive to lend to the likes of BDC or StanChart because government bond yields are not only safer than corporates but also offer similar, if not better rates.
The government has been frequenting local capital markets seeking to raise funds to stimulate the economy after witnessing a long-term decline in savings due to persistent fiscal deficits over past years. It has drawn down from its savings to fight the COVID-19 pandemic coupled with a deficits financing. “COVID-19 pandemic only exasperated the already existing stress on government’s savings through the need for increased spending to fund the ERTP (Economic Recovery and Transformation Plan), alongside significant reductions in government revenues,” Econsult economists Sethunya Kegakgametse and Kitso Mokhurutshe wrote in a quarterly report.
The two disclosed that government savings at the Bank of Botswana have declined from a peak of approximately P45.5 billion in April 2015 to about P4.9 billion in September 2021, this showing that the entire historical savings have almost been depleted over the past few years. “The remaining balances are required to cushion the impact of short-term fluctuations in revenue, given that government’s average monthly expenditure is estimated to be around P6 billion for the 2021/22 FY, and are no longer sufficient to finance budget deficits,” Kegakgametse and Mokhurutshe wrote.
The budget deficit hit P16.4 billion or 9.4 percent of GDP in 2020/21 as revenue shortfalls weighed on planned expenditures. In 2021/22, the budget deficit is expected to fall to P10.2 billion or 5.1 percent of GDP. This is largely on the back of buoyant mineral revenues, according to Thupayagale, Babitse and Tadubana. Revenue is anticipated to have increased to P63.4 billion in 2021/22 (from P49.4 billion in 2020/21) against expenditure of P73.6 billion (compared to P65.8 billion in 2020/21), resulting in the much narrower budget deficit.
First National Bank of Botswana’s quant Gomolemo Basele noted immediately after the budget speech in February that the improvement in revenue stems from a surge in diamond sales over the course of 2021, resulting in elevated levels of mineral revenue. “Expenditure, on the other hand, was pushed up by COVID-19 related costs which included procuring various equipment and vaccines,” he said in a report released through RMB, an investment unit of FNBB.
Given the decline in savings and uncertainty over external sources of income, Kegakgametse and Mokhurutshe have advised that moving forward the government will now be more reliant on both domestic and foreign borrowing to finance budget deficits. Over the medium-term, the government’s debt to GDP is projected to stabilise at approximately 25 percent of GDP.
Over the past decade, Thupayagale, Babitse and Tadubana have observed that overall debt dynamics have been on an uptrend, rising from the lower teens to around 20 percent of GDP before jumping to the current level of around 25 percent. Kegakgametse and Mokhurutshe previously warned that it is projected that accumulated debt will reach 31 percent of GDP in 2022/23 financial year. The law requires that total public debt must not exceed 40 percent of GDP, divided into 20 percent domestic and 20 percent external debt.
Observers mention that it is always better and cheaper to borrow domestically. This is a welcome development for pension funds, insurance funds and other market players who have an appetite for long-term government bonds, Kegakgametse and Mokhurutshe said. While they have noted that the impact is already evident as there has been a sharp rise in government bond yields over the years. Ninety One experts are worried that the government’s Sharpe ratio is better, hence there is incentive to borrow only to government. Their fear is that all the money will flow to the government and the private sector may suffer. The cost of borrowing for government has gone up.
Market players observed that the government curve has ‘sold-off’ dramatically compared to a year ago when the state struggled to attract funding amid rapidly deteriorating economic and fiscal metrics. While it appears like the sell-off in government bonds has troughed up, experts note that corporate issuance is poised to expand further as companies loosen their capital structures. Further, the continued accommodative stance is likely to support further issuance, particularly in the credit space as the sector continues to grow and diversify. This, according to economists will mean greater opportunities for bond investors to add yields to their portfolios. Competition for funding has certainly become tighter in the market.
Bonds have varying terms depending on the needs of who the investor is; some have long-term mandates while some are short. Insurance companies and pension funds are set for long-term investments. As noted by Econsult economists, in the current context they stand a chance to benefit given their appetite play on the longer curve. Observers note that the impact of crowding out might be more prominent on the shorter end. Commercial banks play on the shorter end to handle requirements by the central banks.
As an alternative to borrowing locally, the government has room to borrow externally. However, given the current events unfolding on the global landscape there are concerns about the cost of borrowing going up as with the domestic market. Absa Bank Botswana warned last week that the Russian invasion of Ukraine has sparked a rise in global financial market volatility which could result in risk aversion among international investors. An economist with the bank cautioned that risk aversion often leads to flight of capital to safety. Said Naledi Madala: “This will probably raise the cost of external financing and elevate credit spreads for emerging markets and developing economies in 2022, which we had already expected to increase owing to FED tapering, rate rises and a stronger US dollar.”
Thupayagale, Babitse and Tadubana argue that a key part of restoring fiscal sustainability and rebuilding Botswana’s buffers – in addition to reducing fiscal deficits and public debt – is to rebuild “our savings”. The Government Investment Account (GIA) (the government’s equivalent of a savings account) is forecast to be only 1.4 percent of GDP at the end of FY 2021/22, compared to 17.4 percent of GDP in 2017/18, they wrote. “The erosion of this buffer indicates rapid and significant withdrawals which weren’t or couldn’t be replenished timeously,” they wrote. In other words, to finance its spending, the government simply dipped into its savings and these drawdowns have grown. The government forecasts that it will replenish the level of its savings account to 3.5 percent of GDP by 2023/24.
Preliminary budget figures indicate a more positive outlook for Botswana’s fiscal position as a result of a substantial rebound in mineral revenues coupled with recovery in the level of SACU receipts. Current estimates point to the deficit narrowing to -3.2 percent of GDP in 2022/23. The medium-term forecast sees a small budget surplus (of P5.5 billion or 2.3 percent of GDP) in 2023/24 as the state curtails expenditure (by mostly reducing development spending).
Even so, Ninety One analysts are concerned. They believe the government’s revenue forecasts are overly optimistic, given the inherent volatility in commodity markets. “The government forecasts the non-traditional primary balance (a better measure of the underlying position of public finances) at a deficit of almost 16 percent of GDP in 2023/24, compared to a deficit of nearly 24 percent of GDP in 2020/21,” the three wrote, noting that to ensure and signal fiscal sustainability, this indicator will be reduced by eight percentage points during the next two years.
Finance minister Peggy Serame has outlined measures to restore fiscal sustainability with key themes being revenue mobilisation and managing fiscal expenditure. Strategies include reducing and effectively managing the government wage bill, reducing subventions to commercial SOEs, reducing revenue support grants to local authorities, cost containment, improving preparation and prioritisation of development projects and rebuilding fiscal buffers.
While Ninety One commends the focus on restoring fiscal sustainability and embracing the green economy to foster longer-term growth, they still have several concerns. Many of the measures outlined to restore budget sustainability from both a revenue collection (e.g. broadening the tax base) and spending management (e.g. reducing the wage bill and weaning SOEs from government) have been touted numerous times in the past without any apparent follow-through, the experts have noted.
“Little consideration is given to the nature, direction and magnitude of structural reforms that are needed to stimulate economic growth and employment in the private sector,” the three wrote. “While Botswana is currently benefitting from a robust recovery in the demand for polished and rough diamonds, longer-term fiscal consolidation is going to be more reliant on spending discipline and economic (and therefore revenue) diversification, to ensure sustainability.”
To improve the current revenue mix, Basele in his report advised that Botswana will have to improve its tax collection efforts in order to create a buffer against any volatility in mineral and SACU revenues. He said diversification efforts will also need to be ramped up to broaden the local tax base. “As the country approaches the start of NDP 12 in 2023/24, it will have to contend with key issues as part of its efforts to promote fiscal sustainability,” he said noting that these include the country’s reliance on diamond mining activities for both growth and fiscal revenue, and the resulting vulnerability to external factors affecting diamond demand.