Ghana's US$ bond sell-off accelerated this week to such an extent that its curve briefly inverted after the government announced last Friday (15 October) that it had cancelled its plans to issue a US$1bn sustainability bond and will not return to the market this year. The government cited strong reserve coverage, the SDR allocation and market conditions as the reasons not to go ahead, although in truth, with Ghana yields already nudging 10% in the middle of the curve, and the 26s near 9%, it was becoming too expensive.
Given Ghana's addiction to debt (we think Ghana had been the third most active issuer, after Egypt and Ecuador, and ahead of Sri Lanka, out of Frontier low-income countries over the last decade, issuing US$14.8bn (gross) in bonds, although Nigeria's recent issue has now pushed Ghana into fourth place), one might have thought that the eurobonds would have rallied on the news that there would be no more supply this year. The borrowing plans have been a hot topic in the market, even as the government sought to scale back its plans from the US$2bn headroom afforded in the budget to US$1bn because of the SDR allocation in August, and so not issuing again may have come as a small relief. But the bonds didn't rally. Instead, the news had the opposite effect.
Yields on the benchmark 2032s have risen 90bps since the announcement to 10.7%, with the bonds falling 5pts to 85.1, while at the front end, yields on the 2026s have risen 180bps to 11.3%, with the bonds falling 4.5pts to 91.7, as of cob on 21 October on Bloomberg (mid-price basis). In fact, the decline was even greater by the middle of the week although prices recovered slightly yesterday, perhaps due to bottom fishing on the expectation that the sell-off has gone too far, for now, given there seems little imminent risk of default. Still, the 26s have fallen by 12pts since 15 September and nearly 15pts since end-July.
As we have noted before, Ghana had already been one of the main underperformers in the market sell-off since September, and that underperformance has got worse. The total return on the 32s YTD is -14%, compared to the Bloomberg EM Aggregate Index of 2%.
Funding difficulties
An ex post rationalisation of the move this week is investor concern over how Ghana will fund itself if the market has closed for the country and it cannot issue eurobonds. Ghana typically issues in the first part of the year (in recent years it has issued in February-April), so if market conditions persist into next year, Ghana will have difficulty meeting next year's equally high funding needs, increasing default risk.
Where else will the authorities find the money? That is, assuming the government is unwilling to cut spending in line with the lower funding available (US$1bn is about 1.3% of GDP). Alternative funding options, quickly and in size, are limited.
In the first instance, it probably means resorting to already high domestic borrowing, and that comes at its own cost, or running down reserves. The government has already issued (or planned to issue) a total of US$15bn (equivalent) in domestic government bonds this year, according to our calculations, although most of this (90%) is for rollover. The additional call is c7% of the total and such volumes could stretch domestic appetite for government securities, putting upward pressure on local interest rates, and further crowding out the private sector.
Foreign reserves would seem ample, standing at US$9.5bn in July (IMF IFS definition, international reserves ex-gold), about 4 months' import cover, and were boosted by the US$1bn SDR allocation in August, although much of Ghana's reserves have been borrowed, and net reserves are much lower, projected at US$5.2bn (2.2 months of imports) at end-2021 by the IMF in its Article IV.
However domestic borrowing or using reserves would not be tenable if Ghana needs to raise another US$3bn next year (like it did this year). Otherwise, it could resort to central bank financing (not desirable), or turn to official lenders such as bilaterals or MDBs, but official money would take time to secure (and may no longer be possible without an IMF programme). We think Ghana would only turn to the IMF as a last resort, and we're not quite there yet.
So, while Ghana may be able to fill any residual financing gap this year, next year would be more problematic. Of course, the obvious solution would be for a stronger and credible fiscal adjustment, but this seems unlikely (not until Ghana's back is more firmly against the wall).
Debt sustainability
Meanwhile, debt sustainability is on a knife-edge. The budget deficit doubled to 15% of GDP last year, in part due to the government's Covid response, and public debt jumped by 16ppts to 79% of GDP, based on IMF figures. As we noted at the IMF’s Spring Meetings, mitigating the economic impact of Covid has come at a large fiscal cost, reviving concerns about debt sustainability. These concerns have not gone away; in fact, partly due to lack of more concerted action, they have got worse.
The government's fiscal deficit target this year, as per its 2021 Budget, is 9.5% of GDP (overall balance excluding financial and energy sector restructuring costs), a figure it left unchanged in its mid-year budget review in July. This compares to a deficit in 2020 of 11.7% of GDP.
Fiscal performance so far this year, however, also reveals Ghana's perennial problem on domestic revenue mobilisation (ie tax receipts). While, according to official figures, the budget deficit outturn has been broadly on track this year (the overall deficit was 6.1% of GDP in the first seven months compared to a target deficit of 5.7%, according to the central bank), the deviation has been due to revenue shortfalls. Revenues were 12% below target, at about 1ppt of GDP below target (7.8% vs 8.8%). The government has sought to correct for this, in order to preserve the deficit target, by cutting spending. Total spending was 13.9% of GDP compared to the 14.5% target.
The weaker fiscal performance is even more surprising given the stronger pick-up in growth. Real GDP is projected at nearly 5% this year, after 0.9% in 2020, rising to 6% next year, according to the IMF. It is questionable why Ghana needs to keep the high level of fiscal stimulus it plans given such strong growth rates.
Weaker fiscal performance and commitment to bring the deficit down threatens debt sustainability. The IMF already projects debt to rise to 84% of GDP this year. Indeed, we already warned a year ago over the risks from the slow pace of fiscal consolidation targeted by the government.
In fact, Ghana's debt looks unsustainable. One only has to look at the IMF's Article IV published in July to see this. Despite showing a 9% of GDP primary adjustment over the next three years in its baseline, in line with the authorities' 2021 budget plans, which might ordinarily seem more than sufficient, the IMF say this is not enough and it needs to be larger to ensure debt sustainability (this adjustment itself is partly based on lower restructuring costs rather than underlying fiscal improvement).
In fact, looking at the overall balance, the IMF projections suggest it expects little fiscal consolidation over the next three years and that the government will miss its own fiscal targets (the IMF projects a 10% deficit this year compared to the authorities' 9.5% budget forecast).
Yet even in the baseline, which isn't enough, the IMF's fiscal realism tool shows that the primary adjustment is in the top 4% of historical cross country experiences (ie it is unlikely Ghana could pull it off).
IMF's Fiscal Realism tool
Source: IMF 2021 Article IV
In addition, the baseline would see primary spending falling by a nearly 40% by 2026 compared to 2020 to 13.7% of GDP, a level it touched over 2014-2017, and essentially taking it back to levels we saw immediately post-HIPC. That would put Ghana's primary spending as a share of GDP in the lowest decile of our broad sample of around 100 EM and Frontier markets in the IMF WEO (excluding fragile states, developing countries and the richer energy exporters) while the change would be the third largest (behind Aruba -51% and Zambia -48%). While Ghana may not be unique here, with some other countries such as Indonesia, Costa Rica and Dominican Republic also seeing primary spending fall to a similar level, and Nigeria even lower (9.5% of GDP), this must raise a question over whether it is sustainable.
Instead, the Fund note that consolidation should be accelerated, with a more aggressive fiscal tightening "starting already with the forthcoming mid-year budget review". The IMF seems to argue for a primary adjustment that is 50% bigger than the baseline, a baseline which is already heroic based on past standards. It notes "an ambitious scenario assumes stronger fiscal consolidation, with additional revenue measures of 2.4% of GDP from 2021 to 2023 over the baseline, for an overall fiscal adjustment of 3.4% of GDP per year over the period." This compares to a primary adjustment averaging about 2.3% of GDP per year in the baseline.
Yet, even under the Fund's ambitious scenario, the IMF concedes that Gross Financing Needs (GFNs), an important variable under the IMF's new debt sustainability framework, remain high (over 20% of GDP).
In all, our conclusion is that Ghana's debt is barely sustainable, even though the IMF's DSA classifies Ghana's debt as sustainable, albeit at high risk of debt distress. The IMF admits that implementation of the fiscal consolidation in the baseline, supported by continued market access, ensures debt sustainability "only narrowly". It noted "a deeper consolidation effort based on well-articulated measures is urgently needed." Unless, Ghana can grow out of its debt problem.
Budget options
All eyes are therefore on the upcoming 2022 budget, which is expected in November. The government missed the opportunity in its mid-year budget review in July to present a more ambitious and credible fiscal adjustment, which we think disappointed both the IMF and investors, and contributed to Ghana's bond market sell-off into the summer and its subsequent underperformance in the general market sell-off since September.
The IMF projects a 2022 fiscal deficit of 9.5% of GDP (ex-restructuring costs), little changed from the 10% it sees this year, falling to 8.5% in 2023 and 8.2% in 2024. By contrast, the government says it will return to the 5% legal requirement under its Fiscal Responsibility Act by 2024, although it is not clear how it will get there.
The problem now, in our minds, is we're getting to the point where there is no longer any budget that Ghana could credibly present that will be enough to restore debt sustainability and reassure investors. If the government sticks to gradualism, markets will be disappointed. Again. However, if it presents a much more ambitious fiscal consolidation, few will believe the government's commitment to it or whether it is achievable.
On a positive note, thanks to active liability management operations (LMOs), to Ghana's credit, its debt service profile on its foreign bonds has reduced near-term refinancing risks. There is practically nothing due over 2022-2023 in terms of principal, and only US$333mn in 2024, although payments pick up to an average of US$1.2bn a year over 2025-2029. That said, annual interest payments on the bonds amount to a chunky US$1bn a year over 2022-2025.
Indeed, interest is the killer. Total debt interest (domestic and external) is projected at 8% of GDP this year by the IMF, the second highest in the world after Egypt (8.7%), rising towards 10% in 2024 (under the baseline), based on IMF WEO data. Rarely do countries sustain such high interest burdens for any length of time without a crisis, an IMF rescue, or default/restructuring. For example, of the twenty EM and Frontier countries in our sample with the highest projected interest bill this year (interest/GDP over 4%), over half have had some kind of debt crisis (restructured or IMF bailout), and of the five at around 6% or more, all have – except Ghana.
In fact, over half of the 28 countries in our sample that have seen interest burdens over 5% over the last twenty years had restructured or required an IMF bailout. The two obvious cases with persistently high burdens of Jamaica and Lebanon carry their own warnings – Jamaica had to undertake a domestic exchange in 2013 (after a previous failed exercise) and Lebanon defaulted last year (pre-Covid). The only larger markets to run persistent high interest burdens without a debt crisis are Brazil, Egypt and India.
Yet, although interest on the US$ bonds is running at US$1bn a year, the bulk of the interest bill comes from domestic debt. According to IMF figures, interest on public domestic debt is 6.4% of GDP (80% of the total) compared to 1.7% of GDP (20%) on public external debt.
That suggests to us, Ghana needs a domestic debt operation to lengthen the maturity and lower the interest rates on its domestic debt. That would be a relief to foreign bondholders, although arguments over inter-creditor equity, and why should foreign bondholders be let off the hook, would surely prevail. Nor is Ghana Ethiopia (you can leave out the sole foreign bond on de minimis grounds) or Zambia (bondholders argue they haven't lent to Zambia since 2015).
But a credible domestic debt operation might require an IMF programme, which may not be something the authorities will countenance, and even if the authorities wanted one, the IMF may now conclude in a programme context that the debt is not sustainable. This would inevitably mean PSI under the Common Framework.
Recovery scenarios
We think the bonds are currently pricing in something like a modest 10-15% nominal haircut, at an (optimistic) 8% exit yield, everything else unchanged (ie keeping the same maturity and coupons).
We model some possible restructuring scenarios to gauge downside risks to prices, although these are for illustrative purposes as we haven't done a full DSA at this stage. We consider a 50% coupon haircut (more aligned to the precedent set by Argentina and Ecuador last year), a 25% principal haircut, and a combination of the two, with no maturity extension. To keep the analysis tractable, we focus on the 2026 and 2032 bonds.
The results are shown below.
Under our benchmark 10% exit yield, there is 7pts downside on the 26s, and 21pts downside on the 32s, under our more benign scenario of a 50% coupon haircut.
However, if Ghana is able to restore market confidence, and yields return to 8% (say), that provides upside of 8pts and 15pts, respectively. The ratio of upside to downside may be more defensive on the 26s.
Overall investment conclusion
Having missed this leg of the sell-off, we retain our Hold on the 32s, with a yield of 10.7% (price 85.1) as of cob 21 October on Bloomberg (mid price basis). We think, at this stage, risks are evenly balanced and await the 2022 Budget for more details on the government's fiscal plans. Ghana has also been here before (back in 2013-2015), when a combination of election-related fiscal slippage and an adverse external environment led to a crisis, but it managed to get through it, albeit with IMF help (it led to the 2015-2019 ECF) and the World Bank guaranteed bond issue in 2015, but that crisis took place at a much lower debt burden than it has today and a much smaller bonded debt stock.