Repercussions of unbridled government-guaranteed debts

The massive borrowing, both domestic and external, taken by state-owned enterprises (SOEs) and other agencies is causing financial stress on the government. What has made the matter very worse is that the sheer size of the debts is so gigantic that neither they can be settled by federal government budget nor are they within the financial capacity of the enterprises to repay the loans.

In a bid to tackle the problem, a new entity is under formation to takeover the government-guaranteed debts of the state-owned enterprises (SOEs) taken from the commercial bank of Ethiopia and external lenders. What is puzzling is how did we get where we are now?

The state-led economic development Ethiopia has pursued for more than a decade forced the government to step in economic spheres where the private sector is presumed to be unwilling to engage including power generation, sugar and fertilizer factories, railway, military and industrial complexes and so on. These investments burdened the government with debts of extraordinary proportions. Waste, inefficiency, and project delays combined with inflation induced escalating costs have socked the borrowers in increasing debts with little hopes of redeeming.

One of the major lenders of these SOEs is the Commercial Bank of Ethiopia (CBE). Excluding credits given for housing development, regional governments and cooperatives, between June 2005 and December 2019 the loans taken by SOEs from the CBE soared to ETB443.8 billion from ETB3.2 billion. These debts of SOEs went up from 11Pct to 49Pct of the banking industry credits. More than half of these debts were given to the state-owned Ethiopian Electric Power (EEP). Such massive loans in the form of corporate bond with medium or long-term feature have been taken from a bank that relies on demand and short-term saving accounts.

The mind-boggling puzzle to solve is how on earth was a loan amount that is several times the capital of the CBE given to a single borrower while the National Bank of Ethiopia (NBE) had rules regarding single borrower limit. The trick falls on “government guarantee”. The NBE rule (Directive No. SBB/29/2002) excepted loans that are guaranteed by the federal government. And the government exploited this exception beyond the limit, resulting in the concentration of debts of larger size in a handful of SOEs. Under autonomous financial supervisory regime, such exception would have been closely monitored and a reasonable limit would have been set. Unfortunately, the body with a supervisory responsibility, the National Bank of Ethiopia (NBE) failed to do its job as it was crippled by a proclamation that brought it under the executive branch of the government.

Guaranteeing debts is one of the blunders made by the government over the past decade. It encouraged excessive borrowing by SOEs, undermined accountability, and exposed the Commercial Bank of Ethiopia (CBE) to extraordinary credit risks and maturity mismatches.

If there was a need for government guarantee, there should have been clear limit to it – a limit which could have been handled within the financial capacity of the federal government even under the worst-case scenario. Guaranteeing massive amount of debts on the assumption that the state would not default is a breath-taking responsibility. The state’s financial resource is limited; so is its guaranteeing capacity.

Global experiences of the past few decades show that the state could default. During the Latin American debt crisis in the 1980s several countries defaulted, resulting in a lost decade of economic growth. The crisis in the 1980s was caused by the debt binge of the 1970s that resulted enormous accumulation of debts taken from international lenders. During the recent financial crisis, many countries were on the verge of defaulting. With the bail out package of the international financial institutions, they survived financial havoc that would come with defaulting. However, the conditions of the bail out made them pay considerable prices.

The guaranteed debts in Ethiopia stuck the government between a rock and a hard place. The size of the debts is neither within the capacity of the federal government budget nor is repayment by the borrowers in sight. Moreover, these debts are tainting the financial picture of the SOEs. This makes not only borrowing, especially from abroad, difficult but it also calls the financial viability of the entities into question.

To come out of this quagmire, the government has come up with a scheme – the guaranteed debts will be taken over by a new SOE, Asset & Liability Management Company (ALMCo). The new entity will become either a shareholder or a lender (most probably a long-term), or both, in lieu of assuming their debts. This measure will make the financial position of the SOEs, whose debts are taken off, look sound.

The new entity with more than half a trillion ETB debt will manage the investment activities of the SOEs, and several sources of funding are earmarked for it including privatization proceeds. What is very doubtful is the final goal of the enterprise -securitization of itself in foreign currency. In simple terms, the issue becomes issuing a foreign currency-denominated security against its stake in the SOEs.

With the significant part played by debt packaging and securitization in the recent financial crisis not far from our memory, aiming to issue a foreign-currency denominated security against stakes of ailing SEOs is too good to be true. If the ALMCo manages to get buyers, the security will most probably be discounted massively to reflect both firm specific as well as country risks, resulting in huge losses.

It would be better keeping aside realistic sources of income like the privatization proceeds to pay off the debts over a reasonable time span. What is more important is taking a lesson from these government-guaranteed debts fiasco. A lesson that will ensure that the financial affairs of the SOEs are properly monitored; their projects are well executed, limit to government guarantee is set, lending rules applicable to private banks are also extended to work for state banks, the supervisory regime of the NBE strengthened, and finally accountability is established.

9th Year  August 30 – September 30 2020  No. 90