MALAWI’S FOREIGN DEBT CANCELLATION…
GOOD NEWS TO COMMERCIAL BANKS

Friday, September 1st 2006 has left a memorable mark on Malawi’s socio-economic calendar and this has to do with the foreign debt – 90 percent of foreign debt of close to MK400 billion (about US$3 billion) was declared water under the bridge. This good news of debt cancellation was welcomed by aggressive publicity and a deep sigh of relief nationwide. There is hope that this would translate into immediate economic stability and growth should the government effectively use the savings (of about MK15 billion per annum) from debt cancellation. However, while we are all excited about debt cancellation, chances are that very few people really understand the ‘whys’ and ‘whats’ about national debt. By the way, is foreign debt cancellation good news to Malawi’s commercial banks? Let me start by defining national debt.

National debt (also known as government debt or public debt) is the accumulated central government debt from successive years of budget defits. In other cases this debt can be accumulated by other levels of government; either federal government, municipal government or local government. As the government represents the people, government debt can be seen as an indirect debt of the tax payers, i.e., the national debt in Malawi is primarily held by the citizens and institutions in Malawi.

National debt can be categorized as internal debt, owed to lenders within the country, and external debt, owed to foreign lenders. Governments usually borrow by issuing securities such as government bonds and bills. Less credit-worthy countries sometimes borrow directly from commercial banks or supranational institutions. Some people consider all government liabilities, including future pension payments and payments for goods and services the government has contracted for but not yet paid, as government debt.

Another common division of national debt is by duration. Short term debt is generally considered to be one year or less, long term is usually more than ten years while medium term debt falls in the middle.

How did Malawi get entangled in unsustainable foreign debt?

Just as was the case with most developing countries, much of Malawi’s foreign debt was amassed following the 1973 oil crisis when the western members of OPEC pushed the price of oil up making the Arab nations very wealthy. They decided to deposit this money in large Western banks. The banks did not want all of this money lying around so it was lent to the third world countries. Banks lent large amounts of money to developing countries without much attention to where the money would be spent or whether countries would be capable of repaying the amount. While some of this money went towards trying to improve the living standards for those in the countries, most of the loans never reached the poor. A large percentage of foreign debt was either spent on large-scale development projects, most of which proved to be of little value, or ended into private bank accounts of dictators. It should however be noted that getting foreign debt was not wrong per se but what was wrong was how the funds were put to use.

How good is this ‘good’ news of foreign debt cancellation particularly to commercial banks?

There are various arguments that can be raised in favour of foreign debt cancellation. In the following paragraphs I will attempt to explain some of these advantages. Firstly, the debt incurred by the present generation will have to be repaid by future generations, including the interest on the debt. This means, by reverse, foreign debt that Malawi was paying until last year, was incurred by the previous generation. This could therefore be viewed as an unacceptable burden by one generation on another. Now debt cancellation will bring about new resources because it will allow Malawi to be released from debt overhang. With the end of the cycle of expending more resources overseas than domestically, monetary resources started being released to be spent on poverty reduction and economic growth. In addition, it is expected that government’s financial position will improve and this might allow it to reduce the burden of taxation in the economy, and lower taxes might spur initiative, hard work and enterprise in the economy. Surely this is good news to every one including commercial banks.

Secondly, the existence of unsustainable foreign debt was putting pressure on government to overspend. The government over-expenditure was by and large financed by an increase in local borrowing through the sale of government securities. An increase in the number of securities on the market required the interest rate to rise in order to encourage their sale. The result of this was that the cost of private sector investment was perpetually increasing leading to ‘crowding-out effects’. In other words, high interest rates were deterring certain kinds of private investment spending. It therefore, follows that debt cancellation will have ‘crowding-in effects’ implying that the private sector will be encouraged and have an opportunity to borrow from the local commercial banks. This will not only build strong ties between commercial banks and the general public but also will spur economic growth and development through enhanced private sector investment.

Thirdly, huge foreign debt was a stumbling block to foreign direct investment. Most foreign investors worry that governments will fiancé their deficits by printing money, and so allow inflation to erode real value of their debt. Fears that countries may inflate their way out of trouble could lead foreign investors to demand higher interest rates, thereby exacerbating debt burdens. With debt cancellation, it implies that Malawi is becoming an attractive destination to many foreign investors and surely this is a welcome development to the financial sector.

Finally, foreign debt cancellation has saved the economy from debt trap that was looming. A debt trap may be defined as an unsustainable government financial position in which a rapid rise in government debt can no longer be presented, either by an increase in taxation or by a decrease in government discretionary expenditure. In contrast to a position where government debt as a rate of gross domestic product increases over time but could be reversed by monetary and fiscal measures, in a debt trap situation a structural correction of the economy would be required, which includes a major reformulation of the government’s functions, duties, powers, rights and obligations.

One major implication of a debt trap is that the authorities become unable to prevent monetisation of government debt, i.e. they have to ‘print’ money to fiancé the deficit to an increasing extent, which means that the growth in money supply gets out of control and poses an inflation risk. The higher inflation rate then pushes up the interest rates on government securities, which adversely affects the government fiscal position. Such a situation is likely to have negative repercussions on the financial sector particularly through significant decrease in real profits.

In conclusion therefore, it can be argued that foreign debt cancellation is very good news to commercial banks just as is the case to all patriotic Malawians. It will indeed support long-term sustainability if it is accompanied by good strategies of how to spend the released money. Malawi can now commence budgeting into the future with a more reliable and accurate basis with greater control over sources of income. Surely, our commercial banks should be excited as they look forward to operating in a stable and predictable macroeconomic environment. For local entrepreneurs, a new chapter has been opened where they are going to reap the fruits of having commercial banks that are now poised to accommodate them. Are you going to visit a bank today? Hasta la vista…