Govt cheats on wife

As global markets waited last year to see whether the world’s largest economy and debt consumer, the United States (US), would default on its debts as President Barack Obama’s Democrats and opposition Republicans haggled over raising the federal debt ceiling and avoid a default that could wreck the global economy, I remember a statement during one of the many debates on the issue that I tucked away.

I invoke it now to try and explain what has happened to Malawi.

That statement came from Jim Kessler, a co-founder of Third Way, a highly regarded US think tank.

“You can cheat on your spouse and maybe your marriage will survive, but your marriage will never be the same again,” he said. “And you can default on your debt as a nation and your country will survive. But the way your country is viewed will never be the same again,” declared Kessler last year.

The government of Malawi has just broken its repayment fidelity promise by stating in the 2011/12 mid-year budget review that it has postponed repayment of domestic debt to the next fiscal year.

In the 2011/12 approved budget, government set aside K15.4 billion, which represents 1.5 percent of gross domestic product (GDP), to repay domestic debt. That will not happen.

Whatever way you look at it and no matter how the Ministry of Finance and Development Planning chooses to spin this embarrassing development, this is a default—a debt service default to be exact.

According to Wikipedia, in finance, default occurs when a debtor has not met his or her legal obligations according to the debt contract, for example, if he or she has not made a scheduled payment, or has violated a loan covenant (condition) of the debt contract. This can occur with all debt obligations including bonds, mortgages, loans and promissory notes.

What Finance and Development Planning Minister Ken Lipenga has done is outrageous for two reasons.

First, public debt servicing—which relates to principal repayment and payment of interest on debt—is a statutory obligation. It is not debatable, not even in Parliament. That is why it falls under the non-voted expenditure category alongside the Presidency, Compensations and Refunds, as well as Pensions and Gratuities.

Deferring debt repayment—especially when it is almost the whole planned amount—is a cardinal sin only equated to adultery.

This is what the European Union and the International Monetary Fund have been trying to stop happening to Greece, Portugal, Spain, Italy and other Eurozone countries with exploding debt levels that could have contagion effects on other countries through the common currency and in global markets through the interconnectedness of the world financial system.

Yet, our debt problems are not as serious as these countries’ are, so why did the Malawi Government abdicate its constitutional responsibilities and jeopardise its creditworthiness?

The second reason this is so outrageous is that while the decision only affects domestic debt and spares external debt—probably to preserve whatever is remaining of our tattered international reputation—this move could have devastating effects on the economy in general, public finances, local financial markets and individuals.

The move also further undermines the market’s confidence in government papers—especially Treasury Bills and bonds—whose key selling point is their rock-solid reputation for safety or what one would call their freedom from risk.

When that happens, where will government get the K12.5 billion it needs to borrow to fill the revised budget gap? Who will still be interested in TBs or the K30 billion bond the Reserve Bank of Malawi (RBM) has just reissued?

In fact, that bond is already struggling on the market, with analysts saying investors are worrying about negative macroeconomic signals policy makers are flashing.

In short, the government will meet very unwilling buyers of its papers on the money market—after all, everyone wants to be paid and if investors are no longer sure of getting back their money with interest, why should they bother?

What this also means is that the degree of risk in government papers is now higher. Risk-takers will, therefore, need very good reasons in terms of promised returns, to consider putting their funds in TBs or bonds.

They will be looking for a better deal to try and hedge against the risks. They will demand far much higher interest rates, what with the ugly fangs of high double digit inflation arriving to erode their gains!

And because government will be desperate for cash, it will agree to the higher interest rates to attract investors, which would send shock waves throughout the economy as the cost of borrowing explodes and crowding out effects suffocate the private sector into a coma if they are lucky or death by strangulation if unfortunate.

And that will be an economic disaster as the rupture I predicted several months ago spreads its deadly lava throughout the system.

And, oh, there is also the small matter of what the K15 billion would have done had it been paid to rightful owners—investors. They could have spent it through consumption and investments in the economy.

Instead, 1.5 percent of GDP is stuck somewhere around Capital Hill—if it ever was there—leaving investors with just some paper promising to pay them one day, hopefully before it turns into junk.

Now that is some real economic engineering!