The Economy: The pros and cons of borrowing excessively before first oil in 2020

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Among some of the ideas being promoted as ‘oil advice’ by some oil consultants and some others in the public discourses on oil, is that the government should borrow money now to pursue critical developmental projects for Guyana. The rationale for this suggestion is because Guyana has found oil and it is almost guaranteed the country is poised to earn substantially in 2020 when first oil is set to commence. In other words, this idea is suggestive that the government should simply borrow now against the discovered oil reserves offshore Guyana. This article seeks to address this concern or ideology by examining the pros and cons of such an approach – within the framework of Guyana’s current economic structure – and the most likely trajectory of the global energy markets – meaning what are some of the factors that could adversely affect oil prices to the extent where an oil market crash (oil price) is rather inevitable.

Economic arguments supporting an increase in Government borrowing

There are many sound arguments for the government to borrow – provided that such borrowing brings economic and social benefits – here are some of the arguments.

  1. Shock Absorber: short-term rise in the budget deficit might be caused by external shocks (e.g. in the U.K. the credit crunch) which will unwind at later stages of the economic cycle when the economy recovers.
  2. Demand management: arise in government borrowing helps to stabilize aggregate demand during a downturn (i.e. it is a form of Keynesian active demand management) – an important tool of “counter-cyclical” macro-policy especially if monetary policy has become less effective.
  3. LRAS (the long run aggregate supply curve): borrowing to finance extra capital investment is perfectly legitimate – because it adds to the economy’s stock of capital and can support long-term growth (i.e. an increase in LRAS) – the economy benefits in the long term from investment in schools, hospitals and critical infrastructure.
  4. Self-financing borrowing: some government borrowing is self-financing if it leads to a rise in economic activity, higher employment, and a future increase in tax revenues.
  5. Tap into overseas savings: Government debt is currently low, expressed as a percentage of GDP – so there is plenty of scope for higher borrowing without any upward pressure on interest rates – finding people to buy the government’s debt should rarely be a problem given that the economy is open to capital flows from overseas.

Counter-arguments – concerns over the size of government borrowing in U.K (as an example)

  1. Crowding out: extra borrowing could push up long-term rates of interest and therefore creating some “crowding out” effects on the private sector of the economy – higher interest rates might negatively affect consumer spending, business confidence and capital spending.
  2. Debt burden s:Higher government borrowing today adds to the accumulated national debt which increases the future interest payments on this debt (this involves an opportunity cost) and is a burden on future generations of taxpayers.
  3. Taxing teenager s:there are inter-generational equity issues involved with rising and persistent budget deficits the – principle is that each generation should meet the costs of the benefits they derive from current government spending – today’s teenagers will be paying higher taxes because of excessive borrowing by the state.
  4. Rising tax burden: increased government borrowing may eventually require higher taxation to fund it – again this raises equity issues and may cause some “crowding-out” e.g. higher income taxes erodes disposable incomes and higher business taxes may reduce investment and employment in the economy – threatening competitiveness.
  5. Might stoke up inflation: too much borrowing risks creating demand-pull inflationary pressures (this depend on other factors though).
  6. Waste? Thereare concerns about the social return from extra public spending – how much actually goes into improving public services? Is too much state sector spending wasted?

Cited from (economics of government borrowing, tutorial).

 

Key indicators for the period 2014-2018

GY $Millions, unless stated otherwise

  2014 2015 2016 2017 2018 2014-2018 (change in %)
Total Public Debt 329,620 317,740 330,606     12.3 %
Total Public Debt Service 36,101 22,149 13,020     5.7 %
Total Current Revenue 145,726 161,710 177,289     36.1 %
Total Current Expenditure 133,834 147,638 170,152     48 %
Exports of Goods and Non-Factor Services 278,445

(US$1,167M)

269,730

(US$1,151.3M)

318,196

(US$1,440.6M)

    -10 %
Imports US$1,791.3M US$1,491M US$1,447.8M      
International Reserves & Net Foreign Assets (held by the Bank of Guyana)  

US$652M

 

US$594M

 

US$596.7M

 

US$584M

 

US$552.8M

 

-15.2 %

Source:  Debt Management Division, Ministry of Finance and Bank of Guyana

Note: 2017 and 2018 figures are not published as yet for the national debt indicators and imports and exports.

Having thus outlined a theoretical framework of the basic pros and cons of increased government borrowings above, it is now worthwhile to contextualize Guyana’s current structure using the most recent publicly available data on some key debt indicators among others, as illustrated in the table above.

It is an ambitious idea to increase government borrowing against the almost guaranteed oil revenues that will start flowing in 2020 – this will avert the likelihood of increasing taxes to servicethe increased borrowings, provided that all things remain equal. However, assuming that the administration decides to borrow between now and 2019 an additional $100 billion for example, adding to the current stock of debt of $330.6 billion as at the end of 2016, this will result in an increase of debt-GDP ratio to about 60 % which would still be considered manageable. If they were to borrow beyond 60 % of GDP – in order to avert a debt or a liquidity crisis, these supposedly new debt will have to be negotiated for at least a one year moratorium – whereby payments will commence in 2020 when the oil revenues start to flow. Otherwise, it will heighten pressure on central government spending to service these increased levels of debt until the oil revenue start to flow and would eventually lead to some of the adverse consequences as outlined earlier in this article.

Another important factor is that from the table above, one could observe that there has been a steady decline in the country’s foreign reserve by a negative 15.2 percent from 2014 to date or about US$100 million. This outcome could lead to some negative economic consequences for example, as a rule of thumb, a country needs to maintain a minimum import cover of three months. In Guyana’s current state, this minimum benchmark is adequately maintained wherein there is just about three months import cover. Import cover – in layman terms means – a country’s ability to import goods and services – and to do so – there needs to be adequate availability of foreign currency to pay for imported goods and as such the minimum level of foreign reserve a country needs to maintain to accommodate this is three months. Countries like India and China have more than 9 and 12 months import cover.

Worse case scenario, if a country is unable to maintain the minimum benchmark of three months it means that imports would become expensive to the extent where the country would not be able to import any goods or services given that there simply would not be enough foreign currency to pay for imports. To this end, as one can observe, foreign reserves has been declining steadily which is not a good sign. This, coupled with the fact that critical industries like the sugar industry is being literally destroyed, and there are currently no sound national economic policies to incentivize and create a much more competitive and strong, diverse agriculture sector, is worrying – to the extent where it could lead to economic devastation. For example, there is lack of export markets for agriculture produce, there is lack or an inherently uncompetitive framework to promote and enable value added creation in the manufacturing sector – and to ultimately export value added goods thereby bringing in foreign exchange – and stabilizing and strengthening the domestic currency and so forth.

There is another factor surrounding this – that is – the uncertainties of global oil prices come 2020 and beyond. To this end, countries such as China, India, Norway, Australia, among many others, are investing close to or more than US$1 trillion dollars combined, in climate change policies currently, 2020 and beyond, more so, the advancement of transitioning to renewable energy – which is projected to be far cheaper by 2020. These new directions of the global economy and the world at large, would have a bearing on global energy markets – meaning oil prices – and in respect to Guyana – if the oil market crash (oil price) – which is quite inevitable against the backdrop of the changing dynamics of the global energy markets – is very likely to occur within the next decade or two; such an outcome, will adversely affect Guyana’s earnings in the long run from the projected oil revenues.

Notwithstanding the foregoing preamble and analyses, the question of whether Guyana should borrow now against the potential oil revenues in 2020, warrants thorough debates at the parliamentary and perhaps national level, taking into consideration the pros and cons as outlined in this article as a blue print in this regard.

*The author of this column is the holder of a Master of Science Degree from a UK university in Business Management, with specialism in Global Finance and Financial Markets.

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