Accra: Ghana's increasing reliance on domestic borrowing has not mitigated its exposure to financial risks but has instead created new vulnerabilities involving banks, investors, and the exchange rate, according to former Bank of Ghana First Deputy Governor Dr. Maxwell Opoku-Afari. In a recent policy note titled "How Not to Miss a Crisis: Lessons from Ghana," Dr. Opoku-Afari discusses how the shift towards cedi-denominated debt was initially intended to reduce foreign exchange risks and bolster the domestic capital market. However, the strategy ultimately intensified the link between government debt and the domestic financial sector.
According to Ghana Web, Dr. Opoku-Afari's report describes this complex relationship as a sovereign-bank "doom loop," where banks become heavily exposed to government securities. Meanwhile, weaknesses in the financial sector can further strain government finances. The report highlights that Ghana's 2022 debt crisis was foreseeable rather than abrupt. "Domestic borrowing was politically appealing because it was perceived to reduce exposure to exchange-rate risk and to avoid external conditionality," the report states. Despite these intentions, exchange-rate vulnerabilities persisted due to significant non-resident participation in domestic debt markets.
Dr. Opoku-Afari notes that domestic debt rose from about 31% of GDP in 2019 to more than 40% in 2020 and 2021. Concurrently, banks, pension funds, and insurance companies emerged as major holders of government securities. By the end of 2021, more than 30% of Ghana's domestic debt was held on banks' balance sheets. This created significant risks when confidence in the government's financial stability waned. The report also points out that non-resident investors had become key players in Ghana's domestic bond market, with their holdings peaking at 38.5% of total domestic instruments in 2017. However, as fiscal and external imbalances worsened and the COVID-19 pandemic took hold, foreign investors began to exit.
Dr. Opoku-Afari argues that these developments revealed the flaw in considering domestic-currency debt as inherently safer than external debt. The report explains, "This shift towards domestic debt was often seen as positive 'de-dollarization'," but increased non-resident holdings muddied the distinction between domestic and exchange-rate risks. The situation worsened during Ghana's Domestic Debt Exchange Programme, which weakened the capital and liquidity positions of banks. Dr. Opoku-Afari recommends implementing stronger limits on banks' holdings of government securities and conducting regular stress tests to evaluate the impact of rising domestic interest rates and losses on government bonds on both banks and public finances.
He emphasizes that debt sustainability assessments must extend beyond the size of government debt to consider who holds the debt, its cost, refinancing requirements, and the extent to which financial-sector risks can feed back into government finances.