Treasury Bill Financing with Reckless Abandon. Not Wise!

March 12 , 2022.

Nassim Talib, the author of an acclaimed book titled "The Black Swan", recently tweeted about his observation made years ago: "Economists didn't get anything right." Those in the economics discipline may abhor his conclusion. Yet, many continue to counsel policymakers' decisions that impacted the lives of tens of millions.

The "false prophets" growing influence in the world of policymaking since the Second World War is captured by Binyamin Appelbaum's captivating book, "The Economists' Hour". The subject of his fury is monetary economists, who are the disciples of Milton Friedman. They have a firm conviction that inflation anywhere and anytime results from money growth in an economy. Hence, the appropriate response is to deploy monetary policy tools to reduce the money supply in the market.

Their intellectual nemesis is from the schools of John Keynes. They have policy prescriptions on fiscal expansion to stimulate demand, hence monetary expansion by default but with a risk of budget deficits. They would rather worry about managing deficit than stifling growth and economies' potential to create millions of jobs. It is interesting to note that the lot in the economics field in Ethiopia is overwhelmingly hogged by economists from Keynes' school of thought. Even in the recent years of ideological wilderness, many in the policymaking circle find it too much to shed their pelt.

Ironically, macroeconomic stability in Ethiopia is in peril. So is its management on autopilot.

It is like having a seriously ailed individual give a blood sample, and the result shows markers of diseases such as diabetes, heartache, anaemia, and cancer. The disturbing markers of Ethiopia's macroeconomy are a high level of unemployment, runaway inflation, current account deficits, a highly indebted economy, and slow growth. The high budgetary deficit is also considered a cause of macroeconomic woes.

The Keynesian economic advisors in Prime Minister Abiy Ahmed's (PhD) administration might have found consolation with the growing national debt if it was not for the other markers. After all, the ratio of Ethiopia's national debt to the GDP averaged at 58.11pc for the last decade, less than two percentage points from what the world accepts as a prudent ceiling. The national economy saw its highest debt at 61.11pc in the year when widespread political discontent propelled Prime Minister Abiy and his allies in the EPRDF coalition to office. The lowest national debt in the decade - at 42.18pc - was recorded in 2012, when the ruling coalition lost its ideological high priest, the late Meles Zenawi.

A decade later, the bills are coming due for the federal government under Abiy Ahmed. Considering the convergence of political, economic and public health troubles, particularly over the past two years, it should be all but surprising. A civil war has forced the defence budget to expand exponentially; productivity plummeted, and Ethiopia’s traditional development partners tightened their purses. The pandemic has ravaged several industries, including construction, transport and hospitality. Add to this the fallout from Russia's invasion of Ukraine, which has exacerbated the storm as the cost of essential items, from oil to fertiliser and wheat, is spiralling out of control.

The items in the policy menu to pick from are limited: tax increase, borrowing from external creditors, printing money, privatising public assets or selling government securities. The political skippers know the damage to their popularity if they are tempted to absorb high budget deficits through increasing taxes. Even in good times, it is only around 10pc of Ethiopia’s GDP. The usual and lazy alternative has been to pay for public spending through borrowing from the central bank, usually ordering the printers for more notes. This has its own cost: hyperinflation. Friedmanites are vindicated.

The policy wonks Prime Minister Abiy has onboard - such as Messrs Girma Birru and Eyob Tekalign (PhD) - believe they have found the answer - government securities like treasury bills (T-bill). It is a fiscal policy instrument designed to suck an excessive money supply in the economy, deployed to tame inflationary pressure. The Keynesians in Ethiopia use it for the wrong end: deficit financing. They have gotten a taste for it and would likely inform fiscal policymaking going forward.

For many fellas economics estranged, T-bill financing sounds fancy and complex. It is not. The treasury, better known as the Finance Ministry in most countries, issues "I Owe You" (IOUs) to anyone that wants to buy them. They are to be paid back, with a very low-interest rate, on an initially agreed day of maturity. Buyers prefer them for their almost risk-free investment opportunities.

The federal government has been selling them with enthusiasm.

By the end of last year, it owes 253 billion Br through its T-bill sales, 45pc of the budget slated at the beginning of this fiscal year. More astounding is the rate of growth. Two years ago, it was merely 23.7 billion Br. In the previous two quarters, it has managed to shoot up by 110pc. At this rate, it is not too far-fetched to contain direct central bank advances, which is already at a dangerous 113.5 billion Br. It would be naive to think that Central Bank Governor Yinager Dessie (PhD) and his team have not ordered their UK or German clients to roar the printers for billions of cash notes. If only they are open and transparent about public finance.

The majority of the T-bills will mature in half a year to one year. The 364-day bills take the largest chunk, amounting to over half of the total. The creditors are primarily the pension fund and financial institutions, which is not surprising since the infrastructure and legal frameworks have yet to accommodate businesses to participate in the capital market.

This has been mainly possible because of the policy shift in opening the T-bill market to market forces. It now takes place through auctions that determine the volume of bonds sold and the yields. This was wise. The government's sources of financing needed to be expanded, especially away from deficit financing through the central bank, which is directly printing money - historical causes for hyperinflationary pressure. Treasury bills are far better alternatives, mainly because they induce responsibility. A government is less likely to spend indiscriminately when it knows it has to pay back all the money at some point.

Still, government borrowing through selling government securities is not without its drawbacks. It should not be carried out with reckless abandon. Although the Administration claims 69pc of the 147 billion Br in loans banks advanced went to private borrowers over the past six months, it crowds out the private sector. Nonetheless, the 253 billion Br in T-bills owed to financial institutions is largely credit that could have directly gone to the private sector through commercial banks. Indeed, as long as the Administration is spending, the money still ends up in the economy, fueling consumption and greasing the private sector in its way.

The difference is in its productive allocations for optimal results, which the governments rarely do best, particularly with an expanded defence budget to prosecute a civil war. The service and industrial sector took two-thirds of the total loans advanced in the half-year, leaving a mere 27pc for agriculture in a country where over 80pc of the population's mainstay remains to farm. Agriculture takes the biggest share of export revenues and comprises a little half of the GDP.

More consequential is that government securities could cause liquidity problems at financial institutions, which are spreading themselves thin on capital adequacy. There is no better example of this than the Commercial Bank of Ethiopia (CBE), which has over a trillion Birr in assets for capital of 40 billion Br. It needs to be at least two-fold higher to be considered healthy. This is unlikely to occur when funding the federal government for a bond yield of just around eight percent.

But are banks not buying T-bills out of their own will?

When the system is gamed, not really. Deposit interest rates are only seven percent, while the central bank a few months ago prohibited all collateral-based loans. Worse still, commercial banks are forced to re-invest maturing bonds from central bank bills, which were suspended, while insurers are expected to invest at least 40pc of their savings in T-bills. This does not leave them with many choices.

If T-bill financing continues, the Administration needs to offer an off-ramp to ensure that financial institutions remain on a positive footing. It can start by easing the rate of Birr’s depreciation, which poses a significant financial challenge to banks. The more the Birr is depreciated, the lower the real interest rates are on the bonds banks buy from the government, and the less valuable the returns.

This much borrowing is also not healthy for the federal government. After all, it is still national debt that must be paid back. It won't be a black swan!

PUBLISHED ON Mar 12,2022 [ VOL 22 , NO 1141]

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