From the perspective of many risk averse banks and local financial institutions, it is better though not optimal in the short run to lend to the government for a fundamentally risk free safer return of 22% than lend to private businesses and SMEs who are the engine of real economic growth at 25-30%. The crowding out effect is real as lending to businesses are falling whereas government borrowing is increasing not for infrastructural development which will generate a positive social return but on recurrent expenditure such as salaries and subsidies. Ever wondered why the rush by local and international investors to buy Ghana government securities exist and the jamboree it was oversubscribed by so and so percent persists?
This is what the World Bank Vice President; Makhtar Diop is telling the government of Ghana. Stop the excessive local borrowing for salaries and subsidies and concentrate on regulatory and fiscal reforms to lower the cost of doing business!
Some of the problems of higher government borrowing or leveraging include:
- Higher Debt Interest Payments: As borrowing increases, the government have to pay higher interest rate payments to those who hold bonds (lend government money).
- Inflationary Pressure: Coupled with quantitative easing, very high levels of borrowing make inflation more likely.
- Crowding Out: Monetary theory suggests that with high levels of government borrowing the private sector is crowded out and have little to spend and invest. In a recession though, private spending falls and some kick is needed to jumpstart the economy.
- Higher taxes in the future: More borrowing implies higher debt obligations to settle therefore future tax increases become necessary to balance the deficit or government limits its spending (Austerity)