Raising our debt ceiling reflects badly on Treasury

The government’s move to convince parliament to allow it to borrow more - and specifically move away from the Gross Domestic Product (GDP)-based ceiling sounds tricky. The debate about the ceiling is more political than economic reality.

The reason why the Government wants to borrow sounds convincing. The most pronounced reason is to finance economic development, specifically infrastructure.

The other reason is to bridge the gap between revenues and expenditure and replace old debt with cheaper debt.

This reflects how poorly we have become in managing our finances. When we borrow, we must look at the interest rate now and in future.

This is why intelligent finance managers go for short-term debt when they expect interest rates to decline in the near future, and for long-term debt when they expect the interest rate to rise in the future.

The National Treasury and the Central Bank must build interest forecasting capacity and even the capacity to swap interest rates when necessary.

There are interest rate management instruments that when employed carefully, lower or make interest rate fixed and favourable to the borrower.

Borrowing extensively will not move us away from poverty; we ought to put in place proper policies and solve our ethnic conflicts.

The first step to the effective management of debt is to understand the consequences of the wealth of the borrowing nation and specifically on individuals.  The economists refer to this as the burden of debt.

The effects of debt depend on whether it is internal or external. However, what is certain is that whenever the State borrows money, it is transferred from the investors (lenders) to the government. 

The State is then required to use the borrowed cash to settle government bills on goods and services supplied. Up to this point, things look okay because money is merely transferred from one class of citizens to another, and everyone appears to be happy in the absence of the money burden.

But who are the lenders and what do they get in return?  Those who lend to the government are the rich, and they charge interest on the amount lent. However, to repay the debt and the interest on the debt, the State has to tax both the rich and the poor.

Most of this tax is indirect and since the poor are the majority, they will pay more taxes.  The result is that more wealth is transferred from the poor to the rich.

There will be a loss of economic welfare because rich lenders will benefit at the expense of the poor.

This problem is more pronounced in developing countries.

The other problem is that the burden is transferred from the older to the younger generation because the bondholders are generally the former. Debt can introduce inequality in a country, thus widening the gap between the rich and the poor. The effect of external debt can be worse because it transfers wealth externally depending on whom the holders of that debt are.

Borrowing nation

Initially, external debt transfers wealth from lending country to the borrowing nation.

The problem is that when it comes to repayment of the debt, the wealth to be transferred is more than what was borrowed because it includes interest.

It is important determining how the interest burden is shared between the rich and the poor because the government repays the debt from taxation, and all the citizens pay tax.

If we borrow externally, then the foreign lender will have control over our goods and services, and this reduces our economic welfare. If the tax becomes too high because a country must service its debts, then some citizens will be unwilling to work and therefore, unable to save.

The mathematics of debt and its impact on the economy must be correct for it to be beneficial.

We should only accept debt if it improves our productivity and is devoid of economic injustices.

The worst of debt at the individual and national level is when you borrow, it becomes difficult to finance new projects.

This happens when the amount of debt is huge when compared to the Gross Domestic Product (GDP), and you have exhausted your debt capacity or possibly renowned credit rating agencies have blacklisted you. Private investors will not invest in countries where the government keeps on increasing tax to service its debts.

No irrational investor will invest just to pay tax.

Debt is only recommended when its benefit is greater than the principal and interest paid. It should also narrow the gap between the rich and the poor.

-The writer teaches at the University of Nairobi