UNIVERSITY OF GHANA

DEPARTMENT OF ECONOMICS

MARCH 31, 2014

LECTURER: DR. E. OSEI- ASSIBEY

GROUP 21

TOPIC: PUBLIC VS PRIVATE BORROWING, IS

GOVERNMENT BORROWING CROWDING OUT THE

PRIVATE SECTOR IN GHANA.

NAME ID

ATTOH MAIDATU AMIOKOR 10339124

LAWSON ABENAAB AKANLAKUM 10343222

MARK DZODZEGBE 10337969

MARGARET AKORLEY SAVIOUR 10344228

MAGNUS EDEM DEY 10335323

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TABLE OF CONTENTS

ACKNOWLEDGEMENT………………………………………..Page 2.

ABSTRACT………………………………………………………Page 3.

INTRODUCTION………………………………………………...Page 4-8.

o Background Study

o Objectives of the study

o Research study

o Significance of the study

o Organisation of the study

OVERVIEW………………………………………………………Page 9-12.

LITERATURE REVIEW…………………………………………Page 13-20.

METHODOLOGY, RESULTS AND DISCUSSION……………..Page 21-24.

SUMMARY OF FINDINGS……………………………………….Page 25- 27.

RECOMMENDATIONS…………………………………………...Page 27-28.

CONCLUSIONS……………………………………………………Page 28.

REFERENCES………………………………………………………Page 29

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ACKNOWLEDGEMENT

We would first of all thank the Almighty God for the successful completion of

this term paper. Also, our profound gratitude goes to all our group members

for putting in their best efforts throughout the research work.

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ABSTRACT

Is government borrowing really affecting the private sector through crowding

out their investment? This is a question that would be a concern for most

economies that have any objective of expanding. The purpose of our paper

is to find out the effect of government borrowing on the interest rates,

private investment and the availability of funds to the private sector. At the

end of our discussion we would be well acquainted to the sources of funds

for both the private and public sector in Ghana and the relation between the

two.

In our discussion we used secondary data from the statistical bulletin of the

central bank of Ghana, statistical service and www.tradingeconomics.com to

analyse the relationship. It was revealed that government borrowing had a

major impact in crowding out the private sector in Ghana although some few

times it had crowded in private investments.

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1. INTRODUCTION

1.1 Background study

Ghana is a developing country whose capital formation is very minimal hence

has a great challenge in acquiring financial resources for its various

institutions both private and public. Most often than not, the government

goes into borrowing in order to offset its debt which is outstanding usually

because Ghana has often got a budget deficit hence it needs extra funds to

offset such deficit as well as raise revenue for its expenditures. This is not

only a challenge to the government (public) but a challenge to the private

sector as well since they also have to generate enough funds to expand their

operations. Due to the above challenges, there is a kind of competition

between the public and the private when it comes to the availability of funds

for each other. Therefore, the concern of whether the government

borrowing which usually have an upper hand has an effect of crowding out

and creates a high cost of credit for the private sector is of great concern as

the private sector contributes greatly to every growing economy. Ghana

certainly faces a debt problem. Central Government gross domestic bonded

debt alone stands at over 25 percent of national output and 123 percent of

total budget revenue. The domestic debt attracts interest payments that far

exceed government expenditures for development. The domestic debt has

grown very fast over the last six year, with the increasing deficit that has

become structural. In 1990 the debt was less than 3 percent of national

output; but, made a leap to 25 percent in 1996 and has hovered around that

level since. If the domestic debt as at the end of 2000 was to be shared

equally among Ghanaians (including babies), each Ghanaian would be

carrying a debt burden of about 420,000 cedi. This certainly is an enormous

burden on the economy.

Since independence, Ghana has always had problem with central government

finances. Government has never been able to marshal enough revenue to

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take care of its expenditures. This creates deficits, which have to be financed

either by borrowing (from domestic or external sources) or by resorting to

the "printing of money". The latter form of financing the deficit can be

inflationary while the former creates debt. In the 1970s, the deficit was

mostly money financed leading to strong inflationary pressures. This mode

of financing was forced on the economy by the financial environment of the

time. The financial system, particularly the money market, was

underdeveloped and Treasury bill was not a popular financial instrument;

thus the Government could not borrow from domestic sources to support

the budget. On the other hand, foreign borrowing was also limited, as the

international financial community had blacklisted the country following

repudiation of some external debts by the Government of the National

Redemption Council led by General Acheampong. Hence, the only avenue

open for financing the deficit was through the "printing press". This caused

inflation to spiral upwards, hitting 123 percent in 1983. The domestic debt

is a problem of the 1990s. Gross domestic bonded debt (which refers to the

domestic borrowing) rose sharply from 3 percent of GDP in 1990 to about 25

percent of GDP at the close of the millennium.

1.2 Objectives of the study

The paper at the end of analyses, seeks to find out certain ways that can be

adopted by both the public and private to achieve a maximum benefits of the

funds available to them in order to enhance the growth of the economy. At

the end of discussion we would want to be well acquainted with the

following:

The sources of government borrowing and private borrowing in Ghana.

The effect of government borrowing on interest rate and investment in

Ghana.

The implications of crowding out on the private sector.

The effect of government borrowing on the private sector.

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Measures to take in order to curb the crowding out effect on the

economy

1.3 Research Questions

What are the sources of government borrowing and private borrowing

in Ghana?

What is the effect of government borrowing on interest rates thus the

cost of credit as well as investment?

Is government borrowing really crowding out the private sector in

Ghana?

What are the economic implications of the crowding out of the private

sector in Ghana?

What are the measures that can be put in place to curb the crowding

out of the private sector if it really existed?

1.4 Significance of the study

Government borrowing from domestic banks has increased dramatically in

developing countries starting from late 1990s. Thus the effects of such

phenomena on private credit have become especially important for policy

analysis in the last couple of decades. In the classical view, public borrowing

authority accumulates resources for its own use leaving private sector with

lesser part. The phenomenon is popularly termed as crowding out of private

investment (Majumder, 2007).The literature on crowding out in the context

of developed countries focuses on the effects of government debt on the

equilibrium interest rate (Ardagna et al. (2007), Blanchard (2007), Gale and

Orszag (2004), Faini (2006), Friedman (2005), Evans (1987, 1985), Bradley

(1986)). The financial sector, especially the banking system, in most of the

developing countries has historically been subject to extensive government

interventions and the interest rates were often set administratively by the

central bank. If the interest rates are not determined by the market clearing,

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then the "availability of credit" will be more important in understanding the

effects of government borrowing on private investment. Although financial

liberalization policies have been implemented in most of the developing

countries in recent years, government interventions still remain significant in

many countries. Even if the banking sector is fully liberalized, the effects of

government borrowing on the private investment in the developing countries

might still be mediated primarily through the credit availability, given that

the credit markets are less developed and credit rationing might be more

important (Ghosh et al. (2000), Ray (1998)). Besides, the importance of credit

constraint for private investment in developing countries is well-recognized

in the literature (Haramillo et al. (1996), Banerjee (2004), Banerjee and Duflo

(2004), Emran et al. (2007), Shafik (1992), Rama (1993)).

The research on whether the government borrowing has an effect on the

private sector or not is a very important area of study as government

borrowing in itself has its own impact on the economy of a country. Also,

high cost of credit or interest rate in any country creates a sort of

disincentive in attracting investors into the country hence the issue of

government borrowing affecting the cost of credit is a great concern to every

growing economy. The outcome of this research would help in undertaking a

critical look of certain economic policies that might be taken by the

government especially when it comes to its ways of borrowing in financing

projects.

1.5 Organisation of the Study

Our paper would be divided into six broad sub section of which

Our first section would introduce the topic of our study by giving a

background to the study, the significance, objective and trends of the

key issue of our research study.

The next section would have an overview of where the private and the

public in Ghana get their financial resources from thus the sources of

funds for both the private and the public as well as the trend of

government borrowing and the related effect on interest rate as well as

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investment in Ghana from the past years. Also we shall discuss on why

interest rates must be an issue of concern to every growing economy.

In our further discussion we shall use these premises to serve as a

supporting argument to either back or reject the claim that

government borrowing is crowding out the private sector in Ghana.

The third section would have the literature review which would be

divided into two major aspect; the theoretical and the empirical. The

theoretical section would explain certain key terms pertaining to our

topic using various theoretical modules and the empirical section

would review write-ups of various researchers that have made certain

previous findings in this area of government borrowing and its effect

on the private sector.

The fourth section would provide the method we are going to use in

analysing our data as well as the sources of the data we are going to

be use throughout our analyses.

The fifth section would analyse the various data and evidences

available to us to verify if in reality government borrowing is actually

crowding out the private sector In Ghana or not. In this section we

shall also talk about the effects of the analyses on the private sector

and we would suggest ways in which government can take in order to

curb the situation of crowding out effect on the private sector if it

really existed.

Our final section would conclude by giving a summary of our entire

findings on the subject together with a highlight on our

recommendations.

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2. OVERVIEW

2.1 The sources of government and private borrowing.

Government borrowing is the total amount of money that a country’s

government borrows to fund its spending on public services and benefits.

The public (government) gets it borrowing from either internally that is from

domestic as well as from external source thus from foreign borrowing.

Internally, government usually borrows from the issuance of bonds, treasury

bills and the central bank. Externally, government borrows from international

corporations like the International Monetary Fund (IMF), World Bank etc. In

Ghana, statistics showed that over 55% of the money government borrows

comes from the local market (rich individuals) with the rest of the funding

coming from the international bodies. In Ghana domestic borrowing is fast

growing and gaining more momentum not only due to expansion in

coverage but also the diversification of sources and types (ministry of

finance and economic planning, 2010). In view of the market types and types

of facilities involved in domestic borrowing such as domestic suppliers, there

is no minimum limit set for domestic borrowing. There are three main types

of domestic borrowing. One of which we have government securities where

the government borrows through the issuance of treasury bills and bonds on

the domestic market usually by the bank of Ghana as agent. Another form of

government domestic borrowing is from commercial banks and non-bank

including SSNIT loans (pension fund loans). There is also the domestic

supplier credit which involves pre-finance contracts carried out by the

domestic contractors or suppliers.

On the other hand, private corporations in Ghana usually get their finances

from borrowing from banks, issuance of company shares, stocks and all

form of equity. According to the association of Ghana industries, business

barometer for the fourth quarter of 2012, indicated difficulties in accessing

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credit and high interest rates as the topped on the list of the challenges

hampering the growth of business in Ghana.

2.2 Trend of government borrowing and its impact on interest

rates as well as investment.

The government is often a big player in the markets where it competes with

other users of funds. In that sense, the public sector borrowing requirement

(PSBR) has a big influence on the price of funds or the interest rate.

Companies and individuals also borrow for consumption and investment

purposes. Their demand for funds will also influence the price or interest

rate. Government borrowing to finance budget deficits has been one of the

major factors that have sustained the high level of interest rates in Ghana.

The immediate effect is on the Treasury Bills and Notes/Bonds market. But,

as noted, interest rates across market segments tend to be linked somewhat

through “arbitrage”—and also because of limited resources—government

borrowing has an effect on all interest rates. When government issues high

levels of its securities, it has to pay a high price—in the form of interest—to

be able to raise its financing target, because of resource limitations. By

competing with other users of funds, government borrowing may put

pressure on interest rates in other market segments as well as crowd out

private borrowers. That is the reason why high deficits and excessive

government borrowing may be bad for the economy.

Borrowing by the government can be dated back to the days of our first

republic that was spearheaded by Dr. Kwame Nkrumah. In the Ghana

Macroeconomic Review and Outlook 1997, according to the domestic debt

register, the domestic debt increased by GHC452 billion from a stock of GHC

1672 at the end of 1996. The banking system data show government

deposits falling by nearly GHC140 billion from GHC570 billion at the end of

1995 to GHC431 at the end of 1996. Together these figures implied that

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Ghana Government mobilized about GHC590 billion from domestic sources

to finance the deficit and the net external loan repayments in 1996.

Gross capital formation, measured as a proportion of GDP (investment ratio),

has remained stagnant or declined since 1994. However, the average

investment ratio for the period 1991-1995 (14.6%) is higher than that of the

decade 1986-1995 (13.1%). The stagnation or decline of the investment ratio

is especially worrisome since the investment serves as the primary means of

increasing the productivity capacity and productivity of a nation. Even

though the level of total investments is important, it has been demonstrated

that what is even more crucial is the composition of the investment that

takes place. The issue here is the extent to which basically, private and

public investments are complements or substitutes. Preliminary estimates

shows that in Ghana over the years, the output elasticity of public investment

was higher than that of the private investment. The situation however

reversed in the nineties, with the output elasticity of the private sector

investments about three times that of public investment. In 1995, over 70%

of total investment emanated from the government sector. The sub

optimality of the public/private investment mix gives cause for concern.

Several studies have demonstrated the inverse relationship between

macroeconomic instability and growth. In these studies a key measure of

instability was identified a public sector borrowing requirement/ gross

domestic output ratio (PSBR/GDP). The high PSBR/GDP implies that there was

an excessive government borrowing in domestic and foreign output markets

which in effect has a resultant crowding out of the private investment.

2.3 Why the cost of credit is a major concern in an economy.

Probably, nobody has a better appreciation of the effects of high interest

rates than industrialists who are at the forefront of production in the

country. It is not surprising, therefore, that the Association of Ghanaian

Industries (AGI) along with the United Traders Association of Ghana (UTAG)

and the Ghana Chamber of Commerce (GCC), has been the most vocal in

decrying the high level of interest rates. As these various bodies will tell you,

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high interest rates reduce the incentive to invest and thereby slow down not

only industrial growth but also economic growth. Indeed, Ghana's relatively

high interest rates and high cost of credit make the country less competitive

in attracting investments, which inhibits its growth. High cost of credit ranks

among the top concerns often cited by investors as impeding business in

Ghana. If interest rates, and the cost of credit, are brought down

significantly, Ghana would be able to attract higher levels of investments

which would add several notches to its growth rate.

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3. LITERATURE REVIEW.

3.0 Introduction

In this section we would be explaining certain key terms that is captured in

our research topic such as crowding out, cost of credit, public and private

borrowing. We would be explaining the theoretical concept of our topic. We

shall be reviewing an empirical literature that was a case study of Egypt on

the same issue of government borrowing whether it was crowding out the

private sector written by Mona Esam Fayed, Assistant Professor, Faculty of

Economics and Political Science, Economics Department, Cairo University.

Finally, we shall cite other researchers on the same topic and their findings.

In the end, we would use the various evidences to do a thorough analyses of

our topic.

3.1 Explanation Of Key Terms.

Public borrowing is the money borrowed by the government through

issuance of securities, bonds and bills such as the treasury bills. Government

usually borrows money to make up for the differences between its revenues

and expenditures thus the debt it owns. Usually this borrowing is to offset

the budget deficit of the country.

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Private borrowing can also be said to be the monies or funds borrowed by

private firms or individuals from either loaning from banks, issuance of

shares, bonds and equity.

‘Crowding out’ refers to all the things which can go wrong when debt

financed fiscal policy is used to affect output. While the initial focus was on

the slope of the LM curve, ‘crowding out’ now refers to a multiplicity of

channels through which expansionary fiscal policy may in the end have little,

no or even negative effects on output. A first line of argument questions

whether fiscal policy has any effect at all on spending. Changes in the

pattern of taxation which keeps the pattern of spending unaffected do not

affect the inter-temporal budget constraint of the private economy and thus

may have little effect on private spending. This argument, known as the

‘Ricardian equivalence’ of debt and taxation, holds only if taxes are lump

sum (Barro, 1974). Some taxes which induce strong inter temporal

substitution, such as an investment tax credit for firms, will have stronger

effects if they are temporary; for most others, such as income taxes, changes

in the inter temporal pattern may have only a small effect on the pattern of

spending. The Ricardian equivalence argument is not settled empirically and

its validity surely depends on the circumstances. A change in the inter

temporal taxation of assets such as land or housing, leaving the present

value of taxes the same, will have little effect on their market value, thus on

private spending. An explicitly temporary income tax increase may have little

effect on spending while the anticipation of prolonged deficits may lead

taxpayers to ignore the eventual increase in tax liabilities. Evidence from

specific episodes, such as the 1968 temporary tax surcharge in the United

States, suggests partial offset at best. Changes in the pattern of government

spending obviously have real effects. But here again, various forms of direct

crowding out may be at work. Public spending may substitute perfectly or

imperfectly for private spending, so that changes in public spending may be

directly offset, fully or partially, by consumers or firms. Even if public

spending is on public goods, the effect will depend on whether the change in

spending is thought to be permanent or transitory. Permanent changes,

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financed by a permanent increase in taxes, will, as a first approximation,

lead to a proportional decrease in private spending, with no effect on total

spending. Temporary changes in spending, associated with a temporary

increase in taxes, lead to a smaller reduction in private spending and thus to

an increase in total spending.

In summary we can say Crowding out is an effect that can be said to have

been occurred when there is an increase in government borrowing, a kind of

expansionary fiscal policy that tends to reduce investment spending usually

by the private sector. Thus the increased in borrowing crowds out the private

investment. This is because an increase in government borrowing usually

generates from an increase in government spending. When there is an

increase in government spending through a fiscal policy coupled with a less

revenue, this would create a deficit in the budget and this deficit would be

financed by government borrowing. Hence an increased government

expenditure eventually leads to a large deficit which in the end results in

increased borrowing by the government. Then the increased borrowing leads

to increasing of interest rates as the demand for the funds has increased

with a relative fewer available funds. This situation causes the cost of

borrowing thus the interest rates to increase which in tend reduces

investment especially for the private as they usually are deterred from the

high interest rates. Hence creating a crowding out in the private investment.

Cost of credit can be referred to as the interest rate associated to

borrowing.

3.2 A Case study on the crowding out effect of public

borrowing in Egypt by Mona Esam Fayed, Assistant Professor,

Faculty of Economics and Political Science, Economics

Department, Cairo University.

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Egypt, like most governments in developing countries, faces significant

constraints on raising revenue as the set of policy instruments available is

limited given the structure of the economy and low level of income (Fielding

(2007), Sah and Stiglitz (1992)). Facing such constraints, the government has

strong incentives to finance its expenditure through domestic and

international borrowing. However, the access to international credit market

may sometimes be limited. Thus, the government, in recent years, resorted

to borrowing more from the domestic sources. A plot of a simple time series

by World Development Indicator seemed to have indicated a positive

correlation between government borrowing and private credit, which is they

move together over time. This gives an impression of crowding in effect

rather than crowding out. Hence this relationship needed to have been

further investigated using an adequate econometric model. However,

starting 2008, credit extended to the private sector slowed down crowded

out by the relatively higher growth rate of credit extended to the

government.

Data and Methodology employed.

In an attempt to assess the relationship between government borrowing and

private credit, the study used data spanning second quarter of 1998 to third

quarter of 2010. The data is taken from several sources, namely the

international financial statistics (IFS), the world development indicators

(WDI,) the world governance indicators (WGI), the central agency for public

mobilization and statistics (CAPMAS) and several issues of the CBE annual

reports and monthly statistical bulletins. Also, the analysis focused on two

variables. The first is the private credit, defined as the claims on the private

sector by deposit money banks and other financial institutions. The other is

the borrowing by the government from the banking sector, defined as the

claims on central government by the deposit money banks and other

financial institutions. Both variables are measured as a percentage of

industrial production. The use of industrial production as a proxy for GDP is

due to data availability constraints.

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The basic model specifying the private credit from the banking sector is

expressed as follows:

CT

= β 0

+ β1

Gt + β 2

Yt + β 3

Ft-1 + β 4

IT + β 5

Rt +εt

Where C is private credit as a percentage of industrial production, G is

government borrowing also as a percentage of industrial production, Y is the

log of industrial production, F the level of financial intermediation, I the

institutional quality, and R is the lending interest rate. The subscript t is for

the time index. The above equation forms the basis of our empirical analysis.

It is motivated by the recent work of Djankov et al. (2007). The focus is on

the parameter β1. Crowding out of private credit by government borrowing

implies that β1 < 0. If the risk diversification effect dominates then we

expect that |β1|< 1 when β1 < 0; and in extreme case it can be positive, i.e.,

β1 > 0. If the banks behaviour is better characterized by the "lazy bank" view,

then one expects that |β1|> 1 with β1 < 0. In exceptional case, it is possible

that the risk diversification effect approximately cancels out the lazy bank

effect in the aggregate and we have β1 ≈-1.

3.2A Findings

The crowding out effect was found significant in the long run. The absolute

value of its coefficient was greater than one. The evidence is again in favour

of a lazy bank model of bank response to a higher government borrowing.

However, the estimated crowding out effect is numerically smaller (1.27)

than the estimates in the basic model. The evidence in favour of a lazy bank

model of bank response to a higher government borrowing is thus weaker

according to this specification. The ECM revealed the absence of any

significant variables affecting the private credit in the short run.

3.2B Conclusion.

The paper concluded that there was a possible crowding out of private credit

by government borrowing from the domestic banking sector and its negative

effects on private investment as widely discussed in the policy literature,

especially in the context of developing countries. However, there was little

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evidence on the magnitude of such crowding out effects of government

borrowing on private credit in developing countries. It was important to

understand the efficiency costs of financing government expenditure

through domestic borrowing as part of designing an appropriate fiscal

system.

The central conclusions of the empirical analysis were that

(i) There is a statistically significant negative effect of government

borrowing on private credit, and

(ii) The crowding out is more than one to one. These results go along

with the lazy bank model of the endogenous response of banking

sector to government borrowing.

3.2C Implications

The paper further explained the results as implying that government

borrowing from banks was not the sole reason behind crowding out private

credit. Bank credit demand stemming from the private sector was indeed

likely to slow down within decelerating economic activity. Also, banks

themselves will remain cautious with regards to extending further loans to

the private sector within the context of a drive to maintain their balance

sheets as liquid as possible. In fact, the growth in banks’ lending capacity

and the increase in their holdings of securities and treasury bills, reflect

banks’ preference to invest excess liquidity in a low risk high return

investment, and cannot be a single reason for the decline of credit to the

private sector.

3.3 Empirical Evidences of related studies on the effect of

government borrowing on the private sector.

A paper by Emran et al. (2009) provided estimates of the magnitude of the

crowding out effect of government borrowing on private credit using a panel

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data set on 60 developing countries for 32 years. The evidence showed that

there is a significant crowding out effect of government borrowing from the

domestic banks on private credit. Averaging over the different point

estimates from alternative specifications and estimators, they found that

when government borrowing increases by one dollar, it reduces credit to the

private sector by about one dollar and forty cents.

With regards to Ghana, Akpalu (2002) used annual time series data from

1970 – 1994, on Private Investment, Public Investment, Real GDP, Consumer

Price Index (CPI), Lending Rate, Credit to the private sector and GDP per

capita to model the determinants of private investment. He employed the

Engle-Granger Two Step procedure and the Johansen multivariate test. The

study reveals that in relative terms private investment in the short-run

responded more to real per capita income growth, credit availability and

public investment. Public investment was found to crowd-out private

investment. There was also a significant negative relationship between cost

of capital and private investment in both the short and long run. Further, a

significant positive relationship between real GDP and private investment

was found in both the short and long run models but was not significant in

the short- run. This result indicates a confirmation of the accelerator theory

of investment in Ghana. The Consumer Price Index however was found not to

be significant in both situations.

In a related study, Asante (2000) employed the Ordinary Least Squares

approach to model private investment behavior in Ghana using time series

data over the period 1970 to 1992. Asante finds a positive public-private

investment relationship which was significant at the 1% level suggesting a

“crowding-in” effect of public investment on private investment thus

confirming the theoretical hypothesis between the two variables. The growth

rate of real credit to the private sector also has a significant positive sign in

all the trials. Further, the measure of macroeconomic instability has a

negative in the trials and significant at the 1% level particularly inflation rate.

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Asante also established the detrimental effect of over-valued exchange

rates, lack of foreign, corruption and erratic import licensing, foreign

exchange quotas for various sectors and rent-seeking activities on private

investment over the study period. The political dummy representing political

instability was highly significant and negative in all the trials. Lagged private

investment /GDP ratio was also found to be positive and significant

indicating a good investment climate acts as a good indicator for current

investment decisions. GDP growth rate had negative significant sign contrary

to expectation but marginally significant in a few trials thus rejecting the

accelerator theory of investment in Ghana.

Ibrahim (2000) utilized a vector error correction model within a restricted

Vector Autoregressive (VAR) framework to model the long-run determinants

of private investment using a dynamic optimization approach. A significant

positive relationship was found between mark-up, inventory of finished

goods and real GDP whilst a significant negative relationship was found

between the general price levels, real cost of investment and private

investment in Ghana in the long-run.

Finally, Islam and Wetzel (1991), in a World Bank Study empirically examined

the link between real private investment on one hand and real public

investment/GDP, corporate tax revenues/GDP, credit to the private sector

/GDP, real rate of interest and a dummy for 1976. The dummy for 1976 was

included because of the large and unexplained drop in private investment in

that year. Employing Ordinary Least Squares (OLS), they find a negative

public-private relationship in the case of Ghana thus confirming the findings

of Akpalu (2002) but contrast that of Asante (2000) where public investment

was found to crowd-in private investment in Ghana. The study also

established a positive relationship between corporate tax revenue and flow

of credit to the private sector with all the variables having significant

coefficients. However, real interest rate was found not have a substantial

effect on private investment even though it has the expected negative sign.

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4. METHODOLOGY, RESULTS AND

DISCUSSION

4.0 Introduction.

In our attempt to explain the effect of government borrowing and cost of

credit on the private sector, we would use variables such as the government

debt/GDP ratio, Ghana domestic debt available to the private sector, interest

rates trend in Ghana, investment or the growth pattern of the private sector

over the period.

4.1 Data Source and Analysis.

Throughout our analysis we would be making use of secondary data which

would be taken from the statistical bulletin of the Central Bank of Ghana,

ISSER, Ghana statistical services, www.tradingeconomics.com (online) and

Ghana Macroeconomic Review and Outlook1997.

In our analyses we would compare the variables year to year to year to see

the impact of one variable on the other as well as the trends in the variables.

4.2 Discussion of results.

Figure 1:

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The above figure represents the Ghana’s government debt to GDP from the

year 2004 to 2013. The government debt to GDP also shows the level of

government borrowing. As Government debt is mostly funds owed by the

government mostly through borrowing which could either be internal or

external. A careful analysis of the above diagram shows that government

borrowing was at its peak in the year 2005 and the least borrowing in 2007.

Government borrowing can be said to have been increasing from the year

2008 to 2011. However, the year 2012 saw a decrease in government

borrowing to 43.4. In 2013 there was a further increase in government

borrowing by 1.5 as compared to the previous year.

Figure 2:

Source: www.indexmundi.com

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The above figure represents Ghana’s domestic credit to the private sector.

This shows the amount of credit that is available for the private sector from

the domestic credit. It can be seen from the above diagram that, there was

an increase in the credit to the private sector from 2004 to 2005 but 2006

saw a drastic decline by 4.45. From 2006, there was an increase till 2008

and later the credit to the private sector began to decline from 2009 to

2011. However in 2012, it increased by 1.07.

4.2a Analysis of the Government borrowing and Funds

available to the private sector from 2004 to 2012.

From the two figures above, we can see that from figure 1, the largest

decrease in government borrowing was from 2006 to 2007(48.6 to 26.2).

Similarly, in figure 2, we see the largest increase in credit to the private from

the year 2006 to 2007 (11.09 to 14.49). Also, from figure 1, the year 2008

to 2011 saw increases in government borrowing which corresponded to a

decrease in domestic credit available to the private sector in figure 2 from

the years 2008 to 2011. Furthermore, when government reduced its

borrowing from 2011 to 2012 (46 to 43.4), there was an increase in the

domestic credit to the private sector in 2012 (thus from 15.05 to 16.12).

From the data analysis above, we can see a negative relationship between

the government borrowing and the domestic credit available to the private

sector in Ghana.

Figure 3:

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The above diagram shows the pattern of interest rate over the year 2004 to

2014 in Ghana. It showed be noted that the interest rate serves as the cost

of credit or the cost of borrowing and its affect investment negatively. That

is when the cost of credit increases, the investment level also reduces.

4.2b Analysis of the cost of credit (interest rates) and the

government borrowing in Ghana from the year 2004 to 2012.

From the year 2005 to 2007, there was a decrease in government borrowing

which saw interest rates also reducing (negative slope) in figure 3. Also, from

the year 2008 to 2010, interest rates depicted a positive slope which meant

that the interest rates were increasing. Similarly it corresponded to an

increase in government borrowing from 2008 to 2010 (31.5 to 36.2).

Furthermore, from 2011 to 2012, government reduced borrowing and later

increased in 2013. The interest rates also reduced in 2011 to 2012 and later

increased in 2013. Clearly, from our analysis we can see a positive

relationship between the government borrowing and the domestic credit

available for the private sector in Ghana.

Figure 4:

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Source: www.indexmundi.com

The above figure shows the growth of the private sector over the year 2004

and 2006.

5. SUMMARY OF FINDINGS,

RECOMMENDATIONS AND

CONCLUSION.

5.0 Introduction

In this section, we shall conclude by highlighting our findings on the

relationship between government borrowing and private credit as well as the

interest rates or cost of credit. We shall also highlight on the issue of

crowding out and its associated implications from the various related studied

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that have been reviewed in the literature review section. Some

recommendations would be proposed to both the private and government in

order for both parties to achieve equilibrium in accessing funds and

increasing growth.

5.1 Summary of the findings

In our study we found out that about 55% of Ghana government borrowing

comes from domestic sources that is from private individuals in Ghana

through the issuance of shares and treasury bills. Also, over the years it has

been established that government of developing countries of which Ghana is

part normally have a budget deficit which they usually finance it through

borrowing which further pushes up the interest rates thus making borrowing

costly especially for the private sector. On the part of investment, we saw

that over the years, government investments and private investment have

been complements to each other. However, the trend showed that most

often the government investments were more than the private investments

as it looked like the private investments are being crowded out by the public

heavy borrowing.

In our attempt to analyze why higher interest rates should be a matter of

concern to any economy that wants to grow in all economic growth

indicators, we realized from an article from IEA on the topic ‘higher interest

rates in Ghana, a critical analyses’ that Ghana’s relatively high interest rates

and high cost of credit made the country less competitive in attracting

investments which at the end tend to inhibit its growth. Also, we realized

that high cost of credit ranked among the top concerns often cited by

investors in business Ghana which meant that the root causes of these high

interest rates should be a matter of concern to us here in Ghana which

makes this particular area of study relevant.

Furthermore we studied various literature on related topics pertaining to

government borrowing and the impact on private credit, cost of credit as

well as investment. In the case study of the Egypt case, Esam Fayed,

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Assistant Professor, Faculty of Economics and Political Science, Economics

Department, Cairo University concluded in his findings that “there was a

possible crowding out of private credit by government borrowing from the

domestic banking sector and its negative effects on private investment as

widely discussed in the policy literature, especially in the context of

developing countries. However, there was little evidence on the magnitude of

such crowding out effects of government borrowing on private credit in

developing countries. It was important to understand the efficiency costs of

financing government expenditure through domestic borrowing as part of

designing an appropriate fiscal system”. In a related study pertaining to

Ghana, Akpalu (2002) studies revealed that in relative terms, private

investment in the short-run responded more to real per capita income

growth, credit availability and public investment. Public investment was

found to crowd-out private investment. However, Asante(2000) found a

positive public-private investment relationship which was significant at the

1% level suggesting a “crowding-in” effect of public investment on private

investment thus confirming the theoretical hypothesis between the two

variables. But interestingly, Islam and Wetzel (1991) found a negative public-

private relationship in the case of Ghana thus confirming the findings of

Akpalu (2002) but contrasting that of Asante (2000) where public investment

was found to crowd-in private investment in Ghana.

In our own findings using data from www.tradingeconomics.com, we

established a negative relationship between the government borrowing and

the domestic credit available for the private sector in Ghana. That is anytime

government borrowing increased, the domestic funds available for the

private sector reduced which meant that government and the private sector

are in competition for the available domestic funds in the country. Also, in

our analysis we established a positive relationship between the government

borrowing and the interest rates over the years 2004 to 2013 in Ghana. The

relationship was such that anytime government increased its borrowing the

level of interest rates also increases. On the other hand, when government

reduces borrowing the interest rates also reduced hence revealing a direct

positive relation between the two.

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5.2 Recommendations

Due to the problems posed by a crowding out of the private sector, our

paper would outline certain measures that can be put in place by both

government and the private in other to minimize the problem. For instance,

Esam Fayed’s recommendation in the case study of Egypt could be helpful in

Ghana as he states that although the evidence presented on the government

borrowing is still important for understanding the effects of government

borrowing on private investment. Private investment in developing countries

critically depends on the availability of bank credit especially given that the

capital market is not well developed. Thus crowding out of bank credit may

have significant adverse effects on private investment and consequently on

economic growth in developing countries. Accordingly, much needs to be

done in order to facilitate access to credit and hence boost economic growth.

In the short-term, the government can begin by regaining the confidence of

the private sector and removing barriers for new entrepreneurs. Measures,

such as production subsidies and limited export facilities, could also be

implemented in order to boost production and create jobs. The banking

sector could assume a more proactive role as well in terms of lending.

Coordination by the central bank to avoid repercussions and moral hazard

by targeting SMEs based on merit should be among the government’s

priorities.

5.3 Conclusion

From all the evidences throughout our research we can conclude that there is

a positive relationship between government borrowing and the interest rates

hence making an increase in government borrowing to cause an increase in

the interest rate as well as increase in the cost of credit. This means that the

cost of investment would be high which tends to crowd out private

investment as the private sector cannot compete with the government on the

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basis of high interest rates. However, in certain cases, government

borrowing was found to have “crowded in” investment of the private sector.

Also, government borrowing in most cases was found to decrease the

availability of funds available for the private sector. That is there is a

competition between the private and public when it comes to sources of

funds especially domestic funds.

REFERENCES.

Banerjee, A., and Duflo, E., (2004). Do Firms Want to Borrow More? Testing

Credit Constraints Using a Directed Lending Program, MIT, Department of

Economics, Mimeo.

Blanchard, O., (2007).Crowding Out, Entry in The New Palgrave Dictionary of

Economics, Second Edition, Edited by S. Durlauf and L. Blume.

Djankov, S., McLiesh, C., and Shleifer, A., (2007). Private Credit in 129

Countries, Journal of Financial Economics, Vol. 84, Iss. 2, pp. 299-329.

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Emran, M.S., and S., Farazi, (2009). Lazy Banks? Government Borrowing and

Private Credit in Developing Countries, Institute for International Economic

Policy Working Paper Series No. 2009-9.

Fayed M. E., (2012). Crowding Out Effect of Public Borrowing: The Case of

Egypt.

Ghana Macroeconomic Outlook 1997, CEPA. Pp 39-43

http://en.wikipedia.org/wiki/Crowding_out_%28economics%29

http://www.indexmundi.com/ghana/public_debt.html

Kwame, J.K, (2010). High Interest Rates in Ghana, A Critical Analysis,

Institute of Economic Affairs publications, Ghana.

Marbuah, G & Frimpong J. M, (2010). The Determinants of Private Sector

Investment in Ghana: An ARDL Approach, European Journal of Social Sciences

– Volume 15, Number 2.

Sah, R., and Stiglitz, J., (1992). Peasants versus City-dwellers: Taxation and

the Burden of Economic Development, Clarendon Press, Oxford.

Sowa, N. K., Managing Ghana’s Domestic Debt. CEPA, Accra.

www.tradingeconomics.com