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Public debt crowds out private sector

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PUBLIC debt is crowding out the private sector from the credit market at a time local firms are suffering the effects of legacy debt.

MERLIN GARWE

Confederation of Zimbabwe Industries chief economist Tafadzwa Bandama said the debt was driving out private investment.

Zimbabwe is saddled with an US$18.9 billion pubic debt and is in the midst of an economic implosion.

The crowding out effect suggests rising public sector spending drives down private sector
spending.

There are three main reasons for the crowding out effect to take place which are economics, social welfare, and infrastructure.

By contrast crowding in suggests government borrowing can actually increase demand by generating employment, thereby stimulating private spending.

Bandama said this also raise interest rates, elbowing out private investments.

Foreign investors have been shunning Zimbabwe markets due to various challenges including ease of doing business issues, high country and political risk as well as currency troubles.

“Debt also crowds out public investment (on roads, electricity etc) as government spends more of the budget on interest payments,” she said.

“Public sector can borrow by securitising state resources even if there is high country risk. Government can always borrow locally through short-term high-interest debt, which private businesses cannot afford.

“Local firms are suffering the effects of legacy debt that was incurred when the country was operating an exchange rate regime of 1:1 to the US dollar.”

Bandama said after the exchange rate had depreciated, the costs of servicing the debt increased, although the authorities have promised to extinguish the debt at 1:1 between the Zimbabwean dollar and United States
dollar.

Last year, the country dumped the multi-currency regime, declaring the Zimdollar as the sole legal tender, although the economy is fast dollarising.

Companies were left with huge debts, which the central bank promised to take over to ease the burden of foreign on the affected companies.

Bandama said high country risk increases costs of procurement of raw material supplies and equipment, while interest payments could be higher due to high risk.

“Funders stay away from the local market, they do not participate,” she said.

“Foreign insurers are not prepared to cover debt to Zimbabwe, making it difficult to get supplier credit -everything becomes cash based. High risk perception results in outflow of portfolio investments — which leads to shortage of foreign currency for importation of capital and production inputs.”

In a free-floating exchange rate, financial outflows lead to depreciation of the local currency, which makes importation of capital and inputs expensive, especially in a country like Zimbabwe where companies have high exposure to imported raw materials.

While depreciation of local currency should make exports cheaper, Bandama said production constraints may make it difficult to increase output to meet export demand.

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