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Is debt good or bad?

One of the main constraints that most developing countries are facing today is the issue of a massive debt overhang. Zimbabwe remains a good example. According to Zimbabwe’s Mid Term National Budget, external public and publicly guaranteed debt as at the end of June 2019 was estimated at USD8.0bn, of which almost USD5.9bn is accumulated arrears. Multilateral institutions are owed a total of USD2.5bn of which the World Bank is owed USD1.5bn, African Development Bank USD702m, European Investment Bank USD309m and other multilaterals US$74m. Total bilateral debt amounted to USD5.5bn, with Paris Club creditors accounting for USD3.5bn and Non-Paris Club USD1.6bn.  The predicament is that the country is failing to unlock external funding so as to support local production mainly as a result of the debt overhang.

Piggy believes that managing debt is also critical even at a personal or household level. While debt sometimes provides that ability to build other income-creating assets, it is important that households and individuals move away from financing consumptive expenditure using debt. The cruel truth is that you will always have financial demands.  However, if you put off taking on big debts for a few years and invest aggressively initially, you can often accumulate a big enough lump sum to put down as a down payment which softens the blow of the debt.  The advantage is that if you don’t have excessive debt, the impact of rising interest rates on your pocket will be negligible. Instead, if you have cash reserves, the higher rate will benefit you greatly. Below is a framework that can be used by individuals and households to manage debt;

  1. Classify your debt. Identify “good” and “bad” debt. In this instance, “good” debt refers to financing productive activities whereas bad debt is financing consumption.
  2. Determine your current financial position. Identify your goals and also define your assets and liabilities.
  3. Consider the terms of any loans. Research on the costs involved (Interest rates, loan term and repayment amounts).
  4. Manage your debt. Develop effective debt management strategies by ensuring that monthly repayments do not strain your wallet.
  5. Minimise financial risk. Protect yourself against the unexpected. This involves effective risk management. While we are often helpless when it comes to uncontrollable risks, with good planning, households can be cushioned through appropriate insurance.
  6. Review your situation. Regularly review your plan and take professional advice

The following infographic on debt management is from the Joe Money Podcast

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