Nightmare of Kenya’s debt

A significant amount of government spending has gone towards development projects whose expected economic return might not be able to finance the cost of financing 

Kenya’s Public Debt has been on the rise in the recent years as a result of the Government’s ambitious development agenda evident in the country’s budgets over the last ten years. A number of rating agencies have in the near past relooked at the country’s sovereign credit outlook and changed them to a more negative one. 

In May, Moody’s Credit Agency, for instance released changed Kenya’s sovereign credit outlook to negative, from a previous outlook of stable, but affirmed the earlier on B2 credit rating. The said that the negative outlook was a result of rising financial risks brought about by the country’s large borrowing requirements especially during this time where the fiscal outlook is deteriorating, given the erosion of the revenue base and the high debt and increased interest burden. 

The large borrowing needs and the negative fiscal outlook, the agency says, will and continues to expose Kenya to exchange and interest rate shocks thus threatening any fiscal consolidation measures that had been set by the government.

Standard and Poor’s (S&P), a global rating agency also lowered its outlook in July on Kenya’s economy to negative from stable while affirming the country’s rating at ‘B+/B’, mainly due to the fallouts from the pandemic which have slowed down the country’s growth and weighed down on its already weak public finances. The negative outlook reflects the worsening fiscal position of the country amidst the pandemic and the disruptions to revenue collection.

(Source: National Treasury

Similarly, Fitch Ratings also revised the outlook on Kenya’s Long-Term Foreign-Currency Issuer Default Rating (IDR) to negative from stable, affirmed the Issuer Default Rating at ‘B+’, and downgraded the country’s ceiling to ‘B+’ from ‘BB-’. The agency expects a sharp economic slowdown and deterioration in the budget deficit and the ratio of government debt to GDP on the back of weak fiscal consolidation. They forecast government debt to reach 70% of GDP in FY 2022, as a result of delays in fiscal consolidation brought about by the pandemic and weak revenue growth. Despite the above, the ‘B+’ IDR reflects favourable growth potential and relatively stable macroeconomic conditions.

Essentially, the rating downgrades may influence the country’s cost of borrowing in the international financial markets and make it harder for the country to borrow from the international market.

Current state of affairs 

The national budget has continued to grow, with total expenditure growing at a 6-year CAGR of 7.3% to an estimated Sh2.7tn in FY’2020/21 according to the 2020 Budget statement, from Sh1.8tn as at the end of FY’2015/16. Revenue growth, on the other hand, has grown at a faster 6-year CAGR of 8.6% to an estimated Sh2.1tn in FY’2020/21, from Sh1.3tn as at the end of FY’2015/16. The fiscal deficit came in at Sh0.6tn (equivalent to 5.2% of GDP) in FY’2020/21 as highlighted in the chart below,

The country’s total public debt as at March 2020 stood at Sh6.3tn, with the country having raised the debt ceiling to the absolute figure of Sh9tn from the initial 50% of GDP in October 2019. This means that the Government has headroom to borrow an additional Sh2.7tn before the current debt ceiling is exceeded. The debt mix stands at 51:49 external and domestic debt, respectively, meaning foreign borrowing is currently at Sh3.2tn while domestic borrowing is at Sh3.1tn. 

The country’s debt composition has evolved with the exposure to bilateral and multilateral development institutions declining, to a much more commercial funding structure comprising of Eurobonds and syndicated loans. This has seen the proportion of concessional loans (Bilateral and Multilateral debt), which stood at 90.7% of total external debt as at June 2013, decline to approximately 66.5% as of March 2020. This has seen commercial loans; deemed more expensive because of their high-interest costs, grow from a low of Sh58.9b (equivalent to 7.4% of total external debt) as at June 2013, to Sh1.0tn (equivalent to 33.0% of total external debt) as at March 2020, with suppliers credit accounting for the remaining 0.5% of the total foreign debt. 

It is key to note that: Contribution from both Bilateral foreign debt and Commercial banks’ loans decreased marginally from 33.7% and 34.6%, respectively in March 2019, to 33.5% and 33.0% in March 2020, and; Multilateral foreign debt, which is largely composed of concessional facilities from organizations such as the International Development Association (IDA) and the ADB & ADF, increased from 31.1% to 33.0% over the same periods as illustrated in the table below. 

The country’s cost of debt servicing is expected to rise driven by currency depreciation with the shilling having depreciated by 6% year to date (time of going to press). Additionally, the debt service to revenue ratio is expected to increase mainly driven by the expected decline in revenue.

Debt Service to Revenue Ratio:

For the first half of 2020, revenue collection activities of the government have been affected due to the ongoing pandemic with major economic sectors such as tourism, manufacturing and agriculture feeling the brunt effects of the pandemic following supply-side shocks. According to the National Treasury, the debt to service revenue ratio is estimated at 45.2% at the end of 2019, higher than the recommended threshold of 30% and as such elevating the risks of repayment following shocks arising from the ongoing pandemic and low revenue collection. For this financial year, a total of Sh904.7b has been set aside for debt servicing from the Sh2.1tn projected revenue collection. 

Debt to GDP Ratio

On the hand, the debt to GDP ratio came in at an estimated 62.1% in 2019, 12.1% above the IMF recommended threshold of 50.0%. Late last year, the treasury amended the Public Finance Management (PFM) regulations to substitute the debt ceiling which was previously set at 50% of GDP to an absolute figure of Sh9tn to plug the budget shortfalls without hurting the economy since there was no more scope to raise taxes. According to Fitch Ratings, the shocks from COVID-19 are expected to delay the narrowing of the fiscal deficit. Government debt is forecasted to 70% of GDP in 2021 on the back of rising debt levels and weak revenue growth.

Some might argue that the additional debt is being directed towards development projects, which will, in turn, lead to faster economic growth but this has not been the case. A significant amount of government spending has gone towards development projects whose expected economic return might not be able to cushion the cost of financing. For example, the Exim Bank of China is set to receive Sh43.2b in debt payments for the SGR in the current fiscal year despite the project facing a variety of challenges such as low cargo volumes.

According to the IMF, the Kenyan economy is expected to grow at 1.0% in 2020, while the National Treasury expects the same to come in at 2.5%. The expected decline in growth is already being seen through the suppressed business activity experienced during the second quarter of the year, evidenced by the country’s Purchasing Manager’s Index which dipped to 34.8 in April 2020, the second-lowest level since the index was set up. The GDP growth for the year is expected to be slower than debt financing meaning the debt to GDP ratio will increase significantly since the denominator – GDP Growth – will grow at a much slower pace.

The high debt levels in the country have become a point of concern with both the debt to GDP ratio as well as the debt service to revenue ratio having exceeded the recommended threshold. The economy is expected to face fiscal challenges arising from the global pandemic pointing to a possible further downgrading of Kenya’s creditworthiness. 

Source: Central Bank of Kenya and National Treasury

Despite this, some investors are optimistic with regards to the country’ outlook evidenced by the decline in Eurobond yields over the month of May, pointing to the perception of lower risk in the country going forward coupled with the additional funding received from both the World Bank and the IMF. Locally, the Central Bank through the Monetary Policy Committee has continued to support the economy through the policy rate and the Cash Reserve Ratio and is confident that the measures put in place are having the desired effect. 

Similarly, the government has also made some tax amendments to help boost revenue collection and at the same time cushion the economy from the adverse effects of the coronavirus. 

To sustain its debt, Government should, among other measures, restructure the debt mix by going for more concessional borrowing to reduce the amount paid in debt service; cut on capital expenditure in this period of distress and direct the funds to areas that have a higher economic return; encourage growth in the manufacturing sector to help increase value of the exports and; take a proactive stance in enforcing the recent tax policy changes to curb tax cheating    

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