As many of you may recall, one of the recycled predicates the government gave for making more than a Billion Shillings payments to the fraudulent phantom Anglo-Leasing companies, as lame as it was, was that it needed to show respect for the rule of law to international investors to gain their confidence so Kenya can then issue sovereign debt. And it might have been true that the Presidentâ€™s hands were tied on this particular casehttps://www.youtube.com/watch? v=ST_Seqb7rcc .
About a week ago, the Ministry of Finance announced huge success in the sale of the Eurobonds and stated that Kenya had not only sold 2 Billion Dollarsâ€™ worth of the government paper to foreign investors in the open markets but also surpassed its goal, in social media some of the government spin masters tried to distort the sale by claiming that the Eurobond was â€œoversubscribedâ€ by 500%- this was purposely said to create an illusion of investor confidence in Kenya.
Be that as it may be, I think this financial arrangement entered by the government offers Kenyans a great opportunity to interrogate and vet the efficacy of the governmentâ€™s decisions. What exactly is a Eurobond? How is transacted? What is the value of the Eurobond to Kenya? Who pays for it? How does it affect Kenyaâ€™s fiscal and monetary planning and finally was this a wise move of Kenyaâ€™s part? Let me try to address this one by one and you be the judge.
By definition, a Eurobond is an international bond issued outside the country in whose currency its value is stated. The key concept here is that it is a bond; or a debt investment in which an investor loans money to an entity -in this case the Kenyan government- that borrows the funds for a defined period of time at a fixed interest rate.
Government issued debt is also referred to as â€œsovereign debtâ€. Kenya generally borrows locally, from other countries and world financial institutions such as IMF and World Bank but in this case and for the first time, the Jubilee government borrowed US $1.5 Billion and US $500 Million payable in 10 years and 5 years respectively through the international markets by way of Eurobonds.
A Eurobond, like most debt instruments are sold in the open market. The transaction is generally handled by professionals such as investment bankers for a fee. In Kenyaâ€™s case, the government has not disclosed which professional firm it engaged or the transactional costs associated with the sale of the bond.
The idea of government borrowing is not new, governments world over borrow from time to time to fund capital projects and Kenya is no exception. However, governments borrow with a clear predetermined plan and purpose, in Kenya all the government said was that it is borrowing to fund â€œMega projectsâ€- that is not sufficient disclosure.
Nonetheless, when a government borrows domestically it competes with citizens for the money and in the process increases interest rates (cost) of borrowing even though some of the pressure is deflated as the government then ratchets up spending, on the flipside when it borrows externally it increases the money supply and this in turn makes money cheap to obtain because it lowers interest rates. This is not always the case, especially in Kenya even though that is what the Jubilee government told us.http://www.nation.co.ke/Â business/Eurobond-to-help-cut- Kenya-interest-rates/-/996/ 2361424/-/ubyar3/-/index.html.
Higher interest rates invariably mean high inflation of which Kenya is a perfect example. Conversely, a government can buy its own bonds back or other debt instruments and this also increases the money supply, in some instances help reduce interest rates and ultimately lowers inflation; in short this is what â€œMonetary Policyâ€ is about in this context. So Kenyaâ€™s borrowing is actually not a bad thing.
However, I question the wisdom of such borrowing particularly without a clear purpose, again all we are told is that it will fund â€œmega projectsâ€- which mega projects when you have a 30% hole in the budget? Is the government shooting straight with the people?
In addition to the transaction costs which reduce the final amount the government collects, there are also other market considerations that factor into the valuation of the bond itself; these include the par (face) value, the market interest rate, the coupon rate (interest rate that the government will pay investors periodically) and the duration (maturity) of the bond. The value of the bond itself is calculated as the total Present Value of the lump-sum that will be due to the bondholder at maturity plus the present value of interest payments made for the duration of the bond.
That said, the Jubilee government has not disclosed the net proceeds that it received from the sale the bonds but its coupon rate on its five ($500 Million) and ten year ($1.5 Billion) bonds is 5.875% and 6.875% respectively. The international market interest rates on bonds is currently very low meaning that Kenya most likely sold the bonds at a premium or very close to par.
Be that as it is, what I want everyone to be absolutely clear about is that this is a loan to Kenya that must be repaid and not free money, unlike bilateral and multilateral loan agreements that are generally at much lower interest rates and are sometimes forgiven, the Kenyan taxpayer is now on the hook for a sum total of US $3.16 Billion for principle and interest on the Eurobonds over the next 10 years.
The 5 year bonds will cost US $147 Million in interest expense while the 10 year bonds will cost Kenyan taxpayers US $1.02 Billion in interest expense alone. Translated in Kenyan shillings at todayâ€™s exchange rates i.e. $1=KSH 87.50, that translates into a total of KSH 102 Billion (KSH 12.9 Billion for the 5 year bonds and KSH 89 Billion for the 10 year bond respectfully) just in interest expense.
The bond value Kenya received was KSH 176 Billion not counting discounts and fees but in the end Kenya has to pay back KSH 278 Billion. You do the math. If you listened to some in government swooning in delight over the Eurobonds, you would think it is a free jackpot Kenya just hit, no- this is not free money, it is a loan.
Further, Kenyaâ€™s disposable proceeds from this loan is actually US $ 1.4 Billion (KSH 123 Billion, not KSH 176 Billion) and that is because the government says it has already committed US $600 Million to pay prior loan obligations â€“ I donâ€™t what these prior obligations are. So the anticipated effect of the Eurobond sale on domestic liquidity is exaggerated despite the rosy picture the government is painting.
Additionally, the Jubilee government claims, erroneously in my opinion, that the investors, majority of them American, bought the bonds because of confidence in Kenya- not necessarily true. They bought the paper because a) they were promised almost 1000% better returns than they would get if they bought US government bonds â€“ similar US government bonds coupon rates are 0.125%- five years and 0.625% -10 years respectively compared to Kenyaâ€™s 5.875% and 6.875%; and b) because US investors are insured against most risk particularly when such investments portend certain risks such as Kenyaâ€™s political and security volatility.
So let nobody lie to you that the sale of the bonds is solely a vote of confidence in Kenya but in fairness, Kenya did well in selling the bond and it does indeed speak to investor confidence in Kenya. However much of the investment had to do with what risk the insurers were willing to accept and Kenya seems like a good bet right now especially if it will pay 10 times in interest.
What I question then is why wouldnâ€™t Kenya source its loans from traditional cheaper sources if indeed the outside world had so much confidence in Kenya? Someone need to reconcile that because all indicators are that confidence in Kenya is waning primarily because of political and security volatility, so what does Jubilee know that we donâ€™t?
Now that we all have some background on this, I want you to examine this borrowing in the prism Kenyaâ€™s current fiscal (taxation and spending) and monetary (supply of money) policies. The two are intertwined and I think Kenya is on a dangerous trajectory. If I were to advise President Uhuru Kenyatta on this, I would tell him to slam breaks on any more borrowing until Kenya gets its fiscal house in order. First, all debts simply put enormous budgetary strain on necessary current and future programs. I donâ€™t necessarily blame President Kenyatta for the quandary but the truth is Kenyaâ€™s deficit spending (expenditures exceeding revenues) levels have increased sharply over the last 2 years and nothing seems to be done to mitigate this. They are simply unsustainable. Jubilee inherited a worsening problem but they havenâ€™t done much to help the situation, all they did is tax the living daylights out of ordinary folks to dig their way out but even that is not working.
As long as we have recurring waste disguised as â€œrecurring expenditureâ€ at both the county â€œDevolved Unitsâ€ and national level, it is delusional to even imagine the country can live within its means. The insatiable greed inherent in public servants only means the government will be forced to continue borrowing in perpetuity, year in-year out. That is certainly not the path any leader would want to lead his or her country. So I would advise President Kenyatta to look for other ways to mitigate the short and long term harm that such unbridled spending is causing the country. He has to control wasteful spending both nationally and locally- folks are Taxed Enough Already and the taxes are only lining up the pockets of the very few in government in the form of a high wage bill, allowances and other unnecessary benefits such as travel and allowances paid to MCAs, governors, MPs, Senators and those in the executive branch. If President Kenyatta really wanted he could very easily put a lid on this waste and offset the need to borrow such colossal sums that would most likely be mismanaged or worse, embezzled.
Finally, in my opinion this Eurobond sale would have been a good deal if it were for clearly defined purpose and most importantly if the waste and rot in government wasnâ€™t already so rampant and until Jubilee actually cleans its act and the structural malaise that plagues the government as a whole, I donâ€™t see any real value that this new debt will add to the country as a whole – at this point it is not only a zero sum gain but a negative unless proven otherwise.
This post was adapted from David Ochwangi.