Kenya’s heavy borrowing pushed interest rates up

When Kenya borrowed $2 billion (175 billion) through a Eurobond sale in June last year, National Treasury Cabinet Secretary Henry Rotich said Kenyans would start enjoying lower interest rates since government would cut domestic borrowing.

It was expected that the impact of the Eurobond would be felt in the just concluded 2014/15 financial year.

At the time, analysts too were optimistic that issuance of the Eurobond and its timing would increase liquidity in the money markets, ease pressure on Treasury bill auctions and bring down lending rates.

This is due to the fact that commercial banks, who account for more than half of investment in government securities, would have to look elsewhere to remain profitable.

LOAN BOOKS

The easiest way out would have been expanding their loan books by making credit more available and affordable to the market. That has, however, not come to pass.

Following the $2 billion capital raising in June, and an additional $750 million later in December and the Sh327 billion loan from China for financing the standard gauge railway (SGR), the government is saddled with costly debt and may now not be keen to borrow externally given the direction the shilling has taken.

The end result is that the government’s borrowing option remains the domestic market, further crowding out the private sector and pushing lending rates even higher.

At the moment, local banks are charging borrowers an average of 15.26 per cent interest. When other charges are added, coupled with a borrower’s risk profile, the rates can go higher than 20 per cent.

This rates might go even higher following the raising of the Kenya Bankers Reference Rate (the base rate all commercial banks charge their customers minus other costs) by 1.33 per cent to 9.87 per cent, in a bit to tame weakening of the shilling.

By the time the government floated the Eurobond, the shilling was trading at an average of 87.6 units to the dollar.

Last Friday, the shilling crossed the 101 mark to the dollar, trading at 101.75/85 at the close of trading. The weakening is a clear defiance of the recent rate increase by the Central Bank of Kenya (CBK), in which the policy rate was raised by 3 percentage points in two months. This means for every dollar, the government will pay at least Sh13 more to service the Eurobond and other international debts.

“Kenya shilling’s depreciation is worrying and government should take steps to ensure its stability. With Kenya currently importing majority of capital equipment, the shilling shall only stabilise and stop depreciation in the long-term, once we transform to a manufacturing economy and import less machinery and capital equipment,” analysts at Cytonn Investments said.

At the moment, Kenya requires over Sh5.7 trillion to collectively finance major development projects such as the Sh327 billion standard gauge railway, the Lamu Port and South Sudan Ethiopia Transport project, the 5,000MW power generation, the Galana Irrigation Scheme and the crude oil pipeline from Turkana to Lamu.

Financing the standard gauge rail alone in 2014, worsened Kenya’s current account deficit, which widened to nearly 10 per cent of GDP. In the first quarter of this year, the current account – a measure of receipts from exports against payment for imports – worsened by Sh37.9 billion to Sh101.5 billion. The balance of payment stood at Sh63.7 billion in the same period in 2014.

“In recent years, poor execution of Kenya’s capital expenditure budget typically prevented deficit overruns. Spending was rarely as significant as first announced. But with elections approaching in 2017, Kenya’s record on implementing capital expenditure plans is expected to improve,” says Razia Khan, chief economist at Standard Chartered Bank.

This year, Kenya expects to finance a budget shortfall of Sh340 billion from external financing and Sh229 billion from the domestic market. To allow the government more room to borrow from the international market, MPs last year raised Kenya’s debt ceiling to Sh2.5 trillion from Sh1.2 trillion, a move some said would make servicing debts unsustainable. This reality is fast emerging with the shilling’s rapid weakening.

Analysts further indicate that a weak shilling would result in a greater threat to external-debt sustainability and perhaps even complicate Kenya’s efforts to increase offshore borrowing. With a weaker shilling, some of the major losers include the government and firms importing capital goods which are priced in foreign currency.

“Given its huge allocation to development expenditure and the high cost of servicing foreign debt which will increase due to a weaker shilling, the government is a major loser,” Edwin Dande, chief executive officer of Cytonn Investments, said.

While presenting the 2015/16 budget on June 11, Mr Rotich said the government is keen on ensuring public debt sustainability through level-headed borrowing from domestic and external sources. He further said external borrowing would be undertaken cautiously and limited to key projects to ensure debt sustainability.

A mix of concessional (which is relatively low-priced) and non-concessional loans (which attracts higher interest rates) from the external market would also have worked very well with a relatively stable exchange rate. This is now not the case. 

“In addition, the government will ensure that the level of domestic borrowing does not crowd out the private sector given the need to increase private investment and accelerate economic expansion. A cautious approach will also be adopted in the issuance of external government loan guarantees and the use of the Public Private Partnership framework for funding infrastructure,” Mr Rotich said.

Just recently, Mr Rotich said in an interview that the government would still redirect its borrowing energies to the international market so that it does not put pressure on interest rates domestically.

DOMESTIC MARKET

“You can imagine what would have happened if we raised all the money that we got from the Eurobond from the domestic market. We would be talking a different story on the interest rates,” he said. 

At the end of March, Kenya’s total public debt rose by Sh305 billion to reach Sh2.675 trillion from Sh2.37 trillion in June 2014. In the same period, Kenya’s debt was equivalent to 49.9 per cent of GDP, compared with 44.2 per cent of GDP in June 2014.

The government’s borrowing appetite in the domestic market continues to rise, peaking at Sh229.7 billion in the 2015/2016 financial year.

Analysts warn that the government ought to be cautious on domestic borrowing because it would push interest rates up and it would thus become difficult for firms to access credit.

The overall effect is that economic growth would be slow down. The government has projected the economy would grow at between 6.5 and 7 per cent in 2015 and over the next five years. This is an overly ambitious target given that Kenya still overly relies on rain-fed agriculture, a backbone to the economy.

Coupled with dwindling forex inflows from tourism, which is one of the leading economic sectors, the country may not attain the projected economic growth. In the first quarter of this year, the economy expanded by 4.9 per cent compared to a growth of 4.7 per cent in a similar period in 2014.

To  mitigate apparent risks attached to excessive external borrowing, especially in the face of a weakening shilling, some experts say forging public private partnerships (PPPs) especially in capital intensive projects in infrastructure and energy would be the best way out. This means private funds would be used in supporting public projects, such as the Lake Turkana wind power project, with the investor recouping their money and profit over an agreed period.

In this way, the government would not have to use its own money to finance the huge capital projects.

“The government seems keen on borrowing from the international markets to finance infrastructure development. Why can’t we take the example of other countries, which have taken the PPP route to finance their infrastructure, energy generation, mining activities and other capital projects?” posed Commercial Bank of Africa senior forex dealer, Joshua Anene.

On her part, University of Nairobi’s School of Economics lecturer Dr Joy Kiiru is of the view that government policy should focus on increasing exports for the countryto address the structural challenges partly leading to weakening of the shilling.

“We should start pursuing a policy of export diversification and import substitution more aggressively than ever before if we are to remain competitive as a country and arrest currency volatility. We need to pursue ways of boosting competitiveness of our manufacturing rather than raising interest rates,” she said.