Moment of truth for Jubilee get-rich quick schemes

Not long ago, a number of enterprising Kenyans cottoned onto a minting investment — raising quail.

For a while it was the only game in town. When I was asked about it, my question would always be: where is the market?

No one seemed to know. Some enumerated the many health benefits of quail eggs.

I pointed out that I seldom see people ordering the bird or its eggs in restaurants, and it was not stocked in supermarkets so the local market for it could not be that big.

The quail mania quickly evolved into a pyramid scheme.

The price of an egg rose to Sh100, ten times the value of a chicken egg.

The price was being driven by new investors who were buying breeding stock as opposed to consumption demand.

Then, as inevitably happens, the scheme ran out of gullible investors and it came tumbling down.

Despite evidence that there is no short cut to prosperity, humans will always fall for get-rich quick schemes.

For the last three years, many Kenyans have been taken in by the Jubilee administrations’ get-rich quick projects — bullet trains, plentiful cheap electricity and digital everything that would have investors flocking.

SYNDICATED LOAN
While more and more people have woken up from this reverie, many still are in denial.

The administration’s sudden preoccupation with raising more revenue is the surest sign that Jubilee is in denial.

The pursuit of revenue is escapism — avoiding confronting the reality that the scheme is unravelling.

It is not the lack of market for quail that is the problem. The problem is that people have stopped joining. Solution? Recruit more investors.

Many Kenyans are yet to understand the implications of borrowing $2.75 billion and squandering it.

The only money we know how it was spent was the $600 million paid off syndicated loan.

The government is unable to explain what it did with $2.15 billion.

It is telling us that the bond proceeds was treated as “budget support” to finance deficit.

It was not earmarked for any specific infrastructure project.

Some of it bought stationery, was used as allowances or stolen by addition of zeros here and there.

What if the bulk of the money was absorbed in infrastructure?

A typical project takes three or more years to complete.

Since the money was absorbed last year, how was the government planning to finance completion of the projects?

BORROWING REQUIREMENTS
The only way to do so is borrow. The effect of absorbing the Eurobond proceeds into the budget in a year is to increase the government’s borrowing requirements in subsequent years.

And sure enough, the domestic borrowing requirement shot up for the current financial year to Sh200 billion, up from Sh120 billion.

The sensible thing was to earmark specific projects and ring fence the money to finance them to completion.

By diffusing the money into the budget, it is impossible to account for it. It also makes it easier to steal.

It is easy to detect Sh100,000 stolen from a Sh1 million project.

However, if the Sh1 million is spread over 20 Sh50,000 projects and Sh5,000 stolen from every project, it still amounts to Sh100,000 stolen but it is not easy to trace.

The original purpose of issuing a Eurobond was to offset the $600 million syndicated loan borrowed to support the shilling in 2011.

The figure mentioned at the time was $500 million to $1billion.

How it shot up to $2 billion and why the government decided to tap another $750 million is hard to understand.

A year later, we have gone back to commercial banks and borrowed another $750 million syndicated loan due in two years.

That is a total of $3.5 billion of unplanned commercial debt costing us $230 million or thereabouts in interest or Sh230 billion at current exchange rate.

SMART TECHNOCRATS

It is equivalent to the counties’ share of national revenue for last financial year.

I am asked frequently these days how our smart technocrats could have let this happen.

My stock answer is that Greece, Argentina, Iceland and the other countries that have been in similar mess lately have very smart technocrats.

Spectacular collapses of venerable financial institutions like Barings Bank and Lehman Brothers were caused by the smartest financial brains in the world.

One of the most spectacular and embarrassing institution failures of recent times is that of Long Term Capital Management, a pioneering hedge fund manager, which had among its partners two professors, Robert Merton and Myron Scholes, who would go on to share a Nobel Prize for their contribution to finance.

Of its 11 principals, who included a deputy governor of the US Federal Reserve, seven were economics PhDs, six from MIT and one from the Economics Citadel University, Chicago.

Financial collapses are caused by what Allan Greenspan, former Federal Reserve Governor, termed as “irrational exuberance”.

Irrational exuberance is also the title of an evergreen classic on behavioural finance by 2013 Economics Nobel Laureate Robert Schiller.

The quail mania is a type of irrational exuberance.

On his Treasury website profile, the Treasury PS flaunts the successful “tapping” of the markets for $750 million after the initial $2 billion Eurobond, and goes on to say that we will be soon issuing a “sukuk” (an Islamic bond).

WORSENED CONSIDERABLY
Last year they were talking of a “Samurai” (Yen denominated bond). Irrational exuberance.

This borrowing binge is entirely supply driven. We were borrowing because people were falling over themselves to lend us, not because we needed the money.

The financial markets were falling over themselves to lend us because the world was awash with money from the US Government’s “quantitative easing” (QE) and the “petrodollars” accumulated by exporters during the oil price boom.

The Chinese have been enthusiastic to lend us for two reasons. First to promote their exports.

Second because they need to diversify the investment of their huge foreign reserves which are heavily invested in US Government securities.

Between this binge and the standard gauge railway, the Jubilee administration has borrowed close to $7 billion.

The terms of the railway loans have not been disclosed but going by the typical Chinese loan terms, it would be in the order of $350 million per year.

Add that to the interest on the bank loans above, we are talking $580 million, just about Sh600 billion at current exchange rates, and about the annual tax revenue.

It is 20 times what the Grand Coalition government paid on our external debt in its last year of office.

As at end of June 2014, the average term of our external debt was 18 years, down from 34 years the year before.

The grace period was down from eight to six years and interest rate up from 1.2 to 2.6 per cent.

These parameters will have worsened considerably since this was before the Eurobond and the new syndicated loan whose term is two years.

ASK THE TOUGH QUESTION

We are borrowing more on worse terms. On the domestic front, a lot of progress has been made in the last decade to lengthen maturity of debt.

This is now all unravelling. By the end of the current financial year, we will be back to square one.

Short maturities on term loans means larger instalments, while the bonds and syndicated loans carry refinancing risk.

We could not pay the last syndicated loan until we issued the Eurobond.

The one we’ve just borrowed will be due in October 2017.

The five-year tenor Eurobond, another $500 million falls due in early 2019.

We just have to pray that international markets would be willing to lend us money for these bullet payments, otherwise we will have to pay from revenue and domestic borrowing.

A debt sustainability analysis done by the Treasury and the IMF in 2013 forecasts our external debt service at 5.8 per cent this year, peaking at 13 per cent in 2024.

It is already well over 13 per cent, heading to 20 per cent — the distress threshold.

By the end of Jubilee’s term, our total debt service outlays will be a approaching Sh1 trillion a year, a four-fold increase from when it took office, or 80 per cent of revenue.

We have to ask what the administration has done to increase our debt servicing capacity commensurately.

That the administration is unable to explain which specific projects the Eurobond money went into means nobody knows what the money was spent on.

It is safe to presume that some of the Sh45 billion that the Treasury says was allocated to the Ministry of Devolution was squandered and stolen in the endless procurement scams.

ECONOMIC SELF IMMOLATION
When I challenged the mega infrastructure binge two years ago, the response by my good friend Bitange Ndemo was titled “Where economists go wrong on growth”.

There is at least one thing economists know for sure. Macroeconomic instability is a certain road to stagnation.

When the macroeconomic outlook is uncertain, the most rational thing for investors to do is wait and see. The show stops.

A century ago, Argentina was the twelfth most prosperous country in the world.

It was at par with Canada. Today, Argentina is stuck in the middle income trap with a GDP per capita a quarter of its peer group of a century ago (Canada, Sweden, France, Austria, Denmark).

It has been described as the only country that was developed in the 19th century and is a developing one in the 21st. What happened to Argentina?

Argentina’s history is one of mediocre populist politics and macroeconomic crises — big dreams, borrowing binges, hyper-inflations, currency collapses and debt defaults.

Few countries, if any, can match Argentina’s propensity for economic self immolation. We are working hard at it.