Eurobond billions: Curious incident of a dog in the night-time

“Is there any other point to which you would wish to draw my attention?”

“To the curious incident of the dog in the night-time.”

“The dog did nothing in the night-time.”

“That was the curious incident,” remarked Sherlock Holmes, a fictional detective, in his conversation with Gregory (Scotland Yard detective), in Arthur Conan Doyle’s 1892 short story Silver Blaze.

In May last year, we were informed that our plans to debut in the international sovereign bond market were in jeopardy on account of a judgement debt obtained by Anglo Leasing bandits in international courts.

We were told that if the judgement debt was not settled, the bond issue would fail, and economic chaos would follow. The President ordered the settlement.

Highway cleared of bandits — or so we thought — the Eurobond show hit the road.

It was a roaring success, oversubscribed three-fold and the biggest bond issued by an African country, South Africa excluded.

The government reopened the issue in what is known as “tap sales” and raised an additional $750 million bringing the total to $ 2.75 billion (Sh250 billion).

The Jubilee administration could not stop talking about it, and with good reason.

It was without doubt the most significant public finance development in our recent history.

Accessing international capital markets for the first time is a very significant rite of passage for a country that usually heralds the end of aid dependency.

And ours was, and still is the single largest issue by a sub-Saharan African country, excluding South Africa.

ROTICH'S EXPLANATION
The Treasury has recently published two statutory budget reports, the Quarterly Economic and Budget Review for the fourth quarter of the last financial year, dated August 2015, and Budget Review and Outlook Paper dated September 2015.

Both contain the same economic and fiscal narrative and data, with some important differences that I will come to shortly.

The Eurobond is conspicuous by its absence.

In the Quarterly Economic and Budget Review, the Eurobond is mentioned three times, once in the introduction and twice in relation to exchange rate and foreign reserves.

It is not mentioned at all in the narrative on the budget, even, believe it or not, in the section on external financing.

In the Budget Review and Outlook Paper, it is not mentioned at all.

Not a word. By contrast, the Standard Gauge Railway is mentioned no less than eight times.

The dog did not bark, and it is not the only curious incident.

From the proceeds, the government settled a $600 million (Sh53 billion) debt it had borrowed from commercial banks in 2011, leaving $2.15 billion (Sh197 billion) to spend.

In the prospectus, the government had said that this money would be spent on general budgetary purposes and infrastructure projects.

Cabinet Secretary Henry Rotich recently presented figures to Parliament showing that the entire Sh197 billion was all allocated to ministries for infrastructure projects.

The Planning Ministry, which is listed as having been allocated Sh45 billion denied knowledge of receiving Eurobond funds — arguing reasonably, that it had no way of knowing the source of its budgetary allocations.

SWIMMING IN CASH

This tells us that if indeed the proceeds were at all disbursed, the money was not earmarked for any specific project, but rather applied to the general budget.

I recently came across a press statement by Zambia Ministry of Finance updating the public on how the $750 Eurobond that Zambia raised in 2012 was used.

The one-page statement gives a breakdown of the allocation by project and status of each of the projects.

It is noteworthy that the statement is dated April 2014, a year and eight months after the money was raised, and the projects are all in early stages of implementation, which accords with the normal pace of implementation of public infrastructure projects.

Unlike Zambia, the information Treasury provided to Parliament had to be tortured out of them.

It is rather unlike Jubilee administration not to milk the Eurobond all the public relations it can get out of it, especially now that not much else is going right.

It is of course public knowledge that the government has been experiencing cash flow difficulties.

Although these only came to light a month ago, many suppliers have gone unpaid for several months, meaning that the government was struggling with cash flow even last year.

This is truly curious. Last year, the government should have been swimming in cash.

According to the Auditor-General, the proceeds of the $2 billion bond were credited to the government’s offshore account in the last week of June 2014.

After paying off the $600 million and costs of the issue, the government would have opened the last financial year with a bank balance of Sh120 billion.

Another Sh76 billion would have come in by December.

I am absolutely certain that this is the most liquid that the Government of Kenya has ever been in history.

BUDGET BALANCE
In addition, the Treasury reports that budget absorption last financial year was rather slow, on both recurrent and development accounts.

The government ended up spending Sh220 billion less than the revised budget, made up of Sh170 billion underspending on development and Sh50 billion on the recurrent budget.

So not only did the government have a lot of cash, it was not spending it that quickly.

How does a government with a mountain of cash, and low budget absorption struggle to pay its bills from day one, ending up with a serious cash crunch and distress borrowing a few months later?

It should not surprise then, that the government is unable to account for the Eurobond fully, if at all.

Government book keeping is, as Sherlock would say, elementary.

It has four main items, “revenue”, “expenditure”, “budget balance” and “financing items”.

All money coming to government other than borrowings are recorded as revenue.

All expenses, other than repayment of debt principal, are recorded as “expenditure”.

Budget balance is difference between revenue and expenditure, and may be a surplus, a deficit or balanced.

The “Financing Items” records debt operations, both borrowings and repayments of principal only, referred to as amortisation, as interest payments are recorded in expenditure.

The “Net Financing” , that is, borrowings less principal, should equal the “Budget Balance”.

INCORRECT ENTRIES
For Eurobond accounting, we need only focus on the “Financing Items.”

I have summarised below two “Financing Item” accounts as reported by The National Treasury in the Budget Review and Outlook Paper (BROP) dated September 2015.

These are labelled BROP Table 4 and BROP Annex Table 2. I have added my own labelled “Correct Accounting”.

In BROP Table 4, the Treasury records Eurobond financing of Sh35 billion in FY 2013/14 and Sh75 billion in year 2014/15.

Both these entries are incorrect as they total Sh110 billion leaving Sh140 billion unrecorded.

The government received the first $2 billion (Sh176 billion) in June 2014 and the “Tap sales” of $815 million (Sh73.8 billion) in the second half of 2014.

The account should reflect commercial financing of Sh176 billion in FY 2013/14 and Sh73.8 giving a correct total of Sh250 billion.

If it had done this correctly, total financing after loan repayments in FY 2013/14 should be Sh448 billion against a deficit of Sh307 billion leaving a balance of Sh141 billion to be carried over to FY 2014/15.

Similarly, the total financing in FY 2014/14 should be Sh612 billion against a deficit of Sh407 billion, leaving yet again a balance of Sh141 billion to be carried over to the current financial year.

There is no money carried over to the current financial year in the government’s accounts.

It claims that it was all spent last year.

What explains the discrepancy between their book keeping and mine?

DOMESTIC BORROWING

The answer is to be found in the “domestic financing.”

In the BROP Table 4 account, the figure is given as Sh250 billion.

In the BROP Annex Table 2 account, this figure drops to Sh110 billion. The difference is the elusive Sh140 billion.

In its Quarterly Economic and Budget Review report dated August 2015, the Treasury provides a detailed breakdown of the Sh250 billion domestic borrowing figure, with the Central Bank of Kenya given as the source.

The only way that the books balance with the entire Sh250 billion reflected is by understating domestic borrowing by Sh140 billion.

Back to Sherlock Holmes.

The dog did not bark because it must have known the race horse thief.

There was only one set of human footprints, and those clearly belonged to the trainer of the horse, who lay dead with a blow to his head.

But for a very small surgical blade lying about, there was no other clue.

To cut a long story short, there was no horse thief.

The trainer had been bribed by a crooked bookmaker to inflict a small injury on the horse, so that it would lose a forthcoming race that it was sure to win, hence the surgical blade.

The operation had gone horribly wrong.

It is the horse that had inflicted the fatal blow to its trainer, not a thief, and ran away.

The horse was recovered and went on to win the race.

I suppose the crooked bookmaker lost his shirt. Happy ending for the good guys — but that's fiction.