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Economy in crisis: World Bank warns of debt distress

Thursday October 31 2019

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Customers shop at a supermarket in Nairobi. The ratio of Kenya’s debt to GDP has shot up from 59.1 per cent in 2017/18 to 62.3 per cent in 2018/19, racing towards dangerous levels. PHOTO | FILE | NATION MEDIA GROUP 

PAUL WAFULA
By PAUL WAFULA
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Kenya’s failure to fulfil its commitment to live within its means could make it difficult to repay its debts when they mature, the World Bank has warned.

In its Kenya Economic Update for October 2019, to be released today, the Bank notes that, “with 43 per cent of domestic debt expected to mature within one year, the government could face challenges in rolling over such bonds in an environment of no interest rate caps, low subscription rates and over-exposure of commercial banks to these assets”.

The bank’s warning comes only days after Treasury Cabinet Secretary Ukur Yatani’s admission that the country could not meet its loan obligations unless the debt ceiling was raised.

DEBT RESTRUCTURING

Mr Yattani said the government would run broke and would be unable to finance this year’s Sh3.02 trillion budget if Senate blocked an increase of Kenya’s debt ceiling to Sh9 trillion.

“If we are not guaranteed this amendment, there will be a crisis in the country because we will not be able to implement this year’s budget. We will also be unable to do debt restructuring to retire some of the old and expensive commercial loans with interest rates of up to 9.5 per cent that are choking our economy,” Mr Yatani said when he met the joint sitting of the Senate committees on Delegated Legislation and Finance and Budget at the Kenyatta International Convention Centre (KICC) last week.

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A default on loan repayment would expose the country to ridicule in the international financial markets. It would also result in downgrading of its credit ratings, which would make it more expensive for it to borrow from international markets.

Signs of distress in paying debt came to the surface last month after it emerged that Kenya had defaulted on a Sh500 million debt owed to a Belgian credit company for the construction of a water supply system in Mavoko.

EXPORT CREDIT AGENCY

Credendo Export Credit Agency, an export credit agency of the Kingdom of Belgium, had written to the Treasury demanding the payment by November 1, accusing the government of failing to pay despite repeated reminders.

The World Bank report notes that Kenya is spending up to 18 per cent of its tax revenue on interest on domestic loans alone, up from 16.3 per cent in 2016/17.

The ratio of debt to GDP has also shot up from 59.1 per cent in 2017/18 to 62.3 per cent in 2018/19, racing towards dangerous levels that are fuelled by an insatiable appetite to plug the hole with fresh debt. The Bank recommends a 50 per cent ratio.

In the report, the World Bank also says that delays in paying local contractors has constrained the business environment and an obstacle to higher levels of job creation required by a young and growing population.

The report notes that the latest economic data the National Treasury released in September show a substantial increase in the budget deficit for 2018/19.

BUDGET DEFICIT

A budget deficit, also known as a budget hole, occurs when expenses exceed revenue. This year, the country has a Sh607.8 billion deficit compared to Sh559 billion last year.

The bank is calling for stronger measures to return Kenya to a path of sustainability.

The budget deficit grew to 7.7 per cent of GDP in 2018/19 from 7.4 per cent in the previous year — missing the target of 6.8 per cent by almost a full percentage point.

This, in turn, has resulted in the crowding out of the private sector, an unanticipated rise in public debt stock, and the continuation of slow private sector credit growth.

“This calls for credible adjustment measures by the government to place fiscal accounts back on a prudent trajectory,” the update says.

Measures should include actions to increase revenue, make revenue projections more realistic and strengthen expenditure controls and cash management.

The report says measures to adjust Kenya’s borrowing plans are essential to rebalance the public debt portfolio towards lower cost and longer-maturity debt, to reduce its vulnerability to market instability as well as create fiscal space.

Another significant finding that should worry policymakers is that Kenya’s manufacturing exports to Africa have contracted for the third consecutive year, from Sh242.2 billion in 2015 to Sh216.2 billion in 2018.

COMPETITIVENESS

The decline is attributed in part to intensified competition in these markets, indicating a need to boost competitiveness for Kenyan goods.

Manufacturing exports on the continent accounted for 35.3 per cent of all the merchandise export in 2018. The decline is an average of 3.6 per cent per year.

The economic update notes that despite the less political uncertainty and improved business confidence in Kenya, the private sector’s contribution to GDP growth has been dismal.

Its two-year average contribution has shrunk to about 0.4 percentage points in 2018-19 from 2.5 percentage points in 2017.

“The slowdown is associated with strong government domestic borrowing to fund its deficit, which competes with private sector for credit,” the report notes.

It also says the interest rate caps have been a disincentive to lending by commercial banks to small and medium enterprises (SMEs), curtailing SMEs investment and expansion.

Delays in public payments-pending bills (estimated at 0.7 per cent of GDP in 2018/19) have reduced firm’s liquidity, often delaying their hiring and investment decisions.

“This constrained business environment is an obstacle to the higher levels of job creation required by a young and growing population,” the report notes.

INVESTMENT

The strong role of public sector investment in growth is also decreasing in part due to completion of key flagship investment projects but also due to narrowing fiscal space.

Government’s investment contribution to GDP growth has decreased to about 0.6 percentage points of GDP in 2019 from a high of 2.5 percentage points in 2014.

This in part reflects maturity in investment to key infrastructure projects, including roads and Nairobi-Mombasa SGR.

After a strong rebound in 2018, economic activity in Kenya moderated in 2019, primarily due to lower agricultural output and considerably weak private sector investment.

The economy expanded by 5.6 per cent in first half of 2019, a deceleration from 6.5 per cent in the first half of 2018.

While challenges in agriculture account for a significant drag to growth, private investment has also accounted for a share of the deceleration.

“In 2019, however, economic activity has softened primarily due to lower agricultural output and weak private sector investment,” the report says.

As a result, the World Bank projects Kenya’s growth at 5.8 per cent for 2019 and settling at around 5.9 per cent over the medium term.

On the domestic front, the lender has identified drought, fiscal slippages and crowding out of private sector investment as some of the risks to growth.

GLOBAL SLOW DOWN

On the external side, unanticipated spillover effects from ongoing global slowdown could affect demand for Kenya’s traditional exports, horticulture and textiles, and remittance inflows.

“The contribution of net exports to growth remains negative, although its drag is much weaker than in previous periods,” the report says.

Nonetheless, imports have more than offset Kenya’s exports of tea, coffee, horticultural, and tourism receipts, slowing down growth.

The bank has welcomed the repeal of interest rate caps, but warns that they should be accompanied by measures to ensure the country does not slide back into the expensive interest rate regimes.

“The removal of interest rate caps should eliminate what has been a powerful disincentive for banks to lend to SMEs and restore the potency of monetary policy,” it says.

HIGH INTEREST RATES

“Reforms that address the root causes of high interest rates could be fast-tracked to accompany this step. These include fiscal consolidation (directed at lower government domestic borrowing), measures that strengthen credit-information sharing and promote transparency in pricing of credit,” Felipe Jaramillo, the World Bank Country Director for Kenya says in the report.

The report says that while the ongoing process to contain the wage bill that includes restricting new hiring to critical services has slowed expansion from 5.5per cent of GDP in 2013/14 to 4.5 per cent of GDP in 2018/19, the increased expenses on interest payments offset the gains from wage bill containment.

The report says that in 2018, approximately 9,482 Kenyans were among the world’s high net-worth individuals but personal income tax is far from being a stable revenue contributor.