Ratio Magazine :: The Inside Track to East Africa’s Economies - Kenya: Sovereign Bond Plans: Solving Budgetary Problem, or Just Storing up Trouble?

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Kenya: Sovereign Bond Plans: Solving Budgetary Problem, or Just Storing up Trouble?

Tuesday, 02 September 2008

Deepak Dave comments on sovereign bond plans by the Kenya government. With additional reporting by Harleen Thati.

As the global ‘Credit Crunch’ continues to dominate business reporting in the West, interest has ebbed in the dramatic sovereign bond issues a number of African countries announced last year, Kenya’s included. Yet there is a link that is perhaps worth exploring as this historic time draws ever closer when African governments directly issue dollar or euro-denominated bonds in the global capital market and finally break free of the barriers preventing meaningful investment in social and infrastructural causes. But we need to ask what this magical instrument of financial power is that will solve all our funding problems overnight and whether this is the best way to go.

A bond is a promissory note sold in return for an upfront payment with a commitment to repay the buyer for the full value of the principal shown on the bond. In return for the use of the money, the seller of the note agrees to make periodic interest payments that are a percentage of the value of the principal. Depending on the creditworthiness of the seller, the interest rate will need to be particularly high or low, and the money will need to be repaid within a short time or not. The bond can theoretically be sold in any currency and by any seller.

Kenya has already issued Kenya shilling (KES) denominated bonds previously going out to 15 years. The ostensible purpose of raising a foreign currency denominated bond (FX bond) is to tap the massive global pool of capital that constantly searches for appropriate assets to invest in.

Ultimately, however, buyers of Kenya’s bond will ask some questions before buying into whatever story Treasury and its fabulously rewarded advisors try to peddle. An experienced old banker taught me those on Kenyatta Avenue years ago: What is the money to be spent on? Who is doing the spending? What is the source of repayment? And when is the money coming back?

According to Treasury, the money raised through issuing the bond will be used to fund development projects specifically in infrastructure. According to the press, a USD500m bond is to be issued, theoretically allowing us to allocate KES33-35bn for roads, rail and harbours. This is enough to gladden anyone’s heart and certainly those of our construction barons.

Money spent on infrastructure is ideally recouped through charging those who make use of it. This is not a new concept. Toll roads, berthing charges, rail freight, your monthly KPLC bill, all are based on the same principle. So it follows logically that monies raised for building the facility should ultimately be repaid using the income from such facilities. But for this to work, there need to be projects that are all ready to go and only awaiting the cash flow. Raising the money then having it sit around in the Consolidated Fund while we spend several years putting the projects together will be a mistake. We will be paying interest on a loan we did nott need to take.

Readers of this column will know I have been harping on about governance for some time. This directly addresses my next point about who will be controlling the borrowing and spending. Again, in an ideal situation, independent albeit regulated agencies in charge of specific infrastructural projects would have requested the funds and have a transparent plan on how the money is to be spent. There is no magical aspect to this bond issue. It is no different from the money raised by the government daily through tax, or through the weekly T-Bill market. The money will not automatically be any better managed unless we have the right rules for managing it in the first place.

The government is at pains to stress that issuance of long-term FX denominated debt will improve access to international markets, help set a benchmark for Kenyan firms to access foreign debt and radically restructure the proportion and nature of the government’s debt and interest burden. This is disingenuous to say the least.

Once the Kenyan sovereign, i.e. the government, was rated by external rating agencies, any company right down to my local duka can apply for a rating based on fixed criteria, assuming they are willing to pay the fees. An independent credit rating will tell investors enough about the risk a company represents and fundraising at a given price becomes possible. A government bond in itself does little, and conditions do not remain the same. Even after the bond is issued, deterioration in the government’s creditworthiness will mean every company that has raised foreign debt will be viewed as riskier. A one time issue does not protect against this. The benchmark will exist, but not perhaps what is expected.

As to restructuring the nature of the national debt, I am unable to see the benefit: According to the statistics produced by the Ministry of National Planning, currently 55% of Kenyan state debt is made up of foreign debt. If all of this was short term at a high interest rate and being constantly renewed, there would be a significant pressure on the budget. However, 97% of Kenya’s foreign debt is of over 15 years length, suggesting strongly that most of it is owed to a restricted set of lenders, almost certainly foreign governments or multilateral agencies. The value of the bond is approximately KES34bn against an existing foreign debt portfolio of KES400bn, representing 9% of total debt.

Which leads me to ask why the government wants to raise a type of debt that will be more difficult to manage and more expensive? And it is highly unlikely a bond for a B rated name such as Kenya’s will sell with a 15 year tenor. So we will be increasing the dollars we pay out now and decreasing the shillings we pay out much later. This is a recipe for increasing the budget deficit, already an unsustainable 6% of our annual national income.

Ultimately, SafariCom and the KenGen IPOs have made it clear that there is enormous appetite for good investment opportunities in Kenya. We have a poorly developed debt market and the government has the power to change the nature of Kenya’s capital market. Issuing a bond locally of KES35bn at a 10-year tenor and retiring a portion of the foreign debt would do wonders for the local capital market, restructure the debt portfolio, and keep the money within the country. It would be easier to refinance and ultimately give us the opportunity to pick the right projects. Allowing a local bank to issue the debt would have the added benefit of providing vital experience within the country and, on a cynical note, keeping the KES1bn in fees within our borders.

Foreign fund managers should be responsible for managing the currency risk of investing within Kenya, not Treasury or the CBK.

About the Author

Deepak Dave is a former Director of Risk Management for Renaissance
Capital Africa and previously served as Credit Director for Investment
Banking at Barclays Africa & Middle East. He has worked for a number
of banks, investment funds and NGOs on foreign investment in the
African market.

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