Hard questions debt-burdened Kenya must ask as it pursues infrastructure financing

Jeff Gable, Managing Principal Research, Absa-Barclays

NAIROBI: At 5.1 per cent of the value of the country’s gross output, Kenya’s public debt has raised eyebrows.

The Office of the Controller of Budget last month warned that the country’s rising public debt — which went from Sh2.36 trillion to Sh2.48 trillion between June and December last year — is likely to raise the cost of credit and inflationary pressures, as well as create an unsustainable debt burden for future generations.

A large part of the country’s debt has been attributed to its ambitious infrastructure drive, with trillions of shillings worth of roads, energy and railway projects in various stages of completion.

But how can Kenya finance its high appetite for concrete without going bust, and most importantly, who will pay for this debt, when and at what cost?

To find answers to these and other questions, we had a chat with Jeff Gable, the managing principal for Africa research at South Africa’s Barclays Bank division, Absa Capital.

What are the available options for funding Kenya’s ambitious infrastructure projects, and which one is the most cost-effective to the taxpayer?

The taxpayer is always going to be the one to fund infrastructure, but the question is, over what period of time? Should we raise taxes today so that we have revenues today to pay for an infrastructure project?

These are tricky questions because you are thinking about assets that are going to be long lived and pan out over decades.

It is standard practice in most countries to finance long-lived assets with long-lived debt, with the taxpayer paying a proportion of the interest rate each year, and at some point, the project will amortise itself [pay off its debt].

The preference for many countries is to spread these payments over a long time. This is because the benefits to the economy from an infrastructure project are registered several decades down the line.

The idea, therefore, is to generate enough economic activity in the short-to-medium term to generate the revenues to pay for that project.

Let’s talk about the sovereign bond market that is becoming a favourite for African countries, including Kenya, seeking infrastructure finance. What is the participation of African economies in foreign issuances?

We have seen a lot of activity from African economies going into the foreign bond market. In 2008, we were tracking five countries in Africa that had issued in offshore markets. Today, there are 18 African countries, including Kenya.

At the same time, the size of issuance in 2008 was about $7 billion (Sh651.6 billion) and today we are looking at about $40 billion (Sh3.7 trillion), so this just goes to show you how African economies are increasing their presence in offshore markets.

This is mainly because the projects we are seeking finances for are really large, and the pool of domestic savings is just not enough to fund them.

Thus, many countries are finding themselves having to ask if it is viable to delay these projects until there is finance to put them up — which is tricky if the project is expected to generate economic growth, or encourage more global participants in local markets.

What about on the opposite end? Why are we seeing a lot of appetite in the global market for African debt?

Bond yields in the West are plummeting, and recently, the German government was issuing five-year bonds at negative rates. This essentially means you are paying the government to buy its debt.

In the US, the government can borrow for 10 years for well under two percentage points, and in Japan, 10-year bond yields are not even above one percentage point.

Bond yields in Africa have high returns. As much as part of this appetite is because there is a genuine interest in being part of the African opportunity, some of it is driven by yields elsewhere being very low.

There have been concerns Kenya might be exposing its economy too much by seeking finance in foreign markets. What is your take on this?

The concern comes from the thought that at some point in time, there will be an exchange rate mismatch. We have taken up some hard currency debt in euros and we generate revenue in-country in shillings to pay it back.

So the concern is not just on the interest rate, but on the exchange rate, too. If the shilling were to depreciate substantially, then the debt could turn out to be quite expensive.

There are several financial products you can take up to mitigate or hedge some of the exchange risks, and different countries will have different views on them.

However, there should also be a set of economic policies that are stable enough to generate an environment that allows that debt to prosper.

So is the risk worth it, and what are some of the benefits to the private sector and individuals?

One of the obvious benefits of Kenya going to the foreign markets is the crowding-out aspect. If I am a corporate borrower in Kenya looking for finance and the pool of money available is all taken up by government borrowing, then the little credit available becomes expensive.

This means that domestic interest rates will be dramatically higher, and this cascades down to commercial lending, and individual borrowers feel the pinch.

Kenya’s offshore issuance eases the pressures that would have existed in the domestic market, and that means that people looking to raise finance domestically find the interest rates are more modest than they would normally be.

There will also be, in the long run, large public and private corporations taking the cue from the government and issuing their own offshore debt, which is great for local interest rates.

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