US Fed’s interest rate hike to compound Kenya’s debt crisis

Hikes in interest rates in the US may make debt repayment for Kenya more expensive and reduce the country’s foreign exchange cover.

This is on the back of the expected strengthening of the dollar going into the New Year after the Federal Reserve’s Open Market Committee (FOMC) met last week and raised the lending rates in the US by 0.25 per cent to 0.75 per cent.

This was the second time that the Federal Reserve (Fed) had raised interest rates in two years.

This time, however, the Fed also agreed to make more bumps next year as it accelerates the rate hike pace now that the economy is expected to do even better. The move is expected to encourage capital flight back to the stable economy at a time when President-elect Donald Trump has promised a tax holiday to investors with offshore cash to boost infrastructure spending.

Investors are already asking for a premium in trading Kenya’s Eurobond, an indication that they will demand higher rates when Kenya goes for another sovereign bond.

According to Bloomberg, yields on the five-year Eurobond increased from 4.7 per cent to 5.0 per cent while yields for the 10-year bond rose from 7.7 per cent to 8.0 per cent.

“The increase in yield is attributed to the Fed hiking interest rates by 0.25 percentage points during the week, and investors demanding an equivalent premium in emerging market debt to cater for the risk,” said investment firm, Cytonn in its weekly bulletin.

“Since the mid-January 2016 peak, yields on the Kenya Eurobonds have declined by 3.8 per cent and 1.6 per cent, respectively, for the 5-year and 10-year bond due to improving macroeconomic conditions.” On the repayment front, a stronger dollar means Kenya will need more shillings to buy the dollars to pay back its debts.

Kenya is already paying the cost of a dollar resurgence as it services its debts at Sh102.2 a dollar for loans it borrowed when the shilling was trading at Sh87 against the greenback in June 2014. Last week, the shilling remained stable despite the rate hike as a result of efforts to prop it by the Central Bank, which can be seen in the reduction in import cover.

CBK data shows the forex reserves reduced to $7.2 billion from $7.8 billion in October, reducing the import cover to 4.7 months, down from 4.8 months recorded the previous week. Just two-months ago, on October 6, CBK had 5.2 months of import cover.

“This is worrying as the rate of decrease in the reserve could be an indication that the CBK is using a lot of reserves to support the shilling, and may continue to do so in the near-term given the global strengthening of the dollar,” said Cytonn.