What is a Eurobond?

What is a Eurobond? The name Eurobond is a misnomer and can sometimes be misleading. From the word, you would think either Eurobonds were about the European bond markets or the European currency, the euro. However, Eurobond has nothing to do with Europe or its currency. The term "Euro" in this context is simply used to refer to the international aspect of the bonds. A Eurobond is, therefore, a bond that is issued in a currency other than the currency of the country where it is issued.

The currency in which Eurobonds are issued also determines their name, like Eurodollar, which is issued in US dollars, or Euroyen, which is issued in Japanese yen. So Kenya's is a Eurodollar bond. Through these two bonds, the Government essentially asked investors to lend Sh210 billion on the promise that it will pay it back with interest. The Government, through CBK, gave these private investors a piece of paper known as a bond, and in return CBK collected on the Government's behalf the cash in the form of a loan.

The buyers or investors of these Eurobonds, who are generally large companies, banks or financial institutions and governments, will be paid interest on an annual basis and the principle amounts at maturity. Eurobonds are free of withholding tax and are traded electronically in the secondary markets across international financial centres.

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Potential benefits

There are numerous benefits associated with the issuance of a Eurobond as an alternative source of financing that governments such as Kenya want to tap in.

First, Kenya has a huge infrastructure deficit. It is obvious that the country needs to spend a lot of money on roads, railways, ports, water and energy to ensure steady economic growth. It, therefore, makes good economic reasoning for the country to borrow to fill the financing gap. So proceeds from the Eurobond will accelerate economic growth, poverty reduction and would be helpful for the country's economy if the borrowed funds are spent on infrastructure projects that offer a greater scope for augmenting revenue earnings and creating employment opportunities. Big infrastructure projects require labour. They enable more people to get employed and more companies are formed, hence more jobs are created.

Second, Government borrowing from overseas markets can be good for the economy. At the moment, the domestic markets have been the biggest source of Government borrowing. The current high domestic borrowing by fiscal authorities to finance the Budget deficit increases the competition for funds and drives up interest rates.

Investment credit is normally very sensitive to interest rates and businesses, investors and even households would not borrow and/or the banks would not lend unless they believe the expected earnings before interest and tax on an investment opportunity exceed interest rates.

SEE ALSO :Eurobond money 'earned, but no project'

The Government's huge public sector borrowing, however, is normally insensitive to interest rates. The National Treasury, the largest borrower, would borrow any amount regardless of interest rates. So long as the Government is willing to borrow hugely and the Treasury Bill rate is attractive, local banks would have the tendency to channel funds into the risk-free Bills rather than lend to the real economy, unless borrowers are willing to pay high interest rates.

With Treasury Cabinet Secretary Henry Rotich now planning to borrow less from domestic markets because of this new money from the bond proceeds, there will be pressure on banks to lend the excess liquidity elsewhere. The extra supply of cash will, therefore, hopefully help to bring down bank lending rates to the productive sectors of the economy. The flotation of the bond will also be a step in the right direction for easing pressure on foreign exchange reserves. It would enable the Government maintain a stable exchange rate.

As far as foreign sources of debt are concerned, Kenya's debt has until now been mostly sourced from institutions such as the World Bank and the IMF, aid flows or concessional loans from friendly countries. But these forms of funding tend to have conditions attached, which limit a country's ability to act independently, or in the case of concessional loans, they are often tied to a particular project and procurement source. By contrast, bond issuances come with few conditions attached, allowing governments to channel funds into areas they see as priorities.

Finally, Kenya needed to test its credit worthiness in international capital markets. The successful Eurobond issuance showed the level of enthusiasm foreign investors have for Kenya. Other foreign investments will likely trail the bond issuance and the country is now expected to attract more foreign capital flow.

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EurobondCS Henry Rotich