Kenya's local debt getting out of hand as Sh850 billion due

NAIROBI, KENYA: The calm in the domestic government debt is like a volcano waiting to erupt.

Insiders say the country’s local debt maturity has reduced from 11 years to six years since 2016 - meaning paying the Sh2.2 trillion debt will strain Treasury coffers in the coming years.

Kenya has been much focused on foreign debt that developments in the domestic debt market have gone unnoticed.

Sources say that investors in government paper have panicked and are pricing in the risk of debt default and restructuring as a mountain of local Treasuries mature at a fast pace.

This year alone, Kenya is facing Sh850 billion in maturing local loans according to data seen by the Financial Standard, almost half of Kenya’s local debt.

“The Treasury’s debt planners haven’t been spot on with maturity management. At the close of 2009, Sh112.6 billion worth of outstanding Treasury bonds was due in 6.2 years; which is sustainable. At the close of 2017, Sh1.4 trillion worth of outstanding bonds was due in just 5.7 years’ time. That is not sustainable from a debt perspective,” said George Bodo-head of financial desk at Ecobank Capital.

Mr Bodo also warned that debt congestion was in the offing - and with it comes the risk that the Treasury might struggle to meet the outstanding debt obligations.

“Treasury might be forced, in extreme cases, to resort to such measures as debt rollovers or even refinancing,” he said.

Political risk

Stanbic Bank Regional Economist, East Africa Jibran Qureishi says with the heightened political risk last year, banks and investors kept off longer-term debt and packed short-term maturities.

“Investors realised that instead of locking money longer where if anything happens and they lose it, they put it into the 182 Treasury bills, especially in January because of election pressure,” Mr Qureishi said.

“They decided: I do not want my money locked down without knowing where the political direction is heading. The debts picked up last year is now becoming a problem this year,” he said.

Treasury officials are blaming the Central Bank of Kenya (CBK) for putting the country in a tight spot pointing out that the apex bank in a feat to look macro-economically stable have messed with the government yield curve.

“The CBK has been fixing the Treasury bill rates they look like they have control but it is creating a problem,” the source said.

The apex bank did not respond to our questions on being left to take the flak by Treasury.

However, CBK has been favouring specific rates for the Treasuries since last year, rejecting bids above the market price in what it termed as an effort to stabilise interest rates in the auction market.

CBK Governor Dr Patrick Njoroge said the bank of last resort will only accept bids within the yield curve and would turn down high bids by investors seeking to capitalise on the government’s desperation to borrow.

“When they put in bids, they were not large and some of the prices were way outside the yield curve. There is a feeling that the government has insatiable need to borrow and that is why some of them are bidding on crazy rates,” Dr Njoroge said in January last year.

A normal yield curve is one in which longer maturity bonds have a higher yield compared to shorter-term bonds due to the risks associated with time.

However, in Kenya, short-term Treasury bills have become so lucrative that investors piled all their money on the quickly maturing debt and abandoned long-term securities.

According to the latest CBK auction results, if you give the government money for three months, it will pay you eight per cent.

If you give it money for half a year, you will earn 10.6 per cent making the 182-day Treasury bill the most attractive. If you lock your money for a whole year, you only get 11.1 per cent which is a 0.5 percentage points difference for the extra six months.

If you give the State money for 20 years, you will get 13 per cent which is just 2.4 percentage points more for 19 years and a half months. “There is a somewhat artificial aspect to long-term yields at the moment. We have little liquidity at the far end so prices might not reflect the true measure of default risk?” said Deepak Dave of Riverside Capital, a risk management firm.

“Does the market truly believe default risk for the long-term to be lower compared to today.”

If you factor in inflation, time and mark to market value of the issues, you will see that the shorter-term debt is paying better.

“Our yield curve management hasn’t been the best. There have been occasions where the yield curve is inverted or nearly inverted. The problem with the inversion is that it incentivises the shorter end of the curve, which encourages the accumulation of shorter-tenured debt,” said Bodo.

This explains that in the latest auction the 182-day bill attracted 99 per cent interest, 364-day issue attracted 75 per cent interest and the 91-day bill attracted 42 per cent interest.

A source familiar with the auctions told the Financial Standard that the situations had become so bad that CBK was only receiving 10 competitive bids for the 91-day paper and that banks rarely even put in any bids with the rest being retail investors.

Last year, CBK faced a similar problem although with fewer maturities and decided to scrap the six-month for last eight weeks, as it tried to spread maturity concentration risk.

With government resorting to local borrowing to fill the budget deficit, the state of government debt would be precarious and has only been kept in check by the rate cap which made it the primary borrower for banks looking for less risky borrowers.

“The only sort of lifeline we have right now is that the cap,” Qureishi said.

Mr Deepak said that the interest rate cap, budget deficit and rapidly increasing post-election spending by Government means that there is a good chance we will need some sort of liquidity-induced debt restructure soon.

This naturally concerns the market, since we have long-term viability as a country, but might have to prepare for short-term bumps. It’s a part of maturing as a financial system in a modern economy.

Rate cap

If the rate cap is removed, banks would bid higher and make the debt not only impending but expensive to roll over costing the taxpayer even more money.

Some analysts point out that the government made a miscalculation when the rate cap came into place.

The National treasury continued borrowing as if nothing had changed instead of adjusting their risk-free borrowing to about seven per cent. “The government could have saved the country Sh154 billion and they could have achieved a softer yield curve and not the steep one that rewards short-term and penalises long-term borrower,” a source in government who did not wish to be named said.

However, Mr Qureishi said that the market would resist bringing down the rates citing the fact that the government needed money and could not dictate terms in the liberal market.

“The problem with the spread is that they will say we need the 182-day to 91-day to narrow and we can say no, we think that 91-day should catch up.. also that is a perception of risk,” he said.

To get out of this hole, Qureishi said CBK could narrow fiscal deficit ignore the auction and come in and tap the weighted average rate.