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Why Eurobond could lead to huge austerity measures

By Otieno Odhiambo | Published Tue, March 6th 2018 at 00:00, Updated March 6th 2018 at 08:17 GMT +3
Treasury Cabinet Secretary Henry Rotich. [Photo: Courtesy]

Recently, we predicted in the Financial Standard that the proposed Eurobond issue of Sh202 billion by Kenya in the US and Europe will be successful because liquid investors are willing to take the risk, particularly when it is the State that is borrowing.

The assumption is that governments are not expected to default on their sovereign debt.

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Investment is about taking a risk and the only way to avoid such is to do nothing.

However, since the successful issue of Eurobond, the International Monetary Fund (IMF) has denied Kenya access to its standby credit facility.

IMF is a key institution in the international monetary system.

It helps shield countries from adverse cyclical and seasonal currency fluctuations.

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It also assists countries with trade problems and is a reserve asset i.e it extends special drawing rights to countries in need of financial support.

Then immediately we got the Eurobond, the shilling lost ground against the dollar.

Let Kenya ignore IMF advice its own peril.

Secondly, immediately we got the Eurobond, the shilling lost ground against the dollar. Our debt is around Sh5 trillion. Over 50 per cent of our debt is foreign loans. We do not own the dollar or the pound or the yen yet we have to repay these loans in foreign currency.

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Foreign loans add value and are easier to repay when the proceeds are invested in projects that generate products and services for the export markets.

Exports will earn foreign currency that will be required to pay the interest, and the amount borrowed on the Eurobond loans, in addition to generating income for businesses.

However, most of these amounts might end up being invested in non-foreign currency earning projects.

Maths is not arithmetic of the benefits. The costs of these Eurobond loans is complicated. A study by Central Bank research team on this important subject did not reveal much.

It would be important establishing how the loans and related variables feed into our gross domestic product and the quality of our standards of living.

My prediction is that the first casualty of these loans will be the exchange rate.

The shilling will be weaker; our imports will be expensive, and the cost of living will be beyond many of us. We import medicine and oil, and these will become unaffordable. No one is saying Kenya should not borrow! What IMF and others are stressing is that Kenya will no longer pay interest on additional borrowing and this will impact adversely on our request for future borrowing.

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The Greek debt crisis slumped her into a 25 per cent unemployment, a weak financial system and political crisis.

To appreciate the gravity of Greece debt crisis, we should know the spillover effect affected the whole of Europe - shaking the financial systems and inducing a recession.

Debt crisis

Now that we are at the doorstep of a debt crisis, we need to change the debate from ‘do not borrow more’ to avoid a financial system collapse and a political crisis.

It happened in Greece. It can happen here. Kenya must have the capacity to accommodate additional debts should urgent needs arise.

For example, when commercial banks have problems with their asset portfolio, it is the State that bails them out.

This is what happened in the US in 2008 during the financial crisis. Otherwise, sooner or later, we might resort to printing more money.

Parliament must come out clearly on this debt level, more so after a visit by the IMF bosses. It can alongside the courts insist on a mandatory spending cut to force the Government to observe the required borrowing levels.

Otherwise, we will fall and all of us will feel the pain because, at one point, we will be exposed to austerity measures.

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Austerity measures take the form of reduction of government expenditures that translate into unemployment, loss of income, poor standards of living and increase of tax. Any increase in tax will lower the citizen’s disposal income.

Unfortunately, we might have to go through the austerity measures to avoid a debt crisis.

The likely result is slow economic growth that will make it difficult for us to raise the revenue needed to service Eurobonds.

Continued borrowing exposes us to a debt trap, and we are likely to see more privatisation of State entities to raise the money required to pay off debt.

In developed countries, whenever the debt is more than 80 per cent of its GDP then that country is considered to be in a debt crisis, and that country can only raise additional debt at prohibiting interest rate; in developing countries, the ratio could even be lower.

It is the IMF that imposes austerity measures on countries before the bailout.

In 2016, Brazil’s debt was pegged at 70 per cent of GDP public debt and it was forced to cut spending and raise taxes.

They were lucky that most of the debt was issued in local currency hence the need to service it in Brazilian Real.

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The solution is the government must pursue sound macroeconomic policies.

The bureaucrats at the Treasury must rise to the occasion.

-The writer teaches at the University of Nairobi