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Prepare for economic meltdown should Kenya miss IMF facility

By Dominic Omondi and Otiato Guguyu | Published Tue, September 11th 2018 at 09:10, Updated September 11th 2018 at 11:16 GMT +3

Two days from today (Tuesday), the Executive Board of the International Monetary Fund (IMF), the highest decision-making organ of the Washington DC-based global lender, will make a decision that might echo through Kenya’s future. 

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On Thursday, the Board will decide on whether or not to grant Kenya access to a precautionary credit facility of Sh99 billion ($989.8 million). Should the Bretton Woods institution pull the plug on the Standby Arrangement (SBA), it will set off the country to unthinkable economic destruction.

Kenyans might have to reconsider their opposition to the 16 per cent value-added tax (VAT) on petroleum products as the alternative might be a financial crisis whose effects will be more painful than those of the punitive tax measure being pushed by the IMF.

For example, Financial Standard, has learnt that should the Government fall out with the IMF for failing to meet commitments it made to the lender, some of the bondholders of the $2 billion (Sh200 billion) Eurobond Note will be at liberty to immediately recall outstanding interests and principals, throwing the country into a tailspin.

Accrued interest

This looming financial  meltdown might be triggered by the bondholders of the two-tranche Eurobond. 

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The Eurobond Prospectus reads: “Holders of the 2028 Notes or the 2048 Notes…who hold at least 25 per cent in aggregate principal amount of the relevant Notes then outstanding may declare such Notes to be immediately due and payable at their principal amount together with accrued interest if, inter alia [among other things].” …. the Issuer (Government of Kenya) ceases to be a member of the IMF or ceases to be eligible to use the general resources of the IMF.”

This is only for the second Eurobond that Kenya issued this year.

The Financial Standard has not been able to get hold of the Prospectus of the 2014 Eurobond, but given that conditions under which it was arranged, it’s likely that such a provision also applies to the first Eurobond.

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And, frighteningly, other commercial loans secured by Kenya’s could as well have such a risky clause.

Should the Eurobond investors invoke this provision, they will surely set off Kenya’s economy on a destructive path. Such a path is not very different to the one Argentina has taken.

Yes, CBK has Foreign Exchange Reserves of Sh850 billion ($8.5 billion), but doling out 23 per cent of this hard-to-come-by foreign currency to creditors is the surest path to a financial crisis. With a few Dollars left to buy critical products and inputs such as petroleum, medicines, machinery, clothes, food and beverages, steel and so forth, the Shilling will come under extreme strain.

Should the Shilling weaken, Kenya’s stock of dollar-denominated loans will rise sharply making it even more difficult for the country to repay. While the Shilling has been held steady by increased financial inflows in the form of export earnings, diaspora remittances, foreign direct investments (FDI) - analysts reckon that investors have been urged on by the confidence offered by the existence of the IMF facility. Treasury has frantically tried to avert this crisis. In March they requested the IMF President Christine Lagarde to give them more time so they could put in place a raft of measures that would return Kenya in IMF’s good books. 

That is why the decision made on September 14, might make or break President Uhuru Kenyatta’s legacy.

“Completion of the reviews will enable the Kenyan authorities to have access to funds available under the precautionary SBA,” said the IMF in a statement when granting Kenya its request for a six-month extension of the SBA.

SBA is a precautionary credit facility, sort of like an insurance cover, that Kenya can draw upon in case of an exogenous attack such as drought, hike in global prices of oil, or changes in the international financial market.

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But the reviews, it seems, have not been successful. Kenyan authorities are yet to approve the publication of an IMF staff report. Insiders say that it might be related to IMF’s requirement that Kenya considerably reduces its stock of debts.

It looks like Kenya is married to this witch called IMF- for better or for worse. 

But despite this worrying scenario that is likely to unfold, Treasury remains bullish of securing a deal before relations with the fund gets worse. Principal Secretary Kamau Thugge is confident that the country key indicators are positive and that the country foreign coffers have significant reserves to withstand any shocks.

“Not getting an IMF programme will not significantly affect our strong exchange rate position and we have reached a number of issues with the fund and I expect they will soon publish a staff report as agreed,” explained Thugge even when most of IMF demands remain unresolved.

One of the commitments Kenya made to IMF was to substantially reduce its fiscal deficit, which occurs when a government’s total expenditures exceed the revenue that it generates, by, among other tax measures, levying VAT on petroleum products grow its revenue base.

Interest controls

Kenyan authorities, led by National Treasury Cabinet Secretary Henry Rotich and Central Bank of Kenya (CBK) Governor Dr Patrick Njoroge, had also promised the Fund to either abolish or modify interest controls so that banks could open the drying credit taps to SMEs.

But, not only have members of the National Assembly resoundingly thwarted the two policy proposals having been presented by the IMF, they have also shot down other tax measures that the Government hoped would help it tame its appetite for debt uptake.

Kenya is now left in a precarious position as Judgment Day with the IMF looms large.

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From a technical economic point of view, the IMF aid package may just be the necessary evil for Kenya’s path to economic recovery and job creation

Thus, in the next two days, the Government will aggressively try to patch up some of the commitments it made to the IMF in a bid to renew the Standby Agreement, the remaining $354.629 million Standby Credit Facility (SFC) has since been discontinued as the arrangement can be approved up to a maximum of 24-months.

The IMF warned that Kenya’s public debt might rise to 60 per cent this year without corrective measure. President Kenyatta has been on overdrive in his fight against corruption and wastage in what is aimed at shoring up revenues and reducing non-essential expenditure. The end goal is to beat IMF’s deadline.

Before he could come up with new tax measures, Rotich started by postponing what he called “lower priority capital projects” as he sought to consolidate funds.

Indeed, for the first time in Kenyatta’s term, development expenditure declined in Financial Year 2016/17 compared to the previous Financial Year.

Spending on development activities such as the building of roads, ports, energy projects fell by 25 per cent from Sh654 billion in the Financial Year 2016/17 to Sh489.7 billion in FY 2017/18. 

Indeed, in the Financial Year ending June 2018, fiscal deficit as a fraction of GDP declined to 7.1 per cent, which was within Kenya’s commitment to the IMF.

Meanwhile, President Kenyatta also launched a spirited fight against corruption and wastage.

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Kenya had also promised IMF to further bring down the fiscal deficit to 5.7 per cent of GDP by 1.5 percentage points, get rid of a number of tax exemptions in VAT and Income Tax, widen the tax base and continue with the ongoing improvements in revenue administration to seal tax leakages.  

In the Finance Bill 2018, that is yet to be signed into law by the President, Rotich tried to put in place all these measures, including the removal of the cap on interest rate.

His efforts might come to a naught should the President sign it into law in its current form. At least Rotich might have found a perfect scapegoat in MPs.

But Rotich might have underestimated the influence of populist politics, which saw him fail to convince politicians to back-out of their love-affair with the Marxist policy of capping of the interest rate cap and adopt a loan pricing mechanism that would be dictated by the market.  He forgot that at a time when the neoliberal order is under siege, rationalism never rules and graphs and figures mean little to the memory of Members of parliament who just three years ago had to pay off their own loans at twice as much as they are currently footing.

Thus, legislators voted to keep the rate cap in place, dealing a blow to Rotich’s efforts at keeping the IMF facility.

And they did not stop there, they also fought against a 16 per cent Value Added Tax on petroleum products, which according to Treasury estimates could fetch Sh71 billion, enough to almost settle the principal amount of the Sh75 billion five-year Eurobond Kenya secured in 2019.

Further, they increased Kenya’s need to borrow more fund by scrapping the 0.5 per cent statutory reduction that was to fund President Uhuru Kenyatta’s half a million houses.

Then they threw out recommendations to impose a Robin Hood tax of 0.05 per cent on transactions above Sh500,000 which would have set off the pilot of the Universal Health Care system to be launched in Kisumu, Machakos, Nyeri and Isiolo.

Basically, the MPs had increased the budget deficit, crippled additional revenues that would go into paying debt and sent CS Rotich as an emissary to beg for a bailout package from the IMF having failed to keep his word. “With the current state, I do not think Rotich has a chance with the IMF, otherwise what will they use to justify they have achieved some level of reforms,” a source in the banking sector who has had prior dealings with the Bretton Woods institution said.

Yet in the face of all this despondency, Mbui Wagacha, an economist and adviser in the executive office of the presidency, was quoted by a local daily telling off IMF. He said that Kenya did not need the Sh150 billion IMF insurance loan.

Asked whether Wagacha’s remarks was the position of Government, a Treasury official whose identity we cannot reveal, only said: “Wagacha does not speak for Government.”

CBK governor, Patrick Njoroge, is also recently reported to have said that Kenya does not need the IMF loan, stating that the country has enough foreign currency reserves to pay its imports bills.

Besides, the forex reserve held by Commercial Banks as at May worth $2.6 billion is seen as an added advantage.

World currencies

This means that Kenya is relatively comfortable and dollar demand cannot eclipse supply to cushion the shilling’s value, which in effect carries the risk of increasing the stock of debt if it loses against other world currencies.

But financial markets are queer and what seems calm may be a volcano waiting to erupt.

Take Argentina for example, just a year after issuing a century bond repayable over 100 years, their currency has tumbled and no matter how much reserve money their Central Bank used they could not halt the fall of the peso.

The bank has sold more than Sh1.4 trillion ($14 billion) of reserves this year which has not stopped the Argentine peso tumbling and losing almost half of its value since.

That is how crucial the IMF facility is to restore market confidence.

Standard Chartered Bank Chief Economist for Africa and the Middle East Razia Khan said the country could cover itself by signing up for the IMF’s precautionary credit facility.

“If we sign up for an IMF programme, we will be signing up for a requirement of fiscal policy and that will provide reassurance to investors. So the risk premium that we have to pay on our debt declines,” she said.

“In the event of non-renewal of the facility, Kenya may have reduced buffers in the event of any significant exogenous shocks and significant adverse movements in the balance of payments position.” “In addition, statements made by the IMF may contain adverse information that could negatively impact the price of the Notes,” read the Prospectus.

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