The danger of Kenya’s reliance on borrowed forex reserves

Central Bank of Kenya (CBK) Governor Patrick Njoroge has revelled in this feat as it has helped the shilling to remain steady against the dollar. [Standard]
Kenya has had a checkered history with the dollar, the world’s primary reserve currency. From the exchange control days when being found with the greenback would land you in jail, to the liberalisation-era that coincided with the devaluation of the local currency, the greenback has been at the heart of Kenya’s ups and downs.

And now, the country seems to be swimming in dollars.

Kenya’s sizeable backup of foreign currencies running into $9.153 billion (Sh915.3 billion) as of June 20 this year, offers a strong buffer against any shocks in the global market.

The money is enough to cover the country’s imports or any other external shocks for almost six months.

Central Bank of Kenya (CBK) Governor Patrick Njoroge has revelled in this feat as it has helped the shilling to remain steady against the dollar. But beneath this glitter, is untold gloom.

A good chunk of these dollars have not been earned through the sweat of tea farmers, local mining firms, or manufacturers but through borrowing. 

Last month, CBK honchos celebrated a key milestone, with the country boasting the largest reserve of dollars in history.

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With the Sh201 billion ($2.1 billion) that Treasury had received through its issuance of a third Eurobond, Kenya’s foreign currency reserves jumped to Sh1 trillion, enough to cater for imports for six and a half months.

The country repaid its maiden Eurobond this week, starting off a series of principal repayments that will come thick and fast every two years between 2024 and 2031. There is some merit to this. If Kenya relied on exports over the last five years, it would have earned a total of $25.387 billion (Sh2.538 trillion). But the country was lucky to bring in an additional $22.55 billion (Sh2.2 trillion) since 2014 through debt and diaspora cash.

However, analysts are now questioning the viability of debt-funded forex reserves, with so many debts coming due thick and fast. Basically, Treasury has adopted liquidity management where it borrows more than the repayment that is due, with the dollars finding their way into CBK’s coffers, according to Churchill Ogutu, a researcher with Genghis Capital.

Mr Ogutu reckons that although this has uplifted the forex reserves, it is “quite transitory.” “Thus, the baseline outlook is that the reserves will always remain adequate to honour maturing obligations,” he says.

Yesterday, CBK wired $800 million (Sh80 billion) from the dollar reserves to investors of the maiden Eurobond, shrinking the reserves to $9.2 billion (Sh928 billion) clearly demonstrating the country’s folly of relying on debt-funded reserves; they vanish as fast as they come in.

Even with the additional dollars flowing into the economy from Kenyans in the diaspora, Treasury has continued to desperately borrow in foreign currency to meet its external debt obligations as they fall due.

Unfortunately, the country’s external debt position has worsened as interest payments on foreign loans rise.

This has been the case ever since Treasury mandarins led by Cabinet Secretary Henry Rotich made their first stab at borrowing internationally in 2014, snapping up expensive commercial debt such as sovereign bonds and syndicated loans.

Without adequate dollars of its own, Kenya’s export earnings have remained dismal, forcing the country to borrow more dollars to repay maturing debts, a situation that has seen it stuck in a rut. Although, Kenya continues to meet its external debt obligations, paying all its debts as they fall due, things have got a little precarious.

In the last 12 months, Treasury’s position on the country’s ability to repay its external debt has swung from bullish to cautious as manifested in the Exchequer’s Medium-Term Debt Management Strategy for years 2018 and 2019.   In February last year, Treasury said Kenya’s risk of defaulting on its debts was “low”, and that its public debt was “sustainable” and would remain so in the near future.

A year later, in February this year, the country’s risk of debt distress had fluctuated from low to moderate. In other words, debt burden indicators are not blinking red; they could easily be breached in case of “external shocks” such as a sudden increase in the global prices of crude oil or if civil servants suddenly demanded high wages and the State ceded to their demands, leaving Treasury with little to pay its debts.

CS Rotich insists that Kenya continues to meet its debt obligations promptly with no accumulation of arrears. While this may be true, institutions such as the International Monetary Fund (IMF) have done tests that have indicated that if nothing is done, Kenya will struggle to service its debts.

Accepted threshold

IMF downgraded Kenya’s risk of defaulting from low to moderate, forcing Treasury to eat humble pie by saying as much in its latest debt sustainability report. The February 2019 MTDS shows that at a threshold of 26.2 as of October 2018, Public and Publicly Guaranteed (PPG) Debt service - the total exports ratio - has already breached the accepted threshold of 21.

This means that Kenya is not generating enough exports to earn more dollars to service its debts as they fall due.  This ratio has been deteriorating, rising from 16.5 in 2017. Even with Treasury’s liberal projection, it will still be above the threshold by 2021.

The IMF said in a damning report that Treasury had tried to vote against its release. The global lender noted that by last year, Kenya had breached three external indicators - external debt service-to-export ratio, external debt service-to-revenue ratio, and the present value of external debt to export ratio. Both revenue and export earnings are insufficient to help Kenya comfortably pay external debts.

But how did Kenya find itself here? According to the IMF, it all boils down to “higher levels of debt, together with rising reliance on non-concessional borrowing”, which have raised fiscal vulnerabilities and increased interest payments on public debt to nearly a fifth of revenue.

Thus if Treasury does not tame its appetite for debt, especially expensive external loans, the country will sink further into debt distress like other African nations such as Ethiopia, Chad, and Zambia that have nearly defaulted on their debt repayments. 

Experts reckon that the country needs to urgently restructure its loans - swap expensive, short-term debts with concessional, long-term debts such as those from multilateral bodies like the World Bank.

Worryingly, the share of concessional loans in Kenya’s debt mix has been declining. There have also been calls for Treasury to address the twin fiscal evils of wastage and corruption, which have contributed to revenue loss.

In his budget speech, Rotich announced austerity measures aimed at freeing up some funds that could be deployed to debt repayment.

These include the slashing of hefty travel allowances and per diems to civil servants. The State will also continue freezing new development projects.  Treasury has also come up with stringent regulations aimed at auditing externally financed projects.

“Mr Speaker, we shall continue to remain on this planned path of reducing the fiscal deficit in the medium-term in order to create more fiscal space and to reduce the public debt,” said Rotich. “Official Development Assistance on high concessional terms will be preferred for some of the external financing while medium to long-term Treasury Bonds will remain the primary source for domestic financing,” he added.

Treasury’s silver bullet to the debt problem is to boost productivity. So far, State policy to prop up exports has been less compelling, according to Ogutu, who notes that the country has over-relied on “traditional export streams.”

Last year, the State unveiled export strategies meant to increase exports by re-examining the existing markets. This even as it looks farther for new markets such as India and China.

Kenya has traditionally exported horticulture, tea, coffee, and Titanium to a few countries, mostly Europe and North America, in their raw form.

Treasury has had to introduce a new export levy of 10 per cent on tanned and crust hides and skins to encourage value addition so that they can fetch better prices.

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GreenbackCentral Bank of KenyaGovernor Patrick NjorogeGenghis CapitalMFCabinet Secretary Henry Rotich