Eurobond may ease domestic borrowing

By Tabitha Areba

With its credit rating risk improving, stalled infrastructure projects and high liquidity, time is ripe for Kenya to seek funds from the international capital market.

Last week, the National Science and Economic Council recommended to the Government the need to issue a Eurobond.

Analysts believe the move will reduce reliance on domestic borrowing, which may crowd out domestic borrowers.

"If the funds are used to boost the private sector through infrastructure, schooling and better healthcare the crowding factor is reduced by competition," says XN Iraki, lecturer at the University of Nairobi, School of Business.

This has been witnessed in the way banks have drastically reduced their base lending rates.

But, how prepared is the Government to face the challenge?

Key risks

Analysts say key risks abound, and it is how the country handles the eurobond issue that will determine its success.

"The biggest risk is default if the country fails to pay. Remember a bond is another way of raising money, a competitor to bank credit," says Iraki.

However, he is quick to add that luckily, the Government is not known to default.

"The key risk is failure to achieve full subscription of the issue. This will have further negative implications on how people view Kenya as a borrower," said Bonice Misoka, Investment Associate at British American Asset managers.

Iraki also contends that it a challenge if the bond is undersubscribed and the country fails to raise the money needed.

When investors give money to a country, they look at natural resources, political status and the extent of citizen participation in Government processes.

Global ratings

International rating agencies issue two ratings on a country — economical and political — which determine the cost of borrowing.

For Kenya, the issue of credit rating, which has been low due to political instability, has improved.

According to Standard and Poor, the rating stood at B+ in 2008, a signal that the country was qualified to tap into the international capital markets.

However, this has since slipped to BB — stable, according to the Aprils ratings by the agency. Misoka says if a country’s rating is low, the cost of credit will be high as investors will expect to be compensated for taking higher risk.

"For a country like Kenya, the credit rating risk can fluctuate quite often as seen in the past. We have recently seen Kenya’s credit rating improve," says Job Kihumba Executive Director, Standard Investment Bank.

"If our rating is high, we could get lower interest rates, meaning we are unlikely to default," says Iraki.

Kenya has been postponing the eurobond issue for five years from the time the Narc Government was in power.

The most current reasons for shelving the issue are post-election violence and the global financial crisis. The country’s division over the referendum and the 2012 general elections are also likely to scare off foreign investors.

"We have been caught in the five-year cycle. However, if the constitution review goes on smoothly, we are likely to get good rates for the eurobond," says Iraki.

Besides subscription and credit rating, some experts say the issue could expose the shilling to exchange rate risks.

Borrowing instrument

"The main risk to an issuer related to eurobond is ‘currency risk’. A Eurobond issue is practically a borrowing in foreign currency," said Mr Kihumba.

Kenya is not alone in this quest. Most African countries like Tanzania, Gabon and Ghana are eyeing the international capital market for funds.

"It is a cheaper source of funds, cheaper than loans from banks. Compare the interest rates in Kenya with say UK or USA. Others would suggest it is the vogue. It is a much quicker way to raise money," says Iraki.

Domestic interest rate is higher, ranging between 10 per cent and 12 per cent, compared to between five per cent and seven per cent in the international market.

Kihumba says issuing a eurobond is a way of accessing credit with fewer conditions because it is commercial as opposed to bilateral or multilateral credit.

Issues by African countries are likely to be successful because emerging and frontier markets are offering attractive yields compared to developed countries.

Tanzania has revived its plans to issue its first eurobond, worth $500 million this year to finance infrastructure projects

Growing potential

Ghana and Gabon in 2007 became the first African countries outside South Africa to issue eurobonds.

Angola plans to issue $4 billion in bonds in June but analysts say issuance is more likely to total $500 million-$1.5 billion

There should be no worries about the success rate, as international investors are likely to seek higher and attractive yields from emerging and frontier markets.

Investors have been looking to tap into the potential of the poorest continent, which enjoyed five years of improved growth until last year.

"Competition for funds is high, and reputation matters. We are not the only people seeking funds, funds flow to where they are safest," says Iraki.

Kenya is safe, and investors could entrust the Government with Sh40 billion, but how well will the Government spend to achieve its targets?

From loans to donor funding, cases of misappropriation of funds are rife. Iraki warns that it is a risk if the money is not put to planned use.