The Eurobond issuance in Kenya had been in the pipeline for the last seven years. However, everything was just ink and paper until last week when the Government received $2 billion (Sh175.1 billion) in its account with the Central Bank of Kenya (CBK) after it completed the issuance of a 10-year $1.5 billion (Sh131.3 billion) and a five-year $500 million (Sh43.8 billion) Eurobonds on the Irish Stock Exchange market.

The 10-year and five-year bonds, which carry a coupon of 6.875 per cent and 5.875 per cent, respectively, recorded a large order book, with a total subscription exceeding $8 billion (Sh700.2 billion), much more over and above what Kenya sought to raise in the global capital markets.

What is a Eurobond? The name Eurobond is a misnomer and can sometimes be misleading. From the word, you would think either Eurobonds were about the European bond markets or the European currency, the euro. However, Eurobond has nothing to do with Europe or its currency. The term "Euro" in this context is simply used to refer to the international aspect of the bonds. A Eurobond is, therefore, a bond that is issued in a currency other than the currency of the country where it is issued.

The currency in which Eurobonds are issued also determines their name, like Eurodollar, which is issued in US dollars, or Euroyen, which is issued in Japanese yen. So Kenya's is a Eurodollar bond. Through these two bonds, the Government essentially asked investors to lend $2 billion on the promise that it will pay it back in five and 10 years with interest. The Government, through CBK, gave these private investors a piece of paper known as a bond, and in return CBK collected on the Government's behalf $2 billion cash in the form of a loan.

The buyers or investors of these Eurobonds, who are generally large companies, banks or financial institutions and governments, will be paid interest on an annual basis and the principle amounts at maturity. Eurobonds are free of withholding tax and are traded electronically in the secondary markets across international financial centres.

Potential benefits

There are numerous benefits associated with the issuance of a Eurobond as an alternative source of financing that governments such as Kenya want to tap in.

First, Kenya has a huge infrastructure deficit. It is obvious that the country needs to spend a lot of money on roads, railways, ports, water and energy to ensure steady economic growth. It, therefore, makes good economic reasoning for the country to borrow to fill the financing gap. So proceeds from the Eurobond will accelerate economic growth, poverty reduction and would be helpful for the country's economy if the borrowed funds are spent on infrastructure projects that offer a greater scope for augmenting revenue earnings and creating employment opportunities. Big infrastructure projects require labour. They enable more people to get employed and more companies are formed, hence more jobs are created.

Second, Government borrowing from overseas markets can be good for the economy. At the moment, the domestic markets have been the biggest source of Government borrowing. The current high domestic borrowing by fiscal authorities to finance the Budget deficit increases the competition for funds and drives up interest rates. Investment credit is normally very sensitive to interest rates and businesses, investors and even households would not borrow and/or the banks would not lend unless they believe the expected earnings before interest and tax on an investment opportunity exceed interest rates.

The Government's huge public sector borrowing, however, is normally insensitive to interest rates. The National Treasury, the largest borrower, would borrow any amount regardless of interest rates. So long as the Government is willing to borrow hugely and the Treasury Bill rate is attractive, local banks would have the tendency to channel funds into the risk-free Bills rather than lend to the real economy, unless borrowers are willing to pay high interest rates.

With Treasury Cabinet Secretary Henry Rotich now planning to borrow less from domestic markets because of this new money from the bond proceeds, there will be pressure on banks to lend the excess liquidity elsewhere. The extra supply of cash will, therefore, hopefully help to bring down bank lending rates to the productive sectors of the economy. The flotation of the bond will also be a step in the right direction for easing pressure on foreign exchange reserves. It would enable the Government maintain a stable exchange rate.

As far as foreign sources of debt are concerned, Kenya's debt has until now been mostly sourced from institutions such as the World Bank and the IMF, aid flows or concessional loans from friendly countries. But these forms of funding tend to have conditions attached, which limit a country's ability to act independently, or in the case of concessional loans, they are often tied to a particular project and procurement source. By contrast, bond issuances come with few conditions attached, allowing governments to channel funds into areas they see as priorities.

Third, the Government will use part of the proceeds to retire the $600 million (Sh52.5 billion) syndicated loans it signed in May 2012 and which was recently rolled over to August this year. The bond issuance will thus help lower Government debt servicing costs by substituting these outstanding commercial bank syndicated external debt instruments, which were contracted at higher interest rates, with the Eurobonds, which have lower coupon rates and longer maturities. This will help the country better manage its foreign debt, and in the process help it maintain or improve its current credit rating.

Fourth, in the very near future, the current low interest rate environment in the global markets is likely to change with interest rates in these markets expected to rise. This means governments with "speculative ratings" such as Kenya will not only face higher borrowing costs, but will also face market access difficulties as they would have to compete for funding with other "investment grade" issuers. When that happens, it would be difficult for countries such as Kenya to borrow at the current rates. Kenya, therefore, did not want to miss this prime opportunity to borrow at low rates and lock in good transaction sizes at the right prices. Other sub-Saharan African countries have done the same and Kenya did not want to cede any competitive advantage to its peers in the region.

Fifth, the Eurobond will help establish a benchmark-bond for domestic enterprises planning to finance business activities from overseas sources. The issuance of the country's first global sovereign bond in foreign currency, together with its good credit rating, should now encourage Kenyan companies to borrow at competitive rates from international credit markets. Access to longer-term US dollar funding will help domestic corporates finance economic activities that will help contribute to the country's economic growth.

Finally, Kenya needed to test its credit worthiness in international capital markets. The successful Eurobond issuance showed the level of enthusiasm foreign investors have for Kenya. Other foreign investments will likely trail the bond issuance and the country is now expected to attract more foreign capital flow.

Possible risks

First, as with any other debt, whether we get the full benefits of these bond issuances will depend on how the Government utilises the proceeds of the bond. There is always the danger that the bond proceeds pay for unaccounted items. One of the key challenges, therefore, will be to use the proceeds entirely and efficiently. President Uhuru Kenyatta last week promised Kenyans that the money would be put to very good use and in ways that would bring about positive momentum to the country's economy. It is extremely vital to ensure this will be the case.

If for whatever reason all or some of the bond's proceeds end up funding the many other things our Government wants to do, then we will be in big trouble. If the Eurobond directly or indirectly finances the already increasing Government consumption expenditure, such as to support the big wage bill, then it will bring no relief but will instead harm the economy. The Government would need to identify key projects where the proceeds would be used, and then manage these projects well to ensure they are implemented on time.
Not implementing on time the projects for which the funds have been planned is a serious risk because there are costs for not using proceeds, and these are greatest when there are delays in the relevant projects.

Second, we face the risk of what economists refer to as the "original sin". This doctrine warns against the dangers of borrowing in a foreign currency when you don't have sufficient earnings in that currency and you will service the debt in your local currency. Our bond is issued in dollars and yet we spend and collect taxes in shillings. We are, therefore, exposed to foreign exchange risks. If we suffer a situation where our shilling substantially depreciates against the US dollar, which is what the Eurobond is denominated in, the cost of servicing and repaying the bond becomes higher and this could impact on debt sustainability.

For instance, if at any point during the 10-year lifecycle of our $1.5 billion Eurobond the shilling depreciates markedly against the dollar, it would mean that the Government will have to collect more taxes to translate into dollars or even borrow to pay our foreign creditors. Matters could also become complicated when it comes to paying the principle amounts of $500 million (after five years) and $1.5 billion (after 10 years). If US interest rates rise as expected and investors find greener pastures elsewhere and are not happy to refinance our debt, we could be forced to pay off our Eurobonds using our reserves and that is not good. This will, of course, change if we start to export oil as expected and start earning revenues in dollars.

Big responsibilities

The new status comes with big responsibilities. Having a Eurobond in our books means Kenya is now more connected to its national credit rating and the scrutiny of global bond markets. To a certain extent, we have yielded part of our economic sovereignty to the investors in London, Tokyo, New York and everywhere else our bond is held. Our credit rating and the yield on our bond will now give us instant and economically tangible feedback.

This means Kenya will need to manage its affairs better or the markets will punish it. This is both good and bad for us, depending on how we deal with our new status; that of a country with a bond in the international markets. It is good for us if we use the increased scrutiny  to strengthen our macroeconomic discipline and move transparency and structural reforms forward.

However, the increased scrutiny will work against us if we don't deal with corruption or we engage in bad economic policies. In such a case, investors will dump our bond and drive up borrowing costs for both the Government and the private sector. The Government now needs to put its act together at the level of policy consistency, and politicians will need talk less about issues that would affect investor confidence.

There will also be need for discipline on the statements that come from both the Government and opposition. Loose talk will now cost us money. The Government needs to co-ordinate its communication well and not offer contradictory statements, especially on issues touching on economic policy. Foreign investors must be comfortable with the policy position of the Government in the long term, otherwise you will start to see negative signals coming from the markets. Being in the international bond arena now means we would be required to meet our deadlines, honour our commitments and be prepared to stake our reputation.

The writer is senior vice president, financial risk management, Riyad Bank, Saudi Arabia. [email protected]

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