Long road for counties in bid to tap capital markets

The devolved units could use the bonds to issue debt and raise capital from investors in the capital markets. [iStockphoto]

Infrastructure bonds have long been tipped as a viable tool for cash-strapped county governments to raise funds for development.

The devolved units could use the bonds to issue debt and raise capital from investors in the capital markets.

Access to such borrowing could ease financing pressure on the counties, with proceeds going to financing public projects with defined income streams.

But counties cannot use the money raised from bonds to cover routine expenditures such as staff salaries and other emoluments.

In what signalled markets that Kenyan authorities were poised to implement bond issuance for counties, the World Bank in 2020 teamed up with a major credit ratings agency to issue ratings of local governments.

And since March 2020, Makueni, Kisumu, Bungoma, and Laikipia counties have been adjudged fit to borrow through the Nairobi Securities Exchange (NSE) and other external markets.

They were at the time given a clean bill of health by the South Africa-based Global Credit Rating Company (GCR) out of the nine counties that took part in the pilot scheme backed by the Treasury and the World Bank.

GCR gave Makueni and Bungoma counties issuer ratings of BBB (KE) and A3 (KE) for the long and short term respectively, with a stable outlook.

Financial profile

The firm separately assigned Kisumu issuer ratings of BB (KE) and B (KE) for the long and short term in that order, also with a stable outlook. "The ratings on the County Government of Bungoma reflect its strong financial profile and ongoing government support, counterbalanced by a very weak entity profile, characterised by limited economic activity," said GCR.

"The ratings reflect the County Government of Makueni's stable financial profile underpinned by the consistent transfers from National Government, as well as other ongoing operational and institutional support from National Government," it said of Makueni.

Kisumu's ratings reflected "the deterioration in operating performance and weak audit outcomes... counterbalanced by the strong financial profile and government support."

The ratings were conducted under the County Credit Worthiness Initiative, a programme by the National Treasury, Commission on Revenue Allocation (CRA), the Capital Markets Authority (CMA) and county governments, supported by the World Bank.

The ratings sought to provide the first formal independent opinion on the creditworthiness of the devolved units.

But to date, only Laikipia County has dared to swim in the deep end of the bond market, with the rest of the country's 47 counties shunning it.

Backed by the National Treasury, Laikipia successfully floated a Sh1.16 billion infrastructure bond last year.

But why are the managers of the other devolved units shying away from the capital markets, and why has the model not gained traction as yet?

Political will

According to the former Laikipia Governor Ndiritu Muriithi - under whose helm the county issued the first bond by a devolved unit - it all boils down to a lack of awareness and political will.

"The process is not complicated. It may be lengthy but not complicated," he argues, pointing out that the process is well articulated in the 2010 Constitution that created the devolved units.

Counties must under the law generate their comprehensive integrated development plans as well as debt management and fiscal management plans.

"The projects to be financed by the bond should be in the county integrated development plan," says Mr Muriithi, while urging counties to tap the expertise of the National Treasury, CRA, and the Intergovernmental Budget and Economic Council (IBEC) for due diligence.

"Any county that should want to do it should go to the National Treasury or IBEC for guidance," he adds.

The long-winded process, which is marked by enhanced transparency and accountability, could, however, be pushing away counties from the capital markets, according to analysts.

For instance, in contrast with bonds, loans from financial institutions provide an avenue to access quick capital, supply needed cash flow... and can be easier and less costly to obtain for devolved units than a public debt issuance.

This is because the devolved units do not have to provide offering documents when they take out the loans and do not have to tell traders in the secondary market about them. The alleged shadowy nature of county government financial operations could also be a hindrance.

There have been concerns that some of these huge borrowings are largely hidden from the public view and pose a risk to the stability of the counties.

Analysts say counties need a well-documented history of all their financial dealings for their creditworthiness to be assessed. Bonds require disclosure and spread the risk of default across a wide array of investors.

Analysts say the bond market would be key to addressing the local debt issue, with disclosure requirements helping to impose a hard budget discipline on elected officials. Expanded bond issuance could also enable many counties to cut borrowing costs.

The use of longer-term bonds could also relieve the worrying mismatch between infrastructure investments that may take decades to produce financial returns and the short-term loans that are often used to finance such projects.

Previously, counties could borrow cash from banks for recurrent expenditure, but there was no provision for long-term development borrowing.

Counties also need the National Treasury's backing to issue debt on their behalf.

The arms-length arrangement means it is often unclear if the government is legally responsible for servicing the debt, even though investors assume their bonds are protected by an implicit government guarantee, said Deepak Dave of the Riverside Capital Advisory.

Analysts say the bond market would be key to addressing the local debt issue, with disclosure requirements helping to impose a hard budget discipline on elected officials. [iStockphoto]

"It's like children raising debt based on parents' income," said Mr Dave.

"Let's also say J P Morgan has bought the debt from a specific county, which courts will enforce if the county fails to pay?" he posed, adding there is also little accountability of county government debt management.

Policy change

But in fresh efforts to give impetus to capital raising, CMA last week backed the push by more county governments to borrow from the capital markets.

Nairobi County, which has been laying the groundwork for the issuance of an infrastructure bond, seeking to raise at least Sh17 billion, has stepped up the plans. But Governor Johnson Sakaja is pushing for policy change to enable counties to borrow above the current limit of 20 per cent of their audited annual revenues for development projects.

County governments have the green light to borrow up to Sh60 billion for development projects in a deal reached between the Intergovernmental Budget and Economic Council and the National Treasury.

Counties can borrow up to 20 per cent of their last audited total revenue. The Sh60 billion upper limit is based on the 2018/19 financial year audited revenues.

Revenue is, for purposes of setting the borrowing ceiling, defined as the share that counties receive from the Treasury and own-generated cash that the regional governments raise from fees such as licence and parking charges. "We need about Sh17 billion to address the sewerage situation and expand the water pipes to meet Nairobi's growing population," Mr Sakaja said in a statement after a meeting with CMA representatives. "The county cannot raise these funds from conventional sources such as banks or even from its own revenue thus, the capital markets offer an affordable and long-term solution," he explained.

The Constitution allows counties to borrow from the capital markets and foreign sources once cleared by the National Treasury. The law requires Treasury to guarantee devolved units to raise cash from investors upon meeting stringent conditions.

Capital markets

Counties must, for instance, raise at least 15 per cent of project funds from internally generated resources before the national government can guarantee their borrowing, Treasury rules say.

"The Authority will support the Nairobi County Government to raise funds through the capital markets," said CMA Chief Executive Wyckliffe Shamiah while admitting that challenges abound.

"However, it will be important for the county to demonstrate good governance through the prudent application of funds raised to give confidence to investors for future county capital raising exercises." Stringent conditions for devolved units are aimed at curtailing reckless borrowing. Counties are also assessed on their loan repaying ability over the medium term, meaning counties that are in the red are blacklisted from external borrowing.

There have been concerns over the capacity of some counties to absorb money borrowed and also fears of misuse by some administrators.

But the innovative form of financing could ease funding pressure off counties and avoid straining Kenyans with additional taxes. Newly elected governors recently vowed to implement a new report showing Sh216 billion go uncollected in counties every year.

The report, published by CRA and backed by the World Bank, showed county governments collect only Sh31 billion in taxes annually against their target of Sh52 billion, underlining their inability to tap their own source revenue from residents.

The report's findings could set up Kenyans - who are already facing high inflation pressures - for steeper rents and higher costs of accessing basic services and goods. CRA Chairperson Jane Kiringai said the higher collections could ease the pressure off the National Treasury amid debt repayment obligations and a tightened public purse.