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Kenya’s Eurobond good, but analyst warns against misuse

By Mark Kapchanga | June 9th 2014

Kenya has kicked off attempt to raise between $1.5 and $2 billion debut Eurobond with an ambitious campaign in the United States that started late last week. The amount is expected to fund infrastructure and pay off a $600 million syndicated loan from 2012 whose deadline is August. The Standard on Sunday’s MARK KAPCHANGA had an interview with Mohamed Wehliye, a Senior Vice President, Financial Risk Management, Riyad Bank on the sovereign bond sale.

Does Kenya need to float a sovereign bond?

With a huge infrastructure deficit, it is obvious that Kenya needs to spend a lot of money on roads, water and energy to ensure a steady economic growth. It therefore makes economic sense for the country to borrow from outside to fill this financing gap.

What other benefits would accrue from the sale?

The flotation would enable the government to maintain stable exchange rate, create a vibrant local corporate bond market and establish a benchmark-bond for the domestic enterprises planning to finance business activities from overseas sources. And be a means to diversifying away from traditional sources of government financing such as concessional debt and foreign direct investment. Furthermore, the government will use part of the proceeds to retire the $600 million syndicated loans it signed in May 2012.

Is the timing for right?

Kenya, compared to some sub-Saharan African countries that have issued a Eurobond before, has a strong credit. However, I’m of the opinion that we first needed to work on ways to reduce both the budget and the current account deficits before issuing the sovereign bond. The first step should have been to bring down current account deficit significantly and grow the economy. Ideally, Kenya should be doing a sovereign bond issue from a position of strength, when it is much less vulnerable than it is now.

So, what are the dangers of issuing the bond with these challenges at hand?

External account challenges with weakening trade and current account balances means Kenya could have a scenario whereby the bond issuance will have a negative impact on the balance of payment accounts. This is if, as expected, Kenya uses some of the proceeds to import goods and services and thereby exacerbate the already precarious negative balance of payment situation. Having said that, you have to understand that it is push factors rather than pull factors that are currently driving the purchase of Eurobonds issued by sub-Saharan African countries. The current low interest rate regime especially in the US is pushing investors into increasingly obscure corners of the financial system and most African countries are taking advantage of this. Emerging and frontier market sovereign bonds are now popular because investor opportunities elsewhere are limited. Countries previously considered either too small or too risky with widening budget deficits and big current account deficits are using these investors’ appetite for higher-yielding bonds to issue Eurobonds.

Does this mean that the low interest rate environment is going to change? If so, what will be the impact?

Certainly. In a year or so from now, the low interest rate environment is likely to change. This means the sub-Saharan Africa will not only face higher borrowing costs, but also have to compete for funding with other issuers. When that happens, it is the pull factors that will come into play and investors will scrutinise more and lend based on a country’s policies and the strength of its balance sheet. So, although Kenya’s timing could have been better if it had issued post-tapering like Rwanda did, it still would not want to miss this prime opportunity to borrow at current low rate environment that is unsustainable in the long run.

Do you agree with other analysts that the Eurobond will be oversubscribed? If so, would it signal a success?

An oversubscribed bond offering does not necessarily mean it is a success. Just like any other product, one would feel satisfied if there is a lot of demand for the bond. But we still need to be worried about the yield (the interest rate Kenya will pay to the investors) at which we end up issuing the bond at. This will have an impact on the cost of servicing the country’s national debt and, hence, its sustainability. Therefore, the lesser the yield and the closer it is to the equivalent US bond, the more successful we can say the offering has been.

What are the key attractions that could accelerate its uptake?

When you sell a Eurobond, you need a convincing argument on the viable use of the proceeds to deliver returns. The ‘good’ story must be backed by good fundamentals and robust economic growth prospects. From the preliminary prospectus, I think Kenya has a good story to tell. Kenya has a diverse economy, which is not resource-dependent. It also has a convincing story about the quality of its debt management. Kenya’s debt-to-GDP ratios may be higher than the average SSA ratio but this is largely due to the fact that we did not benefit from the IMF-sponsored Heavily Indebted Poor Countries and the World Bank-backed Multilateral Debt Relief initiatives in 2000s.

At what yield do you think Kenya will issue the bond?

Bonds ideally reflect the value of a country. The sovereign bond yield, at least in the short term, would depend on the fundamental conditions in the economy. It would depend on investors’ perception of the risk of default. Kenya is rated B+ by both Fitch and Standard & Poor’s. The sovereign bond yields would thus need to be relatively high to attract global investors. Apart from the fundamentals, other factors like size and timing of the issue will also influence the yield at issue date. Zambia, for instance, issued its10-year $750 million in September 2012 for 5.625 per cent while Ghana issued a similar bond at eight per cent in July 2013. Is Zambia a better buy than Ghana? Not necessarily. Zambia timed the market well when it did its first issue and came in when the US treasuries were very tight and investors virtually had little or no alternatives. Rwanda had even a better timing and although theirs was a smaller issue of only $400 million, they issued it at 6.875 per cent. Nigeria issued a 10-year $500m bond at the same time as Ghana at a yield of 6.625 per cent. From a timing perspective, I would probably compare Kenya’s with Nigeria and Ghana, which were issued post tapering. I expect Kenya’s to be anywhere between what these two countries issued theirs at and around the 7.5 per cent mark.

Do you think the sale will bring some relief to our struggling economy?

A successful sovereign issuance will show the level of enthusiasm foreign investors have for Kenya. Therefore, other foreign investments will trail any successful sovereign bond issuance in the international capital markets. For this reason, it is expected that we will attract more foreign capital flow after the issuance of the Eurobond. We need to work hard to grow the economy and continue to rely on our own internally generated revenues. Getting this money does not mean our current economic challenges will go away. Remember the Sh132 billion (if Kenya issues $1.5 billion), we will raise will all not be new money as almost half of this will be used to pay off existing loans. Whether this will bring some relief to the economy or not will also very much depend on how we use the proceeds of the bond. The bond proceeds is already budgeted for in this coming financial year but what exactly will it finance? Well, I read the preliminary prospectus and it is noted in there that the remainder, after the $600m syndicated loans and interest are paid off, will be used for ‘general budgetary purposes, including the funding of infrastructure.

This means the money from that bond will go into the national pot to cover part of the Sh400 billion plus deficit. The deficit comes from new spending plans and old spending plans. So although it is said that we are borrowing to fund new infrastructure, in actual fact we are borrowing to meet the revenue gap, which is made up of many things.

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