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Is Kenya’s debt becoming unsustainable?

Recent mega public infrastructure projects in strategic areas like transport and energy in Kenya have not only given the country a facelift, but also toned up its profile as a regional investment hub. However, all this has come at a price—more borrowing. Doubts have begun to emerge about the sustainability of Kenya’s debt, and even the World Bank has waded into the debate, noting in an October 2016 report that “margins for further debt accumulation are narrowing.”

Kenya’s public debt increased from 42.1 per cent of GDP in 2012/13 to 55.1 per  cent  of GDP in 2015/16. Debt is expected to increase even further to 60 per cent of GDP in light of the imminent fresh round of foreign borrowing that the government has announced.

This essentially means that, soon, 60 cents of every shilling produced in Kenya will be owed to someone else. This is alarming, and there is no shortage of concurring commentary. For instance, The World Bank thinks that Kenya’s appetite for debt is spi- raling out control. “although public debt remains sustainable, margins for maneuver are rapidly narrowing,” the World Bank said, indicating that the threshold for what is consid- ered “unsustainable debt” is fast-ap- proaching.

Admittedly, the increase in debt to GDP ratio in the past few   years is a persuasive indicator of just howravenous the country’s appetite for debt has grown. Nevertheless, it is not a sufficient indicator in itself. Economics can never be exclusively limited to numbers, important as they are in quantifying and repre- senting complex economic realities.

Economic discourse must accom- modate a broader discussion that looks beyond the numbers, offers global comparisons and dissects the underlying issues, including issues of a geopolitical and social nature. Only then can a picture that is truly reflective of the facts be drawn.

Global picture

Comparatively, Kenya’s debt to GDP ratio of 55 per cent is much lower than many other economies in the

world. japan, for instance, has a debt to GDP ratio of 229.2 per cent; Greece (176.9 per cent); Lebanon (139 per cent) and Italy (132.7 per cent). There are many more coun- tries with similarly high levels of debt.

The situation in Greece is, of course, one of a kind, and there was social unrest and widespread  uprisings in 2011 and 2012 due to its debt. The country had to be bailed out by international creditors, which in exchange compelled it to institute unpopular austerity measures. On the other hand, japan is grappling with slow economic growth, making debt repayment all the more difficult. Many developed economies are facing higher debt levels than Kenya, but are at the same time still able to provide baseline services to the people, particularly creating jobs, providing housing, healthcare and education.

Kenya’s growing debt load, from a global view, is therefore nowhere near the debt load in many econ- omies, especially in the developed world. nonetheless, a more faithful

reflector of debt sustainability is the ability to pay. Debt sustainability review must take into account the ability to pay. That is, it must look at the country’s economic profile, precisely  projects  that  have been

identified as having the potential to offset debt and drive growth.

 

Costly projects

The general thinking behind Kenya’s borrowing spree is that the over- hauling of public infrastructure will improve the business environment and attract more investment, espe

cially in high growth sectors such as

manufacturing and agro-processing. The growth attributable to pub-

lic infrastructure development is expected to in the long-term off- set the cost of servicing debt. This hypothesis sounds solid on paper. But anyone who understands the reality of public infrastructure devel- opment in Kenya knows too well that the costs often outstrip the expected payout.

a project may be affordable on paper, but its true costs often qua- druple due to corruption. This is an issue that deserves mention in light of the fact that corruption has become a national crisis.

another factor that also com- pounds public infrastructure costs are the high costs of land acquisi- tion and compensation. The drawn out land resolution mechanisms also impact project timelines and intro- duce incidental litigation costs.

Speculators in areas identified for public projects in Kenya typ- ically overstate the prices of their land. avaricious land grabbers also routinely evict communities in close proximity to public infrastructure projects. The resultant conflicts from these land tussles often impact the overall timelines of the projects, attracting higher costs.

“Whenever a public infrastruc- ture project is announced, land speculators  invade intended project corridors, acquire land and position themselves for wind- fall profits by way of compensa- tion,” said the attorney General and Treasury’s office in an august 2016 statement issued to justify new pro- posals aimed at replacing monetary compensation with land swaps in the Land Law.

according to Patrick Obath, an energy consultant and former chair- man of the Kenya Private Sector alliance (Kepsa), inflated land prices have increased the cost of govern- ment’s infrastructure development and pushed up the public debt. “I think the biggest issue is infrastruc

ture development by the government, which is going to be very expensive, pushing up the value of our national debt,” he said.

If the reforms in land laws are not effected sooner rather than later, the country’s public infrastructure costs could spiral out of control. This essentially means that the payout from these projects would not be enough to offset the debt that has been accrued to undertake them.

 

Focus on high potential areas Kenya is more fortunate than many of its african peers as it is not commodity reliant. It is therefore insulated from the ongoing slow- down in africa. Most countries in africa grew at rates above 5 per cent between 2000 and 2014 on the back of high commodity prices. They were overly confident that the commodity rally would persist indefinitely and took on mountains of debt for all the wrong reasons. Lenders were all too happy to provide this debt. now these countries are paying through their noses for this debt following a slump in commodity prices and eco- nomic growth. Sub-Saharan africa’s reliance on commodities has turned from a blessing to curse, and many governments such as nigeria, Ghana and angola are facing tough finan- cial times.

Kenya’s insulation from this resource curse, as it were, gives the nation a definitive edge against its african peers. The East african eco- nomic powerhouse can spread its net across a wider range of sec- tors, unlike most countries which are predominantly reliant on natural resources. The ability to diversify growth can substantially improve Kenya’s ability to not only pay debt, but guard against debt-fueled growth in future.

a priority focus area in Kenya’s economy is agriculture. Kenya has a natural advantage in the sector by virtue of the fact that the sector
contributes around 25 per cent of the GDP, according to data from the Kenya national Bureau of Statistics. There have been some positive indicators that the country is finally realizing the powerful potential of agriculture. at the african Green revolution Forum held in nairobi in September, President uhuru Kenyatta said that the country will spend $200 million on agriculture over the next five years. The funding will help at least 150,000 young farmers and young agriculture entre

preneurs to gain access to markets, finance and insurance.

The next step now is ensuring that the youth understand the poten- tial of agriculture. according to the agriculture Cabinet Secretary Willy Bett, the average age of farmers is between 60 to 62 years. These people no longer have the energy to drive productivity.

Ironically, 80 per cent of the country is below the age of 35, showing that there is a sizeable workforce that can go into the farms, bring out raw produce, add value to the produce through processing and

export it to lucrative export markets. The possibilities are immense, and the youth need to be sensitized on the opportunities that agriculture presents. Such a strategy could sig- nificantly expand the country’s GDP, meaning that debt levels will become sustainable even at existing dollar amounts.

 

Stem dollar addiction

Kenya’s public debt is presently almost evenly split between local currency and the dollar. But with a new Eurobond in the offing, dollar denominated debt could increase. The cost of servicing a uS dol- lar-denominated Eurobond may look cheaper than that of a debt issue in local markets, but if the national currency declines the cost of foreign borrowing rises.

For instance, if the exchange rate is Sh90 for every dollar, a $100 debt will cost Sh9000. But if the shilling weakens or the dollar strengthens and the exchange rate is Sh100 for every dollar, the same $100 debt would cost Sh10000. Currency risk is often underestimated. Deflation of local currency or a strengthening dollar are significant risks for a country addicted to dollar-denomi- nated debt.

 

Deposit rates

The chief reason why  the  coun- try constantly finds itself having to borrow in dollars is because local savings are still too low  to meet the investment needs. Saving as a percentage of GDP are expected to hit 16 per cent at the end of the year from 12 per cent earlier in the year, according to the IMF. This is largely a function of the increase in deposit rates at the wake of the new banking law which stipulates that deposit rates should be at least 70 per cent of the Central Bank of Kenya (CBK) benchmark lending rate.

In the absence of this law, which is a policy intervention,

Kenya’s savings culture is barely non-existent and the coun- try’s savings still fall short of its investment needs of around 25 per cent of GDP. This means that a critical component of the country’s financing strategy should be how to improve domestic savings in order to plug investment needs locally and as much as possible limit dollar-denom- inated debt.

 

Pound of flesh

Similarly, it is important that Kenya remembers that a creditor will always come for his proverbial pound of flesh. Debt may be argued to be good if it is directed towards development, but a more prudent approach is to mobilize resources locally and live within your means. Development that is driven by your own revenue is better than one driv- en by debt.

This may mean tightening the purse strings and cutting back on spending in recurrent expenditure. In this respect, Kenya plans to cut back spending in the fiscal year through june 2017 by a tenth, according to the Treasury. But cutbacks need to continue and be more aggressive in future, otherwise the pressure to meet development financing gaps will be loaded onto businesses and Kenyans who will have to pay higher taxes. alternatively, the government could borrow more.

The country should also devel- op its own internal mechanisms of analyzing whether or not it needs debt. relying on international lend- ers such as IMF for debt sustainabil

ity reviews is like asking a butcher whether meat is healthy for you.“The truth of the matter is that IMF’s debt sustainability frameworks only serve to mask the gravity of countries’ indebtedness,” notes economic writer jaindi Kisero.

David Cowan, Citi’s africa econ- omist, is critical of the widespread reliance on the World Bank and IMF to carry out debt sustainability reviews. “I’d prefer to see borrower countries do that themselves; it’s a basic duty of government to work out what they can borrow sustain- ably,” he observed.

admittedly, concerns about the IMF and World Bank’s  objectivi- ty abound. In recent times, their pronouncements indicate that they are more worried about the Chinese disrupting their monopoly in the international credit market than they are about the economies of the countries they lend money to. This has been particularly evident in their biting critiques of Chinese loans in Kenya—China now owns more than half of Kenya’s debt.

For Kenya, the concern should not be about who among IMF, China or World Bank is the best partner. Its concern should not even be about the many private investors who have replaced official lenders as the default investors in african credit. rather, the country should focus on ensuring that it structures its econ- omy in such a way that it gradually reduces debt dependency and trans- lates economic growth into tangible benefits for the people –jobs, decent housing, affordable healthcare and good education. The economy is ide- ally supposed to be at the service of the people, not the creditors.