On a trip to Beijing, President Kenyatta commits to more Chinese financing, just as the finance ministry rolls out plans to restructure existing debt by issuing another Eurobond this year. Given the slowing Kenyan economy, internal political divisions, and tarnished local banking sector, concerns are mounting over the country’s debt sustainability.
On 26 April, the office of President Uhurru Kenyatta, who was attending the second Belt and Road Forum in Beijing, China, announced that the government had secured USD 666 million in funding from China for new projects. The new funding consists of loans at low interest rates and partnerships with private firms to commission Chinese telecoms firm Huawei to build a new data centre in Konza tech city that is currently under construction near the capital Nairobi, as well as a new highway to link Nairobi airport to suburbs surrounding the capital, a project which is to be carried out by China Road and Bridge Corporation.
Kenya has turned to China over the past few years for funds, technology, and equipment to develop its infrastructure, including its biggest project since independence, a new railway linking Mombasa to Nairobi, opened in 2017. The new commitment to Chinese sources of financing and the country’s mounting debt burden have raised questions over the political motivations of the loans, as well as Kenya’s debt sustainability as servicing costs continue to increase.
The president’s announcements come a day after Kenya’s Finance Minister Henry Rotich said the country would issue a new USD 2.5 billion Eurobond to refinance its maturing five-year dollar bond that was issued in 2014 (Kenya also issued bonds in 2018). News of the upcoming sale sent Kenya’s existing bonds down as much as 1.2 cents, their worst day in more than a month and a half. The drop also made the existing bonds the worst performers in sub-Saharan Africa.
Rising debt, slowing economy
The new Chinese projects build into President Kenyatta’s ambitious policy framework based on his signature ‘Big Four Agenda’ that promotes food security, affordable housing, manufacturing, and affordable healthcare. Key objectives under the ‘Big Four’ include the building of 500,000 affordable houses, as well as ensuring food security, universal health coverage, and an increase in manufacturing’s contribution to GDP from 9 percent to 15 percent by 2022. Road construction and technology development are key to achieving these objectives.
However, the realisation of the ambitious Big Four agenda faces economic challenges. The economy will continue to struggle throughout much of 2019. According to the International Monetary Fund, Kenya’s GDP will grow by 5.8 percent, which is well below the average annual growth that the economy has achieved since Kenyatta’s Jubilee government took power in 2013. Highest growth will be derived from an expansion in agriculture and services. However, growth in these sectors will face risks from an unsteady global economy. Therefore, moderate growth projections do not leave the government much room to achieve its policy objectives.
Another one of the chief economic concerns is Kenya’s public debt, which stood at 56.5 percent of GDP in September 2018. Debt increased from 42 percent in 2013 when President Kenyatta came to power and has since increased due to heavy borrowing to finance infrastructure projects. Public debt servicing will consume about 47 percent of the revenue the government is expected to generate, the result of a need to pay rapidly maturing commercial debt and Chinese infrastructure loans that the government has contracted.
The central bank governor, Patrick Njoroge, believes Kenya has room to refinance its debt by extending the tenure of some of its loans. However, the IMF last year increased Kenya’s risk of defaulting on its debt repayments to moderate from low, citing the government’s public investment drive and revenue shortfalls in recent years. The ministry of finance is therefore discussing issuing the USD 2.5 billion Eurobond to help fund the 2018/19 budget deficit. The government is targeting a deficit of 5 percent of GDP for the 2019/20 fiscal year, yet this seems unrealistic given the government’s massive spending commitments
Impact on banking sector
Because Kenyatta will insist on higher spending for the Big Four, the Kenyan Treasury, contrary to its own convictions, will be forced to borrow on the domestic market, thereby crowding out private borrowers. This will lead to an increasing scarcity of credit for the private sector that was already being felt in 2018. Bad debts among Kenyan banks rose to 12.4 percent of total credit in 2018, the highest level in more than a decade. Njoroge believes that Kenyan banks have shown resilience, helped by the central bank’s efforts to deal with non-performing loans. While credit risk for banks is easing, reckless lending remains a key concern.
Many analysts believe that Kenya would get better interest rates if it secured a standby credit arrangement with the IMF, replacing another one facility that expired last year, before it goes to the market. Finance Minister Rotich has rejected such assessment. Because the Jubilee government has failed to abolish the cap on interest rates that President Kenyatta signed into law in 2016, the IMF will continue to withhold standby credit to Kenya. Meanwhile, the shilling local currency is expected to continue a slide against major currencies that began at the end of 2018.
Even if there are no excessive market shocks, little urgency is expected from the Kenyan government in repealing or adjusting the cap, or in pursuing an alternate IMF programme. This is particularly the case given the highlighted volume of reserves and the buffer they present. That said, a continuity of decline in the Nairobi Securities Exchange and an excessive contraction in private credit could prompt an adjustment of the government’s position on the cap. However, this is likely to be a widening of the ceiling rather than a complete repeal of the restrictive measure. Similarly, a sufficiently large depreciation of the KES or a negative growth shock – due to endogenous and exogenous factors – could see some movement on the cap, but this may be discrete and tapered against political and public sentiment.
Since shaking hands with defeated opposition leader Raila Odinga and agreeing on reconciliation based on the ‘Building Bridges Initiative’ agreed between him and Odinga over a year ago, Kenyatta has insisted that the time for party politics is over and that all political leaders should concentrate on economic development. While Odinga is expected to pay lip service to the Building Bridges dream and the hope of an economic miracle based on the Big Four in the remaining years of the Kenyatta presidency, his main objective will be to secure a referendum to move Kenya from a presidential to a parliamentary constitution. This has led to speculation that Odinga will seek Kenyatta’s endorsement in 2022.
The realisation of such an arrangement undoubtedly comes at the expense of Deputy President William Ruto. From the outset, the Kenyatta-Ruto alliance was built on shaky grounds, with political pragmatism being the clearest binding feature. This came through the understanding that unity between Kenyatta’s largest Kikuyu ethnic group and Ruto’s significant Kalenjin group could guarantee the presidency in 2013 and 2017, which it did. With Kenyatta precluded from running in 2022, he has less of a need to preserve relations with Ruto. Moreover, Ruto may be seen to pose a reputational risk – and be considered an unfitting successor – with his embroilment in myriad corruption scandals.
Economically, the impact of the Kenyatta-Odinga pivot and the potential marginalisation of Ruto is likely to be felt most notably in the policy environment. Ruto may stoke public grievances regarding fiscal consolidation requirements and particularly the repeal of the interest rate cap that has become a contentious political football. Not only will this make it difficult for the Kenyatta administration to re-engage the IMF on the uptake of a formal programme, but it may in fact push the government towards further fiscal expansion and even more debt accumulation. There is also the concern that any division within the ruling Jubilee alliance could result in policy inertia.
While President Kenyatta seeks to consolidate his legacy in his second and final term, his policy agenda is being frustrated by new political, economic, and security challenges. Kenyatta’s governing ethnic coalition will quickly fall apart as the race to succeed some of Kenya’s most dominant political leaders intensifies, which will reshape the country’s political landscape and alliances. Kenya’s rising debt burden and budget deficit, as well as mounting concerns over the strength of the local banking sector are likely to frustrate some of the government’s plans to maintain the momentum of massive infrastructure development.
Under populist influence, political pressure will rise for the government to intervene in strategic sectors, such as telecoms and banking. Eventual oil production will be key to meeting the government’s revenue collection targets and to sustain economic growth expectations. However, the ongoing threat of unrest and Islamist terrorism is likely to temper the tourism sector.
Despite a modest forecasted economic growth, continuity of the interest rate cap due to political pressures will weigh on the scale of private sector lending, investment, and potential growth. Meanwhile, wariness among investors regarding the cap and an October assessment by the IMF that Kenya’s debt is reaching unsustainable levels will continue to pose downside risks to each of the country’s 2019, 2024, 2028 and 2048 Eurobonds.
Kenya’s decision last year to no longer pursue an IMF programme, in the context of uncertain external circumstances and local drivers of risk, such as tourism earnings vulnerable to a volatile security environment, is highly questionable. Should a shock occur without firm IMF endorsement, Kenya will be left exposed to any ensuing market onslaught whose effects could be compounded, especially given the country’s short and long-term debt position.
Nevertheless, Kenya has a relatively strong external position. Foreign reserves stand at approximately 5.7 months of import cover, which provides the country with a reasonably robust buffer against exogenous shocks. The country is also in no imminent balance of payments crisis, hence the lax attitude to the IMF’s conditionalities.