Kenya: Increasing reliance on domestic debt may not be enough

In the first budget after Ruto assumed office last September, his administration has proposed to cut external borrowing by a whopping 29.3% to KSh198.6bn ($1,580bn), which is equivalent to 1.2% of Kenya’s Gross Domestic Product (GDP). The remaining KSh496.6bn will be offset by domestic funding, which was slashed by 14.6%. 

The National Treasury’s decision would decrease exposure to foreign capital markets, where borrowing costs are high amid global conflict and ensuing monetary tightening in the US and Europe.

“The inflation rates have led to high-interest rates and this has hindered the government in performing liability management operation on its debt portfolio,” says the treasury in its draft Budget Policy Statement (BPS) 2023.

CBK forced twice 

The overall drop in borrowing projections always sends a signal that interest rates might slump due to possible supply-demand effects, but can Kenya’s domestic market comfortably fill such a financing gap?

Banks and pensions firms, which dominate the government paper, have equally been hiking interest rates, putting pressure on the Central Bank of Kenya (CBK) to ramp up yields, a move that will impact the treasury’s attempt to borrow cheaply.

In January 2023, the CBK was forced twice to accept bond auctions above the 14% mark. For instance, in the 15-year treasury bond performance released on January 11, the CBK accepted bids worth KSh7.2bn – at a rate of 14.19% –  against KSh14.1bn that were received in total.

Persistent rejection of high bids could dent the performance of bond issues in future, meaning Kenya could be forced to bow to investors’ demands – either locally or internationally –  even as it attempts to have interest rates as low as 10%.

Monetary easing on horizon

Kenya’s domestic borrowing has so far spiralled over the years to make up half of the public debt, buoyed by increased appetite for short-term government paper and the government applying brakes on costly foreign loans.

“I think it [domestic market] can support borrowing. We are seeing a prospect of domestic borrowing coming lower in the next financial year and that automatically sends a signal that probably interest rates might come down,” says Churchill Ogutu, an economist and analyst at investment firm IC group.

It is a lot of money the exchequer cannot afford given the situation.

As of October 2022, domestic debt accounted for 50.2% of the total debt portfolio up from 48.1% in October 2019. 

The reversing of this trend risks crowding out the private sector, which is mainly depending on investment banks, insurance, and pension firms to rejuvenate the hard-pressed economy.

However, with banks’ assets also growing, there will still be a split between public and private sector lending, says Ogutu.

On the flip side, limiting foreign borrowing is likely to help Kenya alleviate hard currency pressure, further slowing down shilling depreciation and protect forex reserves that have been declining now due to the repayment of dollar-denominated foreign debts.

Cognisant of the difficult external market conditions, the treasury has adopted concessional funding from multilateral lenders, such as the World Bank and the IMF, as its primary stance on external financing. 

Return to eurobond

Chances of Kenya tapping another eurobond abound, given the slight easing of interest rates and pressure to refinance maturing bonds. 

“They will have to refinance the $2bn eurobond maturing in June next year. They will have to jump into the market next year, but the conditions between now and then might have changed and global interests soften a bit,” says market analyst George Bodo.

“It is a lot of money the exchequer cannot afford given the situation. That’s the only realistic time I see them going to the market.”

In June 2022, the treasury under the previous administration cancelled plans to float a $1.1bn (KSh143bn) eurobond from international markets due to costly interest demands of about 12%, almost double the rate compared with what Kenya paid in 2021 for the same amount.

The US Federal Reserve recently dialled down the pace of interest rate hikes, which observers see as a sign of it adopting a less hawkish policy, but it is still not clear when the increases will cease.

Kenya has been adjusting its policies to match the Fed, which approved a fourth consecutive 0.75% interest rate hike last November to combat inflation.

Under the current 2022/23 FY ending June, the treasury is planning to raise some KSh111.2bn ($900m) through syndicated loans, comprising international banks to help plug the budget gap left after the inclusion of both domestic and concessional borrowing.

Ruto’s first 2023/24 budget starting next July is estimated at KSh3.641trn against projected tax revenue of KSh2.9trn, with the difference being sealed through debt.