The Public Debt Logjam by Churchill Ogutu, Head of Research

As featured in Business Daily June 18, 2020

Last Thursday, National Treasury CS Ukur Yatani presented the next fiscal year budget starting in two weeks’ time. The CS announced net financing will be KES 840.6Bn, representing 7.5% of the projected nominal GDP of KES 11.3Tn.

In actual sense, total borrowing will clock KES 1.282Tn, factoring in the redemptions in the review financial year of KES 441.6Bn. If I may drift off slightly, the omission of redemptions as an expenditure item split treatment of overall budget estimates into two camps; KES 2.8Tn and KES 3.2Tn. Just to put it out there, I was in the latter group. If at a personal level, one includes the mortgage repayments in his or her monthly expenses, why is this expenditure being knocked off in the national account? Perhaps, a Sisyphean attempt to put a lid on overall budget below KES 3Tn.

Going back to the heart of this piece, the projected borrowing level in the next fiscal year is at par with the current fiscal year’s level. In the current fiscal year, external borrowing breakdown has tilted more towards program loans as opposed to the initial bias towards commercial loans. Furthermore, the domestic financing segment, over and above domestic borrowing target of KES 337.8Bn, is salient with other financing means to the tune of KES 152.1Bn. This includes KES 97.4Bn unutilized proceeds from the May 2019 Eurobond and KES 50.0Bn in government deposits.

Notably, the 2020 Medium Term Debt Management Strategy (MTDS) had recommended a net financing split of 60:40 between external and domestic sources, respectively, in the next three fiscal years. The net financing split tabled by CS Yatani indicated net external financing at KES 347.0Bn and net domestic financing at KES 493.6Bn, representing a 41:59 split, respectively. This high preference of domestic financing will negatively crowd out the private sector.

In addition, the 2020 MTDS recommends the reduction of the stock of T-Bills coupled by the reduced frequency of T-Bills issuance. Two weeks ago, the capital markets witnessed the switch auction of a maturing 364-day T-Bill into a six-year infrastructure bond and this, in my view, was the guinea pig in the context of 2020 MTDS recommendation. This is augmented by the fact that Treasury draft budget documents indicated that net domestic borrowing will fully issue from T-bonds. Furthermore, although 2020 MTDS recommends lengthening of the debt maturity profile, the COVID-19 uncertainty signals that investors prefer front-end-of-the-curve instruments.

My back of the envelope calculation shows that public debt is likely to clock KES 6.65Tn at the end of this month and hit KES 7.5Tn by end June 2021. At this rate, we are likely to hit the KES 9Tn limit by the end of June 2023, a year earlier than my initial estimates. This will have an effect of ballooning the public debt obligations which at KES 768.8Bn in the current fiscal year is expected to grow to KES 904.7Bn in the next fiscal year.

This, obviously results in debt sustainability issues. The latest joint IMF-World Bank debt sustainability report revised the risk of debt distress from moderate to high. Moody’s also recently changed the rating outlook from negative to stable, a window-dressing of a possible rating downgrade within the next two years. Although both are pro-cyclical events due to COVID-19, this laser-focus on debt risks ought to be given importance.

The current Treasury regime has consistently fronted cheaper concessional loans over the expensive commercial loans that includes Eurobonds and syndicated loans. Treasury’s rule of thumb on concessional loans is a loan with fixed interest rate of 1.75% and a grace period of 10 years. In the next fiscal year, concessional loans is projected at KES 152Bn while commercial loan component at KES 6.2Bn. Although the World Bank and IMF facilities did most of the heavy lifting in the current fiscal year’s concessional loan quantum, I doubt the sustainability in tapping the two Bretton Woods institutions year-in year-out. That means, most of the concessional loans will be funded by the official bilateral creditors although the COVID-19 fallout is not conducive.

That said, the trend to sustainable debt starts with viability of projects being funded. Market observers have flagged that borrowing proceeds have been applied towards recurrent expenditure. In approving the 2020 Budget Policy Statement, National Assembly recommended the list of the beneficiary projects to be funded from borrowing in the next fiscal year. To the best of my knowledge, the said list has not been publicized nor published. This also ties in with the proposed Green Sovereign Bond to be issued within the fiscal year and would be a great deal to have visibility of the green beneficiary projects.

Overall, the Public Debt Management Office (PDMO) has a full in-tray as it realigns its functions to the Public Debt Borrowing Policy as from the coming fiscal year. One of the key items that caught my eye is that PDMO will report all loans made to the national government, national government entities and county governments every four months. This will be a good starting point in addressing transparency of external loans’ borrowing terms.

Churchill Ogutu is the Head of Research at Genghis Capital
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