One of the emerging trends in Kenya is that if you support the government position, you are declared either a sycophant or unsophisticated. In the raging debate on borrowing, which we are revisiting, we shall try to be objective, rise above politics and emotions.
We admit it is hard to be objective in such an emotional debate, with some Kenyans calling for President Uhuru Kenyatta to declare national debt a disaster. We can use some data and hopefully put our case forward. We are neither supporting NASA nor Jubilee but common sense.
First, there is a general belief in Kenya that debt is bad and should be avoided by all means. Among the financially sophisticated, debt is normal and part of the lexicon of finance. In fact, without debt, the whole field of finance would collapse, just as mathematics would collapse without zero. In mathematical sciences, zero is not nothing.
Debt is used for a number of reasons. One, you can get money now instead of waiting for years to save. That way, you can enjoy higher living standards. We assume you put the borrowed money into good use. Think of mortgage versus renting. Some workers with low earnings have done great things because of their ability to manage debts, mostly Sacco loans. If you inherited nothing from your parents, and dream big, prudently managed debt can take you far.
It gets even better: debt can be used for leveraging. You use very little money to acquire bigger assets or profits in future. The same way you can use a lever and little effort to move a big load. When you borrow money to invest and get enough returns to pay your debt and continue enjoying your returns, you have leveraged. After all, you get money in lump sum but pay it in small bits.
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Leverage
In extreme leverage, you can borrow money to buy assets or businesses that you believe are undervalued. Once they are in your possession you can sell the business, repay the debt and keep profits. That does not exclude speculation and its risks. One of the most fascinating areas in finance is hedge funds, which use debt or borrowed capital to make huge returns.
If you do not want debt you can use your savings and wait a long time to buy an asset or invest.
In the corporate sector, a firm can borrow by floating bonds or borrowing outright from banks. The alternative is to get money from shareholders by floating shares or through a rights issue in case of an already floated firm.
Franco Modigliani and Merton Miller showed that it does not matter if a firm funds its operations through debt or equity. Modigliani won an economics Nobel Prize in 1985, Miller won his in 1990. Their insight had far-reaching consequences in the field of finance, including raising the status of debt.
The government does not enjoy the flexibility enjoyed by individuals and privates firms in mixing debt and equity. Which leads us to the question: Has Kenya over-borrowed?
If we follow Modigliani and Miller, we should not worry about debt, it does not matter how government finances its projects. It does not matter if it is from taxes or borrowing. The Nobel laureates argued that the capital structure (debt-equity mix) does not affect the share price of a firm. Are we correct in declaring tax as equity equivalent?
We could agree with the laureates if all the debt was put into the right use. We suspect that deep in their hearts, most Kenyans know debt is inevitable, and governments must borrow. After all, when did we last record a budget surplus?
The fear of piling debt arises from a number of sources. One is that the borrower may not be the one to pay, unlike in the private sector. The political regime that borrows might leave others to pay, often decades later.
Think of a 30-year bond maturing in the year 2048. If a child is 10 years old, she or he will be 40 years, already paying for coupons of a bond floated when he or she was a minor. There is nothing wrong with that if as an adult they enjoy better roads, schools, health care and their own children have better job and life prospects than their parents.
The second fear is economic. Debts might discourage investors who might doubt the government’s ability to pay back. Remember the case of Greece? That could raise the interest rates demanded by creditors, making it even harder to pay debts in future. If I lend you money at 10 per cent interest and you fail to pay back on time, I could be tempted to charge you 15 per cent in future. Or your friends might realise you are not trustworthy and charge you more. Soon there might be no-one to borrow money from.
Three is that the creditors might have too much control of our economy. That is not far-fetched. It is believed that one reason USA respects China is that she has lent USA lots of money through treasury bonds. Data confirms that.
Four is that by borrowing too much, the government denies private sector much-needed funds, the so-called crowding out. Yet evidence suggests that the private sector is more efficient in investing funds than governments which have other objectives including retaining political power. That is why floating sovereign bonds like Eurobond makes a lot of economic sense if the money is put into good use. Truth be told, our debts would be higher if county governments had a free hand in borrowing.
There is, however, a bright side to borrowing. If that money is put into good use, we all can enjoy higher living standards sooner. We can build roads, airports, improve our hospitals, schools, sports and many other things. All these projects would increase the productive capacity of the economy, leading to faster economic growth and more jobs. Remember the ‘public goods’ which include research? No matter how hard you work, you shall need some government services.
Most Kenyans worry that some of the borrowed funds are used to finance recurrent expenditure such as paying salaries or wages and servicing debt whose interest must be paid. This leaves little money for other national priorities. Some countries have tried to come up with a debt ceiling, the maximum a government can borrow. Reality keeps them revising upwards. Should we try that?
If our leaders thought inter-generational, seeing the consequences of their decisions long after they are gone, we could worry less about debts.
The spiraling debt is driven by another factor that few want to say loudly. Governments hate raising taxes because of political backlash. They prefer to transfer the problem of financing deficits to someone else. It was even whispered that high government borrowing by Jubilee was done deliberately to make the government unpalatable to contestants. NASA would have inherited all the current debt, a poisoned chalice? The truth may never be known.
- The writer teaches at the University of Nairobi.
