National Debt: Is Kenya about to go bust?

By MOHAMED WEHLIYE

At times economic numbers look scary and sound positively terminal when not probably understood. Trillion-shilling debt here. Hundred-billion shilling deficit there. Big, scary, numbers everywhere.

They get even scarier when some respected economists dishonestly use them and put a spin to give an impression that Kenya is in a "very" precarious position; perhaps on the verge of bankruptcy. It borders on intellectual dishonesty and is unfair to the public when, for example, people who should know better about the economy claim that Kenya rescheduled a $600-million bank loan for another three months because it was "broke". This is despite the fact that the country has more than 10 times that amount in reserves that it could use to pay off the stated loan if it wanted to.

Were some of the proceeds of the proposed Eurobond not supposed to retire these bank loans? So how does a timing issue and a "simple" debt management strategy make one conclude that the country is broke? There have been a lot of negative remarks on the state of our national debt. Is the debt about to kill us as recent newspaper headlines and comments from some economists insinuated? What is our national debt situation like? Do the facts and figures support the views of those claiming we are choking with it? Let us examine the same.

Whilst national debt is one of the most widely discussed issues, it is also often a misunderstood area. Many people talk about national debt. Ironically, only a few care to explain it. Simply put, national debt is the money owed by a country to domestic and foreign lenders. It results from expenditures that exceed revenues. Contrary to what many people believe to be a conventional wisdom, debt is actually a beneficial and recommended pursuit, if used correctly, since it enables a nation to equalise income and expenditures over time, and improve living standards. Show me a rich country and I will show you its debt level.

So, what is the acceptable level of national debt?

As at March this year, Kenya's national debt was Sh2.172 trillion of which Sh1.231 trillion, about 56.6 per cent, was domestic debt. Domestic debt is owed to commercial banks, pension funds, insurance firms, parastatals and other investors. On the other hand, the foreign debt is owed to foreign multilateral, bilateral, banks and other supplier credit sources. So, what does this Sh2.1 trillion number represent then? Is it an inconceivable sum, far beyond anything that we could possibly handle?

This is definitely a lot of money but this headline number in itself isn't important until we place it in the proper context. National debt must not only be benchmarked to the size of a nation’s economy or income but one would also need to look at a number of other factors such as its structure and cost of servicing it in order to determine whether it has reached a "harmful" level or not.

First, national debt is usually looked at in terms of its percentage relative to the gross domestic product (GDP) of a country. There does not exist a threshold above which it will be considered big. But the conventional wisdom is that the higher the national debt relative to GDP, the worse, and vice versa. Some economists have gone a step ahead, and through empirical studies, identified a “tipping point” for national debt – the point at which national debt levels begin to have an adverse effect on economic growth. Based on an analysis of the debt of 100 countries over 30 years, they found out that once a country’s public debt exceeded 77 per cent of its GDP, the amount of debt will have a linear relationship to declines in economic growth. In other words, the more debt you have above that point, the slower your GDP will grow.

They found out that if a country’s GDP is growing at a rate of three per cent per year, and it increases its debt to GDP ratio from 80 per cent to 90 per cent, its economic growth will shrink the following year to 2.8 per cent. That tipping point could be higher or lower for any specific nation, based on the nation’s wealth and countries with emerging economies and lower per-capita incomes were found to have a lower tipping point of around 64 per cent. Kenya’s combined total debt was 52.2 per cent of GDP as at this March.

It is worth considering that other countries, although wealthier than Kenya, have a much bigger ratio. To put this into perspective, Japan has a national debt of 227 per cent, Brazil 57 per cent, India 68 per cent, UK 91 per cent, Italy over 140 per cent and the US close to 101 per cent of GDP. In effect, some of these countries owe more than what they make in a year. However, these are not countries that you would consider "broke" or about to go bust. The high debt levels relative to the size of economies does not mean that the economies are on the road to ruin. In fact, most investors regard some of these countries, for instance Brazil and India, as having robust economies with promising prospects.

Those claiming that Kenya is almost broke today because of its debt levels ought to look at the history of the country's debt. If Kenya is almost bust today, then it has almost always been bust. Kenya's debt relative to the size of the economy is not high by historical standards. In 2003 when the Kibaki administration came into office, the country’s debt stood at about 65 per cent of GDP. It was also more than 300 per cent of annual revenue.

Today, Kenya’s total debt size is higher than it was a decade ago, but its debt ratio is much lower because total GDP is much larger. According to the National Treasury’s own projections, Kenya’s Debt to GDP ratio is expected to decline in the medium term to around 48 per cent by the 2016/17 financial year. This is even before the taking into account the rebasing of the country’s GDP, which will be done this September, to factor in the significance of new sectors of the economy.

It is sad to note that some economists still use the argument that Kenya’s Debt to GDP ratio is well above that of the Sub-Saharan Africa, around 35 per cent, when discussing Kenya’s national debt. This is despite them knowing well that many of the SSA countries benefited from debt relief in the last decade under the Highly Indebted Poor Countries (HIPC) initiative. Kenya did not benefit from this relief partly because its debts have been "manageable" and the country has long been considered better off than many of its neighbours. Kenya’s higher than average ratio is therefore very much a victim of its good management of debt. Others, including Tanzania and Uganda, were rewarded simply because they didn’t manage theirs well.

DEBT STRUCTURE

Countries usually aim to have a higher percentage of their national debt as domestic debt. As at March 2014, almost 57 per cent of the national debt was held by local commercial banks, insurance companies, parastatals building societies and other domestic investors. The remaining was foreign debt. The lower the external debt compared to the internal debt, the better. Partly, this is because when the debt and its interest are repaid to domestic creditors, part or all of it stands a bigger chance to be invested domestically and generate more economic activities. Servicing the debt, therefore, just redistributes income from Kenyan taxpayers to mostly Kenyan bondholders. It is not necessarily money leaving the country.

The domestic debt is also no longer dominated by short-term and excessive inflationary-biased method of deficit financing as it was during the Moi era. It has now more long-term debt component than it used to do. Treasury has in the last decade sought ways to lengthen the average maturity of its domestic debt from 12 months to almost five years. By going long-term, the government has lowered the refinancing risk, meaning there is less pressure to refinance the debt at any one time.

Kenya’s foreign debt, before the recent Chinese deals, on the other hand, is mainly concessional and long-term, with an average maturity of 32.6 years and an average interest and grace period of 1.1 per cent and 7.5 years respectively as at the end of March this year. The country's external financing sources are also well diversified and it does not have big exposures to any individual creditor country. The World Bank and the African Development Fund are the two biggest creditors with the rest of the foreign debt almost equally distributed across geographically diverse economies.

DEBT SUSTAINABILITY

Whereas the raw amount of debt accumulated is what captures people's attention, the real risk from government debt is the burden of interest payments. We can remain perpetually indebted so long as the interest payments we make don't go out of control. Whereas we have loaded big sums of debt in the last few years, interest rates during this period have been about as low as they have ever been. We borrowed many times what we used to borrow a decade ago at a fraction of the cost we used to borrow at and the weighted average interest rate on Kenya’s national debt as at March stood at 4.7 per cent. The debt's current cost to taxpayers is therefore about as low as it has been in decades.

The yearly interest expense on our national debt relative to GDP is a key indicator of debt sustainability. The National Treasury is expected to spend about Sh154 billion at the end of this financial year to service the national debt. That equates to a debt servicing as percentage of GDP ratio of around 3.7 per cent. Not a high ratio by any standards. Experts believe that when interest payments reach about 12 per cent of GDP, then a government will likely default on its debt.

Another way to look at sustainability of debt is to compare annual servicing cost to development expenditure. The amount we will use to service the debt in this financial year (Sh154 billion) is far lower than the amount the country has earmarked as development expenditure (Sh448b) during the same period. This means debt servicing has not yet reached a point where it has limited the country’s capacity to fund its development and other emerging priorities or required us to seek heavy donor involvement.

The Joint World Bank-IMF Debt Sustainability Analysis (DSA) for 2013 has also given Kenya’s public debt thumbs up. DSA assesses how a country’s current level of debt and prospective new borrowing affects its ability to service its debt in the future. According to these two institutions, debt sustainability can be obtained by a country “by bringing the net present value (NPV) of its public debt down to within a certain threshold of its GDP and revenues”. Kenya’s NPV of Debt as a percentage of GDP in 2014 was assessed to be at 39 per cent against World Bank or IMF thresholds of 74 per cent. Against revenues, the ratio was at 151 per cent against a 300 per cent threshold.

Further, stress testing indicates that Kenya’s NPV of debt/GDP ratio would still be within World Bank or IMF debt sustainability thresholds in the medium term even if it increased its borrowings now by another 10 per cent of its GDP. This means that the planned Eurobond issuance and the uptake of the recently contracted Standard Gauge Railway loan will not breach Kenya’s debt sustainability thresholds or modify the favourable conclusions of the last World Bank or IMF debt sustainability analysis on Kenya’s external and public debt position in the medium term.

Kenya’s debt has thus far been well managed and the country has in the last decade implemented wise fiscal policies and sound budget management. But managing the debt will now become tougher than before. The government will need to maintain fiscal prudence while continuing to invest in infrastructure and fund devolution. It will also have to ensure that foreign exchange risk is well managed given that it will now have a foreign currency denominated bond (Eurobond) in its books.

This, perhaps, poses the greatest risk to debt sustainability in the foreseeable future. But a sustained focus on making the cake bigger through economic growth is what will guarantee that Kenya’s debt levels continue to remain sustainable. As it stands now though, all the relevant indicators and other parameters of our national debt show that we are nowhere near being broke. We should not over-politicise the economy.

The fact that we still hold a good credit rating and lenders continue to lend money to us is an indication that they not only don’t believe the government is broke right now, but also don’t see bankruptcy anywhere on the horizon.