Kenya’s doublespeak: Words to hoodwink the market, actions to please the IMF

National Treasury & Planning Cabinet Secretary Henry Rotich [The Standard]

Kenya’s decision to let go of the International Monetary Fund’s $989 million (Sh100 billion) Stand-By Arrangement (SBA) puts the country in an awkward position. 

The market was treated to two conflicting signals that are likely to shape debate in coming weeks.

While the Treasury officials have been bullish in their words over the lapse of the IMF facility,  their actions were reserved and gave a strong indication of a new arrangement with the bank of last resort.

Although the expiry of the SBA is not a catastrophic divorce, it could be described as an unsettling separation. 

And the Treasury mandarins’ body language before and after the September 14 deadline pointed to a wary State desperate for a return to stability.

While the Treasury and Central Bank of Kenya (CBK) sought to calm the nerves of investors, reminding all and sundry that the country’s macroeconomic indicators were in the best of shape, President Uhuru Kenyatta, hours later, returned to the National Assembly an IMF-backed proposal to introduce Value Added Tax (VAT) on petroleum products.  

The prescription

The President proposed an eight per cent VAT on kerosene, petrol, diesel, aviation fuel and gas cylinders, as well as “wide-ranging cuts in spending (and) austerity measures across all arms of government.”

Both measures had the traits of an IMF prescription. 

This was contrary to the bullish sentiment of Treasury Cabinet Secretary Henry Rotich who played down the impact of the IMF’s lapsed facility as a routine financial process that has little bearing on the country’s economy.

Treasury maintains that the country has a strong external position-- the current account deficit has narrowed, export earnings have gone up, the country has enough reserves and the Shilling has had its best run, trading at 100 for a record six months.

“We have had dozens of programmes with the IMF. This has been a two-year programme that has been successful in instituting policy reforms. We will be engaging them with a view to getting a new arrangement,” explained Rotich.

But the tough measures unveiled by President Uhuru hours later provided the true picture what the lapse of the IMF facility meant to the country’s economy.

“I have heard and understood your concerns (on 16 per cent VAT), which is why I have proposed, as part of my memorandum, to cut VAT on petroleum products by 50 per cent – from 16 per cent to eight per cent,” explained the President.

He noted that the country still faced a financing gap, making it difficult to balance the Budget as required by law.

His proposed cuts target “less essential spending, such as hospitality, foreign and domestic travel, training and seminars, and similar categories”.

These measures formed a big part of what IMF had proposed as a corrective dose for a struggling economy.

Meanwhile, Treasury officials came out to say Kenya was not divorcing the Bretton Woods institution. Never mind that the IMF has been a nagging partner in the many years it has had relations with Kenya, including the infamous 1990s Structural Adjustment Programmes (SAPs) that were blamed for the loss of hundreds of thousands of jobs.

“We can still engage and get back into it (Stand-By Arrangement) if we think it is necessary,” said Mr Rotich.

National Treasury Principal Secretary Kamau Thugge was more forthright: “We are not leaving the IMF.”

Dr Thugge was responding to our query about a clause in the Eurobond Prospectus which listed Kenya’s exit of the IMF as one of the events of a default.

When Kenya defaults, the bondholders in the three Eurobond Notes the country has since issued can immediately recall all their principals and interests running into $5 billion – not in Kenyan shillings of 500 billion, but dollars!

CBK does not print dollars – at least, not to dole out to creditors.

The reserve of foreign currencies which Kenya has, valued at $8.8 billion, is largely for the importation of petroleum products, drugs, wheat, rice, industrial sugar, iron and steel, fertilisers and industrial machinery – critical products that help roll the wheels of the economy.

Such payment, if done, could put the shilling under extreme pressure as the demand for dollars exceeds their supply. This would weaken the shilling, triggering a financial crisis.

Should Kenya leave the IMF or not be eligible for the fund’s general resources then “Noteholders who hold at least 25 per cent in aggregate principal amount of the Notes then outstanding may declare the Notes to be immediately due and payable at their principal amount together with accrued interest,” reads part of the Prospectus for both Eurobond I and Eurobond II. 

The Government has also insisted that despite the loss of the second layer of defence against an exogenous attack, it still has enough reserves to stabilise the country’s external shocks.

But they know that the extra buffer is critical in attracting some of the financial inflows.

CBK Governor Patrick Njoroge often cites IMF’s precautionary facility as an additional buffer.

With the facility expiring, “Now, it is like driving a car without an insurance cover,” says Johnson Nderi, the manager in charge of corporate advisory services at ABC Capital.

And without such a cover, Kenya will meet a jittery investor when the time comes for the repayment of its first Eurobond principal next year. 

The just-concluded facility came into play after Kenya issued its first Eurobond in 2014.

It was an ‘insurance’ financing package designed to protect the local market against “a sudden shift in global investors’ risk sentiment”, the IMF noted in a statement in 2015. 

Unless the country miraculously increases its export earnings and diaspora remittances come into the country thick and fast, it is unlikely that the country will have enough dollars to pay off the debt.

Most likely, the Government will opt to go back to the Eurobond market to take another loan to pay the maturing Eurobond debt, what is known as refinancing.

Rotich has already indicated that Kenya will not shun the commercial debt market – once you are into the Eurobond, you are trapped; some have called it ‘Eurobondage’.

“We are there to stay but we will access when we need to. You do not go to the market and disappear. We might not go there to necessarily raise money but for refinancing and other matters since investors are holding our debt,” Rotich said during the launch of the 2019 Budget-making process.

But unlike in 2014 when US interest rates were flat at 0.25, Kenya had promising oil prospects and was in IMF’s good books, things are different in 2018.

The Eurobond II transactional advisors warned the bondholders:  “In the event of non-renewal of the facility, Kenya may have reduced buffers in the event of any significant exogenous shocks and significant adverse movements in the balance of payments position.

“In addition, statements made by the IMF may contain adverse information that could negatively impact the price of the notes.”

Better position

This explains why IMF had to come out assure the market that Kenya was in a better position despite the lapse of the facility.“The second review of the IMF-supported programme has not been completed, and the programme will expire today (September 14). It should be stressed that Kenya’s external position remains strong and foreign exchange reserves are at very comfortable level,” said IMF’s Nairobi representative Jan Mikkelsen.

That is why a separation, as the one that Kenya finds itself in, if not well managed, can be crippling.

“The IMF team will remain in close contact with the Kenyan authorities in the near term,” said Mr Mikkelsen.

Although Kenyan authorities have not requested for a new programme, as confirmed by Mikkelsen, a reunion is very much in the cards. 

The conditions for a reunion will not be any different from the very conditions that led to a fall-out.  Kenya will be required to work extra hard to raise more revenue and prudently manage its finances by cutting back on extravagant spending.

The country will also be expected to remove interest rate controls in what the IMF believes will enable micro, small and medium-sized enterprises (MSMEs) to access credit and grow the economy.

For most investors, an arrangement with the IMF acts as a critical check, an assurance that they will get their money back.

“There exists significant refinancing risks in the fiscal year, especially the maturity of the $750 million Eurobond I next June coupled with a $766 million syndicated loan in March,” Churchill Ogutu, a research analyst at Genghis Capita, said.

Now the US rates are at 2 per cent which means Eurobonds are expensive for premium borrowers like Kenya.

Further, Kenya’s oil prospects have drifted away into the unforeseeable future, especially with the Early Oil Project trucking to a halt after locals raised dust.

But all these might change should Kenya get a new arrangement with the IMF. That is why, despite having failed to keep much of their part of their bargain, the President is still keen to do live by IMF’s guidebooks.

Perhaps this explains why the Government appeared to defy a court order suspending the VAT on fuel by offering the lame excuse of not receiving the order in an attempt to maintain good books with the IMF.Plans are also in top gear to win over growing opposition to the bill by MPs ahead of its passing into law on Thursday this week.

The decision to maintain VAT on petroleum products, albeit at a reduced rate, the austerity measures he proposed, as well as the current fight against corruption and wastage will go towards achieving the IMF-proposed fiscal deficit – which occurs when expenditure exceeds revenue – of 5.7 per cent of gross domestic product (GDP). 

Not that the Government defiantly bolted out of the arrangement with the IMF. Time and MPs were not on its side. The Government had requested a six-month extension from March 14 when both the Standby Credit Facility (SCF) and SBA were expected to end.

During this period, the State promised to get rid of a number of tax exemptions, suspend spending on low-priority projects, abolish or modify interest rates, improve tax administration to mobilise additional revenues, widen the tax net by roping in the informal sector, ensure transparency and accountability in their expenditure.

Some of these measures are being implemented in the current financial year, while others, such as the removal of interest rate caps, have been thwarted by MPs.

The end of SBA shook the market. The 10 year Eurobond is now at 8.44 per cent while the 30-year bond is at 9.1 per cent which is an indication of the prices we are likely to get when refinancing the bonds.

“We expect the reaction on the Eurobond to be negative, as external investors attach a premium to IMF facilities as they are treated as an insurance loan however precautionary they are. The ball is now in Treasury’s court to see what the facility will be replaced with, and that would provide pivotal to investors,” Mr Ogutu said.

This is happening in an environment where African countries are openly defaulting on their Eurobonds.  About 40 per cent of sub-Saharan countries are now at high risk of debt distress, with Chad, South Sudan, the Republic of Congo and Mozambique moving into ‘debt distress’ in 2017.

In the current arrangement with the IMF, we can only ask for its help in times of distress. In these times, the lender comes in as a mortician, and the surgical procedures it prescribes, as recent experiences in Zambia and Argentina have shown, can be painful.

Investors, according to a source, did not expect Kenya to get the facility but they have now put the country under the microscope to see what the Treasury will do next.