Election risks raise premium on sovereign bond

The Treasury’s plan to borrow money through a sovereign bond in an election year will cost the taxpayer more in interest payments as the lenders will require higher premiums to take on the additional political risk, Dyer and Blair Investment Bank has said.

(Read: Companies rush for political risk cover ahead of elections)

Finance minister Njeru Githae said in April that the Treasury would issue a sovereign bond to partly retire a two-year Sh52 billion syndicated loan borrowed from a consortium of international banks.

In his Budget speech read in Parliament last Thursday, Mr Githae said the Sh250 billion deficit would be financed through foreign financing of Sh143.6 billion and domestic borrowing of Sh106.7 billion.

“To ensure a successful uptake of this bond in an election year and compensate for other country risks, the interest rate on this issue will have to be higher than market rates of other African sovereign bonds,” says a Budget Review report by Dyer and Blair.

The analysts expect that Sh42 billion of the Sh143.6 billion external financing will be borrowed in the form of a sovereign bond. “We expect part of this to be funded through the $500 million sovereign bond that is pencilled in for the financial year 2012/2013,” says the Dyer report. Funding of next year’s General Election, setting up new constitutional offices, and the war in Somalia have contributed to the 26 per cent increase in the Budget.

The total expenditure estimates have risen to Sh1.45 trillion. Analysts said that it is difficult to tell how much the debt would cost since African countries that have issued successful sovereign bonds such as Ghana have natural resources to back the debt.

Ghana’s 10-year $750 million sovereign bond was floated at 8.5 per cent coupon. Ivory Coast’s $2.8 billion sovereign bond was issued in 2010 at a ratio of $800 for every $1,000 tendered.

‘‘As Kenya does not yet have commercial quantities of natural resources, we think that the focus will probably be on the foreign reserves held compared to the extent of the debt at the time of maturity,” said Poonam Vora, a research analyst at Dyer and Blair Investment Bank.

The volatility of the shilling, which is sensitive to the political environment, will also make borrowing from the international market pricey.

In a recently released report, international investment bank Renaissance Capital said that the shilling’s vulnerability makes borrowing from abroad expensive.

“The foreign financing option may not be as attractive for the Kenyan government given the weak shilling, which we think would put upward pressure on Kenya’s foreign debt service costs,” said a pre-budget analysis by the firm. Economists, however, said that a slide in the shilling was a sacrifice that Kenya could afford to take.

Mr Mbui Wagacha, an independent macroeconomist, said that time was ripe to borrow since rates at international markets were low.

The recession in Europe and the US has seen central banks lower rates to historic lows, which has given developing countries an opportunity to borrow at affordable rates and Kenya should seize the chance.

Dr Wagacha said that in the long run Kenya could service the debt, only if the money goes to roads, energy, and other projects which will increase output. “Using funds productively such as building infrastructure will enable a higher GDP growth and repayment as incomes become better.”