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Ideas & Debate

Eurobond faces structural risks despite flying start

Kenya has just successfully tapped into the international debt markets. The country’s debut Eurobond secured bids worth $8.8 billion (Sh770 billion) a record level for Africa, and will accept $2 billion.

The bond was issued in two tranches; 2019 tranche which attracted bids worth $2.5 billion and the 2024 tranche which attracted bids worth $5.5 billion.

The Government will accept $500 million for the 2019 tranche at a cost of 5.875 per cent per annum and another $1.5 billion for the 2024 tranche at a cost of 6.875 per cent annually.

The low Eurobond valuations have beat market expectations especially given that pre-issue consensus largely predicted costs to hover in the region of eight per cent.

But most importantly, this is a measure of confidence in the country’s long term economic outlook. Already, the Government projects a nine per cent compounded annual growth rate in Gross Domestic Product (GDP) in the three year period between 2014 and 2017.

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It also cements the country’s position as the economic hub of the larger East, Central and Southern Africa region; in fact, the expected GDP rebasing will likely make Kenya the third largest economy in sub-Saharan Africa, behind Nigeria and South Africa.

But most importantly, it is a sign that investors are likely to continue looking at the country’s growing insecurity problems as more of short term risks and not likely to negatively impact long term fundamentals. And this is further evident in the stock market where foreign investor activities continue to remain strong.

For the period between January and May 2014, foreign investor participation levels rose to 51 per cent on average terms, compared to 46 per cent in a similar period of 2013. There has been growing insecurity since the year began with the worst case being the killing of at least 50 people when unknown militants attacked people, hotels and a police station in Mpeketoni, near Lamu.

The biggest concern has been centred on possible investor flight out of Kenyan assets. But that may not be the case given the performance of the Eurobond and the stock market.

However, despite the fact that investors may continue their bullishness on Kenya’s long term fundamentals, there are still underlying risks mainly from structural weaknesses that will need to be addressed for the country to continue enjoying such low US dollar borrowing rates.

First is fiscal indiscipline; as it is, the government’s overall expenditures are projected at Sh1.58 trillion (or 34.1 per cent of GDP) in the coming financial year 2014/15, up from Sh1.47 trillion (or 35.3 per cent of GDP) in the current financial year 2013/14.

Additionally, the government aims to lower recurrent expenditure to 18.7 per cent of GDP from 20.4 billion per cent in the previous year. However, with the experience of 2013/14, this will not be the case and recurrent expenditure will likely take centre stage and account for a lion’s share of total revenues.

Secondly, a significant portion of the Kenya’s economy remains unrecorded and hence not captured into the tax system. In 2012, the Kenya National Bureau of Statistics estimated that approximately 82.5 per cent of employment was in the informal sector.

In one of the Eurobond pitch documents, the Treasury stated, as a key risk, that the informal economy is not recorded and is only partially taxed, resulting in a lack of revenue for the government, ineffective regulation, unreliability of statistical information (including the understatement of GDP and the contribution to GDP of various sectors) and inability to monitor or otherwise regulate a large portion of the economy.

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