The Treasury has raised its domestic borrowing target to shield the economy from the turbulence associated with foreign debt – opening a new window for local investors to increase their earnings from risk-free government paper. (Also read: Fall in interest rates boosts Treasury’s borrowing plans )
The shift that will see the Treasury borrow up to 70 per cent of total public debt locally was part of the Finance Bill that Parliament passed last week.
“Taking into account both cost and risk considerations, the need to develop domestic debt markets and the feasibility of implementing the strategy in the medium term, the 2011 medium term debt strategy (MTDS) proposes a 70 per cent net domestic financing and 30 per cent external financing,” says the 36-page document signed by Finance minister Uhuru Kenyatta.
Kenya has in the past maintained a public debt policy that required an equal mix of domestic and external debt.
The Treasury is expected to use the new headroom to widen its presence in local bonds where investors have taken refuge in recent months following the decline of activity in the equities market.
Borrowing locally gives the Treasury room to raise cash with speed as need arises compared with external debt which takes long to negotiate and often comes with strict conditions.
Investors in the equities market have lost 20 per cent of the value of their wealth — amounting to Sh233 billion — since the beginning of the year, forcing many to take refuge in the fixed-income debt market where coupon rates have risen by large margins in the past three weeks.
Activity has also been rising in the fixed-income market at the Nairobi Stock Exchange (NSE) where investors traded bonds worth Sh72.2 billion in July compared to Sh19.9 billion in January.
Treasury says in its strategy that it intends to deepen the local bonds market as part of a wider plan to stabilise the cost of debt and strengthen Kenya’s position in dealing with external creditors who have been hardening their terms in response to uncertainty in global financial markets.
Mr Kenyatta said that a key pillar of the new strategy is to have sustainable debt levels with the implementation of the Constitution.
“As we embark on implementing the Constitution, it is important that the burden of public borrowing is equitably shared between the present and future generations,” he said.
Many analysts see the shift in favour of domestic debt as mainly driven by the ease of borrowing and less stringent terms that come with it.
“It comes with better terms than foreign donor terms and shields Treasury from exchange rate fluctuations that increase the cost of debt,” said Mr Robert Gatobo, a trader at the treasury department of Commercial Bank of Africa.
Exchange rate fluctuation has been a major drawback in the management of the national debt in recent months as the shilling suffered its worst beating against major world currencies raising the cost of external debt.
“The most recent cause of the rising external debt burden is the depreciation of the shilling against the hard currencies,” Mr Felistus Kivisi, assistant director at the debt management department of the Treasury, said.
And Mr Gatobo said that domestic debt was also a more reliable source of funds for government compared to external borrowing. “Reliability is going to be important because government can get the cash when it needs it,” he said.
Domestic borrowing could also help the Central Bank of Kenya to mop up excess cash which, apart from food and fuel supply shocks, has contributed to the rise of inflation to a high of 16.7 per cent in August.
“Raising money from within should help reduce inflationary pressure and offer investors an opportunity to place their cash in secure government instruments,” said Mr Samuel Wachira, the general manager at Drummond Stockbrokers.
“But this borrowing has to be for capital expenditure spread over a period and not recurrent spending that has potential to raise inflation”. Higher level of domestic borrowing by government should also help improve liquidity in the secondary market through new bond issues besides reducing the cost of debt compared to the external borrowing.
“But if mismanaged, domestic borrowing has the potential to maintain upward pressure on interest rates as big investors such as banks shift their focus to government paper rather than lending to the private sector,” said a securities dealer who declined to be named because of his participation in the debt market.
Raising more funds locally is also seen opening the door for a further deepening of the fixed-income market – continuing a trend that began in 2009 with the automation of bonds trading at the Nairobi Stock Exchange.
Treasury said that donors – especially western ones – have hardened terms of lending in the recent past, making it prudent to look inwards.
Data from the Treasury indicates that the average maturity period for the new loans as at June 2011 was 32.9 years compared to 38.8 years in 2009 while the grant element has dropped to 59.2 per cent compared to 59.9 per cent in 2009.
Kenya’s external borrowing policy specifies a grant element of at least 35 per cent as the main criterion for approval of loan agreements and the (data) demonstrates a hardening of terms for new external commitments in 2010.
A weakening of the shilling has made foreign debt, which has to be paid in the currency it was procured, more expensive.
The shilling has lost about 16 per cent of its value relative to the dollar, for example, since the beginning of the year, making dollar-denominated loans more expensive in shilling terms.
The Monthly Debt Bulletin dated June 2011 reported that about a third of Kenya’s external debt is in dollars. About a similar amount is in euros, against which the local unit has lost 27 per cent since the beginning of the year.
Of the total external debt, 23.4 per cent is denominated in the yen against which the Kenyan currency has lost 23 per cent since the beginning of this year. The losses incurred by the shilling have therefore increased the costs of servicing the corresponding debts by the same amounts.