David Cowan on headwinds ahead of Kenya post-Eurobond early payments

David Cowan

David Cowan, senior economist for Africa at Citi Bank.

Photo credit: Joseph Barasa

Had Kenya not made a partial payment of its 2014 debut Eurobond in advance in February, it would now be staring at the one-bullet payment for the debt that matures in June.

The early repayment calmed the nerves of jittery investors, put a stop to the depreciation of the shilling, and ended the speculation on its ability to repay its debts amid concerns of debt distress across several African countries.

The Business Daily sat down with David Cowan, senior economist for Africa at Citi Bank, on the backdrop of major macroeconomic developments, including Kenya’s early partial redemption of its debut 2014 Eurobond and the publication of the Finance Bill 2024.

Kenya has just dodged a bullet by meeting its target for a partial redemption of its debut 2014 Eurobond. Is the country now out of danger from sovereign risks?

Kenya had a very specific problem this year with the structuring of the bond warranting a large repayment, and it makes logical sense to spread that out over several years.

The new debt ceiling for me is more profound. What you have now under the IMF programme would drive Kenya’s debt down to the target by 2029, with growth set to an average of five percent, the fiscal deficit at three percent, and the current account deficit at around four percent.

What is the risk of the higher coupon for the new Eurobond?

The government was in a catch-22 situation. Maybe they paid too much, but if they waited, maybe they would pay even more. In a way, there is a benefit to doing a deal that may not be optimal but solves the problem.

We have seen some exchange rate gains this year. With the Central Bank of Kenya (CBK) having expressed concerns about undervaluation, are we now at equilibrium?

We can have a long argument on the shilling fair value. At 160, I agree we were undervalued. The exchange rate came under considerable pressure in 2022 and 2023 because the CBK held the rate at a nominal rate of Sh100 from 2015 to 2020.

My concern now is not whether 130 or 135 is the optimum level, I’m concerned whether the CBK will allow the Kenya shilling to adjust going forward.

If we get to the middle of 2025 and the shilling is at, say 133 that would worry me more because the fundamentals point to some depreciation to maintain competitiveness.

The CBK has insisted on letting the forces of demand and supply determine the exchange rate, would you agree with this?

I do think there are practical problems with having a fully floating exchange rate regime in many African countries. In Kenya, for instance, you know you have periods when FX availability is particularly pronounced, especially during high tourist seasons or after the sale of cash crops such as tea and coffee.

Automatically, you will have lumpy flows of forex into the market, and the Central Bank has to partially intervene at a time when there are no flows as an offset.

Despite the positive sentiment for Kenya after the Eurobond issuance, we are yet to see substantive flows, particularly in the local stock market. Why might this be the case?

Part of the change that has happened, allowing Kenya to issue, was expectations on interest rate cuts by the US Federal Reserve.
The cuts are yet to happen, and as a result, you will kind of see mixed signals.

For instance, foreigners bought considerably into the infrastructure bond, but then sentiment about interest rates staying higher for longer led some of the buyers to sell it as they went back into a risk-off environment.

Should we be thinking about interest rate cuts given the tightness in credit markets or are we too dependent on what other central banks do?

The question to the Central Bank of Kenya would be why it isn’t cutting rates when the policy rate is 13 percent, yet inflation is running at five percent. Most central banks in Africa will, however, be cautious with cuts given the volatility seen in exchange rates across the continent.

Are you seeing a return to portfolio flows by foreigners with the improved sentiment?

Equities are looking cheaper now across major African markets, and I think you would see inflows, which are likely to be dictated by perceptions of what will happen to the Kenya shilling.

Currently, the ongoing discourse is on the Finance Bill 2024. Many feel that newly proposed tax measures have a heavy IMF influence, what do you make of some of the tax measures you’ve seen?

There are two ways to reduce the fiscal deficit, cut spending or raise taxes. When I was doing my PhD in Tanzania, we were going through the first wave of IMF structural adjustments, back then, the solution was to cut spending, which undermined growth. 30 years later, the fund has come back with the focus on raising revenues.

Is the fund asking for a lot? Kenya is being asked to raise its share of taxes to gross domestic product. Kenyans have valid questions to ask. But the idea of raising revenue to fund own spending means depending less on borrowing from overseas, and this is a good idea.

Do you have any doubts about the credibility of the fiscal policy as we see revenue misses despite a ramp-up in tax measures?

This is where there is a bit of an experiment. It’s not clear how fast you can raise taxes, this is a process that’s going to play out and pay out over multiple years including through election cycles. I think what’s important is the direction even if the target is not hit.

Will the painful tax measures give way to better days?

I have lived through this once in my life when we saw big defaults and huge currency devaluations. Governments consolidated their fiscal policies and fixed foreign exchange concerns giving way to the Africa rise story. If policies are fit into place, then we can go back to that story.

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