Economic backlash widens over withdrawn Finance Bill

Kenya anti-tax demos

Demonstrators react as police use tear gas to disperse protesters during a demonstration against Kenya's proposed finance bill 2024/2025 in Nairobi, Kenya on June 25, 2024. 

Photo credit: Reuters

The economic backlash from Kenya’s withdrawn Finance Bill 2024 has widened amid jitters among bond investors and a downgrade by a global credit rating agency on concerns about the country’s liquidity risks due to anticipated higher borrowing.

In the latest blow to Kenya, global rating agency Moody’s on Tuesday downgraded Kenya’s credit rating deeper into junk territory, saying that the country will struggle to address the high cost and volume of public debt in light of the reduced revenue-raising capacity.

Moody’s action came on the heels of reports that the International Monetary Fund (IMF) will likely delay its approval for fresh funding to Kenya under its medium-term programme whose seventh review was concluded last month.

Bond investors also served a warning to the Treasury last week that they expect domestic interest rates to rise, holding onto their cash and offering the government just Sh486.5 million in a tap sale of a two-year bond that sought Sh20 billion.

President William Ruto was last month forced to withdraw the Finance Bill 2024 following street protests that left at least 41 people and hundreds injured.

The failure by the government to push through its revenue-raising measures via the Finance Bill 2 has left it facing a Sh346 billion hole in its projected revenue for the current fiscal year, which it expects to plug through budget cuts amounting to Sh177 billion and additional borrowing of Sh169 billion on top of the Sh597 billion that was already earmarked in the budget.

In its rating report dated July 8, Moody’s said that the expanded financing requirement raises liquidity risk for the government and will keep debt costs high.

Moody’s therefore downgraded the government’s local and foreign currency long-term issuer ratings and foreign currency senior unsecured debt ratings to Caa1 from B3, with the outlook remaining negative.

The downgrade implies that lenders are now likely to demand higher interest rates to lend to Kenya, with the Caa1 obligations defined as being of ‘poor standing and subject to very high credit risk’.

“In the context of heightened social tensions, we do not expect the government to be able to introduce significant revenue-raising measures in the foreseeable future. As a result, we now expect the fiscal deficit to narrow more slowly, with Kenya’s debt affordability remaining weaker for longer,” said Moody’s.

“Importantly, an expenditure- rather than revenue-based fiscal consolidation path will bring significantly less support to debt affordability, a key credit weakness for Kenya.”

The revenue measures contained in the Finance Bill were part of the government’s Medium-Term Revenue Strategy (2024-2027) that aims to raise Kenya’s tax-to-GDP ratio from the current 14.1 percent to 25 percent by 2030.

The revenue measures are also a key component in the conditional International Monetary Fund (IMF) loans that Kenya has been drawing down since 2021, with the others being targets on public debt, foreign exchange reserves, and inflation.

The rejection of the Finance Bill is therefore likely to cause a review of fiscal targets for future disbursements by the IMF under the programme that runs until April 2025 and has a pending drawdown of $968.7 million (Sh124.5 billion).

The IMF executive board was expected to approve the seventh drawdown under the programme this week—following a review by a staff team last month—but in its calendar outlining activities until July 19, the Kenya review is not listed.

The board calendar could, however, change as the agenda for each meeting is normally finalised a day prior.

A delay in accessing the IMF funding will put pressure on the Treasury’s liquidity position, forcing higher borrowing in the short term (frontloading) from the domestic market, and potentially, a return to commercial external lenders for new loans at a time when the negative ratings will likely raise the cost of the debt.

On the domestic front, the markets had anticipated that rates would go down when the Treasury announced a reduced borrowing target in the 2024/2025 budget.

The original budget deficit of Sh597 billion was to be financed through domestic borrowing of Sh263.2 billion and external borrowing of Sh333.8 billion.

The Treasury is expected to announce the new domestic and external targets in a supplementary budget factoring in the additional borrowing of Sh169 billion occasioned by the withdrawn Finance Bill.

The uncertainty over the new target, and the anticipation of borrowing pressure on the exchequer—which would point to higher rates— saw investors adopt a wait-and-see attitude in last week’s tap sale of a reopened two-year bond, denying the government much-needed funding.

Investors offered the Central Bank of Kenya (the government’s fiscal agent) just Sh487.5 million against a target of Sh20 billion, with the CBK taking up Sh476.5 million, despite the short-term paper offering a yield of 17.12 percent.

Instead, the investors pumped for the 91-day Treasury bill, where they offered the government Sh14.8 billion against a target of Sh4 billion, opting to park their cash in the shortest duration of government security in anticipation that rates would go up in the near term.

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