Global ratings agency Standard and Poor (S&P) has cut Kenya’s ratings outlook from stable to negative on concerns about the country’s debt servicing capacity due to constrained international market access and underperforming domestic bond issuances.
The agency’s stance reflects a growing concern that developing nations that have high exposure to external debt will struggle to refinance maturing issuances due to the high-interest rate demands being put forward by potential lenders.
While the secondary market yields for Kenya’s Eurobonds—which guide the pricing of new issuances— have eased from the record high of 22 percent in July 2022, they still remain elevated at between 10.2 percent and 11.8 percent.
This refinancing risk has already forced Kenya to postpone a Eurobond issuance in the past year, putting pressure on the domestic market to carry the bulk of budget deficit financing.
However, the bonds market has recorded under subscriptions in a number of issuances in the current fiscal year, largely due to investors holding out for higher interest rates.
The change in outlook by the rating agency to negative, therefore, points to an expectation that the government could struggle to affordably refinance external debt while meeting budget financing needs.
S&P has also pointed to the recent shrinkage of forex reserves and the inflationary effect a weakening shilling has on external debt and the cost to service the same.
“Constrained external financing led to Kenya suspending plans to tap international capital markets in 2022, prompting the country to draw more extensively on its forex reserves to meet its external debt repayments,” S&P said in its ratings update.
“Our base-case scenario assumes that Kenya will meet its financing requirements for fiscal 2023 (year ending June 30), but risks remain given relatively high foreign debt service obligations in fiscal 2024 (including a $2 billion Eurobond maturing in June 2024) against a backdrop of still-difficult issuance conditions.”
While Kenya’s long- and short-term foreign and local currency sovereign credit ratings remain unchanged at B/B, the agency says it could lower the ratings over the next one year if access to external funding is curtailed, resulting in external financing shortfalls or a sustained decline in foreign exchange reserves.
Kenya’s dollar reserves, from which external debt is repaid, are currently at a near 10-year low of $6.9 billion, having fallen below the required four-months import cover a month ago.
“We could also lower the ratings if we perceived Kenya's economic growth prospects or fiscal metrics had weakened significantly relative to historical norms,” the agency said.
The Treasury noted in the recently released 2023 Budget Policy Statement that market pressures due to the Russia-Ukraine war and monetary tightening in the US and Europe have limited its access to the international market, except for the concessional funding coming from the IMF and the World Bank.
The high Western inflation rates in particular, the Treasury said in the document, have hindered liability management of its debt portfolio, meaning rollovers of maturing debt.
The Treasury added that it would continue to monitor financial conditions before taking actions to lengthen maturities and cut refinancing risk.
Kenya is due in June next year to fork over $2 billion (Sh251 billion) to investors in a bullet payment to retire the 10-year sovereign bond that was issued in 2014.
The most likely option for the country in refinancing this debt under current market conditions is the issuance of a short-term syndicated loan facility, which while expensive, will have a relatively short period of high-interest rate exposure as the country waits for friendlier borrowing conditions.
“As such, we think they will follow through with a short-term syndicated loan to refinance the upcoming Eurobond maturity,” said Churchill Ogutu, an economist at IC Asset Managers (Mauritius).
The BPS has given an indication of the scope of financial manoeuvres the Treasury plans to execute to balance the books in the upcoming fiscal year.
Emphasis on the external front is being placed on the repayment of the Eurobond and China's standard gauge railway (SGR) loans, while the domestic market carries the burden of financing the Sh720.1 billion budget deficit.
Total external debt principal repayments are expected to consume Sh475.6 billion in the 2023/2024 fiscal year, while external interest costs will eat up another Sh146.9 billion.
This leaves room for net external borrowing of Sh198 billion, down from Sh378 billion in the current fiscal year. Domestic borrowing in the meantime will rise to Sh521.5 billion from the current year’s Sh438.1 billion.