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Why Kenya is keen on Yuan for SGR loan payment
The interest on dollar-denominated SGR loan is currently based on Secured Overnight Financing Rate (SOFR) — the global benchmark, which fluctuates based on prevailing economic fundamentals such as inflation, liquidity, and interest targets by the Federal Reserve.
Kenya and China are in advanced talks to swap the dollar-denominated standard gauge railway (SGR) debt to Chinese Yuan in a bid to ease mounting interest repayment obligations.
The National Treasury believes switching to the Chinese Yuan will result in “huge” savings for taxpayers who service the loan in two installments every year.
Kenya Railways Corporation (KRC) is yet to start reimbursing the Treasury the money spent on repaying the debt to Exim Bank of China, which funded more than 90 percent of the SGR project.
How much does Kenya spend on servicing the SGR loan?
The Treasury does not publish the exact amount it spends on repaying the SGR loan, whose principal was initially $3.75 billion (about Sh484.87 billion under the prevailing exchange rate), excluding interest expenses.
This could be because the terms of loans from Chinese loan deals with developing countries are usually secretive, according to AidData — a US research lab at the College of William & Mary— which monitors such deals.
However, repayment of SGR loans accounts for the bulk of the total cost of servicing China’s loans, which are this financial year estimated at Sh129.90 billion, which is largely unchanged from last fiscal year’s Sh129.35 billion.
Chinese state-owned banks —Exim Bank of China and China Development Bank —reportedly also require borrowing nations such as Kenya to prioritise repayment ahead of other creditors.
How does retaining the SGR loan in dollars keep the repayment risk elevated?
The interest on dollar-denominated SGR loan is currently based on Secured Overnight Financing Rate (SOFR) — the global benchmark, which fluctuates based on prevailing economic fundamentals such as inflation, liquidity, and interest targets by the Federal Reserve.
Exim Bank of China loads a mark-up which Treasury Cabinet Secretary John Mbadi has put at about 2.0 percent, bringing the total interest to more than 6.0 percent, given that SOFR is currently at levels near 4.4 percent.
Kenya felt the weight of the swings in SOFR and heavy exposure to the bullish US dollar when it was forced to increase the cost of servicing Chinese loans from Sh112.39 billion, which it had budgeted for the financial year ended June 2024, to Sh152.39 billion.
That was a huge Sh40 billion jump in a year on account of rising global interest rates and a depreciating shilling.
So why the proposal to switch to Yuan?
The National Treasury is hoping the swap will help cut the more than Sh100 billion Kenya spends on servicing the SGR loan every year, thereby lessening the burden on taxpayers.
The savings will be realised on the interest expenses, which the Treasury projects will nearly halve.
This is largely because the swap to Yuan will remove swings in interest rates linked to SOFR, ushering in fixed interest rates, which the Treasury estimates at about three percent.
This will align with Treasury’s strategy of shifting to longer-dated debts largely on concessional terms.
Analysts say Kenya has its sights set on switching the SGR loans from largely commercial loan terms [given the use of SOFR as a benchmark] to concessional. This is likely to help it realise savings on interest expenses.
What are the major risks?
The risk of foreign exchange exposure will remain high because Kenya largely transacts with the international community in US dollars.
This means it will still need to convert dollars into Yuan to service SGR loans.
Churchill Ogutu, a Nairobi-based economist for IC Group, said: “Given the widespread US dollar usage as a reserve currency, it is likely there will be some underlying currency swap to enable the eventual debt servicing of the outsized Yuan-denominated debt”.
Is Kenya looking to extend the tenure of the SGR loan?
Mr Mbadi says the talks between Nairobi and Beijing are restricted to converting the SGR loan from US dollars to renminbi, or Yuan, in line with its policy shift on diversifying its external debt, which is currently heavily denominated in US dollars.
A top official at the Treasury, however, exuded confidence that successful conversion of the loan to Yuan will open the door for “fresh negotiations or agreements on the term limit of the loan”.
