Why Eurobond 3 is the idea whose time has not come

Wet My Whistle”, Midnight Star, 1983. First time I heard the song was also the first time I heard that expression. Though used playfully in the song, the Cambridge dictionary defines it as “having an alcoholic drink”. When the government floated its first Eurobond in 2014, I’d probably would’ve used the expression (tongue in cheek).

I’d still use it (though reluctantly) for the second issue back in February but never when it issues its planned third Eurobond. Why? I think it’s about to get drunk. But more serious, the bar tab may get bigger than expected. Why?

One, pick up in global risk aversion is causing turbulence in the Eurobond markets. Bond yield spreads, seen by many investors as an indicator of sentiment towards the country, have expanded to their widest.

Five-and-ten year yields hit 5.03 percent and 7.566 percent respectively this month, up from 3.142 percent and 5.6 percent in that order from early this year.

The 30-year yields hit their highest at 9.194 percent. This puts five-year yield spread between Kenyan and US bonds above 200 basis points—the widest this year, as Kenyan government bonds come under renewed selling pressure. The 10-year yield gap pushed out even wider to more than 400 bps.

Should fears of a global economic slowdown and an aggressive US monetary policy persist, then the negative sentiment towards emerging market debt would significantly demand. This means our Eurobond faces a steep higher risk premium (gets expensive) to compensate for the illiquidity and currency risk. Already, yields on African Eurobonds have edged up over the past few months.

Two, rating agencies are most likely to give a “downgrade” rating given the government’s pursuit of expansionist fiscal policies that are not putting the country’s debt levels on a sustainable downward path. Judging from assessments by the Bretton Woods sisters, the International Monetary Fund (IMF) forecasts the country’s total public debt to hit 62.3 percent of GDP this year, up from 58 percent last year.

World Bank estimates that as a share of GDP, development expenditure has fallen from eight percent in financial year 2016/17 to 5.5 percent in the last financial year thanks to debt repayments—expected to top Sh870 billion this financial year.

If ratings soon fall, yields would grow. Currently, average debt yields stand at six percent, compared with 5.5 percent for emerging markets, 4.7 percent for Eastern Europe and 5.6 percent for South and Central America.

Three, the last stop on the “high yield” gravy train is fast approaching. The US has been on a rate tightening cycle and this is already pushing back risk capital.

With the Federal Reserve’s latest quarter-point interest rate increase (and still more likely to come), the pressure is mounting for the local unit.

The cumulative effect at some point should knock off resistance. Should this happen, our foreign debt servicing costs would rise.

This likely scenario means a new Eurobond would be quite a burden. Emerging currencies have also lost considerably over the past few months.

Look, this is no doom saying but if we keep on “wetting our whistle” to obscene debt levels, we’ll one day pay a huge price.