Is swelling public debt sustainable in face of slowing economic growth?

Finance minister, Mr Uhuru Kenyatta, has been on a well publicised itinerary at the World Bank headquarters in the US.

His trip will be considered to have been a flop if he fails to unlock the World Bank taps for a reported soft loan of about Sh80 billion ($1 billion) that the government urgently needs to bridge a yawning budget deficit.

About one month ago, Mr Kenyatta and his army of bureaucrats at Treasury and the Central Bank of Kenya (CBK) successfully wooed World Bank’s sister institution, the International Monetary Fund (IMF), into releasing an emergency package of about Sh16 billion ($200 million) to shore up dwindling national foreign currency reserves.

Successive Kenyan governments have already borrowed an estimated Sh1.1 trillion from both the domestic market and international lenders, loading on to the estimated 38 million Kenyans an equivalent debt of about Sh26,300 each.

If the Finance Minister’s stance is anything to go by, the government is ready to push the public debt ceiling even further.

Actually the State appears convinced that there is enough room for Treasury to chalk up more debt.

Mr Kenyatta stated as much in his June 14 Budget speech when he told Parliament that Kenya’s public debt level was still well within the sustainable realm.

He argued that at about 44.5 per cent of the Gross Domestic Product (GDP), public debt was still sustainable, and he made a case for his massive borrowing plan through which he expects to use to plug an historic Sh296 billion budget deficit.

“Debt sustainability analysis done taking into account the planned new borrowing demonstrates that we face a low risk of debt distress,” said Mr Kenyatta.
“We are in a position to comfortably borrow in the short term to finance the proposed fiscal stimulus package without compromising our macroeconomic objectives,”.

He then read out Kenya’s biggest expenditure outlay ever, a Sh866 billion “stimulus” budget whose key objective is to jumpstart economic growth.
The urgent need for increased State spending in a time of shrinking tax revenues is informed by the sharp downturn in economic growth, which has become a state security threat as unemployed youth engage in crime to sustain themselves.

But is Kenya’s swelling public debt sustainable, and exactly how much more borrowing space does Treasury have?

Public debt sustainability is measured against a country’s capacity to collect revenues through taxes and other incomes streams that can be used to offset the debts and interest accruals as they fall due.

A country’s export base, which shows the balance of payment position and foreign currency inflow projections, is also useful in gauging the future ability to repay outstanding and new debt.

The most widely quoted measure of a country’s debt level and its capacity to repay is by comparing the ratio of national debt to a country’s GDP.

Kenya’s total public debt to GDP ratio has been on a general decline, falling from a high of 51.1 per cent in 2006 to 46.7 per cent in 2007 and declining further to 42.3 per cent last year.

What Mr Kenyatta did not tell the public, however, is that by crossing the 40 per cent debt to GDP ratio, the government will be breaching the debt sustainability parameter recommended by the World Bank and the IMF.

According to a joint IMF World Bank Kenya debt sustainability analysis report prepared in August, last year, Kenya’s maximum nominal debt to GDP threshold is 40 per cent.

This means that Kenya’s intention to exceed this limit will potentially expose the economy to a debt servicing distress, where much of the revenue earned will be spent on re-paying public debts.

Last year ,Treasury set aside Sh64.3 billion for debt payment which was a 16.5 per cent increase from the Sh55.2 billion spent in the previous financial year.

Kenya’s untainted public debt servicing record denied it the opportunity to benefit from debt cancellation unlike its African peers who saw a significant portion of their public debts written off under the heavily indebted poor countries (HIPC) initiative and the multilateral debt relief initiative (MDRI).

World Bank and IMF officials argue that a 40 per cent debt to GDP ratio would be a safe “anchor fiscal policy” that would guide Treasury to avoid the risk of falling into a debt trap.

A deterioration of this ratio either through more borrowing or a sustained GDP growth stagnation would imply some risk of debt distress.

“The debt sustainability analysis shows greater risk of unfavourable debt developments, especially under a shock to GDP growth,” states the World Bank/IMF report. “Potentially large but unreported contingent liabilities also pose additional risks to the sustainability of public debt.”

Different scenarios and stress tests as per the study indicate that Kenya’s debt indicators are particularly vulnerable to slower growth, while being broadly resilient under alternative assumptions.

The rising appetite for more debt also puts Kenya at risk of over-relying on donors for its budgetary financing, which could introduce uncertainty into the financing of development programmes.

This year’s budget projections show that Treasury will be counting on “external sources” to finance about 17 per cent (Sh145 billion) of the total budget, a factor that analysts at Old Mutual Asset Managers (OMAM) consider to be the single biggest risk factor that could unravel this year’s budget.

“The main risk to the budget financing plan will be if the expected donor contributions of Sh145 billion do not come through,” says the OMAM chief investments officer Mr George Apaka.

Ratings agency Standard and Poor’s (S&P), which recently gave Kenya a B positive sovereign credit rating, argues that Kenya has a “sophisticated” fiscal and debt management system that reduces the risk of a debt overload but warns that Treasury is carrying a “relatively high debt compared with similarly rated peers.”

“We anticipate that Kenya’s reliance on donors will increase moderately in the near term as a result of policy pressures stemming from the global downturn and other recent shocks,” says S&P.

The ratings agency projects that retreating international liquidity, and the risk of crowding out the private sector through increased local debt issuance will pressure Kenya into relying more on donors for deficit financing.

S&P gives a thumbs up to the government’s strategy of borrowing as far as possible from external lenders on concessional terms (minimum grant element of 35 per cent), while limiting domestic borrowing which is more expensive and entails greater refinancing risk- about a third of domestic loans are short term.
The debate about debt sustainability is not only Kenyan.

Uganda, which benefited from massive debt write-offs about five years ago, recently heard from its finance minister, Fred Omachi, that the country’s debt level was nearing the unsustainable limits.

Uganda’s total indebtedness has risen to $5.7 billion from a low of $1.1 billion following the debt cancellation, a level that is even higher than the pre-write off peak of $4.7 billion.

“Our debt is steadily rising and at the current trend it would tend to reach unsustainable levels by 2012,” said Mr Omachi in a recent address to the country’s parliament.

“There is a need to borrow only for strategic productive investments that will increase production capacity.”

Tanzania also remains heavily reliant on debt for its budgetary financing, with close to half of its budget expenditure projections this year expected to be financed through grants (22 per cent), foreign loans (11 per cent) and domestic borrowing (11 per cent).