18 August 2011

Kenya: Weak Shilling Takes Debt Burden to a New High

Photo: Nation
The woes afflicting Kenya's currency have been building up over the past six months.

The weakening of the shilling and growing demand for public spending pushed Kenya's total debt to a new high of Sh1.5 trillion - or more than half the total annual output - taking the country closer to where it stood at the beginning of the Kibaki presidency in 2003.

Treasury figures show that the total debt is now equal to 53.6 per cent of the country's total annual output also known as Gross Domestic Product (GDP) - more than five percentage points above the International Monetary Fund's (IMF) recommended threshold of 45 per cent.

A high level of indebtedness is deemed to be harmful to growth as it consumes a large amount of resources in the form of interest payments starving the economy of investment.

Continued rise in the amount of money that a country owes its financiers also risks taking it beyond the sustainable debt limits as has recently happened in Greece with grave consequences on social and economic stability.

On Wednesday, the IMF said it expected the prevailing high ratio of debt to fall below the 45 per cent level by 2013.

Many economists are, however, less enthusiastic about Kenya's ability to bring down the level of borrowing or even settle the absolute outstanding amounts within the stated period.

"Borrowing has to be reviewed all the time to make sure it does not threaten future government revenue and growth," said Mr Gerishon Ikiara, an economics lecturer at the University of Nairobi. "Not borrowing is, however, not an option as it comes with its own challenges such as starving the economy of investment with grave consequences on growth."

Mr Ikiara expects the debt levels to continue rising as the government's financial obligations increase with the implementation of the Constitution, famine relief and infrastructure development.

Publication of the latest data comes as national debt remains top on the agenda of international discourse following recent troubles in Greece. The IMF and the EU have had to bail out Greece while imposing stringent conditionalities, including huge cuts in public spending that have sparked riots on the streets of Athens.

Four other Eurozone economies including Portugal, Ireland, Italy and Spain are facing similar debt stress that has severely hampered their ability to sustain public investment and run government. Investors have responded to these stresses by raising of the cost of new borrowing by these countries.

Latest national debt data shows that there has been a steep rise in the size of external debt in recent months as the shilling weakened against major world currencies.

In the year to June, the amount of money Kenya owes external financiers rose 22 per cent to Sh727 billion - closing the traditional gap between it and domestic debt, which stood at Sh764.1 billion.

Exchange rate

IMF head of mission Ragnar Gudmundsson Wednesday said the overall debt level had been affected by exchange rate turbulence that has seen the shilling cede ground against nearly all the hard currencies.

"The figures you refer to, and which I would need to confirm, probably reflect movements in the exchange rates that have contributed to an increase in the value of outstanding loans denominated in foreign currencies," he said.

Domestic debt rose 15.7 per cent to Sh764 billion largely driven by inability of Treasury to get enough cash from the market and a marked fall in spending target caused by inability to absorb allocated cash. Consequently, the Budget deficit fell from the target Sh187.9 billion to Sh144 billion.

Prof Joseph Kieyah, the principal analyst at the Kenya Institute Public Policy Research and Analysis (Kippra), said there is need for caution on the debt build-up but like Mr Ikiara, a former Transport permanent secretary, believes that ultimately, whether the money borrowed is put into productive use or not would determine the rationale to borrow.

"There is nothing bad with deficit or debt. But this is still a matter of concern especially in view of uncertainty over growth arising from the impending general election and even The Hague trials," he said. "The issue here is whether the economy can grow at a rate fast enough for us to retire the public debt."

Prof Kieyah says the government may be forced to revise its budget to accommodate more spending in the year if the shilling remains weak.Huge imports by the government are on the cards particularly in view of the large infrastructure projects.

Concern is also rising over the cost of debt servicing as the pile of debt continues to build up. Last year, interest payments on existing debt rose from Sh6.1 billion to Sh7 billion -- a trend that is expected to accelerate this year.

"Domestic interest payments totalled Sh69.2 billion, higher than the Sh57.4 billion paid during the corresponding period of the previous year, mainly due to higher cost of borrowing," says Treasury's Quarterly Economic Budgetary Review for the fourth quarter 2010/11.

IMF is targeting a debt-to-GDP ratio in the region of 47 per cent by end of this fiscal year but says a debt sustainability analysis is slated for October when officers from Washington visit Nairobi for the second review under the extended credit facility (ECF) that kicked off in January 2011. But Mr Ikiara warned that Kenya's debt sustainability will remain under pressure from the weak shilling, demanding a delicate balancing act between capital expenditure and borrowing.

"The fact that the government principally earns in shillings through Kenya Revenue Authority means revenue will remain strained as we pay more shillings for our hard currency borrowing," he said. So far, the Treasury and IMF have agreed that the country's debt is still within the sustainable limits. But that cannot be guaranteed in the medium term with the currency swings, politico-economic uncertainties and a huge devolved government spending in the works.

Only improved stability, improved revenues and productivity arising from public capital formation can underwrite surging debt in future. The economists we talked to advised government to lean more on domestic debt to preclude the possibility of default against foreigners.

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