BY MOHAMED WEHLIYE
Economic numbers can look scary and sound positively terminal when not probably understood. Trillion-shilling debt here. Hundred-billion shillings deficit there. Big, scary, numbers everywhere. They get even more scary when some respected economists dishonestly use them and put a spin to give the impression that the country is in a very precarious position and is perhaps on the verge of bankruptcy. It borders on intellectual dishonesty and is unfair to the public when for example people who should know better claim that Kenya rescheduled a $600m bank loan for another three months because it was ‘broke’.
This despite the fact the country has more than 10 times that amount in reserves that it could use to pay off that loan if it wanted to. Was some of the proceeds of the proposed Eurobond not supposed to retire these bank loans? So how does a timing issue and a simple debt management strategy make one conclude that the country is broke? There has been a lot of negative remarks on the state of our national debt. Is debt about to kill us as recent newspaper headlines and comments from some of our economists would want us to believe? What is our national debt situation like? Do the facts and figures support the views of those claiming we are choking with debt? Let us examine the same.
What is National Debt?
Whilst the issue of national debt is one of the most widely discussed, it is also often a misunderstood area. A lot of people are talking about the national debt, but few are explaining it. So what is it then? National debt is the money owed by a country to domestic and foreign lenders. It results from expenditures that exceed revenues. It is the running total of all deficits minus all surpluses, from Jomo to Uhuru Kenyatta. Contrary to what many people believe to be conventional wisdom, debt is actually a beneficial and recommended pursuit, if used correctly, since it enables a nation or an individual to equalize income and expenditures over time, and improve standards of living earlier than what would otherwise be attainable.
This is what individuals, corporations and countries do to improve their standard of living and shareholder’s net worth; by pulling their future incomes forward via borrowing. Show me a rich individual, corporation or a country and I will show you debt.
What is the acceptable level of National Debt?
Kenya’s national debt as at March 2014 was Shillings 2.172 trillion of which 1.231 trillion (56.6%) was domestic debt and Shillings 940 billion (43.4%), foreign. Our domestic debt is owed to commercial banks, pension funds, insurance firms, parastatals and other investors. The foreign debt is owed to foreign multilateral, bilateral, banks and other supplier credit sources.
So what does this 2.1 trillion number represent then? How big is it? Is it an inconceivable sum, far beyond anything that we could possibly handle? Two trillion shillings is definitely a lot of money but this headline number in itself isn’t important – until we place it in the proper context. Too big or too small in the context of national debt is relative. National debt must not only be benchmarked to the size of a nation’s economy or income but one would also need to look at a number of other factors such as its structure and cost of servicing in order to determine whether it has reached a ‘harmful’ level or not.
First, national debt is usually looked at in terms of its percentage relative to the gross domestic product (GDP) of a country. There does not exist a threshold or a standard above which it will be considered too big but the conventional wisdom is that the higher the national debt relative to GDP the worse and vice versa. Some economist have gone a step ahead and through empirical studies, identified a “tipping point” for national debt – the point at which national debt levels begin to have an adverse effect on economic growth.
Based on an analysis of the debt of 100 countries over 30 years they found that once a country’s public debt exceeded 77 percent of its GDP, the amount of debt will have a linear relationship to declines in economic growth. In other words, the more debt you have above that point, the slower your GDP will grow. They found that if a country’s GDP is growing at a rate of 3 percent annually, and it increases its debt to GDP ratio from 80 percent to 90 percent, its economic growth will shrink the following year to 2.8 percent. That tipping point could be higher or lower for any specific nation, based on the nation’s wealth and countries with emerging economies and lower per-capita incomes were found to have a lower tipping point of around 64 percent.
Kenya’s combined total debt was 52.2 per cent of GDP as at March 2014. It is worth bearing in mind, that other countries, although wealthier than us, have a much bigger ratio. To put things into perspective, Japan has a national debt of 227%, Brazil 57%, India 68%, UK 91% and Italy’s is over 140%. The US national debt is close to 101% of GDP. So in effect some of these countries owe more than what they make in a year but are not countries that you would consider ‘broke’ or about to go bust. The high levels of their debts relative to the size of their economies, does not mean their economies are on the road to ruin. To the contrary, most investors in fact regard some of these countries, for example Brazil and India, as having robust economies with promising prospects for even more wealth creation.
The Eurozone was hit by a sovereign debt crisis in 2008. If Kenya was a member of the Euro-zone, only Estonia and Luxemburg would boast lower debt-to-GDP ratio. So we are not about to go the Greece way anytime soon.
If Kenya was in the Euro-zone, it would have the third lowest debt ratio (2013 figures)
Those saying we are almost broke today because of our debt levels must look at the history of our debt. If we are almost bust today, then we have almost always been bust. In Our debt relative to the size of the economy is not high by historical standards. In 2003 when the Kibaki administration came into office, the country’s debt stood at about 65% of GDP and was more than 300% of annual revenue. Today, Kenya’s total debt size is higher than it was a decade ago, but its debt ratio is much lower because total GDP is much larger. According to the National Treasury’s own projections, Kenya’s Debt to GDP ratio is expected to decline in the medium term and be around 48% by the 2016/17 financial year. And this even before taking into account the rebasing of the country’s GDP to take into account the significance of new sectors of the economy.
It is sad to note that some economists still use the argument that Kenya’s Debt to GDP ratio is well above that of Sub Sahara Africa (around 35%) when discussing Kenya’s national debt. This is despite them knowing very well that many of the SSA countries benefited from debt relief in the last decade under the framework of the Highly Indebted Poor Countries (HIPC) initiative . Kenya did not benefit from debt relief partly because its debts have been manageable and the country has long been considered better off than many of its neighbours and not in need of such assistance. Kenya’s higher than average ratio is therefore very much a victim of its good management of debt. Others including our neighbours Tanzania and Uganda were rewarded simply because they didn’t manage theirs well.
Debt structure matters.
Countries usually aim to have a higher percentage of their national debt as domestic debt. As at March 2014, almost 57% of the national debt was held by local commercial banks, insurance companies, parastatals building societies and other domestic investors. The remaining 43% was foreign debt. The lower the external debt compared to the internal debt the better. Partly this is because when the debt and its interest are repaid to domestic creditors, part or all of it stands a bigger chance to be invested domestically and generate economic activities. Servicing the debt (paying interest, issuing bonds) therefore just redistributes income from Kenyan taxpayers to mostly Kenyan bondholders. It is not necessarily money leaving the country.
The domestic debt is also no longer dominated by short term and excessive inflationary biased method of deficit financing as it was during the Moi era. It has now more long term debt component than it used to do. Treasury has in the last decade sought ways to lengthen the average maturity of its domestic debt from 12 months to almost 5 years. By going long-term, the government has lowered the refinancing risk meaning there is less pressure to refinance the debt at any one time.
National Debt structure (domestic vs foreign) as at March 2014
Kenya’s foreign debt (before the recent Chinese deals) on the other hand is mainly concessional and long-term, with an average maturity of 32.6 years and an average interest and grace period of 1.1 percent and 7.5 years respectively at the end of March 2014.
Kenya’s external financing sources is also well diversified and the country does not have big exposures to any individual creditor country. The World Bank and the African Development Fund are the two biggest creditors with the rest of the foreign debt almost equally distributed across geographically diverse economies.
Foreign debt by creditor as at March 2014
Debt Sustainability is the single most important factor
Whereas the raw amount of debt accumulated is what captures the headlines, the real risk from government debt is the burden of interest payments. We can remain perpetually indebted so long as the interest payments we make don’t go out of control. Whereas we have loaded big sums of debt in the last few years, interest rates during this period have been about as low as they have ever been. We borrowed many times what we used to borrow a decade ago at a fraction of the cost we used to borrow at and the weighted average interest rate on Kenya’s national debt as at March stood at 4.7%. The debt’s current cost to taxpayers is therefore about as low as it has been in decades.
The yearly interest expense on our national debt relative to GDP is a key indicator of debt sustainability. The National Treasury is expected to spend about 154 billion shillings at the end of this financial year to service the national debt. That equates to a debt servicing as percentage of GDP ratio of around 3.7%. Not a high ratio by any standards. Experts believe that when interest payments reach about 12% of GDP then a government will likely default on its debt. Another way to look at sustainability of debt is to compare annual servicing cost to development expenditure. The amount we will use to service the debt in this financial year (Sh 154b) is far lower than the amount the country has earmarked as development expenditure (Sh 448b) during the same period. This means debt servicing has not yet reached a point where it has limited the country’s capacity to fund its development and other emerging priorities or required us to seek heavy donor involvement.
The Joint World Bank-IMF Debt Sustainability Analysis (DSA) for 2013 has also given Kenya’s public debt thumbs up. DSA assesses how a country’s current level of debt and prospective new borrowing affects its ability to service its debt in the future. According to these two institutions, debt sustainability can be obtained by a country “by bringing the net present value (NPV) of its public debt down to within a certain threshold of its GDP and revenues”. Kenya’s NPV of Dept as a percentage of GDP in 2014 was assessed to be at 39% against WB/IMF thresholds of 74%. Against revenues, the ratio was at 151% against a 300% threshold. Further stress testing indicates that Kenya’s NPV of debt/GDP ratio would still be within WB/IMF debt sustainability thresholds in the medium term even if it increased its borrowings now by another 10% of its GDP. This means that the planned Eurobond issuance and the uptake of the recently contracted Standard Gauge Railway loan will not breach Kenya’s debt sustainability thresholds or modify the favourable conclusions of the last WB/IMF Debt Sustainability Analysis (DSA) on Kenya’s external and public debt position in the medium term.
Kenya’s debt has thus far been well managed and the country has in the last decade implemented wise fiscal policies and sound budget management. But managing the debt will now become tougher than before. The government will need to maintain fiscal prudence while continuing to invest in infrastructure and fund devolution. It will also has to ensure that foreign exchange risk is well managed given that it will now have a foreign currency denominated bond (Eurobond) in its books. This perhaps poses the greatest risk to debt sustainability in the foreseeable future. But a sustained focus on making the cake bigger through economic growth is what will guarantee that Kenya’s debt levels continue to remain sustainable. As it stands now though, all the relevant indicators and other parameters of our national debt show that we are nowhere near being broke. People who are saying the country is broke should be very careful. We should not over politicise the economy. The economy is a very precious thing to any country. The fact that we still hold a good credit rating and lenders continue to lend money to us is an indication that lenders not only don’t believe the government is broke right now, but also don’t see bankruptcy anywhere on the horizon.
(Wehliye is the Senior Vice President – Risk Management at Riyad Bank)