Increased appetite for borrowing risks long-term economic growth #Budget2018

June 12, 2018
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The government intends to borrow Sh300 billion from the international market this financial year as highlighted in the 2017-2018 national budget./FILE

, The National Government’s debt financing pattern has shifted towards external borrowing and more noticeably, sovereign bonds. The government intends to borrow Sh300 billion from the international market this financial year as highlighted in the 2017-2018 national budget.

This means the country could be headed for a third round of borrowing through the issuance of a Eurobond under the planned commercial debt-financed deficit worth Sh300 billion. It would be the third issue of a Eurobond, after the two previous issues of June 2014 and February 2018.

The February 2018 issue was seven times oversubscribed, a move that Treasury interpreted as an indication of confidence in the long-term prospects of the Kenyan economy by international investors.

That said, there is still concern over Kenya’s debt load which has an indirect and unproportional relationship to revenue growth indicating a potential risk of widening gap and consequential pressure on the government to repay loans.

Eurobond funding 

A look into other options of raising funds makes the Eurobond the tenable option or better yet the “bird at hand”. Other options of raising fiscal revenue include an increase in tax rates.

The 2018 draft Income Tax Bill proposes to introduce a raft of measures that include the introduction of a higher corporate income tax rate of 35pc for companies applicable to taxable income in excess of Sh500 million; higher restriction on the deductibility of interest expense on foreign-controlled companies; among others. All these moves seem punitive to the taxpayers therefore making the move to broaden tax bases and increase tax rates undesirable.

Another move is to shift to domestic borrowing. The downside to this is that public domestic debt tends to be more expensive than external debt. This is because as the public domestic debt keeps on rising, governments resort to raising the interest rate to continue attracting investors which raises the cost of public debt servicing. Also, excessive domestic borrowing leads to crowding out of the private sector which is a major driver of economic growth.

An alternative to raising the funds under commercial financing terms would be through syndicated loans, which are more costly and which essentially leads us back to the Eurobond. The solution, therefore, lies in making lemonade out of the Eurobond lemon through effective public debt management.

A look at some Sub-Saharan Africa economies caught in a fire cross in regards reliance on public debt should help shed light on management of public debt to avoid similar pitfalls.

Ghana’s public debt crisis was mainly caused by falling global commodity prices and their over-reliance on commodities and failure to invest amounts borrowed in projects that would yield economic returns coupled with unwise debt management. Mozambique, on the other hand, is in an actual crisis after defaulting on debt payments which saw its debt-to-GDP ratio hitting 113.6pc in 2016.

Making reference to the two cases, policies the government should look into to avoid getting into debt distress include investment of borrowed funds in projects with high enough economic returns to guarantee debt repayments to ensure the cycle of borrowing funds to pay back maturing debt instruments is broken; improved revenue mobilization in an aim to narrow the budget deficit.

This has been seen through the recent 2018 draft bill to revamp the Income Tax Act which had provisions like expansion of tax base by targeting the informal sector by reintroduction of presumptive tax among other provisions to improve KRA administration; diversification of the economy to reduce overreliance on agricultural commodities which are subject to fluctuation of global commodity prices and changes in climate which are beyond the control of the government.

It is, however, important to note that Kenya is moving towards a more diversified economy. Finally, diversification of the currency structure and composition of external debt to minimize foreign exchange risk.

By Anne Bundi, Senior Tax Consultant at EY. Views expressed in the article are not necessarily those of EY

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