By John Mburu
The sustainability of public debt is a hotly debated topic in Kenya. The media and the public sentiment are that the public debt is high, while policy makers – especially at National Treasury believe that the debt level in Kenya is sustainable. The public debate has largely played out on social media with Kenyans expressing anger at the continued government borrowing by starting a petition and a twitter hashtag #stoploankenya to cancel an IMF loan of Ksh 255 billion to Kenya in 2020[1]. The debate on public debt in Kenya is usually anchored on the public debt to GDP ratio, which in 2020 stood at 69 percent[2]. Figure 1 below shows the evolution of debt to GDP ratio for domestic and external debt in Kenya[3]. The figure shows that public debt has been increasing since 2011 and by 2020 had reached the 2001/2002 level. This is quite worrying given the pre-2002 period was characterized by poor economic growth.
Public debt imposes two kinds of costs to a country: fiscal costs and welfare costs. Since public debt must be retired/repaid, it is only possible to repay if economic growth is high enough such that the increase in output is able to pay debt redemption and interest rates. If growth is low, the country faces a fiscal cost, as the government must reduce expenditure in future or increase taxes to repay the debt. A country incurs a welfare cost if debt distorts the incentive faced by private enterprises such that the future level of output or income is lower than it could have without the debt. Excessively high public debt leads to higher interest rates, and can lead to debt crises, and lower future output or income.
To better understand the costs or burden of public debt, we must look at two key issues. First, who is the creditor, and second what is the structure of the debt agreement.
With the first key issue, the creditor matters as different creditors will offer different interest rates and repayment structures. There are three types of creditors that loans to governments: multilateral lenders, bilateral lenders, and commercial lenders. For example, the IMF loan of Ksh. 255 billion is from a multilateral lender, since IMF is an institution formed by a group of countries to guarantee global liquidity and proper functioning of global payments system. On the hand, the loan from China of Ksh. 285 billion to build Standard Gauge Railway (SGR) between Mombasa and Nairobi, is a bilateral loan as it involved only two countries. Commercial lenders are, for example, Kenya Euro bond investors who offered $5.4 billion in 2021 to Kenya for a $1 billion Eurobond issue.
The type of the lender has huge implications for the interest rates, repayment period, grace period and likelihood of restructuring of the loans in case of repayment challenges. Multilateral lenders offer loans at concessional rates and tend to give longer grace periods and repayment periods compared to bilateral and commercial lenders. For example, Nairobi-Thika highway was financed by Africa Development bank (multilateral), China Exim Bank (bilateral) and the Government of Kenya. The African Development Bank offered a loan of $175 million in 2007 at an interest rate of 0.75 percent to be repaid in semi-annual installments starting November 2017 to May 2057. The Chinese Exim Bank offered $100 million in 2009 at interest rates of 2 percent to repaid in semi-annual installments starting from September 2017 to March 2030.
In this example, the bilateral loan was more expensive compared to concessional loan from multilateral lender and has a longer repayment period and grace period than the multilateral loan. Furthermore, as seen during the pandemic, multilateral lenders are more willing to reschedule debt repayment than bilateral lenders. Commercial lenders are even more expensive than multilateral and bilateral lenders. For example, the 2021 Eurobond coupon rate was 6.3 percent, and the 364 days treasury bills average coupon rate was 7.4 percent[4]. Figure 2 below shows the contribution of multilateral, bilateral and commercial lenders to debt stock in Kenya. Here we sub-divide commercial debt into domestic and external debt, as commercial debt can be incurred by issuing debt denominated in local currency or foreign currency like US dollar.
Figure 2: Kenya has shifted government debt composition from cheap to expensive sources[5]
The figure shows the sources of debt has shifted from bilateral and multilateral lenders to commercial lenders since 2014 when Kenya become a lower-middle income country. While in 2000 the share of commercial debt in total debt was around 33 percent, by 2020 the share had increased to 62 percent. This is shift is likely to be accompanied with higher debt repayment obligations because commercial debt, as demonstrated, attracts higher interest rates than multilateral debt. There are several reasons that led to the increase in the commercial debt. First, Kenya rebased its GDP in 2014, which indicated that the economy was larger than previously thought. This led to a reduction in our debt to GDP ratio and made it easier for Kenya to access commercial loans[6]. Second, the rebasing also made Kenya a lower middle-income country and hence, Kenya did not have access to low-cost borrowing. This pushed the Government to look for other sources of financing i.e., commercial lenders.
The second key issue is how the debt is structured. Here the main question here is whether the debt is long term or short term. Most countries prefer long term debt as it is cheaper and less likely to lead to liquidity issues during repayment. Figure 3 below shows the average terms of new external borrowing commitments. The figure shows that the tenor of external debt has reduced from around 36 years in 2005 to 15 years in 2019, while interest rates have increased from 1.3 percent to 3.9 percent in the same period. The grace period (time granted by the creditors before the government can start paying interest rates and repaying the debt) has also declined from an average of 8.6 years to 5.6 years. The shortening repayment period and grace period, and higher interest rates has increased the cost of debt imposed on Kenyans. It implies that Kenyans are required to start paying debt sooner, with a shorter repayment period and higher interest rates. Since debt is used to finance long term infrastructural projects, it is likely that the projects have not generated enough income for repayment. The mismatch between the income generated by the long infrastructural projects and the need to repay the debt, implies that the government either must increase taxes or reduce expenditure.
Figure 3: The average terms of new external borrowing commitments[7].
Figure 2 and 3 indicates that the increasing debt burden in Kenya can be attributed to two shifts in the last 14 years. First, the shift from multilateral debt to commercial debt and second, a shift from debt with long tenor to debt with shorter tenor. These two trends are related as commercial debts is not offered on concessional terms and hence is likely to have a shorter maturity, higher interest rates and a shorter grace period. This development in public debt imposes high fiscal and welfare costs on Kenyans. Therefore, Kenyans should be worried about the current level of public debt because first, the fiscal cost Kenyans are incurring in terms of higher taxes and likely future cuts in government spending in primary services. Second, the wealth cost Kenyans are likely to incur because of crowding out of the private investment. Lastly, the high interest rate payment drains the little foreign reserves available for private investment. This affects the rate of accumulation of capital and technology in Kenya.
[1] As of July 13, 2021, the petition had 236,240 signatures. https://www.change.org/p/imf-executive-board-petition-to-the-imf-to-cancel-the-ksh255-billion-loan-to-kenya
[2] See Budget Statement FY2021/22 point 98
[3] Data source: Central Bank of Kenya (Domestic and external debt) and World Development Indicator (GDP)
[4] https://www.centralbank.go.ke/bills-bonds/treasury-bills/
[5] Source: National Treasury of Kenya: Various annual debt reports
[6] https://www.brookings.edu/blog/africa-in-focus/2014/10/03/africa-in-the-news-kenya-becomes-a-middle-income-country-mo-ibrahim-index-released-south-sudan-peace-talks-yield-promise/
[7] Source: National Treasury of Kenya: Various annual debt reports