The risks of foreign denominated debt for Kenya

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Anyone keeping an eye on the economy will have noted the level of public debt being accrued, particularly foreign denominated debt. Total debt stood at KES 2.37 trillion (USD 26.78 billion) after Kenya’s sovereign bond issue in June. The concern with the debt being accrued is that we are getting into larger foreign denominated debt than previously was the case. Kenya is an import economy so by default, in order to service foreign debt, government has to buy dollars. The assumption being made is that the foreign debt will boost the economy primarily through investment in infrastructure which is expected to generate the capital required to service the debt. It is important to note that although there is support for this hypothesis there are also those who question the logic that infrastructure equals growth. In fact, the London School of Economics states that, ‘empirical estimates of the magnitude of infrastructure’s contribution (to growth) display considerable variation across studies. Overall, however, the most recent literature tends to find smaller effects than those reported in the earlier studies’. This article will not debate this point but instead highlight the challenges Kenya will face should this almighty investment in infrastructure not generate the growth expected. How does payment in shillings affect the economy should the foreign denominated debt fail to yield the returns expected of it? How then, will government raise shillings to service this substantial debt?

Debt The first and most obvious option is for government to raise taxes in order to raise shillings that can then be used to service the debt. But Kenya is already a heavily taxed country and one wonders if we have reached a point on the Laffer Curve where raising taxes further will harm profitability and actually lower revenues. Tax rates that are too high effectively penalize people for engaging in economically productive activities; so government risks harming its own revenue if increasing taxation becomes the main strategy used to raise shillings.

The second option is to borrow shillings locally and use this capital to buy dollars and service the debt. The argument has been made that Kenya entered into foreign debt to ease pressure on local credit and interest rates. But if that investment doesn’t yield what is expected then government may have to borrow locally to service the debt anyway. This borrowing obviously crowds out the private sector and reduces private sector access to credit. One consequence of this it that private sector may not be able to implement activity and developments that were to be debt financed. Further, but borrowing locally, government will put pressure on interest rates possibly pushing them up which again, will make credit less available to private sector borrowers. The economic growth of the country may then be muted because private sector and SMEs would not been able to access the credit they needed to become more productive. Further, borrowing locally does not solve the debt problem but merely rolls it over to be dealt with at a later date.

taxman

The third option for government is to implement austerity measures and reduce recurrent expenditure so that more shillings are made available for debt servicing. But in Kenya, this option does not seem feasible. The prevailing climate in the country is one where those being paid by Kenyans always seem to want to increase their salaries not reduce them. This makes it very difficult for government to reduce recurrent expenditure.

The fourth option through which government can ‘raise’ shillings is by printing shillings. Government has done this in the past and this phenomenon is certainly not unique to Kenya. The problem with printing money is that it expands money supply which often drives inflation up. The excess supply of KES can also lead to a further depreciation of the currency making it even more expensive for government to buy dollars and service foreign denominated debt. Therefore if the government prints KES, it will be effectively making the debt more expensive.

Growth

Clearly, none of these four options are attractive and each has consequences that could have economic and perhaps even socio-political implications. These options present the risks Kenya faces as it enters into an era of acquiring and servicing foreign denominated debt on a scale far larger than ever before.

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