BY KWAME OWINO
On May 12, 2023, provider of financial research, Moody’s Investors Service (Moody’s) reduced Kenya’s long-term foreign currency and local-currency issuer ratings and “senior unsecured debt” ratings to B3 and placed the ratings on review for downgrade, painting a gloomy outlook.
Increase in government liquidity risks is the driver of the advisory note, which was released soon after the National Treasury sent to parliament the estimates of revenue and expenditure in addition to a heavy Finance Bill, 2023.
Now that it has been issued, the decision to downgrade the country’s debt rating is not a surprise to many Kenyans even if the attention that it received may have exceeded that which was accorded to other announcements of a similar kind in the last two years. It leads to the question on whether the debt rankings matter and what the consequences of this downgrade of public debt would be for Kenya.
In the last quarter of the financial year, the government has not only had serious delays in the meeting payments that came due, but also admitted to failures to pay wages promptly and suspended a large number of activities that were included in the financial year that is expected to terminate on June 30, 2023.
The pressure to explain the delays in disbursement of funds to a variety of ministries, departments and agencies of the government led to a disclosure of the state of public finances for the first three quarters of the year. As illustrated in the chart below, public spending by the national government was behind the allocated amounts owing to delays in the revenue receipts from taxes and the expected borrowing from both the domestic and external sources.
The left hand side of Chart 1 above shows the pending balances that were expected to fund the operations of the government for the fiscal year set to commence from July 01, 2023. It shows that on a prorated basis for nine of the 12 months of the financial year, all the 3 sources have shortfalls, confirming the claims that there are significant delays in budget execution.
Since the chart shows the prorated figures for only nine months, the situation suggests that the revenue efforts and the domestic and foreign funding for the final quarter of the year will have to be executed aggressively to ensure that the budget achieves balance according to the approved expenditure. In total, by the end of March 2023, a total of Sh620 billion of which 43% represented balances due to delays in procuring debt from domestic sources in Kenya.
The blue bars on the right hand side of the Chart 1 show the balances for pending disbursements up to the end of March 2023. Disbursements for meeting obligations to the Consolidated Fund Services accounted for 44.83% with county government allocations representing 14.03% of balances to be paid. The combination of the revenue shortfalls and delays in disbursements up to the end of the third quarter of the year become significant in light of downgrade in the sovereign debt rating for Kenya.
Chart 2 presents the same data in chart 1 on a prorated basis with measurement time (months). This time measurement scales the balance for revenues and the disbursements in terms of the months. Again, it provides further clarity to the balances that have been presented in nominal terms in chart 1. Instead, chart 2 illustrates that on a prorated basis, taxation revenues are behind schedule by 1.07 months with an equivalent delay of 3.64 and 3.57 months respectively for approved borrowing from domestic and external sources respectively. These delays in turn are mirrored by disbursement delays of 2.15, 3.67 and 2.64 months for CFS, totals for national government and county governments respectively.
Why the downgrade matters
It should be reiterated that the downgrade matters and there are four main reasons behind this view. The first conclusion from the downgrade is that analysts at Moody’s took account of the facts represented in the two charts above and concluded that the public finances in Kenya are much weaker and the public finance situation for the remainder of the financial year will deteriorate. This is used to justify the downgrade.
Looking at the summary of Chart 1 and Chart 2 above, it is difficult to contradict that view. Kenya is in a precarious situation in respect of sovereign debt. With the delays represented in Chart 2, it is unlikely that the entire gap will be closed in the quarter starting from April and ending in June 2023.
It is important to note that the conclusion of an agreement with the IMF on May 23, 2023, which states that there will be a 10-month extension of the existing agreement on the Extended Credit Facility (ECF) and the Extended Fund Facility (EFF) altogether augmenting the existing agreements by Sh336.8 billion ($ 2.43bn), still holds water. This will ease the pressure for budget execution. However, the statement suggests that the approval of the Board of Management will come in July 2023, which means access to the resources will (only) be available in the next financial year.
Secondly, this downgrade matters for the reason that it provides a counterpoint to the formal Debt Sustainability Analysis (DSA) dated March 19, 2021. By implication, the downgrade suggests that those who would be counterparties to Kenyan government in the bond markets have had their faith shaken about sustainability in the immediate and medium term periods.
The DSA summary stated that the individual risks for external debt distress and overall debt distress were both high. Even with the concession of this high risk of debt distress, the downgrade confirms that the market shows that the DSA situation does not presently reflect overall reality for both the overall and external debt. This deterioration in the debt conditions means that while the downgrade is not deterministic, it creates the impression that the probability of a default by Kenya is higher than it has been in the last two years.
A third consequence of this downgrade will be that a classification of sovereign debt at B3 status means that the borrowing costs for both domestic and foreign loans will rise. This too is not good news because at the end of April 2023, the markets for public debt in Kenya were constrained, with the bids for public bonds and bills falling below offers. For instance, in February 2023 the Central Bank of Kenya sought to sell two bonds of 10 years each and received success rate of 33.4% against the expected sum of Sh50 billion. In the ensuing two months before the announcement of the downgrade, there was difficulty in generating interest and raising the uptake for bonds. Most of the trade was in shorter term debts with an unprecedented cancellation of a 15-year bond owing to demands by buyers for higher interest rates. In essence, the downgrade in May 2023 is likely to exacerbate a serious situation because it will raise borrowing costs further.
A fourth point emerges from the convergence of debt distress and the repayment options that government of Kenya retains. A significant but unseen source of debt pressure for Kenya comes from contingent liabilities and pending bills. The quantum of the contingent liabilities can be reasonably shown but the added risk comes from pending bills that inhere from unauthorized commitment of public funds and weak oversight in contracting. Pending bills are quantified as equivalent to Sh537.2 billion in the Quarterly Economic and Budget Review issued in May 2023, but reflecting data up to the end of March 2023. In view of this reality, the actual extension of the debt problem is larger and will remain a risk for sovereign debt servicing for the medium term.
In conclusion, the assessment by Moody’s is hinged on the incontrovertible fact “that overall liquidity risk” for Kenya has increased. This situation will be carried forward to the next financial year and so a keen watch on government’s ability to raise funds in a situation where inflation has been outside the safe range will constrain its options even further. This situation is also aggravated by the depreciation of Kenya’s currency which makes external debt servicing more expensive. A rating of B3 is a serious commentary that points to not only the challenges of raising funds but also an echo of overall financial management. In addition, the social costs of the new taxation measures and the reduction of public services require handling with dexterity. – via the Institute of Economic Affairs
