The “Why” of Debt

Pre-cursorily, debt is indeed a double-edged sword. Wise and moderate use of the same, history has shown, results in improved welfare. Improper, imprudent and over-indulgence in debt, may end up being calamitous. On one hand, for households, individuals and private entities, excessive borrowing causes insolvency/bankruptcy and the ultimate result is financial decrepitude. On the other hand, for a country, unchecked and uncontrolled borrowing impedes the ability of governments to deliver essential services to the citizenry. Strictly speaking, soaring and lofty debt levels will undoubtedly cause justifiable questions and concerns.

It cannot be gainsaid enough how financing budgets remains a key building block for spurring economic growth and development. Using debts to partly finance budgets is one of the ways of budget financing. With debt, an individual is able to juggle personal needs even with reduced income. For states, the glaring possibility of staying poor without debt to support their financial wherewithal remains high. History, over time, has shown that unchecked borrowing can cause vulnerabilities. The rise of debt ratios beyond prescribed levels, results in severe financial crises. As a result, fiscal authorities need to be on the watch to ensure debts do not reach unprecedented levels, as it is their core function to stabilise the macroeconomy.

Fiscal Consolidation

Kenya, just as any other country, has on various occasions borrowed both internally and externally to meet pressing developmental needs. Over time, the country’s debt obligations have soared high, causing alarm, and possibly the need for a strategic redirection on the country’s approach towards debt management. There also exists the urgent need to raise more revenue by plugging leakages and, most importantly, retiring expensive commercial debt for concessionary debt by multilateral players or the Bretton Woods institutions. In order to finance its ambitious plan christened the Bottom-Up Agenda, the William Ruto-led government has embarked on a fiscal consolidation scheme centred on capping expenditure while broadening tax collection to sustain the economy.

Fiscal consolidation remains inevitable in Kenya’s current context of low growth, high inflation rates, huge debt deficits and the challenge of deteriorating fiscal performance. More so, fiscal consolidation appears unavoidable in the current environment of low growth, high debt, and deteriorating fiscal performance. As Rodrigo de Rato contends, “the reality is that countries that decide to postpone fiscal reform and adjustment for fear of the political and economic consequences usually end up paying a much higher price when economic necessity forces them to act.”

The Medium-Term Debt Strategy, 2023

Public and publicly guaranteed debt in nominal terms as at end of December 2022 was Kshs. 9.1459 trillion compared to the statutory public debt limit of Kshs. 10 trillion as per the PFM (National Government) (Amended 2022) Regulations, 2015. Total external debt was Kshs. 4.6731 trillion while total domestic debt was Kshs. 4.4728 trillion. The December 2022 Debt Sustainability Analysis (DSA) indicates that Kenya’s public debt remains sustainable but the government must reduce fiscal deficits to reduce the rate of debt accumulation.

It is against this backdrop that the National Treasury has come up with a Medium-Term Debt Strategy (MTDS), 2023. Prepared in line with the dictates of Section 33(2) of the Public Finance Management (PFM) Act, 2012 as well as the guidelines enunciated in the Debt and Borrowing Policy, the 2023 MTDS appreciates that there exists an underlying need to address the costs and risks linked to public debt. This position is also anchored in the 2023 Budget Policy Statement (BPS).

In terms of perspective, the 2023 MTDS envisages maximisation of concessional and semi concessional external debt while proposing liability management operations in the domestic and in the international capital markets. The domestic funding components will be through medium to long-term bonds as the stock of Treasury bills is reduced to lengthen the maturity structure and reduce refinancing risk.

The Strategy also appreciates the need to improve and develop the domestic debt market. It underscores that the development of the domestic debt market is a precursor for accelerating attainment of affordable, sustainable long-term financing for economic recovery. This is also in line with Vision 2030 as well as the Medium-Term Plan. The Strategy also appreciates that public debt would be sustainable if there is total commitment to pursue the path of fiscal consolidation as a way of ensuring macroeconomic stability.

With the appreciation of the current risk characteristics of Kenya’s current debt stock, the 2023 MTDS emphasizes on prudent management of public debt, alternative borrowing strategies and adherence to the fiscal deficit approved by Parliament. Salient to the 2023 MTDS, is the aspect of alternative sources of financing. Each proposed alternative emanates from a consideration of the cost and risk associated with each alternative strategy to arrive at the optimal financing strategy. The consideration fundamentally concentrated on potential funding sources from domestic and external debt capital markets and the corresponding risks and costs.

The 2023 MTDS has fronted four alternative financing strategies to fund the fiscal deficits for the FY2023/2024 and the medium-term borrowing. They include: –

1.   Option 1 (S1) –Biased financing towards more domestic borrowing

This strategy assumes a net borrowing of 81 percent from domestic and 19 percent from external sources. Domestic borrowing is through issuance of Treasury bonds while maintaining the stock of Treasury bills to continue mitigating refinancing risk. External sources are assumed to be through concessional debt with no commercial borrowing to reduce the cost of debt and foreign exchange rate risk.

1.   Option 2 (S2) – Biased financing towards more external debt

This option assumes financing majorly from external debt with a net financing of 60 percent external and 40 percent domestic. Under this strategy, financing will be majorly from commercial, semi-concessional and concessional sources. From the domestic market, the strategy assumes Treasury bonds to be the only source of domestic financing. This option aims at reducing refinancing risk and interest rate risk while at the same time reducing the overall cost of debt.

1.   Option 3 (S3) – Gradual lengthening of domestic debt maturity profile

This strategy assumes financing the fiscal deficit majorly from the domestic market with a net domestic financing of 71 percent and 29 percent from external sources. The strategy aims at gradually reducing the stock of Treasury bills to manage refinancing risk and issuing medium-long term Treasury bonds. On the external borrowing, it assumes that the total financing will be from concessional debt.

1.   Option 4 (S4) – Balanced domestic-external financing strategy

The strategy targets a balanced funding of the deficit from both domestic and external sources. The strategy envisages 50 percent net domestic and external borrowing from each source. It will maximise concessional borrowing while commercial debt will be rolled over. The medium to long-term Treasury bonds will be the main source of financing from the domestic market. This strategy is positioned for flexibility in financing the deficit from both sources should one source fail. Under this strategy, the government may consider augmenting any of the two sources depending on domestic and external market conditions.

Call for Reforms

The National Treasury has also proposed some reforms for Kenya’s public debt management. They include: –

(a)  Firstly, the PFM Regulations, 2012, has created the terminologies “Public County Debt” and “Public Debt” which are not envisioned in the PFM Act as well as Article 214(2) of the Constitution and hence the need to align the same.

(b)  The proposal to replace the current public debt limit of Kshs. 10 trillion with a debt anchor hinged on Gross Domestic Product as a desired level of public debt as a ratio of GDP.  The argument is that this allows for flexibility and recognition of the periodic impact of exogenous shocks on debt and GDP. Therefore, the practicability of anchoring the debt limit to National Gross Product will be assessed as a more precise measure of relative size of debt.

(c)   Guidelines for the Sinking Fund to provide liquidity for timely funding for redemption of government securities, and payment of expenses, or incidental to, redemption of an issue of national government loans.

Conclusion

It needs to be appreciated that despite having such an optimal strategy in place, which could potentially lead to reduced overall debt to Gross Domestic Product (GDP) ratio, cost of debt, risk and interest exposure and refinancing of risk, the implementation and success of the strategy will ultimately depend on prevailing market conditions that will trail the current global economic uncertainties. The government will certainly have to ensure its continued participation in international markets by reducing the existing commercial maturities, and possibly consider liability management operations ahead of scheduled maturities if the international debt capital market condition improves.

Fundamentally, the government through the 2023 MTDS, has reiterated the centrality and importance of stepping up reforms in the domestic debt markets to ensure more depth, diversification and increased role of the domestic debt market in meeting the financing needs of the government. The government has again appreciated the role that financial institutions may have to play here, as part of its concerted efforts to ensure public debt remains at sustainable levels.