Treasury Overshoots Domestic Debt Limit

Treasury has busted its domestic borrowing target for the current financial year, pointing to the fact that the economy is not out of the woods yet and sparking debate over the country's ability to cope with the debt in the long term.

Domestic borrowing passed the Sh109.5 billion mark that Finance minister Uhuru Kenyatta set in the budget by Sh250 million according to official figures published in the Kenya Gazette last week with the Central Bank indicating that it might take in more debt in the coming months to meet rising public expenditure needs.

Heavy borrowing by the government is usually associated with high interest rates that arises from the crowding out of the private sector from the debt market but analysts reckoned a combination of monetary policy actions and structuring of the debt has smoothened it out.

"The reduction of cash ratios and a cutback in the benchmark Central Bank Rate has left commercial banks awash with cash," said one economist at Treasury who did not want to be named for lack of authority to speak to the media.

"It has also helped that private sector's demand for debt remains subdued easing competition in the market," he said.

Central Bank Governor Njuguna Ndungu attributed the borrowing overshoot to the rise in public expenditure needs such as importation of maize to stave off mass starvation and procurement of emergency power generators in the wake of severe drought that significantly reduced the country's hydro power output.

"These are expenditures that were not factored in the budget prompting a review that necessitated an increase in domestic borrowing to cover the shortfall," said Prof Ndung'u.

Economists however worried that too much debt might make it difficult for the Central Bank to roll back the monetary easing actions it has taken in the recent past and to get the country back to price stability.

Remains on schedule

Treasury has issued a Sh16.5 billion bond whose auction closes today taking the borrowing level further past the target but Prof Ndung'u maintained that it "remains on schedule as planned with market leaders.'

At nearly Sh110 billion, government borrowing stands at more than double the Sh54 billion it borrowed in the last financial year.

The failure of this heavy domestic borrowing to negatively impact on interest rates has been the subject of intense debate among analysts with some attributing the relative stability to the fact that a significant fraction of the debt is long term and has been put into investment as opposed to consumption.

Kenya has had a bad experience with heavy government borrowing from the domestic market that sent alarm bells ringing when Mr Kenyatta announced plans to take more than Sh100 billion from the local economy in his June 2009 budget.

Robert Bunyi of Mavuno Capital maintained that increased domestic debt could have only a slight impact on interest rates, citing continued improvement in revenue collection and ongoing recovery of the economy.

"We can increase the debt level much further as long as the revenue base and the overall economy remain on the growth path," said Mr Bunyi. "The economy is yet to pick up speed keeping demand for credit by the private sector in check."

The latest 15-year Treasury bond issue carries a coupon rate of 10.25 per cent -- lower than last year's issue of a similar tenor that had a coupon rate of 12.5 per cent.

"The outcome of the 15-year Sh16.5 billion bond on offer should determine the direction of interest rates and the attractiveness of any further borrowing," said Einstein Kihanda, a fund manager at Sanlam, an investment firm.

Government debt has been receiving oversubscription in the recent past pointing to a high appetite for the risk-free debt that analysts expect to persist till the end of current financial year.

Inferior returns

Institutional investors such as fund managers, commercial banks, insurance companies and pension schemes are the largest buyers of bonds in Kenya.

Their appetite for government debt has been linked to inferior stock market returns and the easing of monetary policy that has left banks with loads of cash.

Some analysts however warned that the real import of heavy government borrowing lies in medium to long term implications that are linked to the cost of debt servicing.

As the debt matures, the government will have to fork out more money to service it, posing the danger of putting Treasury in a vicious circle of borrowing.

The cost of domestic debt has increased by 23 per cent in the last nine months, according to CBK with some analysts saying it could rise by up to 50 per cent by the close of the current financial year.

"From July to March the cumulative expenditure on interest and other charges on domestic debt amounted to Sh39.5 billion compared with Sh31.9 billion in a similar period in the last fiscal year", said CBK in its latest Weekly Bulletin.

At this rate, the interest payments is higher than development vote for the Ministries of Roads, Education, and Energy whose votes were Sh28 billion, Sh16 billion and Sh20 billion respectively.

Despite this increase, the government has received rare positive reviews from the International Monetary Fund (IMF) terming it manageable, which maintains that Kenya's debt to GDP ratio remains low leaving sufficient headroom for additional borrowing.

"It has been at 40 and has only risen by two percentage points to 42 per cent of GDP with the current global crisis," said Michael Atingi Ego, IMF's Kenya mission chief and senior advisor at the institution's African department.