The Mombasa Road that runs from Kenya’s capital, Nairobi, to the country’s principal port is a near constant gridlock. A single, cracked lane goes in both directions, leaving the trucks that supply East Africa’s economic hub queueing for miles on the outskirts of the city.
Kenya’s battered and overstretched transport infrastructure is one of the country’s perennial barriers to economic development, adding cost and risk to trade within the entire region and slowing the growth of local enterprises. Finding ways to finance the estimated $4bn a year infrastructure deficit has been a constant challenge for successive Kenyan governments.
A $2bn Eurobond in June 2014 could mark the beginning of an international issuance spree, with the government discussing Samurai bonds and sukuk to exploit market appetite for the country’s debt. But with external debt increasing, analysts are worried about the implications on macroeconomic stability of borrowing in hard currency when global market conditions remain uncertain.
“There’s a sizeable infrastructure gap that they have to close, and Kenya lies at the heart of this region that is expected to take off in growth terms. There will be concrete economic benefits to Kenya from scaling up its infrastructure,” says Razia Khan, head of Africa research at Standard Chartered in London.
“But at the same time we know that Kenya isn’t necessarily immune from shocks. Nobody is saying that Kenya doesn’t have a good plan, but great things will not happen just because it’s got the infrastructure in place. The building blocks are there, but there is need for some conservatism in terms of that external issuance.”
Political and economic turmoil have repeatedly delayed Kenya’s attempts to access international capital markets.
A $500m Eurobond was scheduled for launch in 2008 but was shelved after the country’s 2007 elections descended into violence that killed more than 1,000 people. For six years, Kenya has struggled with the social and economic consequences of that conflict, which hit confidence and growth. GDP growth fell from 7% in 2007 to just 1.5% in 2008 and the recovery has been slow.
In 2011, a combination of speculative attacks on the shilling, rising fuel prices, a drought and the political crisis in Egypt, which was one of the main markets for Kenyan tea, caused the Kenyan currency to collapse from 83 shillings to the US dollar to 100.
In 2012, as another election loomed, the finance ministry doubled the size of the supposed bond issue to $1bn. That election threw up yet another political red flag for investors. The winner, Uhuru Kenyatta, and his deputy, William Ruto, were named by the International Criminal Court as suspected instigators of the 2007-8 violence, complicating their dealings with global powers and potentially destabilising their new government.
A brief period of relative calm in 2013 was shattered when militants allied to the Somali terrorist group Al-Shabaab took over the Westgate shopping mall in Nairobi, killing 63 people and prompting a slump in tourism that was perpetuated by violence in resort towns on the coast.
A putative boom in frontier market debt, which had buoyed issuance from Zambia, Nigeria and Rwanda in 2013, also seemed to have ended after the US Federal Reserve indicated that it would taper its programme of quantitative easing. Ghana, which came to market in July 2013, paid a premium on its $750m Eurobond, with a coupon of 8%.
Despite these environmental concerns — and fears over deteriorating security in the country — the finance ministry embarked on a global roadshow and finally took its $2bn Eurobond to market in June 2014.
VERY DIFFERENT CREDIT
With a coupon of 6.875% on its 10 year note, the bond was not cheap and Kenya paid a premium for the size of the issue. Cote d’Ivoire, a country still recovering from decades of civil war, which restructured its debt only three years ago, paid only 5.625% less than a month later. Even so, the pricing was better than many analysts expected.
“The market has reacted positively to Kenya’s debt issues for a number of reasons. The main one is that compared to a lot of other sovereigns that have already issued it is seen to be a very different credit,” Khan says.
Although Kenya does not have the large current account surplus of Africa’s oil-producing countries, it has a diversified economy with a long history of private sector driven growth. Its successful adoption of mobile finance and financial intermediation has built a sound case for growth.
“All of these things we know about,” Khan says. “But what is untested is how that debt performs when external conditions tighten.”
The Eurobond is only a small part of the overall infrastructure plan. Over the past year, the country has been issuing local currency infrastructure bonds, waiving the holding tax requirements to bring in local and institutional investors. Direct investment, for the most part from China, has begun to flow in as has money from the international public sector. At the end of July, the government agreed to borrow $685m from the African Development Bank for investment in the power grid.
Almost immediately after the Eurobond had come to market, Kenyatta announced that the government was considering a yen-denominated Samurai bond, as well as a shariah-compliant sukuk to increase its foreign debt portfolio and reduce its domestic borrowing requirement by around $1bn.
PriceWaterhouseCoopers estimates that by 2025 the country will be spending $12bn a year on infrastructure, including more than $60bn in public sector led projects between 2012 and 2020. Among the mega-projects underway is a $4bn rail line between Nairobi and Mombasa financed by a loan from the China Export-Import Bank, which will take some of the strain off the existing route. A $500m oil pipeline contract between the two cities was awarded to a Lebanese firm, Zakhem International, in July.
The port at Mombasa is being expanded to add 50% to its capacity, while a new port facility is being built further up the coast at Lamu. Three new airports at Malindi, Mandera and Suneka — in the east, north and west respectively — will take some of the pressure off Jomo Kenyatta International Airport in Nairobi, which is a passenger and freight hub for the region.
Public debt reached 52% of GDP in the first half of 2014 — not high by international standards, but up from 44.5% the previous year. Some investors have expressed mild concern at the direction of travel, given that other frontier market issuers, such as Ghana, have gone to market and then shortly after struggled with rising expenditures without any appreciable increase in revenue.
“That is a big concern, that a country that has good growth prospects but nothing spectacular, nothing to really set it apart in growth terms from its regional peers, already has a high debt ratio and a great appetite for external borrowing,” Khan says. “The concern is that it can do so in current market conditions, but almost nobody expects those current market conditions to remain in place.”
Some of the rise in expenditure has been as a direct result of the country’s efforts to reduce social tensions. After the 2007-8 election violence, the country adopted a new constitution that devolved powers from the central government to regional administrations. In the long term, this could reduce the tensions that still exist within the country, but in the short term it is proving a drain on resources.
SHORT TERM EXPENSE
“There’s been a lot of expenditure to set up these new seats of county government,” says Angus Downie, head of research at Ecobank Capital in London. “When you set up these new seats from the centre to the local level you end up having to put in place these new systems and procedures, which means new headcount but also the physical infrastructure. You’ve got to build new buildings, get the computers in and IT and the chairs and vehicles and the running costs for those vehicles.”
While expensive in the short run, these expenses are time bound and should not have a longer term negative effect on the government’s finances.
“A lot of the expenditure that we’ve seen recently has been earmarked for that devolution of power. You’re not going to see that repeated in years to come. Once they’ve set everything up it’s just the running costs,” Downie says. “Assuming that Kenya can increase its revenues from the private sector, the corporate sector and individuals, trade taxes and everything else in between, I think they should be able to bring the fiscal deficit down.
“Longer term the outlook is good, but I think there are some short term problems that are stretching the authorities’ capacity to deal with them successfully.”
The country collected $11bn in taxes in the fiscal year 2013/14, and has increased its revenue target by 16% for 2014/15. However, tourism arrivals in the high season dropped 4% year-on-year between 2013 and 2014, in part due to travel warnings issued by the US and UK governments.
In the longer term, some of the shortfall could be covered by hydrocarbon exports. Oil was discovered in the north of the country in 2012 and production could begin within the next three years. The sector should attract capital investments — Ecobank estimates that it will need $16bn between now and the expected date of production in 2017.
“Once production starts it will ramp up and the revenue from that, both corporate tax and royalties from hydrocarbon production, should be an interesting new stream,” Downie says. “But whether it’s spent wisely I can’t say. We have to assume it will be, but you only have to look at some of the countries that have been hit by the resource curse. The hope is that it won’t be repeated in Kenya but history does show in Africa that these problems can occur.”