News Column

Kenya's Eurobond Issue Success Comes With Immense Risks

June 27, 2014

Karen Kandie

The oversubscription obtained on the debut Kenya's Eurobond is a vote of confidence by investors on the economic fundamentals of the country, the strength of its balance sheet and its political stability. While the country was willing to borrow $2 billion, the offer from investors amounted to over $8 billion. We have reason to celebrate this success.

The structure of the Eurobond was a two-in-one transaction, with one transaction of $500 million and the other $1.5 billion. The pricing of 5.875% on the 5 year tenure bond of $500 million and 6.875% on the $1.5 billion bond with tenure of 10 years can be considered perfect in view of rates obtained by countries with similar international credit rating.

Going forward, the Eurobond will require $132.5 million in interest the next five years, after which the principal repayment for the five year tenure bond of $500 million will be due in 2019.

Thereafter the interest will reduce to $103.125 million with the second principal repayment coming due in 2024 when the repayment of $1.5 billion becomes payable. All future National budgets have to recognise this amount and reserve it from shareable revenues.

The benefits of the Eurobond issue are significant, especially for infrastructure development such as energy, transport and agriculture that require importation of capital equipment.

However, even as we celebrate the success of the issue, we cannot overlook the immense challenges and risks that a Eurobond issue comes loaded with.

In fact, economists are split on the benefits of Africa issuing Eurobonds, with some of the opinion that the costs may as well outweigh the benefits unless the funds are prudently managed.

Incidentally, among the sub-Saharan countries that have issued Eurobonds, at least two have so far recorded defaults. Seychelles, one of the first issuers of Eurobonds defaulted in 2008 in the midst of falling tourism and a long history of excessive government spending. Ivory Coast also defaulted in 2011 after its disputed elections. Kenya will do well to learn from those defaults and avoid a similar fate.

One, the costs of issuing Eurobonds are significantly higher than concessional loans that have previously been the main source of financing in Kenya. Currently, the interest paid on foreign currency loans are below 5%, making the Eurobond the most highly priced financing.

This means the funds need to be invested in projects that have a higher investment return and multiplier effect, in order to avoid a situation where funds would have to be diverted from other sources to service the Eurobond.

Kenya's credit rating at B+ with stable outlook by Fitch and Standard and Poors places it four notches below investment grade. It is classified as "speculative grade" or junk and its attractiveness to investors is mainly based on the high-yields or interest rate that risky investment attracts. In other words, investors are speculating and for doing so, they demand higher compensation. This makes it very expensive for Kenya as an issuer.

The immediate receipt of funds which are currently in the Kenyan accounts means that interest starts to accrue immediately while the benefits of the funds are yet to be realised.

This has not only the risk of carry cost, but also the risk of diversion to projects not previously properly assessed as suitable for funding from the funds. The longer the funds stay in the accounts before deployment to projects, the higher the risk.

The current absorption rate of 45% on development budget is highly expensive for the Eurobond funds and more will need to be done to ensure that projects are implemented in a more efficient and faster pace.

The risk of increasing debt burden calls for a well structured debt management systems. The risk of excessive borrowing is real and has to be managed. Besides, the "bullet" repayments on maturity of the bonds in 2019 for the $500million bond and in 2024 for $1.5 billion bring additional risks.

There is the risk that the country will not have the funds to repay the loans when they fall due and may be forced to issue more Eurobonds to repay.

This creates a never-ending cycle of debt issuance that does not add value to the economy and that is expensive in term of arrangement and issuing costs.

A volatile macroeconomic environment will also be a risk to the servicing and repayment of the Eurobond. Kenya will need a stable macroeconomic environment, with affordable interest rates, stable exchange rates and low inflation.

With good governance, a stable macroeconomic environment will spar economic growth and generate adequate revenues to sustain rising debt levels.

With the Eurobond denominated in foreign currency, the exchange rate will be critical, as the weakening of the Kenya Shilling will result to a higher debt burden with the attendant sustainability challenges in the medium to long term.

Another risk is closely related to the high borrowing costs is the effect on the budget going forward. The Eurobond involves annual servicing costs

Karen Kandie is a Financial & Risk Consultant with First Trident Capital and a PhD Candidate in Finance at Catholic University of Eastern Africa.

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Source: AllAfrica

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