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September 22, 2018

How Risk Assessments Work For Eurobonds

I have heard mostly two reactions to Kenya’s oversubscribed Eurobond issue: wild excitement because this is such a vote of confidence by investors (and also, hey, LOADSA CASH!) and ‘wait, how does that work exactly? So much money even though Kenya has all these corruption and security problems?’ So what is it ‑ a vote of confidence? Well, yes and no.

A sovereign bond is not the only kind of investment. In fact, it is a very different kind of investment decision than, say, considering investing in a factory out in industrial area. An investor in a sovereign bond will lend to the issuing government, and will consider two factors: will the borrowing government be able to repay, and will it be willing to repay?

What do we know about Kenya before we even crunch numbers? We know that in contrast to, say, Uganda and Tanzania, Kenya was never eligible for debt relief initiatives such as the Heavily Indebted Poor Countries initiative (although it did have some debt restructured under the Paris Club, a grouping of sovereign creditors). Back then, that may have been a bit disappointing for Kenya – other wasteful spenders had their debt written off while Kenya had to pay. But today, that is an advantage: It is an indication that Kenya most likely can and will repay.

Still: Kenya is not as creditworthy as, say, Switzerland. A rating agency will do the number crunching for you to help you determine how creditworthy a country is. Moody’s gave Kenya a B1 rating: this is considered a ‘speculative grade’. This category is subdivided and Kenya does not even feature in the highest sub category, but in the second highest one described as ‘speculative and a high credit risk’. Such a rating automatically drives up the interest rate, i.e. the price for the perceived risk. So the interest rate – while no doubt attractive for a country rated B1 – has already priced in investor concerns.

And what about insecurity and other problems such as corruption? Yes, they are being considered. But on a very top level, we know that Kenya’s economy is generally very resilient and recovers from setbacks like the post election violence. The World Bank has just revised its GDP growth forecast for the current year down from 5.2 per cent to 4.7 per cent to account for the impact that insecurity and this year’s lack of rains will have on Kenya. Kenya could no doubt do a lot better if governance were better, but this is still a solid growth rate.

You could also argue that it looks like Kenya will grapple with insecurity and its fallout on the economy for a few years, given the recent unconvincing government responses to Westgate and Mpeketoni, and the fact that non-terrorist insecurity is rampant. Is this a deterrent for investors? Depends – on what your involvement is, and how much risk appetite you have, and whether you think you can manage the risk. If you are a lender to the Government of Kenya, you may well argue that the GDP growth rate will hold up reasonably well despite all the problems, and even if, say, tourism keeps ailing, Kenya would have oil revenues coming on stream in the not too distant future. So for your investment purposes, there is nothing yet to worry about.

Someone who is looking to open a factory or an office, for example, will take a different approach. For such a direct investor, physical security matters a lot more, as does the state of the infrastructure, or labour costs, or energy prices, etc. If you are considering setting up a business process outsourcing operation here or in Mauritius, and want to bring in some senior experts, you might find that Mauritius would work better. The island has fewer problems with immigration, and your senior staff are less concerned about being shot dead at their gate on the way home.

However, if you are a company exploring for oil, or provide services to the oil and gas industry, then you will probably find ways of managing such risks because you need to be where the oil is, and there will be endless opportunities is such a nascent market. If you are lending to the government, these factors will only interest you if there is a substantial downturn that will affect Kenya’s ability to repay. Has Westgate killed off the overall GDP growth rate? No. So there. Here, have a couple of hundred millions.

So hoorah Eurobond? Well, Iam not holding my breath yet. For one, this is debt that will have to be repaid with interest. In principle, it is argued that such borrowing should not be spent on recurrent expenditures, i.e. things that simply keep the government machinery ticking over. It should be invested so that it generates the returns necessary to service the debt. And that is where another challenge lies: a lot of money allocated for development spending in the last fiscal year has not been invested – this is referred to as low absorptive capacity.

And then we know, of course, that public tendering always tends to lose massive amounts of money. With the Eurobond cash and another $3.8 billion that Kenya will borrow from China, you, tax payer, should watch out: it is your taxes that will have to repay all that money, whether it ends up in infrastructure or someone’s offshore account.

The writer is an independent country risk analyst.


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