While the Budget Policy Statement is popularly acknowledged as an important document and widely discussed, the Debt Management Strategy is less glamorous. And yet a budget is only “balanced” by definition if it does not increase the level of public debt. A “balanced budget” is only achieved when the level of government expenditure is equal to or less than the revenue collection. Otherwise, whenever the government expenditure is higher than the revenue collection, budget deficit arises, and the extra funds needed to fund the expenditure have to be borrowed, hence increasing the level of public debt.
Furthermore, every year that there is a budget deficit, the debt levels increase because the debt is by nature cumulative. The DMS is therefore critical in that it addresses the level of the public debt burden, how the government plans to meet its financing needs, the costs and the risks involved and how they will be monitored, managed and mitigated.
The DMS estimates level of public debt at 49.6 per cent of the wealth of the country-Gross Domestic Product- as at endJune 2015. While there is no particular magic ratio, this is considered a sustainable level because the probability of the economy getting into any debt crisis at this debt ratio is considered low. To put it into perspective, the Eurozone agreement put a debt-GDP limit of 60 per cent, while the Greece debt crisis was precipitated by a debt-GDP ratio that had risen to 175 per cent by 2013.
The current debt-GDP sustainability withstanding, the high pace of debt accumulation is concerning, particularly in the past two years. Furthermore, the current level of debt to GDP ratio is the highest since 2004. Also of concern is the low but rising cost and increasing risk of debt in the last five years since FY2009/2010 as demonstrated by three factors.
One, the rising annual interest payment as a share of GDP has increased from 2.5 per cent to 3.5 per cent. Two, refinancing risk is rising; meaning government has to borrow more often at higher costs. Total debt to be repaid within one year stood at 9.2 per cent of GDP at end June 2015 compared to 6.9 per cent of GDP at end June 2010. Three, the exchange rate risk is rising with the dollar exchanging at above Sh100 compared to below 75 in the last five years, although the DMS describes it as stable.
In formulating the debt strategy of choice, the National Treasury is very candid on the risks facing the economy and has specifically isolated refinancing risk and exchange risk as the two key risks to manage, going forward. The DMS also demonstrates high levels of transparency and analysis in arriving at the strategy of choice. Four options are considered, each of which has its advantages and disadvantages before finally settling on the more optimal choice.
The optimal debt strategy for the next three years is presented within three dimensions all of which present critical trade-offs. These are; external vis domestic sources, concession vis commercial borrowing and local currency vis foreign currency.
First, the government plans to finance 60 per cent of the budget deficit by external borrowing and the other 40 per cent from domestic market in the next three years. The main benefit with this strategy is the widening of the sources of funding. This advantage is not unique to Kenya because there is more money in the global economy than within the borders of any one country. It also means by borrowing less from the domestic market, the government is not competing with the private sector, which has the potential to reduce pressure on local interest rates.
However, a major trade-off is the fact that this strategy does not address the issue of exchange risk, initially identified as one of the two key risks. An analysis by International Budget Partnership shows that indeed public debt is increasingly foreign, rising from 40 per cent in 2014 to 45 per cent in 2015. IBP also highlights that unlike domestic debt, foreign debt is much more difficult to reschedule in the event of a debt crisis. Other than setting the limits, the DMS does not specify any mitigation to the rising foreign exchange risk, and in particular fails to emphasis the risks posed by the increasing imports relative to exports. If we are increasingly importing more than we are exporting, where we get the foreign currency to repay the loans needs to be addressed.
Also, and perhaps more significant, is that DMP recognises the deepening of the local capital markets as an alternative to increased external borrowing, but does not clarify why this option is not pursued further.
Second, it is the government’s strategy that the external debt will comprise of 24 per cent concessional terms, 24 per cent semi-concessional, and 12 per cent commercial terms. Concessional funding is often at highly subsidised interest rates, long grace periods and maturity, hence more desirable. However, the supply of concessional financing has been declining, from 95 per cent in 2004 to 45.3 per cent in 2014. Infact, with the newly acquired status of a middle income country, terms for new loans are increasingly hardening, with more financiers opting for semi-concessional and commercial terms. Concessional funding is not always rosy though, because as the saying goes, there is nothing like a free lunch. It comes with conditions, some of which are not compatible to the desire to write a new narrative for Africa renaissance, free from the legendary perennial begging bowl. The trade-off is more expensive borrowing, lower grace periods and maturity, going forward. This, combined with the fact that commercial lenders are less restrictive-whatever you do with the money, all they want is their money back- means that we all must care that the money is well utilised.
Finally, the third strategy is for domestic debt to comprise of 20 per cent Treasury Bills and 80 per cent Treasury Bonds. T-bills are for short-term borrowing, often below one year, while T-bonds are above one year. Analysis from IBP shows that in 2015, domestic borrowing comprised of 40 per cent T-bills and 60 per cent T-bonds; hence the strategy to have more T-bonds will increase the maturity profile of domestic debt. This will address the refinancing risk identified earlier. This is because when the government holds more short term T-bills, it has to go back to the market more often to borrow when they are due for repayment, exposing itself to the risk of higher interest rates. On the other hand, longer term paper in form of T-bonds means that the interest rate is locked-in for longer periods, and the refinancing risk is mitigated.
It is clear that the DMS is well thought-through, with sound principles, but it involves critical choices and trade-offs. These choices and trade-offs need to be continuously monitored, and revised should the underlying assumptions fail to hold, to ensure public debt remains sustainable.