RATINGS agency Fitch has downgraded Kenya’s credit outlook to Negative from Stable, citing a steady deterioration of the country’s public finances, reflecting “weak revenue performance, increasing infrastructure spending and persistently high current expenditure.”
The agency also affirmed Kenya’s sovereign rating of B+, which is four levels below investment grade, the same as its previous rating for the country – a disappointing position for a country that is this week gearing up to host thousands of delegates for the Global Entrepreneurship Summit this weekend, led by US president Barack Obama.
The analysts say that Kenya’s lack of prudent financial management and ballooning budget and current account deficits dim its credit outlook; a lower credit rating results in higher borrowing costs because the borrower is perceived to be at a higher risk of default.
The National Treasury estimates a revised budget deficit of 8.2% of GDP for the year to June 2015, higher than the deficit of 6.4% announced a year ago June 2014. The deficit is exected to widen to 8.7% of GDP in the next 12 months.
The government plans to increase domestic borrowing to 3.4% of GDP, up from 2.9% of GDP. This risks putting upward pressure on domestic yields, which have risen sharply recently due to an increase in the Central Bank Rate.
Fitch expects government debt to rise to 53.2% of GDP in the current financial year, up from 42.4% in 2013 and 36.9% in 2008. The increase reflects significant new debt incurred to fund infrastructure, and a weaker exchange rate, as well as a steady loosening in fiscal policy since the global financial crisis.
Although there isn’t a clear cut agreement on what a country’s debt-to-GDP ratio should be, international financial organisations such as the International Monetary Fund (IMF) put the figure at around 50% for a developing economy - higher if the country is using the borrowed money to wisely invest in projects that surge productivity and economic growth.
A year ago, the country borrowed $2.75 billion in its debut Eurobond issue ostensibly to finance infrastructure projects. But a leading economist and public policy commentator over the weekend raised the alarm on the lack of substantive evidence of such infrastructure spending so far.
“There is no sign of increase in infrastructure building on a $3 billion scale, other than those projects financed by other loans such as the standard gauge railway. Where did the money go? We are squandering borrowed money,” writes David Ndii.
Although current debt levels are sustainable (on paper), Fitch highlights the risk to debt sustainability of large-scale infrastructure projects, particularly if the anticipated growth does not materialise, without consolidation of the current budget balance.
Kenya’s current account deficit is structurally wide, reflecting stagnant exports and a capital-intensive import bill, due to rapid infrastructure investment. The deficit is expected to widen to 9.9% of GDP in 2015 from 7.6% in 2014.
Increased spending on the Standard Gauge Railway - a $3.2bn project funded on a separate arrangement with China, intended to upgrade the country’s railway network - will largely offset gains from lower oil prices, with the deficit expected to narrow only slightly to 9.7% in the 2016 financial year.
Foreign direct investment in Kenya remains below comparator countries, which puts the country in a bind as it restricts sources of funding to short term capital and domestic borrowing. Net external debt as a percentage of GDP is above the median for other countries rated ‘B’, and rising.
A strong US dollar and a large current account deficit have exerted pressure on the Kenyan shilling, down 10% since January 2015. The Central Bank of Kenya intervened to limit the volatility of the exchange rate, hiking the base interest rate by 300 base points.
As a result, international reserves have fallen to $6.7bn (or 3.7 months of export cover) in July 2015 from $7bn in December 2014 (or 4 months of export cover).
Although economic growth has been robust at 5.3% over the past five years, it’s still below the government’s target of 6%. Fitch expects large-scale infrastructure projects in power and rail to boost growth above 6% in 2015. However, terrorist activity and its adverse impact on the tourism industry will curtail faster growth, the analysts say.
Kenya’s ratings are constrained by weak GDP per capita, which is one-third of the ‘B’ median. The country is in the 22nd percentile of the UN Human Development Index. Kenya’s social and governance indicators are weaker than the ‘B’ median.
A weak business environment is harming competitiveness and foreign direct investments, Fitch highlights; Kenya’s World Bank Doing Business Index ranking slipped to below the ‘B’ median in 2013.