Risks of foreign denominated debt for Kenya

Opinion and Analysis

 

President Uhuru Kenyatta. PHOTO | FILE 

 

By ANZETSE WERE

Anyone keeping an eye on the economy will have noted the level of public debt, particularly foreign denominated loans, has been on the rise.

Total debt stood at Sh2.37 trillion ($26.78 billion) after Kenya’s sovereign bond issue in June. The major concern with the debt being accrued is that we are getting into larger foreign denominated debt than previously.

Kenya is a net importing economy and therefore to service foreign debt the government has to buy dollars. The assumption that policy makers at the Treasury are making is that the foreign debt will boost the economy, through investment in infrastructure which is expected to spur the productivity required to service the debt.

Although there is support for this hypothesis, there are also those who question the logic that infrastructure equals growth. The London School of Economics states that ‘‘empirical estimates of the magnitude of infrastructure’s contribution (to growth) display considerable variation across studies.

Overall, however, the most recent literature tends to find smaller effects than those reported in the earlier studies.’’

This article will not debate this point, but instead highlight the challenges Kenya will face should this enormous investment in infrastructure not generate the growth expected.

How does payment in shillings affect the economy should the foreign denominated debt fail to yield the returns expected of it?

How then will the government raise shillings to service this substantial debt?

The first and most obvious option is for government to raise taxes in order to raise cash to service the debt. But Kenya is already a heavily taxed country and one wonders if we have reached a point on the Laffer Curve where raising taxes further will harm profitability and actually lower revenues.

Tax rates that are too high penalise people for engaging in economically productive activities; so the government risks harming its own revenue if increasing taxation becomes the main strategy used to raise shillings.

The second option is to borrow shillings locally and use this capital to buy dollars and service the debt. An argument has been made that Kenya entered into foreign debt to ease pressure on the local credit market and interest rates.

But if that investment doesn’t yield what is expected, then the government may have to borrow locally to service the debt anyway.

This borrowing crowds out the private sector and reduces entrepreneurs’ access to credit. One consequence of this it that the private sector may not implement debt-financed expansion projects.

Further, by borrowing locally, the government puts pressure on interest rates possibly pushing them up, which again makes credit less available to private sector borrowers.

The economic growth of the country may then be muted because private sector and SMEs may not access the credit they need to become more productive.