Shilling takes a hit after PS announces Sh250bn Eurobond

The shilling exchanged at an average of 101.73 units to the dollar in the interbank market, a level last seen at the end of February. Photo credit: Daily Nation.

The Kenyan shilling yesterday weakened to an eight-month low against the US dollar in what market watchers attributed to excess liquidity in the money markets and demand for the dollar from manufacturers and oil importers.

Analysts, however, said Monday’s announcement that the Treasury is about to issue a new Eurobond is causing a recasting of positions as markets prepare for a looming jump in external debt.

The shilling exchanged at an average of 101.73 units to the dollar in the interbank market, a level last seen at the end of February, having weakened against the dollar by nearly one per cent this month.

The shilling’s performance in the market is being seen as resulting from the negative sentiments on Kenya’s debt position and the ongoing flight of foreign capital back to the US where rates are rising.

The International Monetary Fund (IMF) last week downgraded Kenya’s risk of debt distress from low to moderate, and many observers see the looming Eurobond issue as having the potential to spook the market even further.

Treasury principal secretary Kamau Thugge told Bloomberg on Monday that the external financing bit of the budget deficit will comprise of up to Sh250 billion worth of Eurobonds, and Sh37 billion in syndicated loans.

“The shilling may be further undermined by weaker debt metrics after the IMF’s downgrade of the country risk of external debt distress from low to moderate,” said economists at Commercial Bank of Africa in a note.

The bank said the government’s plan to return to the Eurobond market for the bulk of external debt financing this fiscal year risks aggravating debt sustainability concerns given the potential for higher debt servicing costs.

The shilling’s depreciation in recent weeks has, however, not been characterised by volatility, suggesting that it is an issue of underlying fundamentals rather than speculative actions in the currency trading markets.

The Central Bank of Kenya (CBK) has the option of deploying its sizeable foreign exchange reserves to support the shilling, but this action is likely to be limited as the regulator keeps an eye on growing external debt servicing demands that are drawn out of the same reserve basket.

“Whereas strong foreign exchange reserves have supported recent stability, continuous depletion amid rising external risks highlights its unsustainability as an exchange rate stabiliser,” said CBA.

In the 2018/19 fiscal year, the Treasury expects to spend Sh364.7 billion on external debt servicing, of which Sh250 billion will cover principal repayments, including the maturing Sh75 billion five-year tranche of the Eurobond issued in 2014.

Indications from the market are that the proposed Eurobond issue will attract higher interest compared to the existing ones, going by the higher yields in the secondary market of the bonds that have gone up to nine per cent.

Latest data shows that the secondary market rates on the four tranches of Eurobond ( the five-year issue maturing next year, the $2 billion 10-year 2024 paper, $1 billion 10-year 2028 paper and $1 billion 30-year paper maturing in 2048) have risen by between 70 and 180 basis points this year.

These yields inform investors of how to price new bond issues, and analysts say they will likely factor in the debt sustainability downgrade as well as the lack of the IMF cover for the shilling when pricing risk on new debt.

“The failure to make headway on the previous IMF stand-by arrangement targets, resulting in the Fund not extending a new programme in September, combined with the downgrade in terms of external debt sustainability further supports our concerns and will likely lead to increased market scrutiny,” said Exotix Partners senior economist Christopher Dielmann on Monday.

The Treasury may well opt for another long-term bond to ease refinancing worries in the near term, when the country will also be servicing the hefty Chinese loans for the construction of the standard gauge railway.

Treasury secretary Henry Rotich has moved to cut the fiscal deficit by effecting tax changes geared towards raising more revenue, as well as introducing budget cuts, which he hopes will result in the narrowing of the deficit as a percentage of GDP to 5.7 per cent in 2018/19 from 7.2 per cent in the 2017/18 fiscal year.

The IMF, which had strongly called for the tax changes to remove VAT exemptions, said in its report on Kenya last week that further reforms are needed.