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Swamped in Debt: Examining Kenya's Ballooning IOUs and Strategies to Pay Them Off

Swamped in Debt: Examining Kenya's Ballooning IOUs and Strategies to Pay Them Off - The Debt Trap

Kenya finds itself caught in a perilous debt trap largely of its own making. Over the past decade, the country has relied heavily on external borrowing to finance large infrastructure projects, budget deficits, and general government operations. This excessive dependence on loans has now put Kenya in a highly vulnerable position.

As of June 2021, Kenya"™s total public debt stood at $70 billion, representing 65% of GDP. Alarmingly, loans from China account for about one-third of this debt burden. The problem is that many of these Chinese loans came with short maturity periods of 5-10 years and high interest rates of over 5%. With several loans now coming due, Kenya faces big challenges in paying them back on schedule.

The debt trap only grows tighter as the country borrows more just to pay existing obligations. In 2021 alone, Kenya had to allocate over half its tax revenues to servicing debts, crowding out other critical spending on healthcare, education and social programs. Additionally, the large interest payments mean less money flows into the economy for productive investments.

This debt burden risks crushing Kenya"™s growth prospects. The IMF projects the economy will expand by only 5% in 2022 compared to 7% in 2021 as debt pressures intensify. Kenya already finds itself on the IMF"™s watchlist for debt distress, especially given the large upcoming repayments owed to China.

The trap also threatens Kenya's fiscal stability and sovereign credit rating. In 2021, Moody's downgraded Kenya's credit rating citing the rising debt obligations and lack of transparency around loan terms, especially from Chinese lenders. A further downgrade would raise Kenya's borrowing costs and potentially lock it out of global capital markets.

Escaping the trap will require disciplined reforms. Kenya must channel more resources towards paying down debts rather than accumulating more through wasteful spending. It also needs greater transparency around borrowing terms to ensure loans align with its payment capacity. Additionally, renegotiating repayment periods with China and other creditors will provide some temporary relief.

Swamped in Debt: Examining Kenya's Ballooning IOUs and Strategies to Pay Them Off - Rising Interest Rates Add Fuel to the Fire

Kenya's debt crisis is being exacerbated by rising global interest rates, which add considerably to its already high debt servicing costs. With over half of Kenya's debt owed to foreign creditors, the country is vulnerable to external shocks like increasing international borrowing rates.

The U.S. Federal Reserve and other major central banks have been aggressively hiking interest rates to combat high inflation. This has led to a sharp rise in yields on sovereign bonds issued across emerging markets, including Kenya. Considering over a third of the country"™s external debt is Eurobonds, higher yields directly impact debt service payments.

In 2022 alone, interest rates on Kenya"™s outstanding Eurobonds rose by 2-3 percentage points. This will cost the government an extra $150-$200 million annually in interest payments. Moreover, with several Eurobonds maturing over the next 5 years, Kenya will have to refinance this debt at much higher rates going forward.

Rising interest rates couldn"™t come at a worse time as Kenya already struggles to keep up with its debt obligations. In 2021, interest payments consumed over 20% of government revenues "“ a figure projected to increase further this year.

Higher interest costs will crowd out other critical expenditures in areas like healthcare, education and social welfare. It also leaves less fiscal space for productive investments to boost economic growth. Without growth, generating revenues to service debts will be an even bigger challenge.

In the last decade, Kenya relied heavily on short-term Treasury bills to financebudget deficits, which drove up interest rates in the domestic market due to high demand. This made borrowing more expensive for both the government and private sector.

Private sector credit growth slowed as banks preferred lending to the government over businesses, depriving the economy of investment capital. Government borrowing also pushed the Central Bank of Kenya to maintain high policy rates to reduce excess liquidity and ease inflationary pressures.

Swamped in Debt: Examining Kenya's Ballooning IOUs and Strategies to Pay Them Off - Where Did It All Go Wrong?

Kenya's debt crisis stems in large part from imprudent borrowing over the past decade to finance grand infrastructure projects, many of which failed to generate the promised returns. This misallocation of loans lies at the heart of the country's current debt distress.

A significant portion of Kenya's external debt went into flagship projects like the Standard Gauge Railway (SGR), which came with a mega $3.2 billion price tag. The government touted the railway as a game changer for trade and economic growth. However, ridership has drastically underperformed targets while revenues lag far behind operating costs. As a result, the SGR has become a massive white elephant saddling Kenya with debt but no discernible benefits.

Several other high-profile infrastructure projects followed a similar trajectory. The $25 billion Lamu Port was branded as an anchor for transforming regional trade flows. Yet, five years on, it operates well below capacity despite gobbling up billions in loans. Plans for a tech city in Konza financed by $2 billion in debt have largely stalled after failing to attract investors and tenants.

Beyond infrastructure, Kenya ramped up borrowing to plug deficits resulting from years of unchecked spending. mounting public sector wage bills, and subsidizing loss-making state-owned enterprises. With revenues lagging, loans provided an easy way out to meet recurrent expenditures rather than undertake painful reforms.

Many now see Kenya's borrowing binge as reflective of an "addiction" to debt condemning future generations to repayment obligations. At the root of this addiction is the mismanagement, opacity and corruption that too often surrounds public spending and borrowing decisions.

Contracts and terms for projects financed through debt have largely escaped public scrutiny. This bred mismanagement as funds got siphoned away via inflated costs, kickbacks and bid-rigging. Opacity also enabled bloated vanity projects that served political interests rather than economic viability.

Swamped in Debt: Examining Kenya's Ballooning IOUs and Strategies to Pay Them Off - Corruption and Mismanagement Lead to Wasted Funds

Kenya's debt predicament is aggravated by the systemic corruption and mismanagement of public finances that has long plagued the country. Over the years, millions in borrowed funds have been lost to graft, kickbacks and wasteful spending instead of being channeled into productive investments. The result is a massive debt burden with little to show for it.

A case in point is Kenya's energy sector which has been riddled with corruption scandals over the past decade. Investigations revealed that nearly $1 billion in loans meant for new power plants was instead siphoned off through inflated procurement costs, shell companies and phantom projects. With the money lost to graft, the country faced chronic electricity shortages that hampered economic growth.

The health sector tells a similar tale. In 2016, it emerged that $50 million in loans earmarked for free maternity care was embezzled by Ministry of Health officials through fraudulent procurement practices. This denied countless Kenyan mothers access to critical maternal health services.

Mismanagement and waste are also major problems. An audit last year found that 47 out of 100 county governments failed to properly account for how development funds provided by the national government were utilized. Resources were diverted away from approved projects while others sat stalled due to incompetent planning and execution.

Kenya's Parliament itself has been flagged for wasteful spending on luxury car purchases, overseas junkets and excessively high salaries & benefits for legislators. All this is funded by taxpayers who shoulder the burden of repaying debts.

Experts note that opacity around government contracts and expenditures facilitates such corruption and waste. A lack of transparency prevents adequate tracking of funds which vanish into unnamed accounts. Clear oversight and accountability measures are urgently needed.

Civil society groups have advocated for more robust anti-corruption frameworks and greater engagement of citizens in monitoring public spending. Grassroots monitoring of government projects by communities themselves has shown promise in minimizing graft and improving outcomes.

Swamped in Debt: Examining Kenya's Ballooning IOUs and Strategies to Pay Them Off - China's Role in Kenya's Debt Crisis

China's emergence as a major global lender over the past two decades transformed the infrastructure landscape in many African countries, including Kenya. Chinese state banks and companies provided attractive financing for railroads, ports, highways and other projects as part of China's Belt and Road Initiative. However, these loans have contributed significantly to debt distress across the continent.

Nowhere is China's role starker than in Kenya, where Chinese lenders hold over a third of the country's $70 billion external debt. Much of this comprises commercial loans tied to infrastructure projects with short 5-10 year maturity periods and interest rates over 5%. As these loans come due, observers warn that Kenya faces debt distress given its limited repayment capacity.

A prime example is the $3.2 billion Standard Gauge Railway financed and built by China as Kenya's biggest infrastructure undertaking since independence. This iconic project was the centerpiece of China's engagement in Kenya but has saddled the country with debt while falling short of ridership and revenue targets. With the railway consuming much more in loans than it generates in income, critics see it as a white elephant benefitting China far more than Kenya.

China's extensive lending to Kenya has raised fears of debt-trap diplomacy. The lack of transparency around Chinese loan deals has exacerbated concerns. A leaked contract between Kenya and China's Exim Bank revealed clauses waiving sovereign immunity and requiring all disputes to be arbitrated in Beijing under Chinese law. Such terms are seen as heavily favoring Chinese lenders over borrowing countries.

Moreover, while Chinese loans financed projects advertised as catalysts for Kenya's economic takeoff, the reality has been increased debt obligations constraining growth. The IMF projects Kenya's economy will expand by just 5% in 2022 as mounting repayment pressures curtail development budgets.

With its options narrowing, Kenya has turned to debt restructuring. In late 2021, Kenya negotiated with China to defer SGR loan payments by two years. However, this provides only temporary relief. Unless the railway's commercial viability improves significantly, Kenya will likely have to renegotiate repayment terms again soon to avoid default.



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