Composition of Domestic Debt in Kenya and Implication on Refinancing Risk
Kenya’s budgetary needs have been increasing over the years partly due to high spending on infrastructural projects. A challenge that the economy keeps grappling with is the shortfall in revenues collected against increasing public expenditure needs. This has necessitated borrowing from both external and domestic market as a way of bridging the financing deficit. Borrowing from the domestic market has largely supported financing of recurrent expenditure.
Increased borrowing from the domestic market has been necessitated by a widening fiscal deficit. Net domestic financing rose from Ksh 167 billion in 2012/13 to Ksh 251 billion in 2014/15 then dropped to Ksh 202 billion because of reduced fiscal deficit. At the same time, fiscal deficit widened from 5.1% in 2012/13 to 8.4% in 2014/15 before narrowing to 7.4% in 2015/16. In 2016/`17, domestic borrowing increased by Ksh 107 billion from 2015/16 to hit Ksh 309 billion before reducing to Ksh 274 billion in 2017/18. However, net domestic financing as a share of GDP declined from 3.7% in 2012/13 to 3.1 in 2017/18. The trend in domestic financing of the budget deficit over the last six years is illustrated in below.
Between 2012/13 and 2013/14, domestic debt formed a large share of Kenya’s debt as seen in the figure below. However, since 2016/17, the share of domestic debt stock has been less than external debt. This shift has been a result of government tapping into the international market to access funding for development projects at a relatively lower cost than in the domestic market.
Domestic debt largely comprises treasury bills and treasury bonds. For instance, the two constituted 98% and 96% of domestic debt in 2016/17 and 2017/18, respectively. Besides government securities, domestic debt is also composed of pre-1997 government debt, CBK overdraft, tax reserve certificates and commercial bank advances. However, their share in domestic debt is small. The amount of domestic debt held by the Central Bank of Kenya (CBK) between 2012/13 and 2017/18 averaged 4.3% of the total domestic debt while that held by commercial banks and non-bank financial institutions accounted for 50.9% and 44.8% of the total domestic debt, respectively, in the same period.
Treasury bills are short term debt instruments with maturities of 91, 182 and 364 days while treasury bonds are medium to long term debt instruments with maturities greater than one year. As at the end of 2017/18, the composition of government securities was Ksh 878.6 billion for treasury bills and Ksh 1.511 trillion for treasury bonds. The shares of the components of treasury bills and treasury bonds are represented in the table below.
The table shows that the share of 182-day Treasury bills increased between 2012/13 and 2016/17 but declined in 2017/18. The share of 364-day Treasury bills increased consistently between 2013/14 and 2017/18. The shares of the 1-5 years Treasury bonds has been declining since 2013/14 while the 6-9 years bond shows a similar trend since 2014/15. The increasing share of Treasury bill and decreasing share of Treasury bonds is in contrast with the government’s targets to limit domestic short-term debt issuances (treasury bills) and increasing issuance of treasury bonds. The targets as contained in the Medium-Term Debt Management Strategy versus the actual outturn as contained in various Public Debt Management Reports are shown in the table below.
Since 2015/16, the composition of short-term debt instrument has been larger than targeted. While the government targeted treasury bills to constitute 11% of government securities issuance in 2015/16, the actual amount was 34%, reflecting a deviation of 23%. A similar trend was witnessed in 2016/17 and 2017/18 where the actual issuance of treasury bills exceeded the targeted short-term borrowing.
This increase in share of treasury bills over bonds in the total composition of domestic debt shortens debt maturity profile; that is, the time it takes for a debt to mature. Data from public debt management reports shows that the average time to maturity of domestic debt had been on a downward trend, dropping from 5.14 years in 2012/13 to 4.14 years in 2016/17 but picked up to 4.4 years in 2017/18. The reduction in maturity period exposes the country’s debt portfolio to refinancing risk.
Refinancing risk refers to the risk that maturing debt will have to be refinanced at an unusually high cost or the possibility of the government being unable to roll over a maturing loan; that is, replacing a maturing loan with a new one. Risk measures estimate the potential unexpected increase in debt service payments caused by a surprising shift in market interest rate.
The IMF’s “Developing a Medium-Term Debt Management Strategy (MTDS) – Guidance Note for Country Authorities” gives indicators used in management of refinancing risk. These include average time to maturity of debt, debt maturing in a specific period as a percentage of total debt, and GDP. Average time to maturity is an indicator that measures the weighted average time to maturity of all the principal payments in the debt portfolio. It indicates how long it takes on average to rollover maturing debt. A shortening of average time to maturity indicates that the debt portfolio is being rolled over frequently and, therefore, is more exposed to an anticipated change in market interest rate when the government goes to the market to borrow. A higher than anticipated interest rate will result to refinancing of maturing debt at a higher cost. The table below shows the profile of refinancing risk indicators.
Average time to maturity declined from 5.14 years in 2012/13 to 4.4 years in 2017/18. Debt maturing in one year as a percentage of total debt increased from 13.4% to 37.7% between 2013/14 and 2017/18. At the same time, the proportion of debt maturing in one year as a percentage of GDP increased from 3.9% to 9.5%. The declining trend of average time to maturity and the increasing debt maturing in one year points to an increasing exposure to refinancing risk. Compared to aspirator country such as South Africa whose benchmark of domestic debt maturing in one year as a proportion of total domestic debt is 15%, Kenya’s domestic debt maturing in one year is rather high. However, debt maturing in one year as a ratio of total revenue and GDP registered a decline in 2017/18, indicating an improvement in capacity of the government to service domestic debt that matured in 2017/18.
From the 2018 Medium Term Debt Management Strategy 2018/19-2020/21, the government envisages reducing the share of treasury bills in total net domestic financing ratio to around 13% in 2020/21 from the current 35% in a bid to lengthen the maturity profile of domestic debt. One way of achieving this is financial market reforms to include low denominated securities with longer maturity and expand the investor base of government securities beyond financial institutions.
As shown below, the stock of government securities is largely held by banks and pension funds. Other holders include insurance companies, individuals and non-residents. Banks hold over 50% of the government securities.
M-Akiba bond, a three-year retail infrastructure bond issued by the government sold through mobile phones, provides an opportune avenue to mobilize domestic resources for budgetary support, and a savings scheme for the general populace. Unlike other treasury bonds, proceeds of infrastructure bonds are used to finance earmarked infrastructural projects. Infrastructure bonds have a tax incentive compared to other bonds issued by the government; returns from them are exempt from taxation, making them more attractive to investors. While the pilot phase of M-Akiba was a success, subsequent issues witnessed an under subscription, due partly to confusion in the purchasing process, and lack of reminders to the registered individuals on when the investment round was closing.
To ensure a higher subscription in future and success of M-Akiba bond, there is need for increased awareness to the citizens on government securities and the technology involved (for example, trading of M-Akiba bonds via mobile phone). Furthermore, an increase in commercial banks providing liquidity for the bonds can increase investor activity in the secondary market, thereby boosting retail investor’s preference for the bond. Increased uptake of M-Akiba bond will expand investor base of government securities beyond commercial banks and other financial institutions to include the general populace, and reduce refinancing risk by lengthening maturity of domestic debt portfolio.
Authors: Rodgers Agwaya and James Kimunge, Policy Analysts, Macroeconomics Department