Kenya: First Review Under the Twelve-Month Stand-by Arrangement and the Arrangement Under the Standby Credit Facility, Request for Waivers for Non-Observance of Performance Criterion, and Request for Modification of Performance Criteria—Debt Sustainability Analysis Update

The Executive Board approved on February 2, 2015 a 12-month Stand-By Arrangement (SBA) and an arrangement under the Standby Credit Facility (SCF), with combined access of SDR 488.52 million (180 percent of quota). The first tranche of SDR 379.96 million (140 percent of quota) was made available upon approval of the arrangements, and a further SDR 54.28 million (20 percent of quota) will become available upon completion of the first review. The authorities intend to continue treating both arrangements as precautionary, and to draw only if exogenous shocks lead to an actual balance of payment need.

Abstract

The Executive Board approved on February 2, 2015 a 12-month Stand-By Arrangement (SBA) and an arrangement under the Standby Credit Facility (SCF), with combined access of SDR 488.52 million (180 percent of quota). The first tranche of SDR 379.96 million (140 percent of quota) was made available upon approval of the arrangements, and a further SDR 54.28 million (20 percent of quota) will become available upon completion of the first review. The authorities intend to continue treating both arrangements as precautionary, and to draw only if exogenous shocks lead to an actual balance of payment need.

Underlying Assumptions

1. This DSA is based on macroeconomic assumptions that are consistent with the framework outlined in the accompanying staff report. Main changes compared with the January 2015 DSA update include (text table):

Kenya: Selected Macroeconomic Assumptions

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Source: IMF staff estimates.

For current DSA update, average 2021-34. For previous DSA update, average 2020-34.

  • Further frontloading of public infrastructure spending. Projected spending on the Nairobi-Mombasa Standard Gauge Railway (SGR), is even more frontloaded than in the previous DSA, as the authorities target completion by June 2017. This results in a higher primary fiscal deficit in the near term, with the deficit being brought down in the medium to longer term consistent with the East African Community (EAC) Monetary Union convergence criteria.

  • Revised current account path. The current account deficit is significantly wider in 2014–16, reflecting a wider than projected current account deficit outturn in 2014, and additional frontloading of infrastructure-related imports in 2015 and 2016. The current account deficit is projected to narrow from 2017 with infrastructure-related imports tapering off.

External Debt Sustainability Analysis

2. All indicators of public and publicly guaranteed external debt remain well below the policy-dependent debt burden thresholds under the baseline scenario, and no thresholds are breached under any of the standard stress tests. The main results of the external DSA are the following:

  • Under the baseline scenario, the debt burden remains sustainable over the 20-year projection period (Figure 1). As a result of the debut sovereign issuances and first disbursements of the railway-related loan package, the NPV of public and publicly guaranteed (PPG) external debt is estimated at 20 percent of GDP at end-2014. With additional project financing and moderate additional commercial financing, the NPV of PPG external debt is projected to peak at 22 percent of GDP in 2016–17 (well below the 50 percent indicative threshold). Nonresident holdings of domestic debt are reportedly low (Annex I). The NPV of the debt-to-exports ratio would plateau at around 123 percent in the medium term, remaining well under an indicative threshold of 200 percent.

  • Standard stress tests do not reveal significant vulnerabilities as even the shocks with the highest impact would maintain debt levels below the relevant indicative thresholds (Table 2 and Figure 1). The shock that would have the largest near-term impact on external debt dynamics is a one-time 30 percent nominal depreciation of the exchange rate, increasing the PV of debt to GDP ratio from 22 percent in 2015 to 31 percent in 2016–17.

  • Temporary delays in external debt service payments emerged in 2014–15, reflecting a coordination failure rather than inability to pay. The external arrears reported between July 2014 and March 2015 cumulated to around US$64 million, but were individually small—signaling capacity constraints at the National Treasury’s Debt Management Office (DMO) and interagency coordination problems rather than an underlying inability to service external debt. All reported arrears have been cleared. The authorities are taking corrective measures to address the identified capacity and coordination problems.

Figure 1.
Figure 1.

Kenya: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2014-2034–Baseline 1/

Citation: IMF Staff Country Reports 2015, 269; 10.5089/9781513520544.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2024. In figure b. it corresponds to a One-time depreciation shock; in c. to a Combination shock; in d. to a One-time depreciation shock; in e. to a Exports shock and in figure f. to a One-time depreciation shock
Table 1.

Kenya: External Debt Sustainability Framework, Baseline Scenario, 2012-2034 1/

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Includes both public and private sector external debt.

Derived as [r - g - ρ(1+g)]/(1+g + ρ+gρ) times previous period debt ratio, with r = nominal interest rate; g = real GDP growth rate, and ρ = growth rate of GDP deflator in U.S. dollar terms.

Includes exceptional financing (i.e., changes in arrears and debt relief); changes in gross foreign assets; and valuation adjustments. For projections also includes contribution from price and exchange rate

Assumes that PV of private sector debt is equivalent to its face value.

Current-year interest payments divided by previous period debt stock.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Defined as grants, concessional loans, and debt relief.

Grant-equivalent financing includes grants provided directly to the government and through new borrowing (difference between the face value and the PV of new debt).

Table 2.

Kenya: Sensitivity Analysis for Key Indicators of Public and Publicly Guaranteed External Debt, Baseline Scenario 2015–34

(In percent)

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Sources: Country authorities; and staff estimates and projections.

Variables include real GDP growth, growth of GDP deflator (in U.S. dollar terms), non-interest current account in percent of GDP, and non-debt creating flows.

Assumes that the interest rate on new borrowing is 2 percentage points higher than in the baseline, while grace and maturity periods are the same as in the baselin

Exports values are assumed to remain permanently at the lower level, but the current account as a share of GDP is assumed to return to its baseline level after the shock (implicitly assuming an offsetting adjustment in import levels).

Includes official and private transfers and FDI.

Depreciation is defined as percentage decline in dollar/local currency rate, such that it never exceeds 100 percent.

Applies to all stress scenarios except for A2 (less favorable financing) in which the terms on all new financing are as specified in footnote 2.

3. As noted in previous DSAs, recent resource discoveries represent significant upside potential to Kenya’s external position. Kenya is currently a net oil importer, but significant oil resources were discovered in 2014. Oil and gas exploration activities are continuing, despite the large fall in oil prices over the past year. If recent discoveries are confirmed as commercially viable, Kenya’s medium- to long-term external position could improve by significantly more than currently projected.

4. The picture remains unclear for private sector debt. Available data from the Foreign Investment Survey (FIS) suggested nongovernment external debt of some 10 percent of GDP as at end-2011. Stock data for later years are not yet available, but the authorities are currently conducting a FIS covering 2012 and 2013, and plan to release the results in September 2015. As noted in the previous DSA update, addressing data gaps is essential to limit the risk of an unmonitored buildup of external vulnerabilities outside the government sector.

Public Debt Sustainability Analysis

5. Public debt has been increasing rapidly owing to infrastructure-related borrowing, but under program policies is projected to taper off in 2015–16. Overall gross public debt1 reached 53 percent of GDP at end-2014, owing to the $2.75 billion in sovereign bond issuances2 in June and December, and initial disbursements of the SGR-related loan from China’s Eximbank. Taking into account the frontloading of subsequent disbursements, overall public debt is projected to increase to 56 percent of GDP in 2015–16 (Table 3). In subsequent years, program policies envisage bringing the primary deficit back below 3 percent of GDP in 2017 and gradually further down thereafter, consistent with the EAC convergence criteria. Reflecting this medium-term fiscal consolidation and robust real GDP growth boosted by infrastructure spending and easing of bottlenecks, public debt would ease back below 50 percent of GDP after 2020. In PV terms, the public debt-to-GDP ratio would peak just below 50 percent in 2015–16 (Table 4), and fall thereafter. The PV of public debt-to-revenue ratio would gradually decline from around 240 percent in 2015 to around 200 percent in 2018–19.

Table 3.

Kenya: Public Sector Debt Sustainability Framework, Baseline Scenario, 2012-2034

(In percent of GDP, unless otherwise indicated)

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Sources: Country authorities; and staff estimates and projections.

Refers to gross debt of the central government.

Gross financing need is defined as the primary deficit plus debt service plus the stock of short-term debt at the end of the last period.

Revenues excluding grants.

Debt service is defined as the sum of interest and amortization of medium and long-term debt.

Historical averages and standard deviations are generally derived over the past 10 years, subject to data availability.

Table 4.

Kenya: Sensitivity Analysis for Key Indicators of Public Debt 2015–34

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Sources: Country authorities; and staff estimates and projections.

Assumes that real GDP growth is at baseline minus one standard deviation divided by the square root of the length of the projection period.

Revenues are defined inclusive of grants.

6. The projected baseline path of public debt is sustainable in the Low-Income Country (LIC) DSA framework, but coverage issues also need to be taken into account.

  • As noted in the previous DSA update, the LIC DSA framework currently remains relevant for Kenya, since a majority of its external public debt remains concessional or semi-concessional. However, the 2014 sovereign bond issuances and the commercial component of the SGR have resulted in a significant rise in the share of commercial external debt.

  • The projected debt path remains below the EAC public debt convergence criterion (ceiling of 50 percent in PV terms), albeit with tighter margins than previously projected. Significant shocks could take the debt path above the 50 percent ceiling.

  • The projected debt path is also below the LIC DSA public debt benchmark for those countries whose CPIA score for quality of policies and institutions is assessed as strong (74 percent of GDP, also in PV terms) above which the risk of public debt distress is heightened. However, this public debt benchmark applies conceptually to the widest possible coverage of the public sector, and ideally should include the obligations of regional and local governments, and government-controlled enterprises (especially in cases where the government owns more than half of the voting shares).

  • The measured public debt path excludes legacy debts of the pre-devolution county governments, whose size is not yet fully clear. In addition, public debt should include planned annuities intended to finance road construction: although the annuity obligations may not necessarily be classified as debt under local law, they nevertheless represent public debt obligations for GFS purposes.

  • Excluding publicly guaranteed external debt, contingent liabilities are not conceptually part of the public debt but do represent a source of fiscal risk. The extent of contingent liabilities stemming from Public Private Partnerships (PPPs), mostly in the energy sector, is not yet fully assessed.

7. Excluding a fixed-primary-balance scenario that is distorted by temporary factors, the alternative scenarios and bound tests indicate that the projected paths for public debt indicators remain within the relevant thresholds (Table 4 and Figure 2). Under a standard scenario that keeps the primary balance unchanged from its 2015 level, the PV of public debt to GDP would remain on a steady upwards trajectory, remaining permanently above the EAC convergence criterion reference value and exceeding the 74 percent benchmark in the late 2020s. Since the 2015 primary deficit is boosted by temporary SGR-related spending, Figure 2 also includes a scenario fixing the primary balance excluding SGR-spending: public debt would remain on an increasing trend in this scenario, albeit more gradually, and remaining in PV terms under the 74 percent benchmark (subject to the coverage issues noted above).

Figure 2.
Figure 2.

Kenya: Indicators of Public Debt Under Alternative Scenarios, 2014-2034—Baseline 1/

Citation: IMF Staff Country Reports 2015, 269; 10.5089/9781513520544.002.A002

Sources: Country authorities; and staff estimates and projections.1/ The most extreme stress test is the test that yields the highest ratio on or before 2024.2/ Revenues are defined inclusive of grants.

Main Findings and Conclusions

8. This DSA update finds that Kenya remains at low risk of external debt distress. The recent emergence of temporary external payment arrears do not reflect an underlying inability to service debt and so do not change this conclusion, but do signal a need for prompt action to strengthen capacity at the Debt Management Office as well as interagency coordination. Standard stress tests suggest scenarios in which external debt would increase, but remain within sustainable bounds. Under such stress tests, a large exchange rate shock represents the largest upside risk to external debt. At the same time, Kenya has strong market foundations and long-standing sound macroeconomic policies—absence of price controls, flexible exchange rate and interest rates, limited budget subsidies—which give it scope to respond to shocks.

9. Overall public debt remains sustainable, though fiscal policy efforts are needed to ensure that the recent increases taper off. The baseline public debt path remains consistent with the EAC convergence criteria and below the relevant public debt benchmark, subject to coverage issues including outside the national government. Recent increases in public debt reflect increased borrowings to address infrastructure needs, and temporarily high primary deficits. Standard stress-testing scenarios show that if the primary deficit were to remain at current levels, public debt would remain on an upward path. These scenarios are more pessimistic than the authorities’ stated policy intentions—which are to reduce the primary balance in the medium term consistent with the convergence criteria for the EAC monetary union—but also highlight the need to follow through on the intended medium-term fiscal consolidation.

10. As noted in the previous DSA update, risks to debt dynamics are to the upside in the near to medium term. In the near term, the fiscal deficit and borrowing needs could widen further if execution rates on foreign-financed projects (for which debt has been contracted but not disbursed) rise faster than expected; if management of the devolution process falters and the new county borrowing framework lacks sufficient safeguards; and/or if risks materialize from contingent liabilities. In addition, the picture is particularly uncertain with regard to nongovernment external debt in view of long-standing data gaps that the authorities have begun to address; in the meantime, however, risks remain of an unmonitored buildup in external vulnerabilities.

11. In the medium to long term, however, natural resource discoveries represent positive potential. If confirmed as viable, resource discoveries could translate into exports that significantly improve Kenya’s external prospects, as well as an additional source of revenue. Prospects for viability could be tempered by the further declines in energy and commodity prices since mid-2015, especially if these are sustained.

12. The authorities agree with the conclusions of the DSA update. They concur that Kenya is at low risk of external debt distress. On this basis, they are requesting that the SBA-SCF arrangements discontinue the ceiling on nonconcessional external debt, in line with the Fund’s new debt limits policy.

1

The World Bank in 2013 upgraded its classification of Kenya to “strong” in terms of the quality of its policies and institutions as measured by a three-year average of the World Bank’s Country Policy and Institutional Assessment (CPIA) Index (average score in 2012–14: 3.84). This classification is unaffected by the slight decline in Kenya’s CPIA score from 3.9 in 2013 to 3.8 in 2014, which reflected a larger fiscal deficit. The relevant indicative thresholds for this category are: 50 percent for the NPV of debt-to-GDP ratio, 200 percent for the NPV of debt-to-exports ratio, 300 percent for the NPV of debt-to-revenue ratio, 25 percent for the debt service-to-exports ratio, and 22 percent for the debt service-to-revenue ratio. These thresholds are applicable to public and publicly guaranteed external debt.

1

Including gross debt of the national government and the central bank.

2

The June 2014 issuance comprised two tranches: a five-year $500 million bond at a yield of 5.875 percent, and a 10-year $1.5 billion bond at 6.875 percent. In December 2014, Kenya added $250 million to the five-year tranche at a 5.0 percent yield and $500 million to the 10-year tranche at 5.9 percent.

Kenya: First Review Under the Twelve-Month Stand-By Arrangement and the Arrangement Under the Stand-By Credit Facility, Request for Waivers for Non-Observance of Performance Criterion, and Request for Modification of Performance Criteria-Press Release; Staff Report; and Statement by the Executive Director for Kenya
Author: International Monetary Fund. African Dept.
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    Kenya: Indicators of Public and Publicly Guaranteed External Debt under Alternative Scenarios, 2014-2034–Baseline 1/

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    Kenya: Indicators of Public Debt Under Alternative Scenarios, 2014-2034—Baseline 1/