KENYA'S EUROBOND 2014/2015 AND DEBUT SUKUK 2015/2016

June 2014, Kenya plans to sell USD 1.5 billion Eurobond to American and European investors to fund infrastructure projects including rail and roads as part of the program to transform the country into middle income country by 20130 became a reality.

The issuance of the Eurobond by International Finance Corporation (IFC) was initially expected to be in January 2014 or several years back as Mohammed Wahliye writes "The Eurobond issuance in Kenya had been in the pipeline for the last seven years. However, everything was just ink and paper until last week (June 2014) when the Government received $2 billion (Sh175.1 billion) in its account with the Central Bank of Kenya (CBK) after it completed the issuance of a 10-year $1.5 billion (Sh131.3 billion) and a five-year $500 million (Sh43.8 billion) Eurobonds on the Irish Stock Exchange market." (The Standard, July 1st 2014).

According to some media reports, Kenyan government received Shs 250 billion from Eurobond loan, a total of Shs 196.9 billion transferred to Exchequer account and Shs 53 billion used to repay syndicated loan.

The 10-year and five-year bonds, carried a coupon of 6.875 per cent and 5.875 per cent, respectively, recorded a large order book, with a total subscription exceeding $8 billion (Sh700.2 billion), much more over and above what Kenya sought to raise in the global capital markets.

What is Eurobond?

A Eurobond is a bond that is issued in a currency other than the currency of the country where it is issued. According to Mohammed Wahliye "The currency in which Eurobonds are issued also determines their name, like Eurodollar, which is issued in US dollars, or Euroyen, which is issued in Japanese yen. So Kenya's is a Eurodollar bond. Through these two bonds, the Government essentially asked investors to lend $2 billion on the promise that it will pay it back in five and 10 years with interest. The Government, through CBK, gave these private investors a piece of paper known as a bond, and in return CBK collected on the Government's behalf $2 billion cash in the form of a loan. The buyers or investors of these Eurobonds, who are generally large companies, banks or financial institutions and governments, will be paid interest on an annual basis and the principle amounts at maturity. Eurobonds are free of withholding tax and are traded electronically in the secondary markets across international financial centres."

Expectations versus reality.

1. Kenyan's expected Eurobond to go towards financing huge infrastructure projects such as roads, railways, ports, water and energy to ensure steady economic growth. Mohamed writes "So proceeds from the Eurobond will accelerate economic growth, poverty reduction and would be helpful for the country's economy if the borrowed funds are spent on infrastructure projects that offer a greater scope for augmenting revenue earnings and creating employment opportunities." However,accroding to Business Daily of 6th November 2015, it is unclear what happened to all that money. Media reports that Treasury Cabinet Secretary (CS) Henry Rotich 'has been at pains to explain which infrastructure projects were funded by the Shs 196.9 billion.'

Though Mr.Rotich gave a statement to media on how government shared billions among ministries to fund infrastructure projects, 'the CS has, however, been unable to list the specific projects the money was used to fund fuelling speculation that the funds could have been used to pay salaries and other recurrent projects or that they could have been stolen.' Mohamed Wahliye sadly states that "It is extremely disappointing that we can't put a finger on any meaningful asset the bond has helped finance."

2. Eurobond expected to ease interest rates.'The current high domestic borrowing by fiscal authorities to finance the Budget deficit increases the competition for funds and drives up interest rates.' Wahliye writes. He further said that 'With Treasury Cabinet Secretary Henry Rotich now planning to borrow less from domestic markets because of this new money from the bond proceeds, there will be pressure on banks to lend the excess liquidity elsewhere. The extra supply of cash will, therefore, hopefully help to bring down bank lending rates to the productive sectors of the economy.'

Contrary to expactions, June 9th 2015, CBK raised the benchmark interest rate to 10 per cent from 8.5 per cent, setting the stage for a rise in the cost of loans in the coming months. And on October 22, 91-days treasury bills peaked at 22.5 per cent while interbank lending rate reached 25.84 per cent. According to Business Daily of October 24th 2015, banks started to advise their customers on the interest rates changes which according to some banks have gone high up to 27% and likely to take effect before end of November.

However, according to media reports that CBK has intervened and directed banks to freeze all planned interest rates increases and instead reduce their market rates on loans in line with the current market conditions. Lenders were however quick to dig in with their lobby group (KBA) indicating that the industry might ignore the directive and the rates high. (Daily Nation, November 13). Currently, only Standard Chartered Bank and Barclays bank informed their customers that they had shelved their plans to increase rates. Equity Bank followed suit with the cancellation of notices sent out last month that had informed borrowers of the bank’s intention to increase rates by upto six %age points with effect from November 19. This move by banks triggered by a steep fall in Treasury Bill and bond yields from 22.5% on October 21 to 9.7% last week (Business Daily, November 17).

3. Eurobond expected to reduce domestic borrowing by the government as it were before. Wahliye writes that 'at the moment, the domestic markets have been the biggest source of Government borrowing...With Treasury Cabinet Secretary Henry Rotich now planning to borrow less from domestic markets because of this new money from the bond proceeds, there will be pressure on banks to lend the excess liquidity elsewhere.'

With the current cash crunch facing the government due to KRA below expected average collections, 'The government is seeking to borrow a staggering Sh78.8 billion in syndicated loans from local banks to plug a gaping Sh600 billion hole in the budget, which has been made worse by low tax collection and wastage.' (Daily Nation, October 14, 2015). Daily Nation October 14 reported that ' government has borrowed Shs 100 billion from the local market since july and all the money used to settle local and foreign debt."

By November 4, Treasury was looking for Shs 80 billion but managed to borrow Shs 60 billion commercial loan from Citi bank, Standard Bank and Standard Chartered Bank as the first tranche. The rest will be secured from 'other sources' according to Treasury Principal Secretary Mr. Kamau Thugge. Again, the treasury says the money will go to infrastructure projects!

“With respect to interest rates, the intended reduction in the borrowing rates has not been felt. The 91-day Treasury Bill rate reduced slightly in August 2014 after the bond was issued in June 2014 and stabilised until May 2015 when an upward trajectory was witnessed. This indicates that the sovereign bond did not have a huge impact on the domestic borrowing by the government,” the Budget Office said in a brief prepared for PAC.

Currently, the public debt stands at Shs 2.6 trillion, equivalent to 46.8% of GDP (Daily Nation, November 4). The opposition has become vocal and accussed the government of 'over-borrowing, over spending and over stealing.' (The standard Nov 2). The government says any debt below 50% of the GDP is sustainable and rejected the wrong doing.

4. The flotation of the bond expected to be a step in the right direction for easing pressure on foreign exchange reserves. It would enable the Government maintain a stable exchange rate. It is expected that the dollar proceeds from the bond, Kenyan shilling is expected to receive a cushion.

Despite proceeds being received, Kenya shilling against dollar reached an all time high of 106.15 in September of 2015. According to exchangerate.org.uk, by June 2014 Kenya shilling exchanged with dollar at 87.88. A year after the bond, the rate reached 102.30 and now after ups and downs it has reached at 102.35 per dollar. The Parliamentary Budget Office said the Eurobond had had no impact in stabilising the exchange rate.

Now Uhuru government is "facing criticism over the current economic uncertainty facing the country, which have been characterized by a serious cash crunch, sliding value of currency, high interest rates and sky rocketing public debt." Jeffrey Gettlemen writes on Business Daily of Nov 6, 'Kenya is going deeper and deeper into debt'

DEBUT SUKUK (ISLAMIC BOND).

Mr. Henry Rotich speaking after a successful debut $2 billion Eurobond in 2014 said that Kenya plans to issue another international bond in fiscal 2015/16 and may consider a Sukuk. The Star newspaper reported that "The National Treasury is also working on an Islamic bond, popularly known as Sukuk, to draw foreign investments from oil-rich Gulf and Middle East regions whose participation in the hugely successful $2 billion (Sh177.60 billion) debut Eurobond last June was religiously prohibitive."

With the current political climate, outcry on mismanagement of the Eurobond proceeds, mismatch between expectations and reality coupled wiht serious corruption allegations where it is reported that 'the publication of an official audit found just one percent of Kenya government spending and a quarter of the entire $16 billion (15 billion euro) budget was properly accounted for.' (Daily Nation, July 31st 2015), "...the money from the Eurobond was deposited in an offshore account over which she had no power,” " Agnes Odhiambo (controller of budget)also disclosed money from the Sh175.6 billion ($17billion) Eurobond has been received and approved for spending, but Treasury has not been clear on what the money has been used for,” (Daily Nation of October 22, 2015) makes one wonder if the country is ready and prepared to issue Sukuk.

Unless situation changes, Sukuk is likely to be shelved for more years due to political climate but more importantly, to prevent religious motivated investors from facing high Shari'ah non-compliance risk due to negative Eurobond precedent.

Normally, Sukuk proceeds are expected to be channelled to specific projects or specifically used in Shari'ah compliant manner. With many questions sorrounding Eurobond and its aftermaths, extra efforts will be required from the government, Shari'ah scholars (who will approve the structure) and other stakeholders to assure investors that the funds won't end up in servicing any existing government interest loans or invested in conventional banks to earn interest (Some reports shows that Eurobond earned Shs 14 million interest from offshore banks), or ending up in corruption scandals.