The government finalises its foreign currency bond sale

A major highlight for Kenya’s capital markets sector in 2014 was the government’s first foreign currency bond sale in June 2014. Successfully issuing the two tranches of a eurobond on June 16, 2014, Kenya joined a select list of sub-Saharan countries that have sold foreign-currency-denominated debt, including Nigeria, Ghana, Zambia, Rwanda and South Africa. The issue raised $2bn from international investors, making it the largest debut for an African country in the sovereign bond market.

The environment was more challenging than in years prior: the drawdown in quantitative easing (QE) by the US Federal Reserve had lowered the appeal for frontier and emerging market debt, and poor fiscal indicators elsewhere on the continent had raised yields for recent sub-Saharan African issuances. As a result, Kenya was not expected to get the low yields some other leading countries in subSaharan Africa have gotten in recent years. However, with a strong set of long-term fundamentals, the country saw demand from international investors, and yields were lower than initially thought.

Among A select Few

With road shows beginning in April 2014, the issue was expected to raise $1. 5-2bn in 10-year eurobonds, the name for debt issued in a currency other than the domestic one. The range was expected to be between 8% and 10% as of April 2014. However, the issuance yielded two notes: a $500m, five-year bond with an interest rate of 5.875% and a $1.5bn, 10-year note with a yield of 6.875%.

Kenya plans to spend the money in part on infrastructure but also on taking care of existing debt. The country had considered selling a eurobond in 2012 but instead opted for a $600m syndicated loan from a trio of foreign banks: Citigroup of the US, the UK’s developing-markets-focused Standard Chartered Bank, and Standard Bank Group of South Africa. The loan structure does not oblige Kenya to make regular payments but instead to satisfy the debt in a balloon payment, using a part of the proceeds of a sale of sovereign bonds issued before the loan comes due, which was originally at the end of Kenya’s past fiscal year on June 30, 2014, but was later extended by three months.

The domestic bond market, which has been comparatively active in recent years, is not seen as an option to raise funds to pay back the loan because absorption capacity is low; Kenyan bond investors are widely perceived as having had their fill for now. The IMF recommended the sovereign bond as a way to diversify funding sources.

Diversifying Offerings

The Nairobi Securities Exchange (NSE) has also undergone a rebranding in 2014 and relocated to new premises in Nairobi’s Westlands neighbourhood, which has become an alternative to the central business district for financial services firms. The next step is to work together with the Capital Markets Authority on bringing new products to the NSE. That starts with real estate investment trusts (REITs) in 2014, as there are several applications in to the CMA to start one and five investment firms have been licensed to manage them. The plan is to offer investment REITs to hold mature assets and share out the monthly income to owners, as well as development REITs for new construction. After that single-stock futures will be introduced, as well as financial and commodity derivatives. Currency hedging is in demand, as at present investors with currency risk can negotiate a forward exchange contract with a bank but cannot trade them with other investors on a regulated platform. The general strategy for futures contracts is to focus first on those that do not require the physical delivery of a commodity, as storage space is lacking for grains and other such crops. When it comes available, trading in futures contracts becomes feasible. The country has significant potential as a major price-discovery centre for black tea and coffee in particular, as it is the world’s largest exporter of the former and also a substantial seller of the latter.

Common Conditions

Other African countries were also looking to sell eurobonds in 2014. Earlier in 2014, a planned issuance by Ghana for a $33m bond was put on hold due to a less-than-favourable external environment. Senegal, which had announced a eurobond sale in June 2013, two months later was reported to have put the plan on hold after a gauge of market sentiment showed that a likely yield would be 8.75%. That compares with the 5.6% rate Zambia got in 2012, when demand for emerging market debt was high, fuelled by US monetary policy. The US Federal Reserve impacted conditions in 2013 when it shifted its basic approach to monetary policy from QE to the “tapering” of that strategy. The effect of a reduction in QE is more capital retained in US government debt, and thus less available to buy emerging market debt. With less demand in the market, investors have been demanding higher yields for the bonds of developing countries.

However, the impact from QE’s rollback is not uniform across all markets and, apart from Kenya’s favourable domestic traits, there are two reasons that tapering in the US may not fundamentally impact Kenya’s plans, or those of other developing countries keen to sell eurobonds, infrastructure bonds, or other types of dollar-denominated debt. The first is that the European Central Bank may embark on its own QE plan in 2014, based on statements from Mario Draghi, president of the European Central Bank, in the first week of April 2014. The second is that, regardless of how the current economic cycle impacts monetary policy at key central banks, emerging market bonds still retain significant appeal given the low growth elsewhere.

“There’s been a change of thinking, and clearly a bid for emerging-market bonds as an asset class,” said Blaise Antin, head of sovereign research at the Los Angeles-based investment firm TCW. “About 12% of investible global fixed-income assets are in emerging markets, and institutional investors probably have less than 5% of fixed-income allocations in emerging market bonds.’’ NEW ASSET CLASS: Even amidst the diversity of options in the emerging and frontier market asset classes, Kenya retains a certain level of appeal. The country’s credit rating is below investment grade, but has been consistent: Fitch Ratings has kept Kenya’s long-term foreign-currency rating at B+ for its last six country reviews, dating back to December 2007. The outlook has been stable with the exception of a review in January 2008, which came in the weeks after the political violence in the wake of the disputed national election in December 2007. The most recent review, from Fitch in January 2014, kept the rating at B+ and the outlook at stable.

The IMF said in its late-2013 Kenya country report that an additional $1.5bn in government debt would not change the fund’s debt sustainability analysis. IMF projections expect a debt-to-GDP ratio of 45.1% at the end of the 2013/14 fiscal year on June 30, and that the figure will likely fall to 41.7% by the end of 2016/17, indicating that the country has room to safely take on more debt. Oil looms in the long-term analysis. If the government begins to see revenue from oil production later this decade, its capacity to cover debts may see a significant jump.

The perceived risks to Kenya’s ability to repay a 10-year sovereign bond are led by a general uncertainty about expenditure allocation, and whether funds would be channelled to revenue-multiplier projects, such as infrastructure, or current spending such as public sector wages, according to Fitch’s January 2014 review. The recent devolution of powers from the state to 47 counties may only exacerbate that problem if the national government’s wage bill does not shrink appropriately to reflect its smaller scope. However, the government hopes to contain the problem through its Salaries and Remuneration Commission (SRC), which is expected to deliver a report by June 2014 on how to handle the civil service, according to correspondence between the government and the IMF in late 2013.

“The SRC work will help rationalise the salary scheme for all levels of government in line with the PFM (Public Finance Management) law and limit the scope for ad hoc wage increases,’’ according to the letter, which was addressed to Christine Lagarde, the managing director of the IMF, and signed by Njuguna Ndung’u, governor of the Central Bank of Kenya, and Henry Rotich, cabinet secretary of the National Treasury, akin to a ministry of finance in Kenya’s government structure.

Another concern at the macro level is investor protection and judicial recourse, a worry sparked in part by the Anglo Leasing affair, a procurement deal in 1997 that was revealed in 2004 to have been the cause of several incidents of graft and corruption. The lawsuits resulted in the Kenyan government being ordered to pay 18 contractors. In August 2014, the government had begun honouring the verdicts by beginning to pay out a total of KSh1.6bn ($18.2m).