Country on the verge of collapse

Last week, I received a telephone call from an old pal and a fairly big local investor in Treasury bonds who said he wanted to engage me on recent goings-on in the markets for government securities.

He had invested a fairly substantial amount of his savings in infrastructure bonds over the years. As we all know, infrastructure bonds are very popular with investors because one doesn’t pay taxes on the earnings. 

He told me how, with the uncertainty surrounding investment in government paper and the constant talk by officials about the imminent restructuring of debt, he had wanted to liquidate the infrastructure bonds and put the money elsewhere.

To his surprise, the offers he was receiving from prospective buyers showed that the secondary market was demanding huge haircuts on paper. He was considering the option of asking his investment bankers to put the money in Eurobonds. 

Apparently, the prevailing wisdom in the marketplace is that Eurobonds will not be affected by any restructuring arrangement the government may opt for.

I made a mental note that my friend’s predicament was a case of a pre-emptive bond switch by an investor who has decided to act just in case the government is forced to implement any bond switches, implement haircuts or unilaterally postpone payment of maturities on bonds. 

Clearly, the troubling trends in the primary market for government securities are also beginning to precipitate strains and uncertainties in the secondary market for long-term government paper.

A fund manager of a large pension fund told me that he was yet to observe any panicky behaviour by a pension fund manager. The sentiment in the market is that pension funds are usually not affected during debt restructuring. In Ghana, the sector was left out.

Still, the most-talked-about of troubling trend remains the investor auction boycotts that we are witnessing in the primary market. Indeed, domestic investors and bondholders have essentially ceased lending to the government except on short-term 90-day Treasury bills.

In the latest bond auction, only Sh1.7 billion in bids were accepted out of Sh30 billion on a re-opened three-year Treasury bond. A 15-year bond that was also on offer was cancelled in its entirety.

Yet the most revealing piece of statistics was the average weighted interest rates of the bids offered by investors in that auction. The numbers disclosed that those bids were slightly above the average commercial bank lending rates.

Is it not a sign of the times we live in that investors are demanding from the risk-free guy—namely the Government of Kenya—rates higher than those offered by commercial banks? Are the investors drawing incorrect parallels, reading too much from what happened in Ghana, and, therefore, pricing a sovereign default risk in the bids?

Or are we suffering from the effects of negative reports by rating agencies that have been assessing our situation by persistently categorising and lumping us together with countries that have defaulted, such as Ghana?

What is clear is that the parallels the investors are making with the predicament Ghana has fallen into are not just based on sentiment and perception. When Ghana defaulted and proceeded to announce bond switches, postponement of payment of maturities and haircuts on investors in December last year, the country was at 62 per cent in terms of total debt service to revenues. Kenya is already at 65 per cent of total debt service to revenues. 

The similarities in the debt metrics for the two countries don’t stop there: Ghana was at 70 per cent debt to GDP when it defaulted. We are also at 70 per cent.

But is a sovereign default imminent?

This is what the Director of the Department of Debt at the National Treasury, Dr Haroun Sirma, told me when I put the question to him the other day: “As long as we are on an IMF programme and are B-rated by sovereign rating agencies, lenders will continue giving credit to us.” 

What we are seeing, in reality, however, is that investors are beginning to lose faith in the stability of government finances. 

The fact that the government has been having difficulties paying salaries has not helped. When the Council of Governors threatens to shut down operations in the counties because the government has not effected constitutionally mandated transfers, it sends wrong signals to financial markets. 

These are the types of events that continue to sap confidence and foment nagging fears in investors and the public that the worst is inevitable. Yet when you listen to government spokesmen, you don’t see the sense of urgency to get to the root of the debt problem.

If the emerging pressures in the secondary market worsen, it could trigger a bout of instability in institutions that hold large bond portfolios—especially where the bonds held are marked-to-market.

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