Ideas Thinkpieces

Living on the edge

Since the year 2002, Kenya has spent heavily on building infrastructure, trying to address a huge infrastructure deficit caused by decades of underinvestment.(e.g.Singapore spent about US$ 1 trillion on infrastructure between 1960 and 2015, 7 times more than Kenya in the same period).
The increased government spending on infrastructure has largely been paid for by public debt, both domestic and external. As it stands, 49% of Kenya’s total public debt is external debt, denominated in foreign currencies. And this makes sense: Kenya’s external debt is much cheaper than domestic debt, costing 0.7% of GDP, while servicing domestic debt currently costs the country 3% of GDP.
With Kenya needing to continue spending on infrastructure, a financing strategy that relies on external debt (rather than domestic debt) seems to make sense. Except that external debt increases the economy’s exposure to exchange rate risks. In fact, “a sustained 2% appreciation in the bundle of currencies in which Kenya’s external debts are denominated would make the external debt portfolio more expensive by about US$ 340 million, or KES 34 billion.” I think there could be another way forward, one that just may allow Kenya to have it’s cake (infrastructure) and eat it too (protection from exchange rate risks).

Antifragility is beyond resilience or robustness. The resilient resists shocks and stays the same; the antifragile gets better.
In Antifragile: Things that Gain from Disorder, Nassim Nicholas Taleb, the Distinguished Professor of Risk Engineering at the New York School of Engineering, acclaimed author and essayist, philosopher, former option trader and avid Twitter user puts it forcefully that debt “fragilizes economic systems,” that is, makes them weaker. 

As our society has grown richer, we have grown more indebted. This is not unique to Kenya. The richest countries in the world are also the ones with the most government debt relative to GDP (link). Nobel-winning economist Paul Krugman has often argued that government debt is beneficial to the economy. In “Debt is Good” (link), Krugman makes the case for government debt, stating that it provides a safe asset for investors who use government securities to manage risk and hold them as a substitute for cash. By issuing debt, governments can raise the money required to pay for useful things. This line is frequently used in Kenya when the public debt is being discussed. In trying to be a good student of economics, I wholeheartedly agree. If debt is used to fund productive investments such as transport infrastructure, the direct (say a new road where once was none) and indirect benefits can be astonishing (from the increase in land prices after completion of the new road, to the farmers who spend less to transport their produce, to the transporters who spend less on maintaining their vehicles, and so on). I am not a betting man, but I would confidently wager that that the Thika Superhighway has generated exponentially more than the KES 34 billion that was spent to construct it. So what is the problem? 

I know better than to argue with Krugman, so I will not. Mine is about risk. Specifically, the economic fragility and increased exposure to risk that is caused by an increase in government debt. In truth, not all government debt is equal. If debt is denominated in the local currency, it is easily manageable. The government can issue bonds (which are basically pieces of paper or entries in a computer) and collect money from investors, promising to pay the principal and any interest back. When payments fall due, the government has at least 2 options: issue more bonds (or treasury bills) to pay for previous interest and principal payments, or print money to pay back investors. This can theoretically go on forever, a point Krugman makes (link) when he describes domestic debt as “money we owe to ourselves”. But it doesn’t go on forever. Simply, the demand and supply of money causes the price of money (interest rates) to fluctuate. Too high an interest rate and money can become too expensive for borrowers; too low an interest rate and it can make money too cheap, potentially causing the prices of goods to rise (inflation) as consumers make higher bids for a finite number of goods. For these and other reasons, governments complement local borrowing with external borrowing, in foreign markets and in foreign currencies. Because the debt is borrowed in foreign markets, the demand-and-supply effect on local interest rates is not as strong as it is when debt is issued domestically. 

However, external debt is serviced in foreign currency. If Kenya holds US$ 1 billion in debt, it must pay interest and principal in US dollars. And herein lies the worry. What happens if Kenya holds US$ 1 billion worth of debt, and the US dollar appreciates relative to the Kenya shilling? Kenya has to pay more to honour the same debt, since more Kenyan shillings will be required to make US$ 1. Just as less Kenyan shillings would be required if the US dollar lost value relative to the Kenya shilling. In good times (i.e. when the shilling is strong against foreign currencies), more foreign-denominated debt is a good thing for Kenya, since the debt portfolio loses value and it becomes cheaper to service external debts. But when things take a negative turn, it could spell doom.


As of the 2017 Medium Term Debt Management Strategy Report (link) by the National Treasury, 49% of Kenya’s total public debt is external debt. In fact, the 2014 Eurobond accounts for 7.9% of Kenya’s total public debt. A sustained 2% appreciation in the US dollar would make the interest and principal payments on the US$ 2 billion Eurobond more expensive by US$ 44 million dollars. A sustained 2% appreciation in the bundle of currencies in which Kenya’s external debts are denominated would make the external debt portfolio more expensive by about US$ 340 million, or KES 34 billion. Imagine what could happen if the bundle of currencies appreciated by 5% or 10%.

If this was to happen, Kenya would probably first make use of the Central Bank reserves to try and stabilise the exchange rate prices by allowing more US dollars into the economy. As reserves dwindle the National Treasury and CBK would probably turn to the IMF for a dollar credit line with which to shore up the Kenya shilling. Remember that as this is happening, the price of imported goods would have risen sharply as the Kenyan currency depreciated. So fuel and all the other imported goods (Kenya is a net importer) and commodities would be much more expensive, with inflation rising and the cost of living shooting up. Depending on the level of interest rates, the CBK could try to arrest inflation by raising interest rates, and making the cost of money in the economy rise. With higher interest rates, access to credit by borrowers slows down and the economy cools off. However, because the inflation is mainly imported, this does not have the desired effect on inflation. With the economy growing slower, there are less jobs to go around, less money for everyone and less taxes collected by the state. This means that the government would have to reduce development spending to meet external debt obligations. This is a rather macabre vision of the future, but with the American and North Korean nuclear face-off escalating by the day, who knows what could happen to the US dollar and other reserve currencies.

Government debt is good, and can be a potent tool for fast-tracking infrastructural development. But there is a dark side to it; external government debt fragilizes the economy by increasing its exposure to foreign exchange rate movements.
There is, thankfully, a silver lining for Kenya. Tullow Oil, an oil and gas exploration company, estimates that there could be over 750 million barrels of oil (link) in the South Lokichar Basin. If Kenya could extract and export oil, it could develop some much-needed antifragility. If the oil is exported in US dollars, yes, Kenya would receive less per barrel if the US dollar depreciates relative to the Kenya shilling. But this would also make Kenya’s imports, such as oil, and the external dollar debt portfolio cheaper. If the US dollar appreciates, yes, imports would be more expensive. But the earnings from Kenya’s oil exports would increase as well, offsetting the rise in the costs of servicing external debt.

If Kenya could be able to export just 100,000 barrels of oil per day, and be able to earn a net profit of just KES 20 per litre (a barrel contains about 159 litres), the country could be earning up to KES 316 million a day (about US$ 3 million). In the medium-to-long term, if such resources could be used prudently, Kenya could theoretically pay all its current external debt (KES 1.72 trillion as of the 2017 Medium Term Debt Management Strategy Report) from the South Lokichar Basin alone. This is a huge “if” and would depend on how well Kenya -through its political class and state technocrats- uses the oil dollars, and how well it can stave off the resource curse (link), yet another source of fragility. Whatever the case, Kenya is likely to continue borrowing from domestic and external markets to fund infrastructure projects and try to close the infrastructure deficit caused by decades of underinvestment. The infrastructure that such debt pays for is an important and necessary catalyst for sustained economic growth, but the fragility that external debt introduces into the economy is a growing strategic weakness.
The gods have given us black gold, and with it an opportunity to strengthen (add some antifragility) our economy and pay for much-needed infrastructure. What will we do?


Thanks to Faith Nyawira for reading a draft of this.


By Brian

I’m Brian Gachichio. I advise and consult on strategy design and execution, performance measurement in organizations, and business process management.

My goal is to provide the innovative thinking that leads to high-impact solutions to business problems and help produce above-average results.