Size of debt is not a problem; repayment period is

By MUNGAI KIHANYA

The Sunday Nation

Nairobi,

03 February 2019

Is Kenya’s public debt too large? That’s the wrong question. The size of the debt does not matter at all! What is crucially important is whether the country is able to generate enough revenue to make the installment payments on time and still carry out its normal activities.

This is where those engaging in this debate are missing the point. They are focusing on the wrong parameter. According to the Annual Public Debt Report (2017-18) published by the National Treasury, we spent Sh460bn on repayments in the last financial year. This was 34 per cent of revenue. This is the number that should really worry us; not the total debt (as percentage of GDP).

A few decades ago, banks in Kenya used to assess loan applicants almost exclusively on the basis of the security presented. But this was wrong; they soon realised that what matters most is the applicant’s ability to pay and that this has very little relationship to the property owned.

Many a time, applicants would present title deeds of family land and then default on the payments. The bank was left with a security it coldn’t sell because other relatives would protest the sale of their “ancestral land”!

 Now; suppose you borrowed Sh500,000 at 14 per cent repayable in three years. How much would the monthly installment be? I have discussed the details of that calculation in past articles and the answer is about Sh17,000.

What if you negotiated a longer payment period of, say six years (double the previous one)? In that case the monthly installment drops to Sh10,300. The repayments have reduced by about 40%.

What if you negotiated a much lower interest rate, say, 7 percent (half of the previous one) but still repayable in three years? In this case, the installment drops marginally to Sh15,400: a 10% reduction.

We find that increasing the repayment period has a much bigger impact of the installments than reducing the interest rate. But this outcome is only true up to a certain point.

Suppose now, that the Sh500,000 was at 14 per cent but repayable in 20 years. The monthly installment would be Sh6,200. Doubling the period to 40 years at the same interest brings down the repayment to Sh5,855.

On the other hand, if the interest of the 20-year loan is reduced by half to 7 per cent, the monthly payment goes down to Sh3,875.

Clearly then, the government needs to start re-negotiating the debts with two objectives. For the short-term loans, ask for increment of the repayment period. It is unlikely that lenders will entertain talking about the interest rate. For the long-term ones, the government needs to focus attention on the interest rate.

Going forward, any additional borrowing should be based on our ability to pay for, as they say in business, cash is king. A profitable business without cash will close down but a loss-maker awash with cash will continue operating.