There was once a kingdom that had a huge reparation bill in favour of a rival following a failed annexation battle. Fearing it would deplete its gold to honour the bill, the King held private meetings with goldsmiths who offered to lend him their gold to be offset against future tax obligations.
The goldsmith depositors who had rented out gold storage spaces got wind of the King’s plans and feared for their deposits. The next morning, nearly all the depositors showed up at the goldsmiths’ doors demanding back their gold.
In the kingdom of Kenya, the private pension industry, which currently sits on assets worth over Sh1.0 trillion (just about $10 billion) have offered to roll over interest payments on existing holdings of Government securities for a limited period. Quite a noble gesture.
But as in the case of the Kingdom’s tale, it is equally dangerous. First, the fact that the National Treasury is warming up to such an idea exposes a dire state of public finances, which could easily spook investors and probably trigger a sovereign credit ratings downgrade. But most importantly, it amounts to a reverse default by the Kenyan government, and introduces an element of credit risk on all government debt, which, in turn, will mean that financial institutions must now hold capital against any exposures. I don’t think they are ready for such a scenario.
Second, it will slow down the secondary bond market since holders of bonds whose interest payments will have been deferred will not offer them for secondary trading; and pension funds are some of the biggest players in the secondary market.
A more pertinent question is how to value bonds whose interest payments have been deferred since this is done on the basis of defined and expected cashflows.
Finally, it presents liquidity challenges for pension funds with annuity products (such as income draw-downs), and who have to meet monthly payment obligations.
All said and done, private pension funds can still contribute to public finances in a special way. The government can issue a special edition coronavirus local currency bond with zero-coupon, with the tenor based on the government’s own projection of post-coronavirus economic bottom-out.
Pension funds, in turn, will invest on a pro-rata basis, with the large pension schemes having the largest participation.
Somehow, the Government will need to print itself out of current crisis, and this is just one side of the coin. The other side of the coin, captured in my article titled “Virus calls for extraordinary monetary rescue initiatives”, lays out a case for the central bank role in bailing out the fiscus to the tune of Sh150 billion.
Section 46 of the Central Bank of Kenya (CBK) Act allows the apex bank to make direct advances to the national government for offsetting fluctuations between receipts from the budgeted revenue and payments of the government.
In fact, they should now add “acts of God” as another exception. Nonetheless, the advance is conditioned that it is secured by negotiable securities with a maturity of not later than 12 months.
Further, the Act directs that total advances to the government shall not exceed five per cent of last audited revenues.
With this in mind, the Treasury can issue a special bond of similar amount, being a negotiable security, in favour of the CBK in exchange for full subscription and the proceeds go into the Covid-19 economic stimulus programmes. This is plain debt monetisation.
The next step should be for Parliament to amend the Act to (i) extend the tenure to beyond the current 12 months; and (ii) increase the cap to beyond five per cent of audited revenues. Extraordinary situations call for extraordinary responses.