Kenya’s budget headache as domestic borrowing hits a snag

By Herald Aloo
Posted on Thursday, 6 October 2022 14:38

Kenya shilling coins and notes are pictured inside a cashier's booth at a forex exchange bureau in Kenya's capital Nairobi, April 20, 2016. REUTERS/Thomas Mukoya?

An increase in interest rates in global markets has made emerging market assets less attractive, with investors coy to lend to the Kenyan government, exposing the new administration to a funding headache.

For the fourth consecutive week in September, Treasury Bills in Kenya performed poorly, with a record low performance rate of 38.8% in the last auction of 30 September 2022. This saw Central Bank of Kenya (CBK) receive bids totalling just KSh9.3bn, compared to an advertised amount of KSh24bn.

Since the beginning of this financial year in July, the 91-day Treasury Bill interest rates have increased on average by 0.704% to reach 8.47% at the end September. The 182-day and 364-day Treasury Bill rates bear a similar upward trend.

Bond sale results for 14 September were also weak following the reopening of 10 and 15-year papers (first sold earlier this year) raising only Ksh39bn. Hoping to earn Ksh50bn from the auction, the CBK rejected Ksh7.1bn bids as investors demanded interest rates that the central bank was unwilling to meet.

“The primary cause of weakness in the government of Kenya domestic securities market is that the big buyers of these securities are the banks and it is clear that they are maxed out, particularly given the recent context of events in Ghana, where the government is restructuring its balance sheet ahead of a fresh IMF facility,” says Aly-Khan Satchu, an investment analysts.

Ghana’s domestic bondholders, mainly pension schemes and banks, are currently staring at an extension of loan maturity dates and haircuts on principal and interest payments as part of a restructuring plan pegged on the $3bn IMF loan the country requested in July.

IMF, which has influence in Kenya’s policies, is expected to give a regional briefing in the course of this month regarding economic outlook and policy priorities.

Higher interest rates on the horizon

The under-performance in domestic borrowing means Kenya falls short of its borrowing targets for the current fiscal year at a time when securing funding from the global market is equally expensive, due to the high interest rates demanded by international investors.

“Investors wish to avoid bond revaluation losses, which are price declines below their purchase cost or original value resulting from rising interest rates,” investment bank Sterling Capital said in a note regarding the capital market in Kenya.

Risk models at the banks are blinking amber and for the central bank to sell more securities an element of price discovery will need to be introduced

The CBK has resisted pressure to increase the bond sale interest rates above 14%, which could attract investors, but have a burden on the country’s debt stock. The CBK is accepting up to 13.9% interest rates on long-term bond auctions, explaining the high rejection of bids.

Indeed, the National Treasury abandoned plans to issue a Eurobond and syndicated loans early this year due to expensive borrowing costs, with investors at times demanding rates of up to 22%.

Breaching the 14% interest rate mark on bond sales poses a knock-on effect on the commercial banks lending rate that could surge and further impede lending to the private sector.

However, analysts say the CBK may be forced to accept higher-priced bids to improve the performance rate of bond sales going forward, while Kenya could possibly look into taping concessional loans as a quick fix.

“Risk models at the banks are blinking amber and for the central bank to sell more securities an element of price discovery will need to be introduced,” says Satchu. “Expect the clear price to be considerably higher, something which would also impair existing holdings on bank balance sheets.”

Budget support

President William Ruto’s administration aims to borrow about KSh578bn from the domestic market, as part of financing for a KSh845bn budget hole. Since July, Kenya has issued four bonds to seal budget gaps, but most have fallen short of hitting the targeted amounts.

Failure to secure enough funds means the government will be lagging on its development expenditure amid push to prioritise steering a pandemic-battered economy with drought-stricken areas as well as rising fuel and food prices.

CBK governor Patrick Njoroge recently lamented that a decision by a host of central banks in developed economies to raise interest rates to tame inflation has disadvantaged developing countries in accessing financial markets.

The new administration is facing the challenge of maintaining a low cost of borrowing with Ruto insisting that his government will have to cut spending, debt stock and minimise borrowing, especially the foreign commercial loans whose costs are surging.

In the past five years, Kenya has relied on concessional loans to cut expensive short term bilateral debt from foreigners, such as China, which excluded Kenya from the 17 African countries granted debt relief this year.

Findings of Stanbic Bank Kenya’s Purchasing Managers Index (PMI) — a monthly survey on the private sector — suggest that in August, business production levels fell steeply and at the quickest pace for 16 months. However, this was partly linked to election jitters.

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