Cash-strapped Kenya looks to expand bond market to attract skittish investors

Since President William Ruto assumed office in September 2022, his economic stewards have scouted for potential special bonds – whose modalities are yet to be established – with the goal of changing the market’s low appetite for long-term securities.

Kenya’s economy is saddled with various shocks including regional drought, global political tensions, and exchange rate fluctuations.

The targeted dollar-denominated bond sale expansion includes offers on diaspora remittances, foreign currency savings in local banks, and fuel subsidy arrears – all revenue-sourcing avenues to fund budget deficits – together with the hotly criticised housing levy.

These are also part of attempts to quell the country’s foreign exchange turmoil, which has marginally improved since reviving the interbank market in March.

Domestic market hitches

Key details need to be ironed out, such as whether the targeted bond sale will be limited to Kenyan citizens. Regulations, processes, and maturity duration also remain unclear.

The bonds may prove a tough sell considering investors’ reluctance to tap government papers for long periods over default fears. Kenyan investors favour short-term projects despite their high price, while the government puts its hopes in market improvement in the near term.

“We have incoming resources that could trigger more participation in domestic lending,” the incoming Central Bank of Kenya governor, Kamau Thugge, tells The Africa Report.

Thugge, who was nominated by Ruto and vetted by parliament this week, is set to officially take over the bank next month, replacing Patrick Njoroge. The outgoing governor suspended the interbank forex market, which has partly been blamed for a biting greenback shortage.

Tight liquidity

In mid-April, the government was compelled to cancel the auction of a 15-year bond amid low interest from investors and the three-year bond that opened in mid-May is fetching average returns of 14.23%.

“Now that inflation is also going down, banks may also be willing to have lower interest rates,” says Thugge.

The inflation rate declined to a 10-month low of 7.9% in April, down from 9.2% in March.

In 2021/22, the Kenyan central bank raised 89% of the borrowing programme target compared to 57.3% (KSh249bn, or $1.8bn) in the current financial year (as of May 2023).

Tight domestic liquidity conditions have persisted on delayed budgeted external financing against a backdrop of heightened global inflationary pressures, the war in Ukraine, and significant financial market volatility that have devastated developing economies such as Kenya.

Kenya has long tried to maintain an even split between domestic and external borrowing, but the new administration is trying something radically different in the upcoming 2023/24 budget cycle. The split proposed is at roughly 72:28 in favour of the KSh521.5bn (around $3.7bn) in domestic borrowing. External borrowing is capped at KSh198.6bn ($1.4bn) from the previous Ksh395.8bn ($2.8bn), largely due to the redemption of the maturing $2bn Eurobond.

Central bank warning

Judging by its bond expansion plans, the Kenyan government will try chasing the Ksh1.1tr ($7.9bn) stashed in foreign currencies by wealthy people and businesses. Around Ksh554bn ($4bn) in diaspora remittances collected in the 12 months to April 2023 could be tapped should the bonds get floated.

Oil sellers may also be willing to let their KSh45bn ($320m) fuel subsidy dues be converted to interest-earning, three-year debt instruments such as bonds, saving the treasury from the strain of a lump sum debt settlement.

However, bridging revenue shortfalls via domestic financing generally bares market risks and is nearly unattainable, some experts warn, noting that the economy is already depressed. Local banks and pension firms are expected to join external investors in the costly pricing of loans.

“Due to elevated financing needs, the capacity of the domestic market to finance the deficits, especially over the past two financial years has been limited,” Njoroge warned the government’s public debt and privatisation committee.

Njoroge asked the government to rather consider revising downwards the “quite ambitious” domestic financing target to avert extending the overall value of the outstanding debt stock.

This risk, plus the possibility of crowding out the private sector, could be mitigated by effective liquidity management and exploring external financing options with an optimal mix of concessional and commercial funding.

Credit rating downgrade

The status of the bond market is “quite debatable”, says Alpesh Vadher, the CEO of PKF Kenya, an audit firm that advises the government.

“Do we have a leeway to increase interest rates? If your money sits with the bank, you can access it at any time. But if it is a bond, as an investor, the question is whether the shilling will devalue further and whether the government is willing to pay,” adds Vadher.

As of the end of May, yields on the 10-year Eurobond maturing in 2024 stood at 15.68%.

Kenya has already suffered an early blow in its quest to return to the international markets for financing after Moody’s downgraded its credit risk rating from B2 to B3, serving as a further warning to potential investors who might elevate interest rates further. The government has dismissed the ratings.

Trying to reject expensive bids will, however, dent the performance of bonds issued in future. As a result, the government could be cornered to bow to investors’ demands – either locally or internationally –  even as it desperately tries to only accept interest rates at or below 10%, as aspired to by Ruto.

Revenue shortfalls 

Cognisant of the difficult capital market, Kenya has extended or tapped new multilateral concessional funding from both the World Bank and the International Monetary Fund as its primary stance on external financing.

The warning shot by Njoroge over the ambitious borrowing plan echoes the worries of the budget and appropriation committee, which has also cautioned that the revenue collection targets given to the Kenya Revenue Authority are nearly unachievable.

With this year’s economic growth rate downgraded to 5.4% from 2022 projections of 5.8%, revenue collection might take a hit, while a newly proposed raft of tax hikes is also likely to dampen consumption.

“This revenue target is quite ambitious. Should the revenue collection target not materialise, it will necessitate a downward revision in expenditure through a supplementary budget,” reads a report by the budget committee led by parliamentarian Ndindi Nyoro, an ally of the Ruto government.