Kenya: Amplified government debt appetite to maintain upturn in yields as threats from COVID-19 persist.

Succession politics continue to dominate news headlines at a time when Kenya’s economic recovery is being threatened by rising COVID-19 infections as well as mutant variant strains. Latest COVID-19 data suggests that the positivity rate is progressively steadying towards double digit territory while risks from new variant strains has forced the government impose a 14-day quarantine restriction on travelers from 6 countries.

Source: WHO. The WHO has suggested a positive rate lower than 10% – but better is lower than 3% – as a general benchmark of adequate testing

While the arrival of the 1 million COVID-19 vaccines last week lifted optimism around the country’s recovery, I must say that rising infection rates could somewhat dampen the momentum. And it truly seems that the economic momentum could be tempering.

According to the February release of the Markit/Stanbic PMI on private sector activity, the index recorded its weakest expansion in nearly eight months as headwinds to business and household spending limited production.

All said, not all hope is lost. As the economy comes out of the slack that was 2020, the low base, vaccine hope coupled with less stringent COVID-19 restrictions both locally and internationally should remain supportive of some kind of expansion. This of course is notwithstanding concerns that fresh restrictions from key trading partners could somewhat lower demand for our agriculture produce which could hamper activity in the agriculture sector – a sector which contributes nearly a third to overall GDP.

For now, the baton to support growth will remain primarily with the government. The necessary fiscal space to do so has however been a sour point owing to weak revenues amid amplified spending.

Granted, the revenue performance has gradually improved (month to month) owing to better activity but businesses remain highly fragile and unlikely to materially enhance their investment spending given the prevailing uncertainty associated with the duration of the pandemic. Meanwhile, consumer spending remains modest mirroring fragile incomes. I also expect that many consumers will remain price sensitive and largely focused on essential expenditure.

Source: Kenya Gazette. Compiled by Hot Blooded Business

Bridging the fiscal deficit has increasingly leaned towards local debt financing as external debt markets remain highly volatile. This enhanced government local debt appetite continues to raise interest rate expectations. This has been reflected during Treasury sales with yields maintaining an upward inclination. To be sure, since the start of 2021, T-bill yields have risen by 11.80bps, 36.50bps and 72.30bps to 7.024%, 7.765% and 9.071% for the 91, 182 and 364 day papers respectively.

Source: Central Bank of Kenya. Compiled by Hot Blooded Business.

Auction to auction though, the upward momentum in yields has remained contained within a 3 – 5bps range in line with a healthy investor subscription that remains supported by improving liquidity conditions.

The quantum of liquidity has been supported by improved government flows especially after revenue collections rose following a reversion to pre-covid tax rates. However, the distribution remains extremely skewed. Case in point last week, the overnight rate touched a near three-week high of 5.09% on Friday, with a majority of overnight borrowing/lending activity concentrated above 6.00% suggesting some underlying short term funding pressures.

That said, over the last three weeks, T-bills have been oversubscribed with the central bank accepting virtually all the bids received affirming the government’s amplified appetite for domestic debt.

For Treasury bond auctions, papers have sold about 30bps above their prevailing yields at the time of auction. This suggests the government’s willingness to absorb more expensive debt having only met about 56% of it KES 572.50Bn domestic debt target for the FY 2020/21.

Papers with shorter tenures have thus far tended to be more attractive. Since the start of the FY 2020/21 T-bond auctions have offered papers with an average 10.80 years to maturity. Though the government’s objective is to lengthen the average time to maturity on domestic debt, it continues to appreciate evolving trends in the market considering the uncertainty induced by the COVID-19 pandemic. I assume this is why they have been offering more twin auctions (offering both a shorter and longer paper) as well as selling papers with lower than pre-covid maturities.

In other news of note, the Budget and Appropriations Committee provided some recommendations to the 2021 Budget Policy Statement (BPS). The committee recommended the fiscal deficit (as a % of GDP) to be pegged at no higher than 7.50%. The committee also recommended that a deficit higher than the cap not be approved. This will perhaps force the government to better manage its coffers.

The committee also appreciated the National Treasury’s, through the Medium Term Debt Strategy (MDTS) resolve to shift away from local debt financing and lean towards the external debt market more so towards concessional and favorable terms.

The debt mix is therefore expected to be 57:43 (net external financing and net domestic financing ratio) with net foreign financing limited at KES 530Bn while net domestic financing set at KES 399.90Bn.

Source: Report of the Budget and Appropriations Committee (BAC) on the Budget Policy Statement for 2021/2022 & The Medium Term Debt Management Strategy

Lower domestic debt appetite should curtail expectations of a sustained rise in interest rates in the FY 2021/22. Moreover, the National Treasury is as well expected to reduce the stock to T-bills KES 200Bn  in a bid to lengthen the average time to maturity on domestic debt.

NB: According to the BAC, the debt mix strategy presented in the Medium Term Debt Management Strategy and the 2021 BPS differs which makes its unclear which strategy they are likely to take.