Domestic Bonds

Treasury’s insatiable appetite for loans crowds out the private sector


Central Bank of Kenya building on Haile Selasie Road, Nairobi. [Wilberforce Okwiri, Standard]

One of the first miracles former President Mwai Kibaki performed when he came to power in 2003 was to turn well-prepared bankers into hawkers.

They have been seen pitching tents along the dusty streets of Nairobi, peddling loans to a languid crowd.

Five years earlier, they could just sit in their air-conditioned offices decorated with long faces waiting for desperate clients to come in for a loan application process that smacked of extortion.

Data from the Central Bank of Kenya (CBK) shows that these customers paid an additional 300 shillings for every 1,000 shillings borrowed from local banks. Take it or leave it.

After all, the government – the safest borrower – paid 230 shillings for every 1,000 shillings borrowed by issuing the 91-day treasury bill, a short-term government bond.

President Kibaki, economist and former finance minister, threw it all down. At the end of 2004, banks were lending to the private sector at an average rate of 12.5 percent.

But that’s because his administration paid an average rate of 4.07 percent for the 91-day government paper. This is a substantial drop of 119% from an interest rate of 8.92% in 2002.

Eight years later, it seems Kenyans are in need of another miracle. Frightened by the Covid-19 pandemic that has left businesses bankrupt and employees laid off, banks have once again turned government securities into a lucrative hunting ground.

Income options

And the government, short of options to raise revenues, is increasingly relying on domestic loans to cover its deficit, raising fears of crowding out of the private sector.

Kenya Bankers Association (KBA) chief executive Habil Olaka hopes some of the measures highlighted by Cabinet Secretary of the Treasury Ukur Yatani will enable the banking sector to extend credit to the private sector.

“You cannot, for example, crowd out the private sector by borrowing heavily on the same market … to the point of not being able to access the same credit,” he said.

KBA is a lobby for commercial banks and microfinance banks.

Over the next fiscal year, the Treasury is expected to borrow a massive Sh1 trillion from local investors, mainly banks, pension funds and insurance companies.

This includes net borrowing of Sh 658.8 billion for development and budget support activities and debt repayments of Sh 346.8 billion.

The loan will offer fierce competition to the private sector in urgent need of credit to emerge from the ruins of the Covid-19 pandemic.

Analysts noted that after the government did much of weightlifting last year by offering tax breaks to businesses and workers, cash transfers to vulnerable people, youth and women, and from debt repayment holidays to borrowers in difficulty by Covid-19, it is now the private sector’s turn to revive the economy.

Businesses and households will therefore need a lot of credit from banks. They may not get it.

Churchill Ogutu, head of research at investment bank Gengis Capital, explains that the reason the country has increasingly turned to the domestic market is that Kenya has failed to meet its target on collection of taxes and fees, even if external loans from multilateral institutions, bilateral lenders, or commercial loans have fizzled out.

“So the remaining balance must come from the country,” he said. And local investors have gladly put their money in treasury bills (short-term government securities up to one year) and treasury bills (long-term securities).

“In an environment where ordinary income targets have been drastically reduced due to Covid-19, this in itself has necessitated an increase in domestic borrowing in the current fiscal year and the next,” Ogutu added.

Despite the low yields, with interest on 91-day T-bills falling to their lowest in seven years at 6.01%, local investors, especially banks, put most of their money in papers government.

The seven largest banks increased their investments in government securities by 14.8% on average last year to 1.3 trillion shillings from 901.7 billion shillings the previous year.

Co-operative Bank increased its investment share by 44.2 percent to Sh161.9 billion from Sh117.7 billion in 2019.

Equity Bank, the most profitable bank, placed an additional 40 billion shillings in government securities, bringing its stock of government papers to 162.3 billion shillings.

In addition, the seven banks saw their income on government securities increase by 24 percent on average, bolstering their income in a period when lending to the private sector was considered risky.

The NCBA, the third-largest bank after KCB and Equity, saw its income from government securities increase 82.6% with the lender, associated with the Kenyatta family, earning 16.8 billion shillings against 9.2 billion shillings in 2019.

The KCB recorded a 64.5 percent increase in revenue from its government lending activities, earning Sh 23.2 billion from the treasury.

Equity profits from government securities rose 23 percent to 20.9 billion shillings in 2020.

At the same time, total loans to the private sector increased by 11.7% last year to reach 3 trillion shillings, from 2.7 trillion shillings in 2019.

Although the CBK cut its key rate to allow banks to lend more cheaply to the private sector, banks have avoided extending credit to businesses and households.

The pandemic has shaken the markets and rocked the economy. People were losing their jobs as planes stayed in hangars and the flow of tourists dried up.

Restaurants and pubs have closed and the stock market has taken a hiatus for the first time in years.

It was a flight to safety. Much of the capital either left the country to secure assets abroad or ended up in treasury bills or treasury bills.

The government’s domestic debt stock increases by 546.4 billion shillings, 18 percent, to 3.5 trillion shillings.

Domestic debt is readily available and does not come with terms such as those of the International Monetary Fund (IMF) and the World Bank.

Plus, you can always avoid the exchange rate fluctuations that are common with external borrowing, which is denominated in foreign currencies, specifically the US dollar.

When the dollar strengthens against the shilling as it did during the Covid-19 period, the country’s stock of external debt automatically increased.

Additionally, a deep domestic debt market helps encourage savings among residents, with many households finding a safe haven to place their money.

In his budget speech, Yatani said the government is developing an over-the-counter secondary market platform for government securities.

“This platform will help deepen our domestic debt market, improve price efficiency and transparency in securities trading, thereby reducing yields and the cost of credit in the economy,” he said. he said, adding that the platform will be ready by June of next year.

Normally, treasury bills are listed and traded on the Nairobi Securities Exchange (NSE), which means you can always sell them to a third party if you want to exit or if the price is right.

In addition to crowding out the private sector, domestic debt can be costly. “Domestic debt rates are on average in double digits, so they’re expensive,” Ogutu said.

Pay creditors

The increase in domestic borrowing means that the government has used a large part of its tax revenue to pay creditors.

Over the next fiscal year, for example, domestic debt servicing costs are expected to climb to 768.7 billion shillings, or 65.7 percent of the total public debt servicing costs, underscoring the extent to which the domestic debt is expensive, according to Ogutu.

When Kibaki refused to take loans from banks on their own terms, credit to the private sector increased 30% year-on-year.

This changed as the current administration became more invested in the domestic debt market with single digit private sector growth.

Yatani, reading what appears to be the inherited budget from Kenyatta, sought to show that credit had grown by leaps and bounds under the Jubilee government.

He noted that since Kenyatta came to power in 2013, interest rates have fallen, resulting in increased credit to the private sector.

The lending rate, Yatani said, rose from 17.3% in 2013 to 12% in 2020. Additionally, the central bank rate – or the benchmark rate at which the CBK lends to banks for subsequent loans to banks. borrowers – rose from 8.5 percent in 2013 to seven percent last year.

“As a result, credit to the private sector has increased from 1.5 trillion shillings in 2013 to 2.8 trillion shillings in 2020,” Yatani said.