CBK bets on low cost of funds for bond success

The Central Bank of Kenya expects the low cost of funds in the domestic market to enhance the take-up of the latest infrastructure bond and minimise the government’s debt servicing.

The bond offers a return of six per cent — the same level as the Central Bank Rate — which is more than three times the Treasury bill rates of 1.669 and 1.999 per cent as at the latest auction for the three month and six month tenures.

That investors are willing to take up securities at rates that offer real negative returns compared to inflation, now at 3.6 per cent, has convinced the monetary authority that investors have little room with money market rates averaging between two per cent and 4.5 per cent.

“The Kenyan Treasury bills continue to be uninteresting from an investor perspective. Investors purchasing these short term Treasuries are earning a negative real rate of return. This is not a strategy for creating wealth or even preserving wealth,” says Dry Associates in latest market report.

The Dry Associates report implies that some bonds and other investment instruments can be bought at higher rates on the market than is currently being offered by some government securities - therefore leading to loss of wealth.

With hindsight, the Central Bank was putting its hands where its mouth is when it reduced the CBR by 75 basis points three weeks ago enabling commercial banks in distress to obtain cheaper funds through its lender of last resort window.

CBK governor Njuguna Ndung’u said the returns on T-bill and the T-bonds informed the structuring of the infrastructure bond offer.

Although investors are free to quote a higher price, there is a tendency for quotes to collapse around the coupon rates which are predated on prevailing market rates.

CBK director of national debt Jackson Kitili said the rate offered could have been lower at 5.25 per cent given that the yield on a bond that has about seven years to maturity, is currently at 5.15 per cent.

Dry Associates pointed out that some mid-tier commercial banks they had a relationship with offered higher returns as did the bond market.

Although the T-bill rate has shown signs of rising, Prof Ndung’u said this was temporary.Alexander Muiruri, an independent financial analyst, sees investors seeking some premium on the six per cent coupon for full take-up of the infrastructure bond now that interest rates were reversing.

However, the CBK could counter this by injecting liquidity as several bonds mature this month.

“There are a number of government securities maturing toward the end of August, so I think full subscription is possible provided CBK gives banks the necessary cash reserves through OMO [open market operations].”

Mr Muiruri said that the CBK’s current liquidity is a result of the sudden rise in government spending at the end of financial year ending June 2010.

Apparently, government ministries and departments were in a hurry to spend as the fiscal year came to an end and needed to show reason for new allocations.