Institutional investors such as pension funds, commercial banks and insurance companies could soon be locked out of lucrative infrastructure bonds in a proposed radical shift in the rules for participation in Kenya’s debt market.
This would mean that institutional investors could effectively be barred from participating in an investment instrument that typically attracts a massive appetite due to its tax-free status and relatively higher interest rates compared to standard bonds of similar or closely comparable maturities.
Infrastructure bonds enjoy tax-free status in line with Paragraph 59 of the First Schedule of the Income Tax Act and this provision aims at raising funds for development projects across the country.
Other bonds attract withholding tax of 10 percent for those with a tenor of more than five years and 15 percent for those maturing within five years.
The Treasury has tabled the proposal to the National Assembly as one of the reforms earmarked for the fiscal year running from July 2024 to June 2025 as the government looks to make significant changes in the country’s domestic debt market.
“The National Treasury intends to undertake reforms in the restructuring of the primary market activities to reduce borrowing costs and promote market activity. To manage competition between tax-free infrastructure bonds and Treasury bonds, it may be beneficial to restrict infrastructure bonds to retail investors,” the National Treasury says in the budget summary for 2024/25 tabled before the National Assembly on Tuesday afternoon.
This marks the latest move to reform the bond market in favour of retail investors after the Central Bank of Kenya –the government’s fiscal agent — halved the minimum investment in infrastructure bonds to Sh50,000 in November last year.
Government debt is dominated by banking institutions and pension funds that hold 45.75 percent and 29.44 percent respectively. Insurance companies and parastatals hold 7.15 percent and 5.25 percent respectively while the category of ‘other investors’ which includes retail investors holds 12.41 percent.
The last infrastructure bond the government issued was in February in which it sought to raise Sh70 billion at an interest rate of 18.5 percent but ended up attracting a staggering Sh288.7 billion bids. This points to the appetite with which the market targets infrastructure bond issuances and has been credited with the strengthening of the Kenya shilling over the last two months owing to the strong offshore flows it is reported to have attracted.
Players in the investment and brokerage space have, however, questioned the wisdom of potentially limiting infrastructure bonds to the retail market. They argue that among the long-term impacts of this move could be to undermine the strong offshore inflows that have characterised uptake of infrastructure bonds.
“In as much as the National Treasury’s strategy to limit infrastructure bonds to the retail segment would be vital in lowering tangible foregone taxes from the institutional investors, I think the strategy will bear more long-term costs than benefits,” said Ronny Chokaa, a senior research Analyst at stockbroker AIB-AXYS Africa Limited.
“The incentives to support infrastructure development would be diluted, discouraging the much-needed foreign direct investments. Given the increased mobility of capital and the intense global rivalry for the marginal investable dollar, higher taxes are sure to redirect portfolio flows elsewhere, where real returns are higher.”
An analysis by this publication indicates that the government is foregoing at least Sh23.5 billion annually in tax incentives to investors in infrastructure bonds. The Treasury further says it is implementing a detailed domestic debt issuance calendar to stabilise demand and ensure auctions meet the targeted issuance size. Additionally, the government says it is creating a benchmark bond programme aimed at addressing fragmentation in the domestic debt portfolio.
