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Bond investors press for higher interest rates
The CBK’s decision to take up an amount higher than the targeted Sh50 billion also pointed to the expected increase in domestic borrowing target for the current fiscal year.
Investors in government securities have increased their pressure on the Central Bank of Kenya (CBK) to offer higher rates on new auctions, looking to take advantage of the government’s need to borrow heavily to fund a large fiscal deficit.
Last week’s Treasury bills auction saw investors demand 8.8 percent on the 91-day paper, which was a significant premium on the paper’s prevailing interest rate of 8.13 percent. The buyers put up offers of Sh1.96 billion, with the CBK settling for Sh1.95 billion at 8.12 percent on accepted bids.
Similarly, the July bond sale, which comprised a pair of reopened 20- and 25-year papers, saw investors demand yields of 13.95 percent and 14.43 percent versus coupons (actual interest rates) of 13.2 percent and 13.4 percent respectively.
In securities sales, the yield shows the rate at which investors are willing to lend to the government, while the coupon indicates the actual payable interest rate on the paper and which was set in the original auction.
When investors assign a higher risk perception on a bond, they ask for higher returns relative to the prevailing rates on the securities yield curve, with the government making up the difference between yield and coupon through price discounts.
“The treasuries yield curve is broadly sticky, expectedly following a quiet start to the 2025/2026 fiscal year. This comes after a somewhat neat closure of the prior fiscal year, mainly given revisions through three supplementary budgets as well as a benefit from the market liquidity conditions year-to-date,” said analysts at NCBA in a fixed income note.
“Following a lack of reflection of fiscal risk in this yield curve stickiness, Treasury bond auctions may continue to ignore the yield curve pricing.”
Borrowing target revisions
The 2025/26 budget set the fiscal deficit at Sh923.2 billion, to be financed through domestic borrowing of Sh635.5 billion and external borrowing of Sh287.7 billion.
This projected deficit is lower than the Sh997.5 billion hole in the previous fiscal year that ended on June 30, for which the domestic financing component stood at Sh815.6 billion and external borrowing at Sh184.29 billion.
However, the government has fallen into a cycle of revisions of its borrowing targets through supplementary budgets due to revenue collection underperformance, meaning that there is a likelihood of an adjustment in both the deficit and the domestic and external targets in the current year.
In the previous fiscal year, the June 2024 budget statement had set the initial deficit at Sh597 billion, which was to be financed through domestic borrowing of Sh263.2 billion, and external funding worth Sh333.8 billion.
Three revisions through supplementary budgets followed, eventually settling at the Sh997.5 billion fiscal deficit in the Supplementary III Budget of June 2025.
The CBK’s stance against the higher rate demands will now be tested again in the two August bond sales, which is a reopening of 15- and 19-year infrastructure bonds (IFBs), first sold in 2018 and 2022, targeting a combined Sh90 billion, and which carry coupons of 12.5 percent and 12.965 percent respectively.
The tax free status of the IFBs is, however, likely to soften the overall yield demands by investors, given that the returns are equivalent to 13.889 percent and 14.406 percent on similar tenor bonds that attract the 10 percent withholding tax on interest.
