KENYA: WARY INVESTORS PREFER SHORT TERM GOVERNMENT

UNCLAS NAIROBI 000581 SIPDIS DEPT FOR AF/E, AF/EPS, EEB/IFD/OMA DEPT ALSO PASS TO USTR FOR BILL JACKSON TREASURY FOR VIRGINIA BRANDON COMMERCE FOR BECKY ERKUL SIPDIS E.O. 12958: N/A TAGS: ECON EFIN PGOV KE SUBJECT: KENYA: WARY INVESTORS PREFER SHORT TERM GOVERNMENT SECURITIES REFS: A) NAIROBI 414, B) NAIROBI 355 ¶1. Summary: Confronted by insufficient demand for five-year bonds in the February 14 auction from investors deterred by political uncertainty and fears of rising inflation, the Central Bank of Kenya (CBK) shifted its strategy and offered a Ksh7 billion bond (over $100 million) with a choice of one and ten year terms. Investors' bids oversubscribed the offer at the February 21 auction, with clear preference for the one year bonds. CBK attributed the strong demand to high market liquidity, but the principal buyers also cited a narrowing of investment options, with Treasury securities preferred as generally risk-free. Interest rate trends are unclear, and it is not yet known whether the high demand for public securities reflects low demand for financing from the private sector, or reluctance to lend to it. End Summary. Shift to Short-term Investment Vehicles -------------- ¶2. The January 24 and 31 auctions of Treasury bonds and bills by the Central Bank of Kenya (CBK) saw very low bids, as political uncertainty, and the threats of rising inflation, government borrowing and higher interest rates made investors wary of committing to five-year bonds. The CBK changed its strategy at the February 21 auction, offering a choice of 1-year, zero coupon Treasury bonds and 5-year discounted fixed coupon Treasury bond at a coupon rate of 9.5 percent totaling Ksh 7.0 billion (about US$100 million). The auction attracted bids totaling Ksh 13.2 billion (about US$188.6 million),an oversubscription of 180.7%. Investors demonstrated their preference for short term commitments by applying for Sh7.9 billion of the one year notes, and Sh5.3 billion of the 10 year notes. The offer of Ksh 5.0 billion (about US$50 million) in 91 and 182-day T-bills was oversubscribed by 87.9%. ¶3. While CBK attributes the high oversubscription level to high market liquidity, principal buyers of the bonds attribute it to a narrowing of investment options, with most of them competing for the generally risk-free Treasury securities. The Kenya Revenue Authority (KRA) report that it slightly exceeded its January collection target of Ksh34.19 billion (about US$488.4 million) and the extra Ksh19 billion (about US$271.4 million) brought in from the sale of Telkom Kenya in late December also reassured the market somewhat. Political or Economic Reaction? -------------- ¶4. Investment analysts attribute the huge oversubscription of GOK securities to mean either banks or other lending institutions have reduced lending to private borrowers pending the outcome of the political mediation process, or that there is low demand for loans, leaving banks with excess liquidity. Banks are the single largest group of subscribers of GOK securities, accounting for almost half of all Treasury bonds and bills issues. CBK statistics for February 15 reported banks held 46.3% of all GOK securities floated in the market, insurance companies held 12.1%, and state corporations 10.9%, while other investors including fund managers accounted for the other 30.7%. Peter Wachira, a senior investments manager with AIG Investment Company said that investors are currently putting off their investment and expansion decisions while observing the political negotiations. Unclear Interest Rates Trends -------------- ¶5. Interest rate trends are conflicting. Since January 3, the rate on 91-day T-bills climbed steadily to peak on February 7 at 7.42%, and then declined in the next two weeks to 7.07% on February 21. The rate on 182 day bills has fluctuated without a clear trend in ¶2008. The 12-week moving average interest rate for 91-day T-bills has fluctuated without a clear trend in 2008, while the moving average rate for 182-day T-bills rose steadily in the last four weeks. The interest rate on the 10-year discounted fixed rate Treasury bond declined by 5 basis points to 11.27%. But, the average interest rate on the 1-year, zero-coupon Treasury bond edged up by 36.5 basis points to 8.86%. ¶6. Paul Mwai at Old Mutual Asset Management believes the rate on the 10-year bond does not reflect the inherent risk, and he blames the GOK's insistence on paying low interest rates for distorting the market, warning it could push institutional investors to look for alternative investment opportunities such as offshore accounts and bank deposits. Suntra Investment Bank's Charles Ocholla opined that the low demand for the 10-year fixed-rate bond reflected investor concerns about rising inflation. Comment -------------- ¶7. Investors are demonstrating their preference for short term investments in the current atmosphere of political uncertainty by shifting their bids to short term maturity bonds. The Kenyan Treasury is not yet desperate to raise cash, and the CBK is trying to hold down interest rates while hoping for a peaceful resolution to the current political standoff. It is not yet clear whether the resumed oversubscription of GOK securities indicates a preference for risk-free government securities over private sector lending, or less demand for loans as business also waits for a resolution to the current political crisis. End comment. RANNEBERGER