State faces pressure over domestic borrowing cost

Tuesday, September 19th, 2023 05:50 | By
National Treasury building.
National Treasury building. PHOTO/Print

Kenya’s domestic borrowing landscape is facing turbulent times as the country grapples with soaring interest rates.

Central Bank of Kenya auction results on Wednesday have revealed that the cost of borrowing in the domestic market has reached concerning levels, with a two-year bond fetching a staggering 17.4 percent yield.

Furthermore, a 10-year bond recorded an even higher weighted rate of accepted bids at 17.9 per cent. These figures indicate that investors are now demanding significantly higher returns on their investments in government bonds.

The government is increasingly borrowing more expensive loans from the domestic market in a trend that has set up households and businesses for a new period of costly loans. The borrowing trend points to a government increasingly getting desperate for money to bridge its budget shortfall.

The spike in bond yields comes at a time when commercial banks have been scaling back their lending to the government. Just last week, commercial banks reduced their exposure to government bonds, dropping from over 50 per cent of total domestic borrowing to a lower figure of just 44 per cent.

This shift in lending patterns suggests that banks may be growing increasingly cautious about the risks associated with holding government debt, especially in a rising interest rate environment. Analysts warn that the rise in domestic borrowing costs could have far-reaching implications for Kenya’s fiscal health.

High interest rates on government bonds can strain the country’s budget by increasing the cost of servicing existing debt and making it more expensive to raise new funds.

This situation may require the government to allocate a larger portion of its budget towards debt servicing, potentially diverting resources away from critical development projects.

Exploring strategies

Authorities will likely be closely monitoring these developments and exploring strategies to manage the rising cost of domestic borrowing. Additionally, they may need to consider measures to restore investor confidence in government bonds, which could include fiscal reforms and improved fiscal discipline.

The recent surge in domestic borrowing costs underscores the importance of maintaining prudent fiscal policies and pursuing measures to stabilize the financial markets.

As Kenya navigates these challenging economic conditions, policymakers will need to strike a delicate balance between meeting their financing needs and ensuring the sustainability of the country’s debt profile.

The World Bank has cautioned against persistent crowding out of the private sector due to heavy domestic borrowing by the Treasury.

The multilateral lender noted commercial banks had failed to reach their peak support for investments as the government provided the easy way out by borrowing heavily from the domestic credit market.

“Credit is growing more slowly than GDP, highlighting that the banks’ role in facilitating investments and economic activity remains challenged,” the World Bank stated. Presently, credit demand in the private sector is holding out against creeping fiscal dominance, with manufacturing, transport and communication, trade and consumer durables sectors registering sustained appetites for credit.

In a mini-survey by the CBK’s Monetary Policy Committee last month, banks noted sustained loan applications and approvals.

Customer loans

With commercial banks basing interest rates charged to customer loans on the government securities return (the reference rate), which is widely regarded as the risk-free rate, borrowers can expect to pay a higher premium to access funds from their respective banks.

Data from the CBK placed the average lending rate at 13.21 percent at the end of May, marking the sharpest rate for commercial bank loans since June of 2018. While the CBR is on paper the benchmark lending rate, banks prefer to set the cost of loans to customers based on the 364-day paper returns.

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