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Kenya’s battle to support shilling hits bond trade

By Reuters | July 19th 2015

Central Bank of Kenya’s move to raise interest rates on some short-term debt to support the battered shilling has made lower-yielding longer-term bonds less attractive, potentially deterring foreign investors from buying them.

Kenyan debt has attracted more foreign funds since the 2008 global crisis, as ultra-low interest rates in mature economies sent investors in search of higher yields in frontier markets.

The bond trade brings in foreign exchange and helps cover government borrowing needs. But a sharp drop in trading in existing bonds could deter investors who want to get in and out of the market easily. Turnover tumbled to Sh8.42 billion in June from Sh21.32 billion in May, central bank figures showed.

“(Investors) are having trouble exiting because of the lack of liquidity in the secondary market; it might cost us in the future,” said a Nairobi-based fixed income trader with a commercial bank.

On May 12, the central bank raised the cap on rates offered for term auction deposits (TADs), one of its main tools for managing liquidity, making it more expensive to bet against the shilling, which is now near three-and-half-year lows.

The cap is now 250 basis points above the benchmark lending rate, which has been raised twice since June to 11.50 per cent. TADs, with terms up to 28 days, can offer 14 per cent, while yields on two-year bonds are 12.80 percent. Rates on TADs may not hit the upper limit, but returns are still better than on longer-term debt. A 28-day TAD offered 13 per cent on Friday.

Weakening shilling

John Ashbourne of Capital Economics said TAD issues were unlikely to cause too much disruption. “There might be some effect at the margins, but I doubt that it would be enough to fundamentally harm the secondary bond market,” he said, adding that the central bank could quickly lower the cap if it felt foreign investment was drying up.

The central bank said it was working to keep prices stable and TADs were one of its tools to achieve that.

Inflation at around 7 per cent has been close to the upper limit of its 2.5 to 7.5 per cent target band.

But Alex Muiruri, fixed income analyst at African Alliance Investment Bank, said the measures meant “activity on the secondary (bond) market has taken a back seat.”

Turnover on the bond market has been sliding since last year, along with the currency.

Just Sh8.42 billion changed hands in June this year, compared with Sh44.58 billion in May 2014 and Sh26.88 billion in June 2014.

“Secondary trading has been dead ... for the last quarter,” said another fixed income trader. “Of course the shilling weakening against the dollar does not help much.”

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