The 'ugly' side of the 2011/12 Budget

By Morris Aron

Reading the budget, it appears, was the easy part. Now comes the hard part - its negative implications on the economy and the delicate balancing act that the authorities are already knee-deep in.

The effects started playing out real-time as the budget was being read out in Parliament.

Last Wednesday, the average yield of six-month Treasury bill –short-term maturity promissory note issued by Government as a primary instrument for regulating money supply and raising funds – climbed to over 10 per cent from 6.772 per cent recorded in the last auction last month.

The move saw Central Bank reject nearly all bids up for auction that day arguing that major investors had pushed the rates to levels that make domestic debt expensive to levels that the Government could not commit to. The trend did not wane. By Friday that week, the three-month borrowing costs had climbed to the highest mark in 10 years.

Impact on firms

"You have to be asleep at the wheel not to notice that the markets have issued us with a yellow card (on the budget)," said Alykhan Satchu, an independent investment analyst.

Experts say the trend is not going to ease off "anytime soon" and warned that it is bound to impact negatively on earnings of a number of companies that issued corporate bonds through the capital market.

Those watching the events unfold say that chief executives of companies that issued corporate bonds in the recent past—especially on a floating rate—are not sitting easy with the trend.

According to statistics, PTA Bank’s finance costs now stand at 10.94 per cent, Shelter Afrique at11.44 per cent, Safaricom at 11.79 per cent as a result of the rising yields.

CFC Stanbic’s interest cost on its floating rate bond will jump to 11.69 per cent after factoring in the premium of 1.75 per cent while Barclays Bank and Mabati Rolling Mills, who have issued bonds that are pegged on the three-month treasury bills, have also witnessed an increase in their financing costs.

Yields along the curve have risen sharply in the past few months with traders saying that CBK’s apparent willingness to accept the high yields highlights Government’s desperation for cash as stipulated in the budget.

Generally, rising yields on the short-term debt instruments is not good news to issuers as it means higher financing costs of mobilising capital. "There was a lot of concern in the market on the implications of a big budget deficit especially if it was to be funded through domestic borrowing," said XN Iraki, a lecturer at the University of Nairobi’s School of Business.

Analysts say that in the coming months, the economy is bound to adjust to new realities of the Sh1.155 trillion budget, especially, as a result of a decision by Treasury to raise Sh119.5 billion from the domestic market at a time when all indications point to a double-digit inflation trend.

Budget process

In addition, those who understand the implication of the budget making process on the economy say that the country has one more thing to worry about—the growing levels of budget deficit—which now stands at Sh236.2 billion, almost a quarter of the gross domestic product.

Analysts say with more money being allocated to infrastructure, education and a number of other sectors of the economy—being an expansionary budget, the worry is that the budget implies additional inflationary pressures. Treasury raised money allocated to physical infrastructure by a third to Sh221.4 billion.

The other major cause of the increased domestic debt is due to the money set aside to implement the new Constitution and the economic stimulus programme financed by revenue from taxes that did not meet targets.

"The implications of this is that sooner or later, interest rates are going to assume an upward trend as the expensive borrowing locally will supplement the deficit," said Dr Iraki.

But even as the short-term debt instruments woes begin to unfold, the volatility of the shilling is another key concern among serious investors.

The shilling’s depreciation accelerated to a record breaking all time low of Sh88 to the dollar as of Friday last week, a move that will see importers lose out and threatens fresh rally in prices of commodities that are imported, given that Kenya is a net importer of goods and services. The currency weakening is also expected to downplay the tax revisions proposed on maize, wheat and rice and cancel out the anticipated drop in the cost of basic goods.

Commodity prices

"Internationally, commodity prices are high and the effect of the reduction of duty on maize, wheat and rice may be very minimal or nothing at all," said Patrick Obath, chairman of the Kenya Private Sector Alliance

Projections point to inflation remaining in the double-digit range for the rest of the year with the shilling hitting the Sh90 mark to the dollar at some point in the course of the year. The development is bound to keep members of the monetary policy committee on the edge.

"We have faith that the authorities concerned will put to use the instruments at their disposal to tame inflation and interest rates as a result of the on-going developments," said Akinyemi Muyiwa, the chief executive officer United Bank of Africa.

As a sign of things to come and as a pre-emptive strategy, monetary policy committee recently made a decision to tame money supply in a bid to address the inflation worry—something that is going to be a headache in the coming months—and check on the shilling volatility.

Rate review

The committee raised the benchmark interest rate by a quarter percentage point to 6.25 per cent and the cash reserve ratio by the same amount to 4.75 per cent—decisions meant to mop up excess liquidity in a bid to tame inflation while at the same time making it a bit more expensive to borrow.

This is a clear pointer that interest rates may soon be on the upswing, again in the near future.

Emerging on the sidelines of rising inflation trends that hit the 12.95 per cent mark in May against the target of five per cent is the erosion of disposable income levels, a fact that results in reduction in investments as earnings shrink. Statistics indicate that Kenyans’ savings level has dropped to a five-year low of 12.2 per cent of the gross domestic product as soaring inflation eats into disposable incomes. Moreover, low deposit returns offered by commercial banks discourage customers from putting their money in financial institutions.

The move has seen the Central Bank of Kenya announce plans to pressure banks to raise deposit rates with a threat of re-opening of the long-term bonds. According to the Economic Survey 2011, the savings level as a ratio of the gross domestic product stood at 14.8 per cent in 2006, before rising to 16 per cent in 2008 then falling to 12.2 per cent in 2010.

But even as the tale-tell signs emerge, CBK Governor Njuguna Ndung’u maintains that all is well. According to Prof Ndung’u, Treasury’s decision to turn to the domestic market to raise cash has not crowded out the private sector due to the fact that credit to the private sector has grown significantly in the last couple of years.