Kenya Fixed Income Update: March 2015

USDKES Exchange Rate under pressure as supply side remains constrained

The local currency’s fall against the USD has been attributed to a number of factors mainly deriving from supply side constraints as inflows from tourism remain subdued from the start of the year whilst the value of tea inflows has taken a hit from drought conditions in tea producing regions. On the other hand, rallying of the USD globally is a significant external factor adding pressure to the local currency. We expect the local unit to remain under pressure in the month of April due to underlying security risks which are spurring dollar demand. A strong dollar which surged to an 11 year high in the first week of April on the back of increased likelihood that the Federal Reserve will raise interest rates this year and supply side constrains will also add pressure on the unit.

Consequently, we portend the USDKES exchange rate to trade within the range of 92.85-93.95 over the course of the month as the monetary regulator consciously works to prevent further downfalls through proactive liquidity management.

Primaries to hold steady as investors bid cautiously

Yields on treasuries held relatively steady in the month of March. Subscriptions during primary T-bill auctions decelerated slightly in the second half of the month as liquidity in the money market tightened. Greater interest was observed for the 182-day and 364-day papers indicated by higher subscription levels. We expect yields to continue to remain relatively steady in the month of April as the regulator will proactively manage liquidity in the money market. The treasury is likely to revise its borrowing target upwards in its supplementary budget release this month between KES 120-128 billion this month, however the possible review is unlikely to place significant downward pressure on yields in the near term.

Monetary regulator expected to keep tight lid on liquidity to forestall exchange rate depreciation

Currently liquidity in the money market has eased on account of government payment disbursed in the first week of April. A sum of KES 3.06 billion treasury bills and KES 37.56 billion treasury bonds are due to mature during the month. We expect the monetary regulator to remain proactive throughout the month mainly to manage the local exchange rate by controlling supply of the Kenyan Shilling in the money market and rolling over maturing money market instruments.

MPC expected to retain CBR in next meeting

The MPC retained its Central Bank Rate at 8.50% during the meeting held on 26th February 2015 which also marked the last meeting presided by the CBK Governor Njuguna Ndung’u whose term came to an end in March. Although inflation rose to 6.31% in the month of March mainly on account of a rise in food prices which have surged up as a result of drought in food producing regions, underlying inflation remains within bound as factors other than food and fuel are under control. We expect the monetary policy committee to retain its benchmark rate steady at 8.50% in order to continue anchoring inflationary expectations.

Heightened trading as NSE faces price correction

Trading in the equities ramped up 28.8% in the month of March to volumes worth KES 20.49 Billion spurred by full year earnings announcements on the financial stocks. Following the 7-year high of 5,491.37 points and 175.70 points, investors were skewed towards the sell side as profit taking activities on large cap counters impaled NSE’s key indices whereby NSE 20 and NASI declined by 4.4% and 0.3% to 5,248.16 points and 175.11 points respectively as at 31st March 2015. Foreign investors led the charge on the NSE’s market correction with participation wavering between 52% and 65% as the strata re-evaluated portfolio weightings following wide-spread earnings announcement at the bourse.

Of interest in the coming weeks would be the highly anticipated rights issue on Kenya’s largest sugar miller-Mumias Sugar Co. Ltd (NSE: MSC). Earlier in March, the troubled and highly publicised sugar miller made public its intention to raise capital through the equities market pre-empting a decline of 12.5% on the counter and constricting investors’ wealth to KES 3.75 Billion. Having navigated a barrage of downside risks stemming from lifting of COMESA safeguards that would open up the market to stiff competition from cheaper sources, to shutting down of its water bottling plant, the Government devised a rescue plan to salvage the company from its death bed involving; KES 1 Billion bailout package to mitigate arrears owed to farmers and halving the management board to institute operations reforms in the firm, the company now seeks to raise KES 4 Billion to turnaround operations. Going forward, it is expected that the market will waver in search of triggers following winding up of the earnings season.

By end of March 2015 the Central Bank of Kenya (CBK) raised its borrowing to KES 549.96 billion -An improvement from KES 461.90 billion the previous month against maturities of KES 445.32 Billion which resulted in new net borrowing of KES 104.42 billion relative to KES 66.92 billion raised in the previous month. The strong performance in borrowing was spurred by the KES 50 billion infrastructure bond issued during the month.

Currently, the borrowing target for FY 2014/2015 still remains at KES 101.7 billion. We portend that the treasury may slightly raise this target between KES 120-127 billion in the supplementary budget expected to be published in the course of the month.

Bond turnover wavered in the month of March. The auction of the 12-Year infrastructure bond as well as tight liquidity in the money market towards the end of the month affected trading as bond turnover diminished significantly from KES 16.93 billion in first week to KES 1.17 billion in the final week. Trading was mostly concentrated on the long end of the yield curve and the FXD 1/2012/20 was the most traded bond posting turnover of KES 9.09 billion. We expect trading in the secondary market to remain steady in coming weeks; however the cautious nature of investors may add some pressures on total volumes traded. However, we expect the listing of the 12 Year amortized infrastructure bond in the secondary market to spur trading towards the end of April and into May. The absence of a monthly bond auction in the primary market in April is likely to keep investors interests pegged to secondary trading.

MPC expected to retain CBR in next meeting

The MPC retained its Central Bank Rate at 8.50% during the meeting held on 26th February 2015 which also marked the last meeting presided by the CBK Governor Njuguna Ndung’u whose term came to an end in March. Although inflation rose to 6.31% in the month of March mainly on account of a rise in food prices which have surged up as a result of drought in food producing regions, underlying inflation remains within bound as factors other than food and fuel remain under control. We expect the monetary policy committee to retain its benchmark rate steady at 8.50% in order to continue anchoring inflationary expectations. Pressures arising from the recent steep depreciation in the local exchange rate are also heightening risks as they are likely to increase pressure on local prices triggered by imported inflation as buying goods from trade partners becomes expensive.

Regulator Keeps Tight Lid On Liquidity in March

The month of March embarked with a relatively liquid money market which was supported by government payments and maturities of Repurchase Agreements (REPOs) and Term Auction Deposits (TADs). As a result, the government intervened in the market to mop up excess liquidity from the money market. As redemptions of treasury bills and treasury bonds piled the monetary regulator revved up its open market operations, sterilising liquidity worth KES 35.8 billion in the week ending 13th March 2015. Depreciation of the Kenyan Shilling (KES) against the US Dollar which is currently rallying globally added pressure on the regulator to tighten its grip on liquidity which culminated in the offers of REPOs and TADs every week for the remaining part of the month.

Consequently, the interbank rate rose to 8.25% on 31st March. Receipts to the government through the payment of taxes as well as weekly auctions of treasury bills and the infrastructure bond auction worth KES 50 billion added further restrains on liquidity

Amortized 12-Year IFB minimizes potential refinancing risk

IFBs auction was a popular choice amongst investors as the amortization feature favours the current maturity structure of the bond portfolio and will effectively minimize potential refinancing risk. The feature also made it more attractive for investors as they will receive the same coupon level for different periods during the life of the bond. The offering will also accelerate trading in the secondary bond market, which has previously indicated strong investor interest for infrastructure bonds.

Performance Report of IFB1/2015/012

The auction of the amortized IFB 12-Year was very successful given its popularity amongst foreigners as well as local investors as it is tax free, recording a performance rate of 206.63%. The government accepted bids worth KES 25.70 billion at a Weighted Average Yield to Maturity (WAYTM) of 11.556%. Commercial banks continued to remain the largest bidders accounting for 62.92% of all bids followed by custody investors which accounted for 25.64% of total bids. Consequently, commercial banks were allocated 45.69% of accepted bids while the custodial sector secured 37.82% of total allotment. The IFB auction was followed by a tap sale where the government offered a further KES 25 billion at a coupon rate of 11.00%. The tap sale was equally successful and the government accepted KES 24.02 billion worth of bids in order to meet its KES 50 Billion allowance.

Exchange Rates

The KES displayed varied performance against major international peers in the month of March as it deepened its fall against the US Dollar (-1.13%), but extended its gains against the Euro (EUR) and Sterling Pound from the previous month as its strengthened by 2.91% and 3.35%, respectively. The local currency’s fall against the USD has been attributed to a number of factors mainly deriving from supply side constraints as inflows from tourism remain subdued from the start of the year whilst the value of tea inflows has taken a hit from drought conditions in tea producing regions. On the other hand, rallying of the USD globally is a significant external factor adding pressure to the local currency. Meanwhile, weaker-than-expected industrial data and the rising risk of prolonged political uncertainty ahead of a tight British election next month have caused a weakening in Britain’s national currency. On the other hand, the EUR wavered modestly over the month as ECB’s diverging monetary policy which began its bond purchasing program on March 9th 2015 settled in.

Bearing in mind the volatility of the KES the monetary regulator remained on its toes throughout the month of March as it struggled to manage the circulation of the KES through robust open market operations. However, despite the regulator’s efforts the local currency has continued to succumb to external pressures whilst heightened dollar demand forced the CBK to sell dollars in the money market a number of times over the month.

We expect the local unit to remain under pressure in the month of April due to underlying security risks which are spurring dollar demand. A strong dollar which surged to an 11 year high in the first week of April on the back of increased likelihood that the Federal Reserve will raise interest rates this year as well as supply side constrains will also add on pressure. Consequently, we portend the USDKES exchange rate to trade within the range of 92.85-93.70 over the course of the month as the monetary regulator consciously works to prevent further downfalls through proactive liquidity management.