Central Bank Takes Measures to Reduce Kenyan Shilling Volatility

Treasury bill auction subscriptions declined this week to 33% from the previous week’s 69%; the decline was due to tight liquidity in the money markets. Tight liquidity was caused by Central Bank’s mop up activities in support of the shilling and also the maturity and subsequent payment of the 5 year treasury bond. The tight liquidity led to a jump in the interbank rate to 16.4% from 13.6% last week.

Similar to the previous week, there continues to be higher appetite for shorter dated securities, indicating investors expect interest rates to continue increasing. Yields on the 364-day T-bills increased by 50.2 bps to 13.0%, while yields on the 182-day and 91-day T-bills registered marginal increases to 12.4% and 11.5%, respectively.

The 5-year reopened bond received total subscriptions of 85% with the average yield increasing to 14.3%, a 108 bps increase from last month’s auction. The huge increase in this bond’s yield means that investors who invested in the bond have lost more than 2% of the value of the bond on a Mark-to-Market basis.

Assuming that the increase in yield cuts across all the tenors in a parallel manner, bond portfolios might have lost close to 10% over the last two months given the average duration of the market is slightly over 5 years.

Just weeks after raising the base lending rate to 11.5%, the Central Bank has issued a directive that limits commercial banks’ daily forex transactions to 10% of their core capital. With reduced transaction volumes, there will be less speculative trading, which should in turn reduce volatility of the Kenyan Shilling. During the week the Kenyan shilling gained 1.7% to the dollar to close the week at 100.7, bringing the year to date decline to 11.1%.

We are of the view that CBK’s actions will offer support to the Kenyan shilling in the short term, however, for longer term stability, the government and market players need to address the underlying structural problems cited in our Cytonn Weekly Report #28, which include:

• allowing time for the Central Bank Rate increases to be transmitted into the market
• reduce the rate of the budget growth,
• manufacture locally to reduce importation, and
• diversify the economy away form agriculture and tourism.

We expect inflation figures for July to be much higher than in the previous months driven by

• the revision of electricity tariffs,
• increase in fuel prices by Kshs 4.34 per litre of petrol and Kshs 3.97 per litre of diesel, and
• currency depreciation, which affects most components of the inflation basket both directly and indirectly.

We maintain our expectation that interest rates will remain high because of (i) the government’s need to finance its budget deficit through local borrowing, and (ii) the need to support the shilling.

We hold our earlier recommendation that investors should invest in short duration fixed income instruments as we await correction of the rate environment.