Interbank Rate Remains below CBR

The interbank rate has remained below the CBR, indicating relatively good levels of liquidity in the market.

The central bank has been actively rejecting aggressive bids on the papers recently issued, in a bid to keep interest rates low in the market, usually caused by higher costs of domestic borrowing. ϖ The government targets to fund half of the budget (KES 1.48Tn), through external funding. This could come in the form of syndicated loans like what the government received from China and not necessarily from a sovereign bond in the near term. Other sources could be export-credit arrangements and bilateral agreements.

This is in line with the government’s target of keeping interest rates at a manageable level without hurting economic growth.  

In light of the stable macroeconomic conditions and high liquidity levels as depicted by the low interbank rates, we anticipate relatively high participation in this two issues, thus we recommend a BUY on both papers.

Interest Rates and Inflation on an uptrend

During the month of Jun-16, inflation rates rose to 5.8% y-o-y from 5.0% recorded in the month of May-16. This was propped by the monthly increase in food & non-alcoholic beverages index (2.06% m-o-m) and transport index (0.34% m-o-m).

Based on the rise in the pump prices to KES 92.93 for a litre of petrol and KES83.24 for a litre of diesel, on account of factoring in the increase of KES 6 on the road maintenance levy; we are of the view that inflation rates may average at around 6.20-6.50% y-o-y in July 2016.

An uptrend in the inflation rates is expected to push the short-term interest rates up. The 91- day T-bill rate has peaked up steam this month with the latest auction posting a WAR 7.649% (previous- 7.027%). Performance of the 91-day paper and the 364-day paper is also significantly high, signalling that the market expects a period of rising yields in the near to medium term.

The month of May also saw the Central Bank’s Monetary Policy Committee slice the CBR by 100bps to 10.5%, on the back of falling inflation rate, a stable foreign exchange and higher foreign reserves. However, due to the expected rise in inflation rates, we opine that the rate may hold steady around the same level, as the forex reserves are still adequate to shield the economy from any shocks. The exchange rate has also contributed heavily in propping the CBR at those levels.

Nevertheless, some slight economic shocks could be observed as the government enters into another fiscal year, with expectations that public spending and a higher fiscal deficit could offer pressure on the interest rates.

The National Treasury received the long-awaited KES 60Bn syndicated loan from China in the previous week, expected to enable the government to pay outstanding amounts to contractors.

This resulted in a net spike in the country’s forex reserves to a record USD 7.87Bn, equivalent to 5.15 months of import cover. Despite the influx of forex reserves, we have witnessed a slight depreciation on the shilling, with the currency averaging at KES 101.20-101.35, from a previous average of 101.10-101.15.

The government is raising funds through the two issues for budgetary support. Thus, there is no much pressure for the government to accept bids with high interest rates as they are significantly cushioned against any macroeconomic shocks that may arise from the market.

We are experiencing a flattening yield curve, accentuated by stagnating yields on the long term papers (10 years and above papers). This is also as a result of the short-term interest rates rising faster than the long-term interest rates. Majority of the investors have remained sceptical on the macroeconomic outlook, going by the rising concerns over the hiking of the Fed rate in the near term. This has however been dispelled by the recent news, that chances are that we may only experience one Fed rate hike this year, as the economic data from States doesn’t support multiple rate hikes.

Therefore, we expect a higher participation in the short end of the curve as compared to the long end of the curve, as short-term papers are offering more competitive interest rates. ϖ The yield curve shall continue to flatten in the remaining two quarters of the year, given the outlined domestic borrowing target in FY17/17 National Budget.

With approximately KES 58.2Bn worth of expected redemptions in July-2016 vs. the targeted issues worth KES 89Bn in both T-Bills and bonds, we are of the view that amounts equal to the redemptions will be used to repay the principal amounts of papers maturing within this month, thus being absorbed into the system.

The rest of the new borrowings in tunes of around KES 30Bn, will however be spent towards budgetary support. The figures stated could have some margin of error as some of the papers have posted a lower performance rate.