For the first time in two weeks, Treasury bills in Kenya faced an underwhelming reception in the auction market, marking a stark contrast to the oversubscription rates recorded in previous weeks. The Central Bank of Kenya (CBK) raised KSh 18.9 billion against a target of KSh 24 billion, resulting in an undersubscription rate of 78.6%. This is a significant drop from the 138.1% oversubscription achieved in the prior week.

The undersubscription comes amidst a sustained decline in interest rates following progressive interest rate cuts by the CBK, signaling a shift in investor sentiment and raising questions about the sustainability of the current monetary policy stance.

Breakdown of Treasury Bill Performance

The performance of the Treasury bills varied across the three tenors offered, with demand skewed heavily towards the 364-day paper:

• 364-day Paper: The longest tenor proved the most attractive, receiving bids worth KSh 10.03 billion, translating to a 100.3% subscription rate. This aligns with investor preference for slightly higher returns offered by the longer tenor amid declining yields.
• 91-day Paper: The shortest tenor recorded bids worth KSh 3.4 billion against a target of KSh 4 billion, resulting in an 85% subscription rate.
• 182-day Paper: The mid-range tenor struggled the most, attracting bids worth KSh 5.4 billion against a target of KSh 10 billion, representing a 54.5% subscription rate.

The CBK accepted 96.1% of the total bids received, amounting to KSh 18.1 billion, while rejecting expensive bids to maintain control over borrowing costs.

Yields on a Downward Trajectory

Yields on all tenors continued their downward trend, with rates falling below the 12% mark, a stark contrast to the highs of 18% witnessed in February 2024. The decline in yields reflects the impact of the 175 basis points rate cut by the CBK in 2024, part of its aggressive monetary easing strategy.

• 91-day Paper: The average accepted yield dipped by 0.03% to 9.5647%.
• 182-day Paper: Yields fell marginally by 0.005% to 10.0299%.
• 364-day Paper: The average yield declined by 0.03% to 11.3044%.

The decline in yields has moderated borrowing costs for the government but has also dampened investor appetite for short-term government debt instruments.

CBK’s Monetary Policy Strategy

The CBK’s aggressive monetary tightening in 2023, which carried over into early 2024, had initially driven yields to peak levels, making Treasury bills highly attractive to investors. However, the subsequent rate cuts in 2024 were aimed at stimulating economic growth by reducing borrowing costs for both the government and the private sector.

As inflationary pressures eased and the Kenyan shilling stabilized, the CBK adopted a more accommodative monetary stance, leading to a series of rate cuts. While this has succeeded in reducing the cost of borrowing, it has also contributed to the decline in returns on Treasury bills, which appears to be affecting investor participation.

Investor Behavior and Market Trends

The undersubscription of Treasury bills indicates a shift in investor preferences, driven by multiple factors:

1. Declining Yields: Lower returns on government securities are prompting investors to explore alternative investment opportunities, including corporate bonds and equity markets, which may offer higher returns.
2. Liquidity Constraints: Reduced participation may also reflect tighter liquidity conditions in the financial system, particularly among institutional investors like banks and pension funds.
3. Rate Expectations: Market participants are anticipating further rate cuts or stability in the next CBK Monetary Policy Committee (MPC) meeting scheduled for February 5, 2025. This expectation may be discouraging investment in fixed-income securities with declining yields.

Economic Context and Outlook

Kenya’s broader economic environment is playing a critical role in shaping the performance of Treasury bills and the debt market at large.

• Inflation: Inflation has been easing in recent months, providing a conducive environment for the CBK to maintain or further reduce interest rates.
• Currency Stability: The Kenyan shilling has shown signs of stability after a volatile 2023, aided by improved foreign exchange reserves and better balance of payments.
• Government Borrowing Needs: The Treasury’s borrowing requirements remain significant, driven by fiscal pressures, including infrastructure projects and public sector wages.

Despite the current challenges in the Treasury bill market, Kenya’s debt management strategy aims to strike a balance between reducing borrowing costs and ensuring sufficient liquidity to meet government financing needs.

Implications for the Banking Sector

The decline in Treasury bill yields has implications for Kenya’s banking sector, which has traditionally been a significant participant in the government securities market.

1. Profitability: Lower yields could compress interest income for banks that rely on government securities as a major revenue source.
2. Credit Growth: The easing monetary policy environment may encourage banks to increase lending to the private sector, potentially offsetting the impact of lower returns on government securities.
3. Liquidity Management: Banks may need to reassess their liquidity management strategies, given the changing dynamics in the Treasury bill market.

Policy Recommendations and the Road Ahead

The CBK and the Kenyan government must carefully navigate the evolving dynamics in the debt market to ensure continued investor participation and macroeconomic stability.

• Targeted Interventions: The government could explore targeted measures to attract institutional and retail investors to Treasury bills, such as tax incentives or promotional campaigns.
• Monetary Policy Communication: Clear and consistent communication from the CBK regarding its monetary policy outlook can help manage market expectations and improve investor confidence.
• Diversification of Borrowing: Beyond Treasury bills, the government could consider diversifying its borrowing portfolio, including issuing infrastructure bonds or tapping into international capital markets.

Conclusion

The recent undersubscription of Treasury bills underscores the challenges facing Kenya’s debt market as the CBK continues its monetary easing cycle. While the decline in yields has reduced borrowing costs for the government, it has also dampened investor enthusiasm, particularly for shorter-tenor securities.

As Kenya prepares for the next MPC meeting in February 2025, all eyes will be on the CBK’s policy stance and its implications for the broader economic landscape. Balancing the need for fiscal discipline with growth-stimulating policies will be critical in ensuring the resilience of Kenya’s financial markets and overall economy.

In the meantime, the government and the CBK must remain vigilant in addressing market concerns and fostering a conducive environment for investment in Treasury securities.

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Photo source: Google

By: Montel Kamau

Serrari Financial Analyst

17^th January, 2024