Kenya: Interest Rate Increase Raises Fears of Surge in Borrowing Costs

The Central Bank's latest move to stabilise the shilling by mopping up liquidity in the financial system came under scrutiny as the overnight borrowing rate shot to 15.68 per cent, raising fears of a surge in the cost of government borrowing. The CBK discount window rate rose sharply for the third day in a row from Tuesday's 13.87 per cent and Monday's 11.34 per cent. Wednesday's rate was above all interest rates that the State is paying on Treasury bonds. The highest yield on Kenya's 30-year bond is trading at around 15.50 per cent.

Fred Mweni, a member of the informal CBK advisory group comprising top traders of government securities, said the regulator appeared "overly concerned" with the exchange rate and was using the higher short-term interest rates as a way to defend the currency.
"The government and even other actors in the economy are likely to experience increasingly higher borrowing costs because the Central Bank has raised the over-night borrowing window in its attempt to defend the Shilling," said Mr Mweni.
Liquidity crunch
He added that interest rate bids in the oncoming treasury security auctions were likely to be more aggressive.
The government has suffered under-subscriptions in the past few bond and even T-bill auctions because of a liquidity crunch caused by CBK's recent tightening stance.

Mr Mweni said the defence of the currency through tightening was not necessarily going to succeed -- in view of an overall dollar shortage, a view also shared by Joshua Kagia, head of treasury at Consolidated Bank. "The Central Bank appears to believe that commercial banks are hoarding foreign currency. The CBK is tightening so that they can release it to the market. This should then strengthen the Shilling as dollars are offloaded into the market," said Mr Kagia.
"My personal view is that there are no dollars in the market and tightening may not achieve the intended objective. So what might happen is that short-term rates are just continue rising even though lending rates are not likely to go up in the short term," said Mr Kagia.

He said the inter-bank rate was up mainly because there was not enough liquidity in the market as institutions held bonds that were difficult to dispose of without making a loss in the currency interest rate environment.
"Banks have high liquidity but this does not mean that they have actual cash and they are not selling the bonds to get cash because it would lead to losses as interest rates have shot up," said Mr Kagia.
He said government securities holdings at the end of last week were down to Sh116 billion from Sh126 billion the previous week because institutions did not roll over their maturities into the new treasury bills and bonds - thus explaining why last week's paper was not fully subscribed.