The anticipated issuance of a $2 billion sovereign bond by Kenya is expected to push interest rates further downwards in the coming months as the government cuts domestic borrowing.

Treasury Cabinet Secretary Henry Rotich had said that the bond — which he said would be more than $1 billion but not more than $2 billion — would be floated in the first quarter of 2014, which ends next month, with details of the issuance expected in the next few weeks.

Latest data from the Central Bank of Kenya shows that overall interest rates have been falling over the past few months, with both deposit and lending rates declining.

This has seen interest spreads — the difference between what banks charge borrowers and what they pay depositors for their money — decline, potentially squeezing the industry’s profitability.

Kenyan banks largely rely on wide interest spreads to grow their profits and their willingness to cut lending rates is a sign of the pressure they are under to grow their loans by making credit more accessible.

The CBK said interest spreads fell to 9.49 per cent in November 2013, from 10.16 per cent in July. But on average, spreads surged in 2013 compared with 2012. The data shows spreads averaged 10.02 in the first eleven months of 2013 compared with 9.98 per cent the previous year.

While banks on average cut lending rates, they also slashed the rate they pay depositors to cushion their profitability, the data shows. A cut in lending rates alone would put pressure on the bankers’ margins.

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The fall in deposit rates is being attributed to increased cash arising from an ongoing economic recovery. Low deposit rates are set to hurt the return of high-net worth investors, especially pension fund managers who two years ago enjoyed an a regime of pricey deposits.

“As a result, interest rate spreads are comparably higher in Kenya largely due to comparably lower deposit rates while average lending rates are much higher in Uganda and Tanzania,” says the CBK in a document seen by The EastAfrican.

In Uganda, interest spreads stood at 11.70 per cent while in Tanzania, the rates are oscillating around 5.5 per cent, the data shows.

READ: Higher interest spreads attract more Kenyan banks to Uganda

The latest survey by CBK’s Monetary Policy Committee shows commercial banks expect lending rates to remain generally stable or decline in 2014 due to a stable macroeconomic environment, increased competition among lenders and the expected issuance of a Eurobond by the country.

“Issuance of the sovereign bond is expected to ease pressure on yields on Treasury securities, and improve liquidity conditions with an expected increase in GoK spending,” said the CBK.

According to the survey, large banks expect comparably lower average lending rates in 2014 due to comparatively higher liquidity levels and lower cost of funds.

But analysts argue that although the Eurobond is expected to reduce government appetite for local borrowing, growing spending pressures as well as the pick-up in economic activity could put pressure on interest rates.

“The planned Eurobond issuance could trigger a significant rally in the domestic bond market by the second quarter of this year [April-June] as issuance of local-currency bonds is reduced significantly. However, the recent supplementary budget — and its reliance on additional borrowing rather than spending re-prioritisation for its financing — could see the government issue more bonds,” said Razia Khan, the head of Africa research at Standard Chartered Bank.

The government is thought to be favouring a 10-year dollar-denominated Eurobond.

With prospects for growth among African countries seen as more robust than their counterparts in Europe (who are pulled down by the debt crisis in the Eurozone), investors have been keen to take up African debt.

In April last year, Rwanda issued a debut $400 million Eurobond, which was heavily oversubscribed.

“The appetite for sub-Saharan sovereign credit continues to grow and as this will be the first flagship issue, I expect it will find good sized demand, probably 15 times oversubscription. I foresee a more nuanced approach after this flagship issue. I believe we will see a lot of asset-backed bonds as Kenya looks to finance the heavy capital intensive infrastructure and energy rollout,” said Aly Khan Satchu, a financial markets analyst and the chief executive of Rich Management.

Analysts said the premiums for the bond are likely to be higher than other markets because Kenya seeks to attract huge amounts of funds to finance its projects.

“At 8.5 per cent interest, it will attract stiff competition from both domestic and international markets, with an expected oversubscription rate of over 100 per cent,” said Eric Munywoki, an analyst with Old Mutual Securities.

Nigeria last year issued a $500 million five-year bond at a yield of 5.375 per cent and a $500 million 10-year bond with a yield of 6.625 per cent. The two attracted bids worth $1.77 billion and $2.26 billion respectively.

The yield on the 10-year bond is less than the seven per cent the West African country paid in 2011 for a similar bond but still lower than what Kenya is offering. Rwanda’s 10-year dollar bond was issued with a 6.875 per cent yield.

READ: Investors scramble for Rwanda’s Eurobond

Kenya factored the proceeds of the Eurobond into this year’s national budget to help the Treasury partly seal a Ksh330 billion deficit.

“If successful, it could boost the government’s liquidity and help it fund its local development projects, easing pressure on the domestic market,” said Eric Musau, an analyst at the Stanbic Investment Bank.

“If it flops at the international market, the interest rates might remain the same or even go up because the domestic market has not yet picked up and there might be inadequate liquidity to support the bond,” said Mr Musau.

The Eurobond is expected to further push up Kenya’s public debt, which hit 52 per cent of national output last year, up from 44.5 per cent the previous year.

Kenya’s total debt jumped from Ksh1.95 trillion ($22.9 billion) as at July last year to Ksh2.23 trillion ($26 billion) last month.

Debt yields have shot up over the past few months after the US announced in mid June that its four-year-long massive cash injection programme, also known as quantitative easing (QE), would be wound down later this year.

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Some analysts said that Kenya should opt for a larger bond to keep it off the domestic market for a while.

“The government should go for at least $2 billion if market conditions allow, enabling it to meet its huge expenditure requirements. This will square off the its short cash position and therefore the call on the local markets will be reduced and this will translate into lower rates,” said Mr Satchu.

Data from the CBK shows credit to the private sector grew at 12.8 per cent in the six months to June last year, which was short of the government target of 15 per cent, as customers concerned at the existing high interest rates shied away from taking on new loans.

Banking sector gross loans and advances increased from Ksh1.28 trillion ($14.71 billion) in June 2012 to Ksh1.45 trillion ($16.8 billion) in June 2013. The high interest rates also saw a rise in defaults, with the stock of gross non-performing loans (NPLs) rising by 34.4 per cent from Ksh57.5 billion ($660 million) in June 2012 to Ksh77.3 billion ($888 million) in June 2013.

Credit uptake has however picked up since them, with banks, according to the CBK survey, on average expecting credit to expand by 25.5 per cent while demand from the private sector is expected to increase by about 21.5 per cent due.

Slash lending rates

Analysts however see the CBK moving to lower the benchmark Central Bank Rate (CBR) — the rate at which the CBK lends to commercial banks — in coming months with a view to encouraging lenders to further slash their lending rates. The CBR is currently at 8.5 per cent.

“Commercial banks’ lending rates have remained relatively high. To support economic growth in 2014, CBK is likely to marginally reduce the CBR. However, given commercial banks’ reluctance to lower lending rates in line with the declining CBR in 2012/13, there is a need for the CBK to find an alternative way to influence lending rates,” said ICEA Lion Group in a note released last year.

The shift from a centralised government structure to a devolved county system coupled with growing demands for increased pay from a section of the country’s civil service is also seen as a threat to interest rates.

By Peterson Thiong’o and Scola Kamau