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Kenya lifts rate cap, boosts hope for new IMF agreement

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Local Kenyan shilling-denominated bond yields had risen in the weeks leading up to the vote

Bank stocks rallied and investors rushed to buy local Kenyan government bonds after the country’s parliament voted on Tuesday to remove the cap on banks’ commercial lending rate, a move that will stimulate economic growth and improve access to funding for the riskiest parts of the economy. 

With the country’s lenders encouraged to turn the credit taps back on, access to financing for the country’s under-funded small and medium-sized enterprise sector is expected to improve, while the pick-up in credit growth will lead to a recovery in the asset quality of local banks.  

The agreement will be good for Kenya’s economy, for its growth prospects and will support the already existing strong growth momentum seen this year, according to Guy Tossou, a portfolio manager at BNP Paribas Asset Management based in London.

The cap was imposed in 2016 as part of the government’s bid to reduce the cost of borrowing, expand access to credit and increase the return on savings, but it had the opposite effect, keeping many fund managers sitting on the side lines. Now though, they are more willing to invest.

Tossou moved his position to overweight Kenya local on Tuesday.

Local Kenyan shilling-denominated bond yields had risen in the weeks leading up to the vote, with the renewed credit push expected to prompt banks to sell bonds, providing an attractive entry point for funds such as his, says Tossou.

Adesoji Solanke, banks analyst at Renaissance Capital, says: “As the rate caps go off, the banks can now reallocate away from government securities into risk assets. There will be a lag, but as banks turn on the taps, we’re expecting to see GDP growth increase to 6% next year.”

The move will prove especially beneficial to Kenya’s SME sector, which has been starved of credit because banks felt that the lending rates were not reflective of the risk.

SMEs were then forced to turn to “dark borrowing corners where loan sharks and other lenders deal at exorbitant rates,” according to Renaissance Capital.

This has led to a negative spiral across companies’ value chains, from a build-up in inventories to the extension of customer credit days by manufacturers, slower sales and cash-flow constraints, leading to non-performing loan problems at the banks.

“As credit growth picks up and the government settles its obligations, we expect the asset quality [of banks] to improve,” says Solanke.

Dollar performance

Kenyan dollar bonds had also rallied in anticipation of the vote, but with much of the good news now priced into the market, attention turns to Kenya’s ongoing fiscal issues and any agreement with the IMF.

Kenyan dollar-denominated bonds are up 25% this year, outperforming the JPMorgan EMBI Global Diversified index, which was up 13%.

“The fiscal [deficit] is still something [the government] will need to tackle,” says Tossou. “Clearly the backdrop remains constrained, revenue collection is very weak and they will continue to keep up the expenditure at they are on today as they have big infrastructure projects.”

But lifting the interest rate cap it likely to accelerate discussions with the IMF, which is already due to meet Kenyan officials for its Article IV review at the end of November.

“The IMF will certainly agree finally to sit at the table again and find a solution to help,” says Tossou.

Tossou says he expects the agreement to take the form of fiscal support, rather than a standby-credit agreement that would help with balance of payments short-falls.

At around 60% of GDP, Kenya’s debt levels are above the 55% level beyond which the IMF considers there to be a strong risk of debt distress. Debt servicing is also a concern for investors: the country spends 4% of its GDP on meeting its obligations.

But the government is working on an “elaborate roadmap” to manage its debt, which includes retiring short-term commercial loans and increasing its reliance on concessional financing to fund the country’s infrastructure projects, acting finance minister Ukur Yatani told Euromoney in October.

Earlier this year, Kenya raised $2.3 billion in the international bond markets with amortising notes of seven and 12 years and at a yield of 7% and 8% respectively.