Jolt for Kenya as Inflation Exposes Futility of Rate Ceiling

(Bloomberg) -- The Kenyan president's interest-rate pledge is in tatters.

Just five months before Uhuru Kenyatta seeks re-election, the country's inflation rate has surged to the highest level since 2012 and the government is struggling to borrow money at yields it's ready to offer. That's left the caps he imposed on commercial interest rates all but unviable in a country already heading for a cash crunch.

The bank teller-turned-politician, whose father was the nation's founding president, has put central-bank policy makers in a dilemma as they prepare to meet on March 27. They must raise interest rates to restore the flow of funds to a government that's missing borrowing targets and tax collections. Yet, if they do so, they risk choking off bank loans to the industry and undermining Kenyatta's 2013 pledge to reduce borrowing costs.

“They are between a rock and a hard place,” said Kenneth Minjire, the head of securities at Nairobi-based Genghis Capital Ltd. “There is a bit of pressure coming through and they can only hold the rates for so long against market fundamentals before something happens.”

Negative Returns

Kenyan investors are earning negative real returns after inflation quickened to 9.04 percent in February, 42 basis points above the rate for 91-day Treasury bills. That's sparked a stand-off between the government and bond buyers, who disregarded the central bank's warning against demanding high yields in the last three debt auctions through last week. Investors were trying to protect their margins from rising inflationary pressures, according to Dominic Ruriga, a research analyst at AIB Capital Ltd.

But the government hasn't blinked yet. The Central Bank of Kenya has become more aggressive in rejecting “expensive money,” Harrison Gitau, a research analyst at ApexAfrica Capital Ltd. said. Officials, who canceled this week's sale of 182-day bills, want to ensure that government rates don't rise above the 14 percent cap for bank lending, which could make gilts more lucrative than riskier private-sector loans.

President Kenyatta, who will seek a second term at the general elections in August, introduced the caps last year against the advice of the central bank and the Treasury, fulfilling a campaign pledge he made before coming to power in 2013. It's failed to rejuvenate credit growth, which slowed 4.3 percent in December, the weakest since at least 2005, from 18 percent a year earlier.

The International Monetary Fund said last month the limits could reduce growth by at least 1 percentage point or as much as 2 percentage points a year.

“We need indisputable data to show us what has happened,” Central Bank of Kenya Governor Patrick Njoroge said in an interview in London, referring to the interest cap. “We need to be patient.”

Zero-Sum Game

Higher lending rates will drive credit growth even lower, said Johnson Nderi, a corporate finance and advisory manager at Nairobi-based ABC Capital Ltd. Treasury yields above the cap would draw capital out of the financial system, leaving smaller banks in a liquidity crisis, he said.

Last month, the central bank rejected 83 percent of the bids for a new 12-year infrastructure bond. It went back to the market with a tap sale by capping the yield, but managed to raise only 34 percent of the targeted amount.

“This could mean investors are willing to wait for higher yields as a result of the government's high debt appetite and large amounts of maturing debt,” according to a note from ApexAfrica.

Fiscal Bind

The government has a high debt wall to climb in the next three months:

• It must raise 354.6 billion shillings ($3.45 billion) before June 30 to pay off maturing bonds and bills.
• A supplementary budget has increased recurrent expenditure by 75.3 billion shillings.
• Tax collections in the six months to December came in at only 40.5 percent of the full fiscal-year targets.
• The government is also trailing its domestic borrowing targets, raising only 40 percent of the projected 236 billion shillings.

“From a policy point of view, they are in a tight corner,” Ruriga said. “Raising the rate is not even politically viable because they have pressure from lawmakers to maintain rates, at least until elections.”

--With assistance from Selcuk Gokoluk

To contact the reporter on this story: Adelaide Changole in Nairobi at achangole2@bloomberg.net.

To contact the editors responsible for this story: Dana El Baltaji at delbaltaji@bloomberg.net, Srinivasan Sivabalan, Paul Richardson