Ending rate cap to hit Treasury with expensive debt

Removal of the rate cap may result in more expensive debt for the Government. This may also not sort out the decline of credit to the private sector, rating agency Moody’s has warned.

The rating agency affirmed that Treasury runs twin risks if it is to play the largest borrower in the domestic market including continuing to squeeze out the private sector and facing huge costs once the rate cap law is lifted and banks adjust lending rates upwards.

Moody’s says if the Government continues to miss tax targets and increases appetite for local loans, banks will just take advantage of the absence of the cap and charge Treasury a premium to make more money from the less risky treasuries rather than give to the private sector.

“Fiscal slippages that would further raise financing needs and likely also increase the sovereign’s borrowing rates would make sovereign investments more attractive, further crowding out lending to the private sector,” Moody’s noted in its latest report on Kenya’s banking sector.

Domestic borrowing

This comes as Parliament called for public participation on the review of the caps to ‘minimise the adverse impact on credit growth, financial access and monetary policy effectiveness’.

In statements of Treasury’s performance published in the Kenya Gazette last week, Treasury had already surpassed its domestic borrowing target by Sh63 billion by the end of May this year and has continued tapping the local market for more debts.

National Treasury Cabinet Secretary Henry Rotich had borrowed Sh330.1 billion at the end of May against revised targets of Sh267.6 billion.

Although T-bill rates have now stabilised between 7 and 10 per cent since the rate cap was enacted, in 2015 around September, Treasury was aggressive in the local market amid CBK tightening which pushed up Treasury bill rates to upwards of 20 per cent.

This subsequently pushed up lending rates for all other facilities to over 25 per cent making it expensive for the private sector.

Banks have, however, been cautioned about taking too much debt by Moody’s, which has read a worrying trend that has exposed local lenders to the state.

Moody’s says government securities were equivalent to 102 per cent of banks’ equity by June 2017, up from 80 per cent at the end of 2015.

Local lenders own 55 per cent of the 2.4 trillion debt or roughly Sh1.32 trillion. Government securities accounted for 33 per cent of assets at June 2017, following 7 per cent growth in the past 12 months. This means it made up more than a third of banks assets, other than cash, and interest-earning loans.

This situation means the banks are tied to the fate of the State and if Kenya is downgraded, the lenders will also be downgraded thus facing financing challenges.

“Kenyan banks are heavily and directly exposed to the Government to the extent that their credit risk profiles are linked to that of the B2–rated sovereign,” Moody’s said.

Earlier this year, Moody’s Investors Service downgraded three Kenyan banks – KCB Group, Equity and Co-operative – following the weakening of the credit profile of the Government.

The agency said that the lower rating resulted from the downgrade of the issuer rating of the Government.