High-net-worth domestic investors are expected to enjoy a windfall of Sh851.42 billion in the year starting July, as the Kenya Kwanza government ramps up its domestic borrowing to plug budget holes.
Treasury projections show that interest payments on domestic borrowing will jump by Sh84.17 billion from Sh767.24 billion, which will be paid to investors, including banks, pension schemes, and insurance firms, in the year ending this month.
The increase comes on the back of increased borrowing and high interest rates, which have seen the Treasury bonds and bills outpace other asset classes like equities, property and fixed deposits.
The attractive interest rates have prevailed since January 2023, with infrastructure bonds (IFB) issued in February last year offering a return of 18.46 percent compared to a return of 12.9 percent in 2022 and 10.6 percent in 2022.
This triggered investors to pour money into bonds as the stock of domestic public debt rose to Sh6.12 trillion in March from Sh5.23 trillion a year earlier and Sh4.6 trillion in March 2022.
Returns to local investors from government paper have increased from Sh456 billion in the year to June 2022, a near doubling compared to returns for the fiscal year starting July.
While the higher rates are locked in for the coming years, the new offers are expected to offer lower returns as interest rates fall.
At 18.46 percent, tax-free IFBs have emerged as the top asset class over the period, beating equities, property and fixed deposits.
While the State has lost an estimated Sh14 billion in taxes from the bonds annually and absorbed costly interest charges, high-end and savvy investors have emerged as the biggest beneficiaries of the borrowing binge.
Property and banks delivered maximum returns of 10 percent while the NSE oscillated between a negative return of 28 percent in 2023 and a gain of 34.8 percent last year.
"Historical trends indicate a consistent increase in domestic interest costs, in line with the growing stock of domestic debt," the Public Debt and Privatisation Committee of the National Assembly wrote in a report tabled in the House last week.
"With the 2025 Medium Term Debt Management Strategy emphasising greater reliance on domestic financing, interest payments on domestic debt are likely to rise further. The extent of this impact will depend on factors such as domestic interest rates, the depth of the local financial markets, and the effect on private sector access to credit."
Foreign debt was largely flat, growing a measly 1.35 percent to Sh5.23 trillion in the year to March.
Net domestic borrowing for the year starting July is projected at Sh635.5 billion compared with Sh591.9 billion estimates for the current financial year.
The most lucrative of the five bonds, an 8.5-year paper issued in February 2024, pays interest at 18.46 percent.
It also has the highest outstanding amount of any single security in the market at Sh240.33 billion, paying investors an annual interest of Sh44.4 billion.
Under President William Ruto's predecessor, the most lucrative tax-free bond issued in June 2022 offered investors a return of 13.74 percent.
The other IFBs issued since the beginning of 2023 include a 6.5-year paper with an outstanding value of Sh187 billion, at a rate of 17.93 percent, a 17-year paper sold in March 2023 (Sh186 billion at 14.4 percent), and a seven-year bond sold in June 2023 (Sh213.3 billion at 15.84 percent).
Tax-free bonds
At the time of their sale, these tax-free bonds were paying higher interest rates than other ordinary and taxed bonds of a similar tenor, amplifying the premium in earnings enjoyed by their buyers.
CBK data shows that a five-year bond sold in July 2023 pays interest of 16.84 percent or 14.3 percent net of 15 percent withholding tax, while two 10-year bonds floated in February 2023 and March 2024 pay investors 14.15 percent and 16 percent respectively, gross of 10 percent withholding tax.
The uptake of the tax-free bonds in the last two years was boosted by retail investors' growing appetite for government paper at a time when alternative asset classes offered lower or negative returns.
The equities market, for instance, shed Sh554 billion or 28 percent of its valuation in 2023, emerging as the worst-performing major asset class in that year.
The market turned around its performance last year with a gain of Sh500.7 billion or 34.8 percent.
While the higher interest regime presented a boon to high-net-worth investors, it has become a burden to a government that opted not to impose new major taxes or increase existing ones in this year's budget proposals.
The freeze in taxes follows deadly protests that broke out last year against the government's measures to raise revenue.
Domestic interest payment will account for more than three-quarters of the Sh1.097 trillion that the Treasury will pay as interest on government papers.
"Frankly speaking, at one point we became a little bit careless as a country, and this happened even before Covid. Most of them [the expensive loans], are maturing between now and 2032, and that is why we have the pressure," Cabinet secretary for National Treasury John Mbadi said in a recent interview.
The Sh851.42 billion set for domestic interest expenses is more than the Sh742.5 billion development budget for all ministries and even higher than Sh658.4 billion for the entire education sector.
Domestic interest repayment, which excludes principal sums, will consume nearly a third or 30.91 percent of Sh2.75 trillion that the Treasury projects to raise from ordinary revenue sources, including taxes, dividends on government investments, levies, fines, forfeitures and rent on buildings.
"We are still able to pay our debts, but the concern has been about sustainability, where we are spending a lot of our money on debt servicing or the percentage of debt servicing vis-Ã -vis our revenue is high," said Mr Mbadi.
