Foreign investors cut their holdings of treasury bonds by 84.6 percent to Sh4.9 billion in the quarter ending June 2024 from Sh32 billion in the same period last year in search of higher returns from shorter-term papers.
At the same time, foreigners increased their holdings of treasury bills according to disclosures in the balance of payments report for the second quarter.
“Non-residents’ holdings of treasury bonds recorded a notable decline from Sh32 billion at the end of June 2023 to Sh4.9 billion at the end of June 2024, and non-residents appear to prefer short-term government papers with their holdings rising to Sh329 million. Shilling at the end of June 2024.
Foreign investors’ preference for Treasury bills over bonds reflects the choices of local institutional and individual investors over the past year, who preferred to buy short-term paper in an environment of rising interest rates.
In a rising interest rate environment, where yields on short-term paper have risen over the past 12 months, investors have avoided losing out on the return that comes from locking up money in longer-term paper.
However, the possibility of lower interest rates on government securities in the future will likely prompt investors to return to bonds, allowing them to obtain high yields with lower yields.
The Central Bank of Kenya pushed interest rates lower when it cut its benchmark lending rate in August by 0.25 percent to 12.75 percent from 13 percent previously.
This signal was followed by consecutive weeks of falling interest rates on short-term securities.
Interest rates on 91-, 182- and 364-day securities fell for nine straight weeks through the end of September at 15.7183 percent, 16.5888 percent and 16.7999 percent from 16 percent, 16.8506 percent and 16.9212 percent at the end of July.
Widespread market expectations of a further interest rate cut by the Central Bank of Kuwait next week increase the scope for a larger decline in local interest rates, stimulating a move away from short-term paper as investors opt to lock in higher returns for a longer period.
However, fiscal developments are expected to determine the direction of interest rates in the short to medium term, as revenue shortfalls and increased expenditures lead to a wider budget deficit.
For example, the withdrawal of the Finance Bill 2024 increased the fiscal deficit for the 2024/25 financial year to Sh768.6 billion from Sh597 billion previously.
Domestic credit markets are expected to bear most of the growing deficit, with the government setting the net domestic borrowing target at Sh143.1 billion from Sh263.2 billion previously.
The revised target for domestic borrowing is expected to keep interest rates on government securities high, as investors maintain their demand for enhanced returns for holding the papers.
Balance of Payments reports classify debt issued by non-residents as external, regardless of the currency in which the debt is denominated or issued, and vice versa.
However, appetite for Treasury bonds and bills is dominated by local investors, including banks, insurance companies and pension funds.