International investors have raised their risk rating on Kenya’s Eurobonds in response to the widespread anti-tax protests that turned deadly on Tuesday and forced President William Ruto to withdraw the Finance Bill 2024 on Wednesday.
The yields on the Eurobonds that trade on the London Stock Exchange rose to levels last seen in February when Kenya’s credit risk profile had gone up on fears the country could default on its 2014 sovereign bond.
The wave of Gen Z youth-led protests got deadly on Tuesday afternoon after lawmakers voted to pass the controversial Bill, with some protestors storming Parliament buildings and forcing the evacuation of MPs.
The unrest has filtered through to the markets, with investors concerned that the loss of anticipated tax revenue will force the government to borrow more, and potentially default on some obligations due to liquidity constraints.
On Wednesday, the yield on Kenya’s 10-year Eurobond maturing in 2028 had risen to 10.03 percent compared with 9.22 percent in the first week of the month.
That is the highest yield since February 12 when the yield stood at 10.05 percent, just before the government bought back $1.44 billion out of the $2 billion 10-year Eurobond, which matured on Monday.
The yield on the 12-year sovereign bond maturing in 2032 has risen to 10.34 percent from 9.71 percent during the first week of the month, the highest rate since February 14.
The yield on 13-year Eurobond maturing 2034 has climbed to 10.39 percent from 9.81 percent in the review period.
President Ruto withdrew planned tax hikes, bowing to pressure from protesters who had threatened more action this week.
The youth-led protest movement grew from online condemnations of tax rises into mass rallies demanding a political overhaul.
Faced with the most serious crisis of his two-year-old presidency, Dr Ruto has chosen to freeze the plan to raise an additional Sh346 billion to fund a nearly Sh4 trillion budget for the year starting July.
“The escalating protests in Kenya will add to the near-term headwinds facing economic activity as well as raise further question marks over the government’s ability to push through fiscal consolidation measures,” Jason Tuvey, deputy chief emerging markets economist at UK-based Capital Economics, wrote in a note on Kenya before Dr Ruto’s briefing on Wednesday.
“That could ultimately cause fears of a sovereign default – which had subsided earlier this year after a Eurobond buyback – to build again.”
Bond yields in the secondary market rise when risk sentiment goes up, and are matched with a fall in price of the bond. This means that investors are willing to offer their bonds at a discount in order to secure buyers, with an eye on using the proceeds to buy future bonds which they anticipate will vary higher interest rates.
In times of low-risk sentiment, yields fall and prices go up as investors demand a premium to let go of their bonds since there is an expectation that future issuances will offer lower interest rates.
In the local market, the Nairobi Securities Exchange (NSE) largely shrugged off the protests, with investor wealth falling by Sh11.8 billion to Sh1.734 trillion. On Tuesday, the market shed Sh15.6 billion in market capitalisation.
On Wednesday, the NSE 20 index fell 3.5 percent to 1651.93 points, while on Tuesday the index had retreated by 0.9 percent.
The shilling meanwhile remained stable yesterday, with banks quoting the currency at an average of Sh128.50 to Sh129.50 to the dollar yesterday, compared to averages of about Sh128.76 on Tuesday.
The National Assembly Finance and Planning Committee had last week dropped a handful of contentious tax proposals, including a 16 percent value-added tax (VAT) on bread, a 2.5 percent motor vehicle annual tax which was to be deducted by insurers as well a higher excise duty on cash transfers and imported sweets.
The Treasury had warned scrapping the proposed tax hikes in the Finance Bill would lead to a revenue shortfall of Sh200 billion in the 2024/25 budget, meaning equivalent spending cuts would have to be made.
Dr Ruto was banking on the new taxes and expenditure cuts largely targeting non-essential expenditure such as hospitality and renovation of offices as well as slashing allocations to semi-autonomous government agencies to place the country on the path to a balanced budget by 2027.
A balanced budget will mean keeping borrowing at bare minimal levels, something the country has failed to achieve in the past, including during Dr Ruto’s first full financial year in power ending this month.
The plan involved reducing the budget deficit from 5.7 percent of gross domestic product, a measure of economic output, in the current financial year to 3.3 percent of GDP in the financial year starting July.
This was partly to comply with an IMF programme that requires Kenya to increase taxes as well as cut on expenditures to keep deficit in the budget to minimal levels.
The IMF support was key in boosting confidence in international investors to lend Kenya $1.5 billion on February 13, which helped Kenya repay the bulk ($1.44 billion) of the $2 billion maturing in June, cooling fears of a sovereign default.
The country had kept away from direct budget funding from the bank and the IMF during former President Mwai Kibaki’s administration, with most of the funds coming in the form of project support.
Funding from the Bretton Woods institutions largely come with enhanced tax targets for Kenya. This includes the 16 percent VAT on fuel which Dr Ruto’s administration enforced in the first full financial year in office. His predecessor, Uhuru Kenyatta, had failed to fully implement that IMF-backed reforms during his tenure.
