Infrastructure bond investors have enjoyed a windfall in the past two years, as the Kenya Kwanza government ramped up its borrowing using costly tax-free securities.
Central Bank of Kenya (CBK) data shows that between January 2023 and February this year, the value of outstanding infrastructure bonds (IFBs) in the market increased by a net Sh533 billion to Sh1.92 trillion.
During this period, the Treasury sold five IFBs, raising a total of Sh891 billion at rates between 13.84 and 18.46 percent, earning investors record annual returns of Sh147.5 billion.
At 18.46 percent, tax-free bonds 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 Nairobi Securities Exchange (NSE) oscillated between a negative return of 28 percent in 2023 and a gain of 34.8 percent last year.
The most lucrative of the five bonds, an 8.5-year paper issued in February 2024, pays interest at 18.46 percent.
Outstanding amount
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 Dr Ruto’s predecessor, Uhuru Kenyatta, the most lucrative tax-free bond issued in June 2022 offered investors a return of 13.74 percent.
The 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).
Last month, the CBK reopened a 14-year IFB sold in November 2022, netting Sh65.3 billion at a rate of 13.96 percent.
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.
The newer IFBS are also more rewarding than earlier IFB issuances sold between 2013 and 2022 that offered return rates ranging from 10 percent to 13.7 percent for six and 25 years.
Some earlier issuances of IFBs have also matured in the period, hence the lower net increase in overall IFBs value.
The uptake of the tax-free bonds in the past two years was boosted by retail investors’ growing appetite for government paper at a time when alternative asset classes offered lower or negative returns.
Equities market
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.
The newer infrastructure bonds however remained an attractive option for investors, owing to their high interest returns and capital gains on their prices of up to 20 percent in the secondary trading market at the NSE on high demand.
The IFB returns also beat the returns from other main asset classes in 2023 and 2024, underlining their importance in preserving value for investors.
In the property sector, house sale prices in Nairobi and its environs grew by 5.2 percent in 2024 and 2.5 percent in 2023, according to HassConsult -- which compiles a property index.
Land sale prices were up by 10.6 percent in the city’s satellite towns last year, up from 9.3 percent in 2023, and by 6.5 percent in the suburbs.
For those opting to keep cash in fixed deposits, the average interest returns in 2023 stood at 7.6 percent, rising to 10.8 percent last year.
The value of dollar deposits depreciated by 17 percent last year on the back of the shilling’s gains in the forex market, reversing the gain of 25 percent in 2023 when the shilling depreciated to record lows against the US currency.
The large-ticket size and higher rates on the IFBs issued in 2023 and 2024 followed a cash crunch at the Treasury, which took on more loans to compensate for revenue plans it was forced to abandon.
The government had planned to introduce new taxes to help raise Sh346 billion in the fiscal year that began on July 1 last year. It scrapped that plan after protests that led to the deaths of at least 41 people.
Developed economies
Elevated interest rates in developed economies like the US, which were fighting sky-high inflation, meant that smaller economies like Kenya had to offer investors premium rates to attract foreign inflows into their domestic capital markets.
The high rates also curbed the government’s ability to tap external commercial loans due to cost concerns, forcing the Treasury to rely more on the domestic market for budget financing, pushing rates up.
The total value of Treasury bills and bonds in February stood at Sh5.9 trillion, meaning that IFBs accounted for 32.5 percent of the debt stock.
