Financing Domestic Debts in Kenya Research Paper - 4400 Words

The Role of Bond Marketing in Financing Domestic Debts in Kenya (Research Paper Sample) Content: The role of Bond marketing in financing domestic debts in KenyaDeficit Financing1.0 BackgroundDeficit financing of public spending remains at the heart of academic debate and policy making in less developed countries (LDCs) throughout post colonial era. The development of a budget deficit is traced to the Keynesian inspired expenditure led growth theory of the 1970s. The concept behind the model is that the government has to initiate the aggregate demand side of the economy in order to stimulate economic growth. Keynes (1936) argued that government spending in excess of revenue aimed at reversing economic decline and/or accelerating economic growth and employment is justified. This model states that an increase in the government spending stimulates the domestic economic activities and crowds in private investments through provision of legal infrastructure that ensures physical and intellectual property rights and by undertaking investments that deepen the physical an d human capital infrastructure in the country. If government increases its expenditure it will lead to an increase in private investment through multiplier effect. The Keynesian proposition can be illustrated by denoting change in government expenditure as à ¢G and the corresponding change in national income as à ¢Y. Thus the multiplier of government expenditure is given by à ¢G/à ¢Y where à ¢Yà ¢G. This implies that the government expenditure multiplier is larger than 1 because according to Keynesian consumption function C=C(Y-T)à ¢Ã¢â€š ¬Ãƒ ¢Ã¢â€š ¬Ãƒ ¢Ã¢â€š ¬1. When a government increases spending in infrastructure, education health and technology this will create an enabling environment for private investment which in turn increases national income.The budget or fiscal deficit is the amount by which the governments expenditures exceed its receipt during some specified time period normally one year .Countries have different ways of determining which items to include in th e expenditure and receipt side of the budget. For example, in United Kingdom, a budget deficit is defined as the excess of current expenditure over current revenue while in United States of America (USA) a fiscal deficit refers to the gap between budgetary expenditure. In Kenya the overall budget deficit is the difference between receipts (revenue plus foreign grants received) and recurrent plus development expenditure. There are three types of fiscal policy which include: neutral policy where the economy is balanced and all the government spending is fully funded by tax revenue, an expansionary fiscal policy where government spending exceeds tax revenue and contractionary fiscal policy where government spending is lower than tax revenue collected. Majority of the Sub Saharan Africa (SSA) countries have always had an expansionary fiscal policy where government expenditure exceeds its receipts.Budget Deficit Trends in Kenya
Source: Central Bank of Kenya, Monthly Economic Review issue s.The fiscal account in Kenya has been in deficit for many years with the fiscal deficit exceeding 5% of the Gross Domestic Product (GDP) in some years. In the recent years (2008 and 2009) the budget deficit has risen to - 77.2 billion and -110.6 billion respectively due to increase in government expenditure from 405.2 billion in 2007 to 621.9 billion in 2009.Over the years SSA countries had relied on foreign borrowing to cover for their budget deficit. This is because SSA countries could access foreign financing at very low interest rates and for very long maturity periods. As the global crisis continued to persist, concerns have emerged that donors funds may turn out to be scarcer and therefore having sufficiently liquid domestic bond markets is becoming increasingly important. The global crisis has left majority of SSA countries highly indebted making then unable to borrow internationally. Eichengreen and Hausmann 1999 used the term original sin to refer to the inability of devel oping countries to borrow abroad in their own currencies. They argued that if a countrys external debt is denominated in a foreign currency, this result in a currency mismatch such that in the event of a currency crisis a depreciating domestic currency leads to balance sheet problems which become a key source of financial instability and possibility of huge loans. Also the supply of foreign financing is determined by the aid agencies that impose many conditions to funds given to these economies and since these aids are often linked to project financing they cannot finance a governments recurrent expenditures or capital projects.To bridge the gap left by the scarce external funding there was need to develop domestic market to offer alternative method of financing. Government securities market development through issuance of government securities like treasury bonds and treasury bills is one of the alternatives. The only essential difference between Treasury Bonds and T-Bills is the tenor or commitment period between investment and maturity. T-Bills by definition must have a tenor of less than 365 days, whereas Treasury Bonds have a tenor of more than one year. Treasury Bonds in Kenya can be trades in the secondary market more easily with the establishment of Automated Trading System (ATS) making them more attractive and they also offer higher return than Treasury Bills.A bond is a debt instrument and it represents an agreement on the part of the borrower (issuer) to make a series of regular payments (coupons) to the lender (holder of the bond) plus final repayment of the principal on maturity date. The government securities market is at the core of financial markets in most countries. It deals with tradable debt instruments (Treasury bills and Treasury bonds) issued by the government for meeting its financial requirements. The development of the primary segment of this market enables the managers of public debt to raise resources from the market in a cost eff ective manner with due recognition of the associated risks.Kenyas bond market traces its origin back to the 1980s when the Government of Kenya first launched a bid to use treasury bonds to finance government deficit. However, the Kenyan bonds market remained inactive and the government issued Treasury bill when they wanted to borrow domestically (Rose N Justus A). During 1990s the Kenyan economy experienced increased government expenditure outweighing increase in revenue. The decline in revenue was partly due to bad relationships with both bilateral and multilateral donors which led to drastic reduction in foreign aids (Beatrice 2010). In 2001 the Kenyan bonds market experienced a turn around when the government re-launched treasury bonds. Since then the government bond market have played a very big role in financing the government budget (Rose N Justus A.) Currently the government has an auction every month where they reopen an existing issue or open a new tender. The maturities have also been increased and in year 2010 CBK issued the first Treasury bond for 30 years. The government aim in increasing the duration of bonds is to reduce the rollover and other market risks in the debt stock. The government securities market is regarded as the backbone of fixed security as it provide the benchmark yield and imparts liquidity to other financial markets. The government securities market acts as a channel for integration of various segments of the domestic financial market and helps in establishing inter-linkages between the domestic and external financial markets. A vibrant secondary segment of the government securities market helps in the effective operations of monetary policy through application of indirect instruments such as open market operations for which government securities act as collateral.Herring and Chatusripitak (2001) and PECC (2004/5) argued that bond markets are central to the development of an efficient economic system and therefore there is need to develop these markets. They provide greater investment opportunities for both retail investors and financial institutions and help deepen financial markets. The government bonds market belongs to a larger financial services sector which in 2010 contributed 70 per cent to gross domestic debt. Table 2 shows the composition of domestic debt by instruments from year 2000 to 2010. As the government debt continue to increase from Kshs.1, 959,908 Million in 2000 to Kshs 7,989,837 Million in 2010 treasury bonds have the highest growth from Kshs. 350, 646 Million in 2000 to Kshs. 5,570,148 in 2010.Table 2 COMPOSITION OF GOVERNMENT GROSS DOMESTIC DEBT BY INSTRUMENT (shillings million)FISCAL YEARTreasury Bills*Treasury BondsGovernment StocksOverdraft at Central BankAdvances from Commercial BanksOther Domestic Debt**Total Domestic Debt***20001,291,228.12350,646.3427,183.5762,120.7626,300.94202,428.791,959,908.5120011,644,916.15609,688.0617,6 18.6635,357.1926,432.21189,159.452,523,171.7320021,413,721.001,295,989.4317,618.6627,106.7838,057.8694,175.462,886,669.1920031,298,641.451,926,924.6313,106.0565,468.0436,277.21102,549.823,442,967.1920041,223,722.002,231,816.3612,695.81100,438.4033,849.4011,215.803,613,737.7720051,279,408.952,350,163.8412,695.8198,135.5632,508.2814,013.493,786,925.9420061,535,431.382,650,729.5612,392.5388,896.5627,597.365,200.564,320,247.9420071,559,865.473,233,718.209,056.4537,766.5920,540.3210,845.974,871,793.0120081,441,016.103,760,340.949,056.4568,650.40957.1315,965.385,295,986.3920091,796,180.904,347,101.599,056.45100,355.73658.356,809.736,260,162.7420102,220,697.305,570,148.886,028.15175,698.2413,128.144,136.917,989,837.6116,70...