Consider global bonds buyback

Investors have continued to dump Kenya’s 2024 Eurobond (due in June 2024) on account of market prices, disorderly public finances and a much weaker fiscal trajectory. FILE PHOTO | SHUTTERSTOCK

Investors have continued to dump Kenya’s 2024 Eurobond (due in June 2024) on account of market prices, disorderly public finances and a much weaker fiscal trajectory.

The bond matures in June 2024 and already the government is looking to refinance it. The yield on the bond touched 20 percent last week, from 6.6 percent at issue, reflecting investors’ fear of a possible default.

But before we proceed, let’s provide some context. First, a bond is a fixed interest security, a piece of paper in the form of an ‘I owe you” which guarantees the holder two things: annual regular interest payments and also getting the value of the bond back when it matures (its face value).

When the government sells a bond, the bond itself pays a fixed annual amount of interest over the duration of the bond.

And this is known as the coupon of the bond, which is usually paid in the currency of the bond issuance (could be Kenya shillings or US dollars).

And then you have got the market price of the bond. Bonds can be sold and bought in the marketplace.

Bonds are first sold through primary issuance. When you buy the bond fresh, you buy the nominal value (say Sh100). You can then sell it in the secondary market, at which point its market price becomes very important.

And the market price is simply determined by supply and demand. At the point of primary issuance, both the nominal value of the bond and the market price are at par.

At this point, the coupon rate and the yield of the bond are also at par. However, while the coupon on the bond is fixed, the yield varies on account of supply and demand.

If demand is strong, the price goes up and vice versa. Consider a 10-year government issued in 2023. The bond has a nominal value of Sh100 and pays an annual fixed interest of rate of Sh5 (reflecting an interest rate of five percent).

Assuming demand for the bond is strong and the market is willing to pay Sh105 for it, the yield on the bond drops to 4.76 percent.

Similarly, if demand falls and the market is only willing to pay Sh95 for the bond, the yield rises to 5.26 percent.

Essentially, the yield on a fixed-interest bond will always vary inversely with the market price of the bond. In other words, when bond prices are going up, the yield will fall and vice versa (and this is all driven by demand and supply).

With the prices of the 2024 Eurobond plummeting, it opens a window for the government, being the issuer, to buy back the bonds at lower prices.

This presents a cheaper option than seeking to refinance the bond in the international debt markets where Kenya is likely to face pricing constraints.

With peak base rates on the US dollar seen at five percent levels, developing countries, such as Kenya, will face a sustained funding squeeze and are likely to pay a premium to access financing from the international capital markets.

With yields of 20 percent, which reflects an unfolding funding squeeze, the price of the bond has been estimated to fall by more than two-thirds (from the original issue price), which opens a buy-back window with just one year before maturity.

Often, this can be best achieved through a State-run asset management vehicle (such as a sovereign wealth fund) through self-funding.

However, in the absence of such, the government can still activate a number of mechanisms to execute a partial or full buy-back. Extraordinary times call for extraordinary measures.