The classification of Kenya as a middle-income economy has implications on its financing for development. More specifically, the country is now considered less in need of overseas development aid. It also means less consessionality in loans including those relating to social sectors such as health and education. This is because economic status is an important criterion in determining access to funding particularly by the traditional and multilateral donors. The higher a country goes in the income ladder, the less it is considered a priority for soft loans and development support. Although the transition to this tighter funding environment may be gradual, new financing plans will need to take it into account.
The new financing strategy, therefore, needs to be one that weans off the economy from reliance on overseas development funding, while at the same time keeping the cost of borrowing low. One of the ways of raising the much needed funding for development is through mobilisation of domestic resources through the bond market. This is the process by which businesses and government borrow money directly from the market instead of through financial intermediaries. An efficient and well functioning bond market provides long-term funding that is needed for long-term projects such as infrastructure and housing. It has the advantage of local currency and cheaper interest rates unlike borrowing from foreign financial market players that carries considerable foreign currency risk, refinancing risks and country risk premiums.
In fact, research has shown there is a positive relationship between economic activity and the amount of bond issues in developing economies. Besides, the Asian experience after the 1997 crisis showed that a well-functioning bond market is critical to maintaining economic stability. After this crisis, most Asian countries made considerable progress in strengthening their bond markets. This in turn stimulated economic activity and maintained the economy's stability through the global financial crisis that followed in 2008.
Although the local bond market is more advanced than in most countries in the continent, it lags considerably behind South Africa, Asia and Latin America regions. Its value remains largely untapped, but more significantly, its growth momentum is low. Treasury issues dominate the market mainly with short-dated issuance on the primary market and limited secondary trading. Its dominant players are institutional investors, and mostly banks that use a “buy-and-hold” strategy, and prefer to lend to the government than to the real economy. Although pension funds have the largest potential to invest in the bond market, their participation remains low.
To stimulate faster growth of the bond market, institutional and operational infrastructure needs strengthening. The outcome of such measures should specifically attract more players into the bond market, stimulate secondary trading, increase the tenor of issues, and reduce the cost of issuance.