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PUBLIC STATEMENT: ICIFA Perspective on Deferring Government Securities Interest Payments

18 May 2020  

Nairobi, 13 May 2020…Deferring interest on Government securities arises when interest payments are postponed on a loan during a precise period of time. The Institute of Certified Investment and Financial Analysts (ICIFA) has noted various proposals to the Government to consider deferring Government securities interest payment for pension scheme assets for a period of one to two years in a bid to support the Government against the negative impact of Covid-19. While the proposals may have been in good faith, in our view this may instead have a negative impact on the Kenyan economy.

Based on the Retirement Benefits Industry statistics by the Retirement Benefits Authority as at 31 December 2018, the retirement benefits assets under management was Kshs. 1,166 billion with Government securities accounting for the biggest share of the total assets at 39.41%. Therefore, in our view, such a set-up would affect pension funds on both the asset and the liability sides of their business. The deferment of interest payments by the Government may be considered a technical default by a Sovereign, which has grave consequences including downgrading of the country’s credit rating. Corporate credit is priced off the “risk-free” rate offered by Government securities and will therefore negatively affect the credit rating of corporate issuers; this would then increase the liabilities of pension funds and insurance companies, to the extent that the “temporary default” may not be fully reflected in liability reporting, and this would reduce future investment returns. As a result, the solvency status of insurers and pension funds – which may be badly damaged during and after this crisis - could fail to improve or even show some deterioration. This would extrapolate to low re-investment returns on their fixed-income portfolios and consequently, pension funds offering defined-benefit promises and life insurance companies that have sold products with high-return guarantees may have difficulty fulfilling these promises.

Related to the above factor is the likely impact on the Kenya Shilling owing to negative financial media reports as financial markets digest the implications of such an occurrence. The impact of the currency depreciation will increase the value of the Government’s foreign-denominated debt, which will increase the interest quantum on foreign debt and most likely offset any possible savings the Government expected to make by deferring interest.

Owing to such an event/occurrence, investors may demand a higher risk premium to cater for the possibility/probability/risk of default and result in higher interest rates across the yield curve as well as higher interest cost to Government and this will affect participation by investors (both domestic and global) in subsequent Treasury Bond auctions and starve the Government off funds.

In conclusion, deferring interest payments will impact the financial services industry. Deferring interest payments will increase the liabilities of pension funds and insurance companies, with the extent of the impact depending on:

1) Whether future cash flows are fixed; and

2) To what extent benefits are to be paid in the future?

How are these being adjusted to reflect the new economic environment following COVID- 19? Deferring interest payments reflective of a lower-growth economic environment will reduce the returns on portfolio investments. Thus, deferring interest payments could lead to pressure in adjustment of pension promises or guarantees downwards, or to adjust contributions and premiums upwards in order to pay for the pension and insurance promises that may become more expensive.

Possible non-detrimental alternatives the Government may consider include issuance of zero-coupon bonds with staggered maturities which is a less risky option for the Government and investors as well as taking into account that pension schemes are long-term in nature.