The say the nicest and healthiest red roses have the biggest thorns on their stems. A very similar concept to high risk high return phenomenon.
Yields on short dated government debt, in Africa’s copper producer Zambia, are paying as high as 23.56% in the year. Very rosy returns for surplus units searching for margin especially given that inflation is 8.3%, premiums are fairly high. Deposit taking Microfins have made it more attractive by adding 200bps spread above to pay a 26% on 1-year fixed income. Afterall they charge 45% (and above) for retail credit. The 1-year treasury bill has for some time been the most lucrative tenor on the kwacha yield curve taking up over 72% of all T-bill sales for an entire year.
Read also: One year kwacha money will now earn you 24%
This is how it gets thorny. The current term structure of kwacha interest rates reflects a rising cost of funding in the primary market which is confirmed by a 500bps premium in the secondary market. The secondary market seems to suggest kwacha treasury bills are overpriced in the primaries. What this means is that kwacha asset holders are willing to exit government risk positions at 5% haircuts (losses) given the risk pricing profile in light of the balance sheet vulnerabilities and debt concerns Zambia has.
Despite any country being triple A rated for its own paper (a country cannot default on its own local currency instruments) foreign asset holders still reflect the Moody’s/Fitch/S&P rating for the country on its paper hence the yield curve they exhibit.
Treasury yields are used as reference rates for corporate credit pricing such that elevated yields will reflect higher cost of credit in pricing spiral. This is so because T-bill yields are deemed more liquid than the benchmark policy rate (BPR).
Another factor pricing into the secondary market is the currency risk given that the kwacha was on a seesaw trajectory lately with the BOZ with little ammunition (reserves) to smoothen fluctuations.
The 1-year as proxy for the fixed income end of the curve, suggests bond yields are currently suppressed at current levels. This could be with the intent to manage the cost of funding expectations.
Zambia’s rate decision meeting is on, this week but the BOZ MPC surely have to decide to strike a balance between what the fundamentals are saying versus the need to stimulate growth to achieve the fiscal targets.
