Determinants of Local Currency Government Bond Market Development in Kenya

Abstract

Driven by funding restrictions to finance budget deficits, developing economies have concentrated efforts to develop local currency bond market. Developed bond markets are associated with stronger macroeconomics fundamentals, stable financial systems with sounder and stronger institutional framework. In Kenya, the bond market is yet to significantly contribute to its main objective of financing budget deficit hence the government decision to introduced policies focused on building its medium-term to long-term debt securities to help finance vision 2030 objectives. Existing studies on the drivers of bond market development have focused on cross country analysis; sub-saharan Africa, East Africa, developing countries ignoring country specific characteristics. Others give divergent views on how factors affect the development of bond markets. This study to extend strand of literature on determinants of local currency bond market collected secondary data on: bond issuance and previously identified drivers. Annual time series data for the period 1998-2020 was analyzed using linear regression model. The independent variables were put into three groups namely: financial system architecture (corporate bond to GDP, banking sector size, stock market development); Macroeconomic (GDP current, GDP growth rate, GDP per capita, bank lending spread, exchange rate variability, inflation rate, fiscal balance) and governance (corruption index, state governance index, rule of law). The empirical results indicated that three factors; fiscal balance (R-squared =0.3649 p-value=0.0037), banking sector size (R-squared=0.1796, p-value =0.0556) and corruption index (R-squared=0.2533, p-value =0.0200) are all positively significant at 5% significance level this is in line with findings by Adelegan and Radzewicz-Bak (2009) found a positive and significant impact of those variables on government bond markets of Sub-Saharan countries. GDP growth rate was negatively significant at 10% level of confidence. The findings indicate: financial system architecture model insignificant (R= 0.43, p-value =0.1234),Macroeconomic model significant (R= 0.6751, p-value=0.033) and governance model insignificant (R= 0.44, p-value >0.05) whereas the combined model was generally significant at 5% level of significance, the overall R-Square statistic (R=0.83, p-value =0.0172) concluding that a multiplicity of factors appear to be relevant to bond market development in Kenya i.e financial sector, macroeconomic factors and governance .The study thus recommends that governments efforts should focused towards implementing policies that promote the development of financial markets, controlling its micro and macro-economic factors and creating strong administrative structure for a robust bond market