TABLE OF CONTENTS
TABLE OF CONTENTS
LIST OF TABLES
LIST OF FIGURES
LIST OF ACRONYMS AND ABBREVIATIONS
1.1 Background of the Study
1.2 Statement of the Problem
1.3 Purpose of the Study
1.4 Research Questions
1.5 Significance of the Study
1.6 Scope of the Study
1.7 Definition of Terms
1.8 Chapter Summary
2.0 LITERATURE REVIEW
2.2 Effects of Fiscal Policy on Fixed Income Markets
2.3 Effects of Monetary Policy on Fixed Income Markets
2.4 Effects of Capitals Markets’ Forces on Fixed Income
2.5 Chapter Summary
3.0 RESEARCH METHODOLOGY
3.2 Research Design
3.3 Population and Sampling Design
3.4 Data Collection Methods
3.5 Research Procedures
3.6 Data Analysis Methods
3.7 Chapter Summary
4.0 RESULTS AND FINDINGS
4.2 General Findings
4.3 Effects of Fiscal Policy on Fixed Income Markets
4.4 Effects of Monetary Policy on Fixed Income Markets
4.5 Effects of Capital Markets Forces on Fixed Income Markets
4.6 Chapter Summary
5.0 DISCUSSION, CONCLUSIONS, AND RECOMMENDATIONS
Appendix I: Data Collection Tool
Appendix II: Data from CBK & NSE
I dedicate this research project to my wife and child who understood and continued supporting me as I engaged in the research.
The purpose of the study was to determine the effects of government economic policies and capital markets forces on fixed income markets in Kenya. The research was guided by three research questions were to determine the effects of fiscal policy on fixed income markets, to determine the effects of monetary policy on fixed income markets, and to determine the effects of capitals markets’ forces on fixed income markets.
The research was designed as an explanatory study with quantitative data that was collected from the official website of Central Bank of Kenya as well as from the website of Nairobi Securities Exchange. Data was collected for a period of five years beginning October 3, 2012 and ending on October 2, 2017. The data included the central bank rate, fiscal deficit, Kenya NSE Govt. Bond Index, and the computed spread between the market-weighted average rate (ask) and the weighted average of accepted bids (bid). Data analysis used multiple linear regression model, correlation analysis, and covariance analysis. Data analysis was conducted in Microsoft Excel using XLSTAT features.
Findings of the study on the effects of fiscal policy on fixed income markets indicate that fiscal deficits, and therefore the fiscal policies, had a weak correlation with the performance of fixed income markets. A weak correlation indicated that there was a limited extent to which fiscal policies can be used in explaining movements in the fixed income markets.
Monetary policy has a strong effect on the level of interest rates in the fixed income markets. The implications of this finding were that the monetary policy announcements, mainly announcements on central bank rate, can be used in predicting the direction of interest rates charged on treasury bills by the investors. However, the monetary policy announcements had a limited impact on the spread between the market-weighted average rate (ask) and the weighted average of accepted bids (bid) indicating the existence of a random walk in the determination of prices of Treasury bill instruments.
On effects of capitals markets’ forces on fixed income markets, FTSE NSE Kenya Govt. Bond Index has little to no impact on the interest rates charged on Treasury bill instruments in the primary market. The findings indicate that the performance of the FTSE NSE Kenya Govt. Bond Index would not be an accurate predictor of the level of interest rates for treasury instruments in Kenya. However, the performance of the treasury instruments may be used in predicting the performance of FTSE NSE Kenya Govt. Bond Index.
The study concluded that while fiscal policy, monetary policy, and capital markets forces can be used in predicting the direction of interest rates in the fixed income markets, the monetary policies had the greatest impact while the effect of both fiscal policy and capital markets forces is of low explanatory power.
The study recommends further research focusing on the impact of fiscal policy on liquidity in the economy and how this links to the performance of fixed income markets. Secondly, the study recommends the interaction between monetary and fiscal policies be considered in setting future policy. Thirdly, the study recommends that the investors keenly consider monetary policy when making investment decisions on the capital markets. Lastly, investors should continually monitor endeavors on the concurrent application of monetary and fiscal policies in the country. This interaction would be expected to enhance the deepening of the capital markets and hence influence returns in the capital markets.
LIST OF TABLES
Table 3.1: Sampling Frame
Table 4.1: Summary of Regression Analysis
Table 4.2: Covariance Analysis
Table 4.3: Correlation Analysis
LIST OF FIGURES
Figure 4.1: Treasury Bill Auction Results-91 Days
Figure 4.2: 91 DAYS Price per Kshs 100 at Average Interest Rate
Figure 4.3: 91 DAYS Computed Spread
Figure 4.4: Fiscal Deficit Analysis
Figure 4.5: Central Bank Rate Analysis
Figure 4.6: Analysis of FTSE NSE Kenya Govt. Bond Index
LIST OF ACRONYMS AND ABBREVIATIONS
Abbildung in dieser Leseprobe nicht enthalten
1.1 Background of the Study
Government economic policies are tools through which the government influences the economic direction and economic growth of its jurisdiction (Ohanian, Taylor & Wright, 2013). Principally, the government economic policies were categorized into either fiscal policies or monetary policies. The fiscal policies were the means through which the government influences economic growth through controls on government spending and the levels of taxation. On the other hand, the monetary policies include all the means through which the government seeks to direct money supply in the economy and hence the economic growth.
Economists across the world may not agree on how the government policies affect the growth of the economy (Fontana & Setterfield, 2016). Classical economists, neo-classical economists, and the Keynesian economists hold different arguments on how the monetary and fiscal policies affect the economy. However, at the center of the rigorous academiceconomic discourses is the agreement that the monetary and fiscal policies actually affect the growth of the economy and that they had a direct relationship with the levels of gross national income in the economy. Under the gross national incomes of a national is the hidden component of fixed incomes which were the subject of the study (Fontana & Setterfield, 2016).
Fixed income refers to an income, from investment, which is set at a particular figure and does not vary or rise with the rate of inflation (Mankiw, 2014). The two key notes from the definition of fixed income was that fixed income is set at a particular figure which does not vary. The first factor in this definition applies to fixed interest rates or fixed returns on the investment. The fixed rate is payable without any conditions whatsoever (Mankiw, 2014). For instance, if the issuer of a fixed income bond incurs a loss they still would be expect to meet the obligation on the bond simply because such a commitment is not subject to the performance of the issuing entity or any other factor for that matter. The second factor was that in case the fixed income varies, then the variation is only subject to inflation (Mankiw, 2014). This condition applies to the index bonds, also known as the inflation-linked bond, whose income varies partially with the inflation or deflation in the economy. Common in both circumstances however, is the fact that the incomes were specific and predictable (Mankiw, 2014).
The fixed income instruments mentioned above are issued by the government and corporate bodies as bonds. If issued by corporate bodies the fixed income instruments are known as corporate bonds (Ohanian, Taylor & Wright, 2013). On the other hand the bonds issued by the government are known as treasury bonds with the naming of the instruments identifying the issuer of the instrument. In other nations there are the municipal bonds issued by local authorities. The municipal bonds are however not common in the developing nations like Kenya among other nations with reasons ranging from regulatory restrictions and the credit risk of the local authorities. In addition to the bonds there are the equally common treasury bills which represent short-dated government securities, yielding no interest but issued at a discount on the redemption price (Scarth, 2014).
The fixed income instruments trade in both the primary markets and the secondary markets. In the primary markets the securities are created and issued for the first time. It is in this market that the government auctions treasury bonds and treasury bills. The securities can then be traded in the secondary market for securities and in the secondary market, the investors are allowed to buy and sell the securities. The secondary markets for the fixed income instruments basically allow for early redemption of the fixed income instruments for the investors who wish to redeem their investments. It also allows the onboarding of new investors on the securities, especially if the investors did not manage to purchase the securities in the primary markets (Scarth, 2014).
The issuance of the fixed income instruments in the primary market aims at raising capital for the issuer. Government economic policies directly influence the rates of subscription for both the corporate and treasury bonds. The areas of influence include the subscription and uptake rates, the pricing of the fixed income instruments, and the bid-ask spread which is the amount by which the ask price exceeds the bid price for a security in the market. In the case of treasury bonds auction in Kenya, the bid ask spread is represented by the spread between the market-weighted average rate (ask) and the weighted average of accepted bids (bid), whose results are provided by the Central Bank of Kenya every time there was an auction for the treasury instruments. Each of the metrics that investors look at when assessing the fixed income instruments communicates a message which informs the expected income from the fixed income instrument, broadly referred to as the instrument’s yield (Scarth, 2014).
The relationship between government economic policies is considerably important in the international markets with various research studies attempting to explain how the fixed income markets respond to government policies (Odell, 2014). In markets where trading in fixed income instruments is well-developed, government economic policies are met with a lot of skepticism leading to intensive and expansive assessment of the implications of such policies. Skepticism also triggers research on the implications of the economic policies and at the same time, the announcements on government economic policies became the basis of economic-policy-adjustments recommendations by economists. The USA and other developed nations had a lot research and commentaries touching on the implications of government economic policy and capital markets on the fixed income markets (Odell, 2014).
One of the studies focusing on the implications of economic policy announcements on the fixed income markets in the USA was completed by Balduzzi, Elton and Green (2001). In the study titled Economic News and Bond Prices: Evidence from the U.S. Treasury Market, the researchers tested the response of the fixed income markets to economic policy announcements. The study sampled 17 economic policy announcements and from the analysis of the markets, the research established that the announcements of economic policies had significant influence on the pricing of securities in the fixed income markets. The study also established that depending on the “surprise” in the announced economic policy, the impacts of economic policy announcements varied significantly with the maturity of the fixed income securities. Further, the study also established the presence of increased volatility in the markets for fixed income securities after the announcements (Balduzzi et al. 2001).
Dosi, Fagiolo, Napoletano, Roventini & Treibich (2015) established that majority of research studies consistently treated government economic policies separately while on majority of occasions there was interaction between fiscal and monetary policies in the economy. In many instances the researchers provided models characterized by low explanatory power and the interactive effect of the government policies was not fully explained. To a large extent, Dosi et al. (2015) asserted, separating the study of fiscal policies from monetary policies with respect to any variable in the economy is in itself self-defeating. Dosi et al. (2015) emphasized the need for researchers to expand the scope of research on the effect of government economic policies to all the variables at play in the economy.
The effects established in the US market for fixed income securities were consistently established in research studies focusing on Europe. In 1999 most of the incumbent nations in the European Union renounced their fiscal and monetary policies in favor of the policies established by the European Economic and Monetary Union (Furceri & Zdzienicka, 2015). The creation of European Economic and Monetary Union created a research void which was quickly picked by researchers who intended to establish the implications of the supranational monetary and economic policy of the economies of European member states. Research established that the creation of supranational monetary and fiscal policy had major implications on the bond markets of the countries considering the different member states exhibited varied risk profiled (Schimmelfennig, 2014). Kay (2015) established that the risk profile of Greece could not be considered the same as that of Germany yet this happened when the supranational monetary and fiscal policies were formed in Europe. Monetary and fiscal policies were observably critical factors in influencing the fixed income markets as demonstrated in the case of the European Union, with a good example being the case of Greece (Kay, 2015).
Hanson and Stein (2015) narrowed down their research to monetary policy and its impacts on the long-term lending rates. In the study the researchers established the existence of a direct relationship between monetary policy and long-term lending rates. Secondly, the researchers established that the fixed income markets were influenced by monetary policy statements. However, the most important observation made by the researchers was the fact that by focusing on monetary policy alone, the research exhibited bias which would be effectively dealt with by focusing on both monetary policy and fiscal policy.
The need to conduct studies that focus on both monetary and fiscal policy was also established in a research conducted by Sobrun and Turner (2015). While their research focused on the emerging markets, the researchers made the assertion that bond markets, and hence fixed income markets, were greatly influenced by higher and at times divergent economic policies in the advanced economies. In the study, the assessment of the phrase
“divergent policy” established that there were instances in which the monetary policy can be counterproductive to the fiscal policy. For instance, when the government increases spending and quantitative easing but at the same the interest rates were high through the action of monetary policy then it can be concluded that there was the existence of divergent economic policy. By extension, this has implications on the pricing of fixed income instruments.
The research by Sobrun and Turner (2015) also established that in the emerging economies monetary and fiscal policies were influenced by externalities which mainly include economic policies in the advanced economies. This is because the emerging economies were considered capital-demanding economies in which fiscal deficits were common. The implications were that the emerging economies became heavily reliant on external borrowing with the lenders and donors exerting pressure on the economic policy in such countries. Through the influence on the monetary and economic policy, the externalities also influence the local bond markets in the emerging economies. Consequently, there was the need to study the implications of such policy in the emerging economies.
1.2 Statement of the Problem
Bringing the discussion closer home, fixed income markets in Africa have been on the rise. However, there has not been adequate research focusing on the African context of fixed income. This is because majority of the research embarked the impact of government economic policy on the stock markets, but not on the fixed income markets. Further, majority of the research studies in the African context continually separate monetary policy from fiscal policy when studying the markets yet the interaction between the two policy tools is already established. From a general perspective, the fixed income markets were characterized by a major research gap that was partly addressed by this study (Tavares & Valkanov, 2001).
In one of the studies that focused on the African context of fixed income markets, Mu, Phelps and Stotsky (2013) established that the African bond markets have grown steadily but they remained greatly undeveloped. The researchers indicated that the bond markets would benefit a great deal from monetary and fiscal policies that emphasize the local objectives. The assertion that monetary and fiscal policy would help in the deepening of African bond markets indicated that bond markets were correlated with the monetary and fiscal policy such that strengthening of the policy would enable deepening of the markets. In a majority of the studies available from the African context, similar to many other frontier economies, majority of research focused on one policy tool and the stock markets with little to no studies at all focusing on the fixed income markets.
The Kenyan context is not any different from the case in other African markets and the frontier economies in general. A quick search of academic literature on the implications of government economic policy on the fixed income markets indicated that majority of studies attempted to study the relationship between monetary policy and the stock markets. A few studies focused on the relationship between corporate bonds and monetary policy. There were hardly any studies focusing on the relationship between fiscal policy and either stock markets or bond markets. The worst case was that there were no studies that study the interaction between monetary policy and fiscal policy and the implications on the fixed income markets. This is consistent with the findings of Tavares and Valkanov (2001) who termed the relationship of fiscal policy and bond markets as one that is neglected. Despite being conducted more than a decade ago, the research by Tavares and Valkanov (2001) communicates to the status on the study of government economic policies in relation to the fixed income markets.
The background of the study established that there exists major research gaps in the understanding of the inter-temporal relationship between government economic policy, capital markets forces, and the fixed income markets. Past research with the example of Balduzzi et al. (2001) and Dosi et al. (2015) focused on mainly on the implications of monetary policy and the fixed income markets. Hardly is there research focusing on the implications of fiscal policy the fixed income markets. Other than the neglect of fiscal policy and it impact on the fixed income markets, the research also established that many researchers ignored the interaction between monetary policy and fiscal policy and the fact that they all had an impact on the fixed income markets. This created a research gap on the understanding of how interaction in government economic policy tools affects the markets for fixed income.
1.3 Purpose of the Study
The purpose of the study was to determine the effects of government economic policies and capital markets forces on fixed income markets in Kenya.
1.4 Research Questions
1.4.1 To determine the effects of fiscal policy on fixed income markets.
1.4.2 To determine the effects of monetary policy on fixed income markets.
1.4.3 To determine the effects of capitals markets’ forces on fixed income.
1.5 Significance of the Study
The research serves critical importance to various user-groups. These include the investors, policy makers, and the researchers in academia.
The study enables the investor to understand the implications of fiscal policy, monetary policy, and capital markets forces on the fixed income markets. The study sought to create predictive multivariate model that can be used in the prediction of the movements in the fixed income markets. The model appreciates the fact that government economic policies do not affect the fixed income markets in isolation but rather it is the interaction between the policies that affects the markets.
1.5.2 Policy Makers
The study enables the policy makers to understand the manner in which the interaction between fiscal policy and monetary policy, and at the same time the capital market forces, affects the fixed income markets. Consequently, the policy makers should consider the findings of the study in informing future government economic policy. This is important considering that the fixed income markets were not only important in raising funds for the government but also for the purposes of stabilization of the economy and spurring economic growth. The findings of the study will be used as a basis for evidence-based policy-making with respect to monetary and fiscal policy in Kenya as well as with any other policy that may affect the capital markets.
1.5.3 Researchers and Academia
To the researchers and the field of academia the study contributes to narrowing the research gap in the study of interaction between fiscal and monetary policy and the implications of this on the fixed income markets. This is in addition to the capital markets forces. In future, researchers will build upon the findings of the study in consideration of the effects of government economic policies and capital markets forces on fixed income markets.
1.6 Scope of the Study
The scope of this study was limited to the Kenyan context of the fixed income markets. Emphasis was on the treasury instruments issued by the government of Kenya in the period between October 3, 2012 when FTSE Group launched the first bond index (FTSE Kenya Govt. Bond Index) and ending on October 2, 2017. The government of Kenya auctions treasury bonds on a monthly basis and on the same length, the Monetary Policy Committee (MPC) meets on monthly basis to deliberate on monetary policy. The study covered both primary and secondary markets for treasury bonds (fixed income instruments). This was because the study attempted to find the implications of and correlation between capital markets forces (secondary market) and the bid-ask spread in the primary market for treasury instruments.